[Federal Register Volume 67, Number 50 (Thursday, March 14, 2002)]
[Notices]
[Pages 11526-11541]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-6159]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45526; File Nos. SR-NASD-2002-21; SR-NYSE-2002-09]


Self-Regulatory Organizations: Notice of Filing of Proposed Rule 
Changes by the National Association of Securities Dealers, Inc. and the 
New York Stock Exchange, Inc. Relating to Research Analyst Conflicts of 
Interest

March 8, 2002.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on February 13, 2002, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association''), through its wholly owned 
subsidiary, NASD Regulation, Inc. (``NASDR''), and on February 27, 
2002, the New York Stock Exchange, Inc. (``NYSE'' or ``Exchange''), 
filed with the Securities and Exchange Commission (``SEC'' or 
``Commission'') proposed rule changes as described in Items I, II, and 
III below, which Items have been prepared by the respective self-
regulatory organizations (``SROs''). On March 7, 2002, NASDR submitted 
Amendment No. 1 to its proposed rule change.\3\ The Commission is 
publishing this notice to solicit comments on the proposed rule 
changes, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from Thomas M. Selman, Senior Vice President, 
Investment Companies, Corporate Financing, NASDR, to Katherine A. 
England, Assistant Director, Division of Market Regulation 
(``Division''), Commission (March 7, 2002) (``Amendment No. 1''). In 
Amendment No. 1, NASDR revised its response to Items 1(b) and 1(c) 
of the Form 19b-4 to indicate the impact that proposed NASD Rule 
2711 would have on NASD Rule 2210. Additionally, NASDR is inserting 
language in its Purpose section to clarify how the current 
disclosure requirements regarding securities recommendations in NASD 
Rule 2210 would apply if proposed NASD Rule 2711 is approved by the 
SEC. Finally, NASDR is revising the provisions requiring disclosure 
of actual material conflicts of interest to conform its provisions 
to those of the NYSE.
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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. NASDR is proposing to amend the rules of the 
NASD to establish new NASD Rule 2711 (``Research Analysts and Research 
Reports'') to address research analyst conflicts of interest. The NYSE 
is proposing amendments to NYSE Rule 472 (``Communications with the 
Public''), which will place prohibitions and/or restrictions on the 
Investment Banking Department, Research Department, and Subject Company 
Relationships and Communications, and will impose additional disclosure 
requirements on members, member organizations, and associated persons 
preparing research reports and making public appearances.
    The NYSE is also proposing amendments to NYSE Rule 351 (``Reporting 
Requirements''), which will require members and member organizations to 
submit to the Exchange, annually, a written attestation, that the 
member or member organization has established and implemented written 
procedures reasonably designed to comply with the provisions of NYSE 
Rule 472.
    Below is the text of the proposed rule changes. Proposed new 
language is in italic; proposed deletions are in [brackets].

A. NASD Proposed Rule Text

Rule 2711. Research Analysts and Research Reports

(a) Definitions

    For purposes of this rule, the following terms shall be defined as 
provided.
    (1) ``Investment banking department'' means any department or 
division, whether or not identified as such, that performs any 
investment banking service on behalf of a member.
    (2) ``Investment banking services'' include, without limitation, 
acting as an

[[Page 11527]]

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 or similar investments; or serving as placement 
agent for the issuer.
    (3) ``Member of a research analyst's household'' means any 
individual whose principal residence is the same as the research 
analyst's principal residence.
    (4) ``Public appearance'' means any participation in a seminar, 
forum (including an interactive electronic forum), radio or television 
interview, or other public speaking activity 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.''
    (6) ``Research analyst account'' means any account in which a 
research analyst or member of the research analyst's household has a 
beneficial interest, or over which such analyst or household member has 
discretion or control, other than an investment company registered 
under the Investment Company Act of 1940.
    (7) ``Research department'' means any department or division, 
whether or not identified as such, that is principally responsible for 
preparing the substance of a research report on behalf of a member.
    (8) ``Research report'' means a written or electronic communication 
that the member has distributed or will distribute with reasonable 
regularity to its customers or the general public, which presents an 
opinion or recommendation concerning an equity security.
    (9) ``Subject company'' means the company whose equity securities 
are the subject of a research report or recommendation in a public 
appearance.

