[Federal Register Volume 65, Number 14 (Friday, January 21, 2000)]
[Notices]
[Pages 3510-3513]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-1459]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42340; File No. SR-NASD-98-32]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Approving Proposed Rule Change and Notice of 
Filing and Order Granting Accelerated Approval to Amendment Nos. 2 and 
3 Thereto Relating to Filing Requirements for Independently Prepared 
Research Reports

January 13, 2000.

1. Introduction

    On April 9, 1998, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association''), through its wholly owned 
subsidiary, NASD Regulation, Inc. (``NASD Regulation''), submitted to 
the Securities and Exchange Commission (``SEC'' or ``Commission''), 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'' or ``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to amend the Conduct Rules of the NASD to exclude 
independently prepared research reports from the filing requirements of 
NASD Rule 2210. NASD Regulation filed an amendment to the proposed rule 
change on May 14, 1998, which was published in the original notice in 
the Federal Register.\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from John Ramsay, Vice President, Deputy General 
Counsel, NASD Regulation, to Katherine A. England, Assistant 
Director, Division of Market Regulation (``Division''), Commission, 
dated May 13, 1998 (``Amendment No. 1'').
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    The proposed rule change was published for comment in the Federal 
Register on June 15, 1998.\4\ The Commission received four comments on 
the proposal.\5\ NASD Regulation filed amendments to the proposed rule 
change on April 19, 1999,\6\ and November 10, 1999.\7\ This order 
approves the proposed rule change, as amended.
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    \4\ See Exchange Act Release No. 40074 (June 4, 1998), 63 FR 
32690 (June 15, 1998).
    \5\ See Letter from Donald Phillips, President, Morningstar, 
Inc., to Jonathan G. Katz, Secretary, Commission, dated July 6, 1998 
(``Morningstar Letter''); Letter from Lawrence H. Kaplan, Chairman, 
Investment Company Committee, Securities Industry Association, to 
Margaret H. McFarland, Deputy Secretary, Commission, dated July 1, 
1998 (``SIA Letter''); Letter from Henry H. Hopkins, Managing 
Director and Chief Legal Counsel, T. Rowe Price Associates, Inc., to 
Jonathan G. Katz, Secretary, Commission, dated July 6, 1998 (``T. 
Rowe Price Letter''); Letter from Joseph P. Savage, Assistant 
Counsel, Investment Company Institute, to Jonathan G. Katz, 
Secretary, Commission, dated July 6, 1998 (``ICI Letter'').
    \6\ See Letter to Katherine A. England, Assistant Director, 
Division, Commission, from Thomas M. Selman, Vice President, 
Investment Companies/Corporate Financing, NASD Regulation, dated 
April 19, 1999 (``Amendment No. 2'').
    \7\ See Letter to Katherine A. England, Assistant Director, 
Division, Commission, from Thomas M. Selman, Vice President, 
Investment Companies/Corporate Financing, NASD Regulation, dated 
November 9, 1999 (``Amendment No. 3'').
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II. Description

    NASD Conduct Rule 2210 currently requires that any 
``advertisement'' or ``sales literature'' concerning a registered 
investment company be filed with NASD Regulation's Advertising/
Investment Companies Regulation Department (``Department'') and meet 
the content standards of that rule, as well as all applicable 
Commission rules. The rule defines ``sales literature'' to include a 
research report. Consequently, Rule 2210 requires that NASD member file 
all investment company research reports, even when the report is 
prepared by ``independent research firms'' (i.e., those firms that are 
independent of the investment company, its affiliates, or any NASD 
member, and whose services are not procured by the investment company, 
any of its affiliates, or any NASD member).
    NASD Regulation notes that as the investment company industry has 
grown in recent years so too has the coverage of this industry by 
independent research firms. Many of these firms publish reports that 
analyze a wide variety of investment companies and provide information 
about the investment companies, including each investment company's 
historical performance, the investment company's fees and expenses, and 
a description and narrative analysis of the investment company's 
investment strategies and portfolio management style.
    NASD states that members use these independently prepared research 
reports in a number of ways. Some members may make the entire research 
service available to customers at a branch office. Members may also 
distribute an independently prepared research report concerning a 
particular investment company as part of the selling process.
    NASD Regulation proposed the rule change to clarify the meaning, 
administration and enforcement of rule 2210 insofar as it applies to 
certain types of independently prepared research reports. The proposed 
rule change would clarify that certain types of independently prepared 
research reports would not have to be filed with the Department. The 
Department intends to interpret the term ``independent'' in (G)(i) of 
the proposed

[[Page 3511]]

rule change in a manner similar to the use of that term in NASD Rule 
IM-2210-3, regarding rankings.
    Under the proposed rule change, these research reports would 
continue to be subject to the Department's spot check procedures. 
Moreover, the proposed rule change would impose certain conditions 
designed to ensure that the opinions in the research reports are 
objective, that the presentation is balanced, and that investors have 
access to regular updates of the reports. In particular, the proposed 
rule change would impose several requirements derived from an analogous 
SEC Rule--Rule 139--which provides a safe harbor from the definition of 
``offer for sale'' and ``offer to sell'' in the Securities Act of 1933 
(``Securities Act'').
    Thus, under the proposed rule change, a published article that 
analyzes only a few funds or that is not regularly updated in the 
normal course of business would have to be filed with the Department if 
it is to be distributed or made generally available to customers or the 
public. Moreover, while a member could distribute an independently 
prepared research report concerning a particular fund without filing 
the report with the Department, if the member alters the report in any 
material way, then the member would have to file it with the Department 
if it is to be distributed or made generally available to customers or 
the public.
    NASD Regulation believes that the proposed rule change does not 
raise significant investor protection concerns. In its filing and 
review program, NASD Regulation represents that the Department rarely 
has found significant issues with the types of research reports that 
would be excepted by the proposed rule change. Furthermore, the 
exception in the proposed rule change only exempts these types of 
research reports from the filing requirements; the research reports 
must still comply with applicable NASD rules. In particular, under the 
proposed rule change, these research reports would continue to be 
subject to the content requirements of Rule 2210 as well as Conduct 
Rule 2110 (requiring that a member ``observe high standards of 
commercial honor and just and equitable principles of trade''), and 
Rule 2120 (prohibiting use of manipulative, deceptive or other 
fraudulent devices). In addition, Conduct Rule 2210 requires that the 
research reports be approved prior to use by a registered principal of 
the member.
    The proposed rule change would apply to independently prepared 
research reports that are contained in software or that are 
electronically communicated, as well as those on paper.

III. Summary of Comments

    The Commission received four comment letters on the proposed rule 
change, all of which were generally supportive, but requested 
clarification.\8\
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    \8\ See supra note 5.
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    Morningstar and the ICI requested clarification of a provision in 
the rule that would prohibit an investment company, its affiliated and 
any NASD member that would reply on the filing exemption from procuring 
the services of a research firm. Specifically, they sought 
clarification that the rule would not be interpreted to prohibit 
members relying on the filing exemption from: (i) Using research firms 
that charge funds or members subscription fees or fees for producing, 
distributing and redistributing their reports; or (ii) paying fees to 
research firms that are retained on a ``by request'' basis to create 
customized reports or perform other separate research services based on 
a repackaging of information already published by the research firm. 
\9\
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    \9\ See Morningstar Letter; and ICI Letter.
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    NASD Regulation responded by amending the rule proposal to clarify 
that the exemption is not available with respect to the commissioning 
of research. Rather, the exemption will be available with respect to 
the procurement of a research firm's services. Furthermore, NASD 
Regulation will now permit research firms and members to develop 
customized reports, provided that the reports include only information 
that the research firm already has compiled and published in another 
non-customized report and the reports do not omit information necessary 
to make them fair and balanced. \10\
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    \10\ See Amendment No. 2.
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    Morningstar also requested clarification that the requirement in 
the exemption that a research firm prepare and distribute similar types 
of reports with respect to a substantial number of investment companies 
would not be interpreted to require that each report be in an identical 
format or contain identical information. In response, NASD Regulation 
amended the filing to provide that, in order to qualify for the filing 
exemption, the research firm must prepare and distribute reports 
``based on similar research.'' The provision requiring that the 
research firm prepare and distribute ``similar types of reports'' is 
being eliminated.
    Morningstar sought clarification that the exemption requirement 
that research reports be distributed and updated with reasonable 
regularity in the normal course of the research firm's business would 
not prohibit the distribution of customized reports prepared upon 
request. It noted that such reports are entirely comprised of 
information that is otherwise issued under a distribution cycle and, 
when aggregated with reports issued under a distribution cycle, should 
be considered to have been distributed with reasonable regularity in 
the ordinary course of the firm's research business. \11\
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    \11\ See Morningstar Letter.
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    NASD Regulation responded that the proposed rule change would still 
exempt from the filing requirements customized reports prepared on 
request that are entirely comprised of information completed and 
published in another report, provided that the customized report does 
not omit information necessary to make it fair and balanced.
    Morningstar and the ICI also requested clarification that the 
filing exemption would be available with respect to research reports 
containing performance information that does not meet the currentness 
standards of Rule 482 under the Securities Act, as long as the reports 
are accompanied by information that complies with those currentness 
standards. \12\
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    \12\ See Morningstar Letter; and ICI Letter.
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    NASD Regulation noted that its Department has a long-standing 
informal interpretation that members may distribute a research report 
that does not meet the currentness standards of Securities Act Rule 
482, as long as the research report represents the most recent version 
issued by the research firm and is accompanied by information that 
meets those standards. NASD Regulation further noted that the proposed 
rule change would not affect this interpretation.
    T. Rowe Price, the SIA and the ICI sought clarification that the 
proposed rule change would not be interpreted to prohibit a member from 
supplementing an independent research report with additional 
information, such as a clarification of terms and/or ranking systems, 
or additional disclosure required by NASD or Commission rules. 
Morningstar also requested clarification that a research report that 
did not meet the NASD and Commission content requirements, but was 
accompanied by additional information necessary for the report to meet 
the applicable content requirements, would still be eligible for the 
exemption.
    NASD Regulation confirmed that the exemption would explicitly 
permit material alterations necessary to make