(b) Restrictions on Investment Banking Department Relationship with 
Research Department

    (1) No research analyst may be subject to the supervision or 
control of any employee of the member's investment banking department.
    (2) Except as provided in paragraph (b)(3), no employee of the 
investment banking department may review or approve a research report 
of the member before its publication.
    (3) Investment banking personnel may review a research report 
before its publication as necessary only to verify the factual accuracy 
of information in the research report or to review the research report 
for any potential conflict of interest, provided that:
    (A) Any written communication between investment banking and 
research department personnel concerning such a research report must be 
made either through an authorized legal or compliance official of the 
member or in a transmission copied to such an official; and
    (B) any oral communication between investment banking and research 
department personnel concerning such a research report must be 
documented and made either through an authorized legal or compliance 
official acting as intermediary or in a conversation conducted in the 
presence of such an official.

(c) Restrictions on Review of a Research Report by the Subject Company

    (1) Except as provided in paragraphs (c)(2) and (c)(3), a member 
may not submit a research report to the subject company before its 
publication.
    (2) A member may submit sections of such a research report to the 
subject company before its publication for review as necessary only to 
verify the factual accuracy of information in those sections, provided 
that:
    (A) The sections of the research report submitted to the subject 
company do not contain the research summary, the research rating or the 
price target;
    (B) a complete draft of the research report is provided to the 
legal or compliance department before sections of the report are 
submitted to the subject company; and
    (C) if after submitting the sections of the research report to the 
subject company the research department intends to change the proposed 
rating or price target, it must first provide written justification to, 
and receive written authorization from, the legal or compliance 
department for the change. The member must retain copies of any draft 
and the final version of such a research report for three years 
following its publication.
    (3) The member may notify a subject company that the member intends 
to change its rating of the subject company's securities, provided that 
the notification occurs on the business day before the member announces 
the rating change, after the close of trading in the principal market 
of the subject company's securities.

(d) Prohibition of Certain Forms of Research Analyst Compensation

    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.

(e) Prohibition of Promise of Favorable Research

    No member may directly or indirectly offer favorable research, a 
specific rating or a specific price target, or threaten to change 
research, a rating or a price target, to a company as consideration or 
inducement for the receipt of business or compensation.

(f) Imposition of Quiet Periods

    No member may publish a research report regarding a subject company 
for which the member acted as manager or co-manager of:
    (1) An initial public offering, for 40 calendar days following the 
date of the offering; or
    (2) a secondary offering, for 10 calendar days following the date 
of the offering; provided that this provision 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.

(g) Restrictions on Personal Trading by Research Analysts

    (1) No research analyst account may purchase or receive any 
securities before the issuer's initial public offering if the issuer is 
principally engaged in the same types of business as companies that the 
research analyst follows.
    (2) No research analyst account may purchase or sell any security 
issued by a company that the research analyst follows, or any option on 
or derivative of such security, for a period beginning 30 calendar days 
before and ending five calendar days after the publication of a 
research report concerning the company or a change in a rating or price 
target of the company's securities; provided that:
    (A) A member may permit a research analyst account to sell all of 
the securities held by them that are issued by a company that the 
research analyst follows, within 30 calendar days after the research 
analyst began following the company for the member;
    (B) a member may permit a research analyst account to purchase or 
sell any security issued by a subject company within 30 calendar days 
before the

[[Page 11528]]

publication of a research report or change in the rating or price 
target of the subject company's securities due to significant news or a 
significant event concerning the subject company, provided that the 
member's legal or compliance department pre-approves the research 
report and any change in the rating or price target.
    (3) No research analyst account may purchase or sell any security 
or any option on or derivative of such security in a manner 
inconsistent with the research analyst's recommendation as reflected in 
the most recent research report published by the member.
    (4) A member's legal or compliance department may authorize a 
transaction otherwise prohibited by paragraphs (g)(2) and (g)(3) based 
upon significant personal financial circumstances of the beneficial 
owner of the research analyst account, provided that:
    (A) The legal or compliance department authorizes the transaction 
before it is entered;
    (B) each exception is granted in compliance with policies and 
procedures adopted by the member that are reasonably designed to ensure 
that these transactions do not create a conflict of interest between 
the professional responsibilities and the personal trading activities 
of a research analyst; and
    (C) the member maintains written records concerning each 
transaction and the justification for permitting the transaction for 
three years following the date on which the transaction is approved.
    (5) The prohibitions in paragraphs (g)(1) through (g)(3) do not 
apply to a purchase or sale of the securities of:
    (A) any registered diversified investment company as defined under 
Section (5)(b)(1) of the Investment Company Act of 1940; or
    (B) any other investment fund over which neither the research 
analyst nor a member of the research analyst's household has any 
investment discretion or control, provided that:
    (i) The research analyst accounts collectively own interests 
representing no more than 1% of the assets of the fund;
    (ii) the fund invests no more than 20% of its assets in securities 
of issuers principally engaged in the same types of business as 
companies that the research analyst follows; and
    (iii) the investment fund does not distribute securities in kind to 
the research analyst or household member before the issuer's initial 
public offering.

(h) Disclosure Requirements

(1) Ownership and Material Conflicts of Interest

    A member must disclose in research reports and a research analyst 
must disclose in public appearances:
    (A) If the research analyst or a member of the research analyst's 
household 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, future, 
long or short position);
    (B) if, as of five business days before the publication of the 
research report or the public appearance, the member or its affiliates 
beneficially own 1% or more of any class of common equity securities of 
the subject company; and
    (C) any other actual, material conflict of interest of the research 
analyst or member of which the research analyst knows or has reason to 
know at the time of publication of the research report or at the time 
of the public appearance.

(2) Receipt of Compensation

    (A) A member must disclose in research reports if:
    (i) The research analyst principally responsible for preparation of 
the report received compensation that is based upon (among other 
factors) the member's investment banking revenues; and
    (ii) the member or its affiliates received compensation from the 
subject company within twelve months before, or reasonably expects to 
receive compensation from the subject company within three months 
following, publication of the research report.
    (B) A research analyst must disclose in public appearances if the 
analyst knows or has reason to know that the subject company is a 
client of the member or its affiliates.

(3) Position as Officer or Director

    A member must disclose in research reports and a research analyst 
must disclose in public appearances if the research analyst or a member 
of the research analyst's household serves as an officer, director or 
advisory board member of the subject company.

(4) Meaning of Ratings

    A member must define in its research reports the meaning of each 
rating used by the member in its rating system. The definition of each 
rating must be consistent with its plain meaning.

(5) Distribution of Ratings

    (A) Regardless of the rating system that a member employs, a member 
must disclose in each research report the percentage of all securities 
rated by the member to which the member would assign a ``buy,'' ``hold/
neutral,'' or ``sell'' rating.
    (B) In each research report, the member must disclose the 
percentage of subject companies within each of these three categories 
for whom the member has provided investment banking services within the 
previous twelve months.
    (C) The information that is disclosed under paragraphs (h)(5)(A) 
and (h)(5)(B) 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 15 calendar days after the most recent calendar 
quarter).

(6) Price Chart

    A member must present in any research report concerning an equity 
security on which the member has assigned any rating for at least one 
year, a line graph of the security's daily closing prices for the 
period that the member has assigned any rating or for a three-year 
period, whichever is shorter. The line graph must:
    (A) Indicate the dates on which the member assigned or changed each 
rating or price target;
    (B) Depict each rating and price target assigned or changed on 
those dates; and
    (C) 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 15 calendar days after the most recent calendar quarter).