[[Page 3512]]

the report consistent with NASD, Commission or other applicable 
standards. Furthermore, the proposal would not require the filing of 
material that would accompany the report and that would merely clarify 
terms or other information in the report itself.
    Morningstar and the SIA noted that, although the proposed rule 
change would eliminate the requirement to file certain research reports 
with NASD Regulation, Section 24(b) of the Investment Company Act of 
1940 Act (``1940 Act'') and Rule 24b-3 under that Act would still 
require that the reports be filed with the Commission if they are not 
filed with NASD Regulation.\13\Commenters added that such a result 
would be inconsistent with the purpose of the proposed rule change, 
especially if funds and fund underwriters choose to file with NASD 
Regulation to satisfy the requirements of Section 24(b). NASD 
Regulation has amended the proposed rule change to clarify that 
although the qualifying research reports are exempted from the filing 
requirement, they will be deemed filed with NASD Regulation in order to 
satisfy Section 24(b) of the 1940 Act and Rule 24b-3 thereunder.\14\
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    \13\ See Morningstar Letter; and SIA Letter.
    \14\ See Amendment No. 3.
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    The ICI proposed that NASD Regulation include a definition of 
``research report'' to clarify that it is a report that provides an in-
depth analysis of a particular fund, but is not intended to cover 
reprints of articles that appear in widely circulated financial 
magazines.\15\T. Rowe Price supported the ICI's proposed definition but 
suggested that it also include article reprints sent to institutional 
customers in order to exclude such reprints from the filing 
requirements. T. Rowe Price also suggested including a definition of 
``institutional customer'' in the proposed rule change.\16\
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    \15\ See ICI Letter.
    \16\ See T. Rowe Price Letter.
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    NASD Regulation responded by noting that the proposed rule change 
would not apply to article reprints, which NASD Rule 2210 includes in 
the definition of ``sales literature.'' NASD Regulation believed that 
the proposed rule change provided sufficient guidance to members 
concerning the meaning of ``research report.'' NASD Regulation added 
that it also reviewing the treatment of institutional sales material, 
but did not modify the proposal as a result of the comments.
    The ICI requested confirmation that the proposal would exempt 
independent research reports that included performance ranking 
information, provided that the reports meet the proposed exemption 
criteria.\17\ NASD Regulation confirmed that the proposal would exempt 
such reports, provided that they meet the exemption criteria. NASD 
Regulation also noted that such reports would be required to comply 
with the content requirements of IM-2210-3, regarding rankings, as well 
as any other applicable Commission and NASD requirements.
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    \17\ See ICI Letter.
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Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to the Association and, in particular, with the 
requirements of Section 15A(b) of the Act.\18\ Specifically, the 
Commission finds that the proposed rule change is consistent with 
Section 15A(b)(6) of the Act in that it promotes just and equitable 
principles of trade, and generally provides for the protection of 
investors and the public interest.\19\
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    \18\ 15 U.S.C. 78o-3(b).
    \19\ See 15 U.S.C. 78o-3(b)(6). In approving this rule change, 
the Commission has considered the proposal's impact on efficiency, 
competition, and capital formation, consistent with Section 3 of the 
Act. Id. at 78c(f).
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    The Commission believes that the proposed rule change should reduce 
regulatory burdens for NASD members while maintaining investor 
protection safeguards regarding the dissemination of useful fund 
information. Specifically, although the proposed rule reduces the 
filing obligations for qualifying independent research reports, 
investor protection objectives should be served because the exempted 
independent research reports must still comply with the content 
requirements of NASD Conduct Rules 2210, 2110, 2120, and IM-2310-2.\20\ 
In addition, Conduct Rule 2210 would continue to require that these 
research reports be approved by a registered principal of the member 
prior to use. The exempted independent research reports would also 
remain subject to NASD Regulation's spot-check procedures.
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    \20\ NASD Conduct Rule 2110 requires that a member ``observe 
high standards of commercial honor and just and equitable principles 
of trade.'' Rule 2120 prohibits the use of manipulative, deceptive 
or other fraudulent violations. IM-2310-2 requires fair dealing with 
customers, including avoiding fraud violation.
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    The Commission notes that two of the commenters asserted that, 
although the proposed rule change would eliminate the NASD filing 
requirement for qualifying independent research reports, Section 24(b) 
of the 1940 Act and Rule 24b-3 thereunder would still require that such 
reports be filed with the Commission. In response, NASD Regulation 
amended the proposed rule change to clarify that research reports 
satisfying the filing exemption will be deemed filed with the NASD for 
the purposes of Section 24(b) of the 1940 Act and Rule 24b-3 
thereunder.
    The Commission finds good cause to approve Amendment No. 2 to the 
proposed rule change prior to the 30th day after the date of 
publication of notice of filing thereof in the Federal Register. 
Amendment No. 2 addresses several issues. First, it clarifies that the 
exemption is not available with respect to the commissioning of 
research, but is available with respect to the procurement of an 
independent research firm's services. Second, Amendment No. 2 confirms 
that a customized report prepared on request would still be exempted 
from the filing requirements if it is entirely comprised of information 
published in another report, and provided that the customized report 
does not omit information necessary to make it fair and balanced.\21\ 
Third, Amendment No. 2 clarifies that, to qualify for the filing 
exemption, an independent research firm must prepare and distribute 
reports based on similar research. This affirms that the reports do not 
have to be identical in format or contain identical information to 
qualify for the exemption. Fourth, Amendment No. 2 clarifies that 
material changes to exempted independent research reports will be 
permitted when the changes are necessary to make them consistent with 
NASD, Commission or other applicable standards. Finally, Amendment No. 
2 does not raise any new or novel regulatory issues. Accordingly, the 
Commission believes that it is consistent with Section 15A(b)(6) and 
19(b)(2) of the Act to approve Amendment No. 2 to the proposed rule 
change on an accelerated basis.
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    \21\ NASD Regulation also asserts that the rule change will not 
have any effect on its longstanding informal interpretation that 
allows members to distribute a research report that does not meet 
the currentness standards of Commission Rule 482, as long as the 
report represents the most recent version issued and is accompanied 
by information that satisfies the currentness standards. See 
Amendment No. 2. Although this ``informal interpretation'' is not 
part of the proposed rule change and, as such, is not being formally 
approved by this order, the Commission's Division of Investment 
Management indicates that the informal interpretation conforms with 
the intent of Rule 482, provided that the information is not 
presented in a materially misleading manner.
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    The Commission finds good cause to approve Amendment No. 3 to the 
proposed rule change prior to the 30th day after the date of 
publication of notice of filing thereof in the Federal Register. 
Amendment No. 3 clarifies