(7) Price Targets

    A member must disclose in research reports the valuation methods 
used to determine a price target. Price targets must have a reasonable 
basis and must be accompanied by a disclosure concerning the risks that 
may impede achievement of the price target.

(8) Market Making

    A member must disclose in research reports if it was making a 
market in the subject company's securities at the time that the 
research report was published.

(9) Disclosure Required by Other Provisions

    In addition to the disclosure required by this rule, members and 
research analysts must provide disclosure in research reports and 
public appearances that is required by applicable law or regulation, 
including NASD Rule 2210 and the antifraud provisions of the federal 
securities laws.

[[Page 11529]]

(10) Prominence of Disclosure

    The disclosures required by paragraph (h) must be presented on the 
front page of research reports or the front page must refer to the page 
on which disclosures are found. Disclosures and references to 
disclosures must be clear, comprehensive and prominent.

(i) Supervisory Procedures

    Each member subject to this rule must adopt and implement written 
supervisory procedures reasonably designed to ensure that the member 
and its employees comply with the provisions of this rule, and a senior 
officer of such a member must attest annually to the Association that 
it has adopted and implemented those procedures.

B. NYSE 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 
[shall] 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 [shall] 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 [shall] 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) The subject company may not review or approve research reports 
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 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.

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) for attestations to the Exchange regarding 
compliance).

Retention of Communications

    [(c)] (d) Communications with the public prepared or issued by a 
member or member organization [shall] 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 [shall] must be 
ascertainable from the retained records and the records retained 
[shall] 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

[[Page 11530]]

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

    (f)(1) A member or member organization may not issue research 
reports regarding an issuer 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 for 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.
    (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 Legal or Compliance Department.

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) 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 person's overall performance, 
including services provided to the Investment Banking Department (see 
Rule 472(k)(2) for disclosure of such compensation).
    (i) [.30] General Standards for All Communications
    No change
    (j) [.40] Specific Standards for Communications
    (1) Recommendations
    A recommendation (even though not labeled as a recommendation) must 
have a basis which can be substantiated as reasonable.
    When recommending the purchase, sale or switch of specific 
securities, supporting information must be provided or offered.
    The market price at the time the recommendation is made must be 
indicated.
    (2) [(3)] Records of Past Performance
    No change
    (3) [(4)] Projections and Predictions
    No change
    (4) [(5)] Comparisons
    No change
    (5) [(6)] Dating Reports
    No change
    (6) [(7)] Identification of Sources
    No change
    (7) [(8)] Testimonials
    No change
    (k) [(2)] Disclosure
    [When a communication (excluding extemporaneous interviews in and 
with the media) recommends the purchase or sale of a specific security, 
member organizations must disclose the following information:
    (i) if the organization usually makes a market in the security 
being recommended or if some or all of the recommended securities are 
to be sold to or bought from customers on a principal basis.
    (ii) if the member organization was manager or co-manager of the 
most recent public offering (within 3 years) of any securities of the 
recommended issuer.
    (iii) if the member organization or its employees involved in the 
preparation or the issuance of the communication may have positions in 
any securities or options of the recommended issuer.
    (iv) if a member, allied member or employee is a director of a 
corporation whose security is being recommended.]

(k)(1) Disclosures Required in Research Reports and Scheduled 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 five (5) business days before the publication or 
appearance, the member or member organization or its affiliates 
beneficially own 1% or more of any class of common equity securities of 
the subject company. 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, 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.

[[Page 11531]]

Member Organization Compensation

    (ii) A member or member organization must disclose in research 
reports if the member or member organization or its affiliates received 
compensation from the subject company within the twelve (12) months 
prior to the date of the research report. A member or member 
organization must also disclose if the member or member organization or 
its affiliates reasonably expects to receive compensation from the 
subject company within the three months following the date of issuance 
of the research report. 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 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.
    (ii) 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).
[Supplementary Material * * *]
    .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 reports''are generally defined as, 
but are not limited to, an analysis of equity securities of individual 
companies[,] or industries, [market conditions, securities or other 
investment vehicles] which provide information reasonably sufficient 
upon which to base an investment decision and include a recommendation. 
For purposes of Rule 472(a)(2), research reports include, but are 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. They also 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  Other Communications Activities

    Other communications activities are deemed to include, but not be 
limited to, conducting interviews with the media, writing books, 
conducting seminars or lecture courses, writing newspaper or magazine 
articles and making radio/TV appearances.
    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 which 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 
.30. In addition, any activity which includes discussion of specific 
securities is subject to the specific standards in .40.]
    .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.
    .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

[[Page 11532]]

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 making of 
the recommendation to purchase, sell or hold an equity security in 
research reports, or public appearances or establish 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.
    .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 
interview, or other public appearance or public speaking activity.
    .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.

Rule 351  Reporting Requirements

    (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, 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.
* * * * *
    .11  For purposes of Rule 351(f), the attestation must be submitted 
by April 1 of each year.
    .12  The term ``research reports'' is defined in Rule 472.10.

II. Self-Regulatory Organizations' Statements of the Purpose of, 
and Statutory Basis for, the Proposed Rule Changes

    In their filings with the Commission, NASDR and the NYSE included 
statements concerning the purpose of and basis for the proposed rule 
changes. The text of these statements may be examined at the places 
specified in Item IV below. NASDR and the NYSE 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. NASD's Purpose
    According to NASDR, it has worked closely with the NYSE to develop 
rules to address conflicts of interest that can arise when research 
analysts recommend equity securities in research reports and public 
appearances. NASD's proposed rule change is intended to improve the 
objectivity of research and provide investors with more useful and 
reliable information when making investment decisions.
    To that end, the NASD's proposed rule change generally would 
minimize the influence that a member's investment banking department 
has over its research department and would restrict analysts' personal 
trading of securities. The NASD's proposed rule change also would 
require disclosure of financial interests held by the member firm, the 
analyst and his or her family members, and any other material conflict 
of interest associated with a recommendation of a security. The NASD's 
proposed rule change also would require firms to clarify the meanings 
of their research ratings and provide historical price and ratings 
distribution data in research reports to better enable investors to 
evaluate and compare the quality of research.
    A more detailed discussion of the proposed rule's provisions 
follows.

a. Definitions

    The terms ``research analyst'' and ``research report'' are used 
frequently throughout the NASD's proposed rule change. ``Research 
analyst'' would be defined to mean an ``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.' '' ``Research 
report'' would be defined to mean ``a written or electronic 
communication that the member has distributed or will distribute with 
reasonable regularity to its customers or the general public, which 
presents an opinion or recommendation concerning an equity security.''
    Accordingly, the term ``research analyst'' would not include every 
associated person who may express an opinion on an equity security. 
Thus, for example, most mutual fund portfolio managers are not 
principally responsible for the preparation of ``research reports'' as 
defined by the

[[Page 11533]]

NASD's proposed rule change. Consequently, a mutual fund portfolio 
manager generally would not be deemed to be a ``research analyst,'' 
even if the portfolio manager is an associated person of a member firm 
and discusses the mutual fund's portfolio holdings in a television 
interview.
    The NASD specifically requests comments on these definitions. Would 
the definition of ``research analyst'' have any regulatory gaps? Would 
it impose any unnecessary burdens on members, particularly by including 
any associated person who reports to a research analyst? Would the 
definition of ``research report'' properly exclude those communications 
that do not present the types of concerns that the proposed rule change 
is designed to address?
    The NASD's proposed rule change would require research analysts to 
make various types of disclosures in their public appearances. The term 
``public appearance'' would be defined to include any participation in 
a seminar, forum (including an interactive electronic forum), radio or 
television interview, or other public speaking activity in which a 
research analyst makes a recommendation or offers an opinion concerning 
an equity security. Consequently, this term also would include any 
public conference call in which a research analyst expresses an opinion 
on an equity security. The NASD's proposed rule change would require 
only that a research analyst make these disclosures. An independent 
decision by the sponsor of the public appearance, such as a television 
program sponsor, to edit out the required disclosures, would not 
constitute a violation of the NASD's proposed rule. NASD requests 
comment on whether the scope of this definition is adequate to address 
the concerns raised by a research analyst's public speaking activities 
and whether it might impose any unnecessary burdens on members or their 
research analysts.
    The term ``member of a research analyst's household'' is used in 
connection with the proposed rule change's personal trading 
restrictions and disclosure requirements. NASD proposes to define this 
term to include any individual whose principal residence is the same as 
the research analyst's residence. Thus, it would include any family 
member living with the research analyst, as well as any other 
individual living in the same principal residence. NASD requests 
comment on whether this definition is appropriate.
    The term ``research analyst account'' is used in connection with 
the NASD's proposed rule change's personal trading restrictions. The 
NASD proposes to define this term to include any account in which a 
research analyst or a member of the research analyst's household has a 
beneficial interest, or over which such analyst or household member has 
discretion or control. The term would not include an investment company 
registered under the Investment Company Act of 1940 that is managed by 
a research analyst or a member of the analyst's household.