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that independent research reports that are eligible for the filing 
exemption will be deemed to be filed with the NASD for the purposes of 
Section 24(b) of the 1940 Act and Rule 24b-3 thereunder. The staff of 
the Commission's Division of Investment Management supports this aspect 
of the proposal. Amendment No. 3 also amends paragraph (G)(ii) in the 
proposed rule change to clarify that a member may not alter an exempted 
research report except as necessary to make the report consistent with 
applicable regulatory standards. The Commission believes that this 
clarification should help members to understand that the exemption 
relates solely to legal and regulatory standards, and not industry or 
other standards. Accordingly, the Commission believes that it is 
consistent with Sections 15A(b)(6) and 19(b)(2) of the Act to approve 
Amendment No. 3 to the proposed rule change on an accelerated basis.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment Nos. 2 and 3, including whether the 
proposed rule change is consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, 
D.C. 20549-0609. Copies of the submission, 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 at the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the NASD. All submissions should refer to File No. 
SR-NASD-98-32 and should be submitted by February 11, 2000.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\22\ that the proposed rule change (SR-NASD-98-32) is approved, as 
amended.

    \22\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\23\
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    \23\ 17 U.S.C. 200.30-3(a)(12).

Jonathan G. Katz,
Secretary.
[FR Doc. 00-1459 Filed 1-20-00; 8:45 am]
BILLING CODE 8010-01-M