b. Investment Banking Department Relationship With Research Department

    NASD believes that a potential conflict exists between a firm's 
responsibility to provide fair, objective and unbiased research and its 
interest in obtaining or retaining investment banking business from a 
company that is the subject of a research report (``subject company''). 
The NASD proposes to adopt several measures to address this potential 
conflict.

(1) Supervision and Control of Research Department

    The NASD's proposed rule change would prohibit a member's 
investment banking department from supervising or controlling the 
member's research department and from reviewing or approving research 
reports before their publication. ``Investment banking department'' is 
proposed to be defined to include any department or division, whether 
or not identified as such, that performs any investment banking service 
on behalf of the member. ``Investment banking services'' is proposed to 
encompass a broad array of services typically offered to investment 
banking clients, including acting as an underwriter in an offering for 
the issuer, acting as a financial advisor in a merger or acquisition, 
providing venture capital, equity lines of credit, PIPES or similar 
investments, or serving as placement agent for the issuer. NASD 
requests comment on whether this definition of ``investment banking 
services'' is appropriate or inclusive enough in light of the purposes 
of the proposed rule change.
    The NASD believes that this provision would better ensure that 
research is shielded from the influence of the investment banking 
department's relationship with the subject company. Under the NASD's 
proposed rule change, investment banking personnel could communicate 
with research personnel concerning a research report before the 
report's publication only to ensure the report's factual accuracy and 
to screen for conflicts of interest. The NASD's proposed rule change 
would require an authorized legal or compliance official to act as 
intermediary for all such communications. The term ``legal or 
compliance department'' as used in the proposed rule change would 
include any department or division that is principally responsible for 
compliance with applicable securities laws, regardless of whether the 
department or division is named ``legal'' or ``compliance.'' The NASD's 
proposed rule change would not restrict or impose conditions on any 
communication between a research department and an investment banking 
department that does not concern a proposed research report.
    The NASD's proposed rule change also would address the concern that 
the subject company may attempt to influence the conclusions provided 
in a research report. The NASD's proposed rule change would prohibit a 
member from submitting a research report to the subject company for 
approval. The NASD's proposed rule change would allow the subject 
company to review only certain sections of a research report before its 
publication to ensure that it is factually accurate. However, a member 
could not submit in advance to the subject company those sections of 
the report that contain the research summary, the rating or the price 
target. The NASD's proposed rule change would require that if a 
research analyst intends to make changes to the proposed rating or 
price target after review by the subject company, the research analyst 
would first have to receive written approval from the member's legal 
and compliance department.
    The NASD requests comment on the ``gate-keeping'' functions that 
the proposed rule change would impose on the legal or compliance 
department. The NASD recognizes that these responsibilities may require 
members to hire additional legal or compliance staff and to dedicate 
resources to these gate-keeping functions. Nevertheless, the 
possibility that investment banking departments exert undue influence 
over the contents of a research report has necessitated the proposed 
gate-keeping provisions. NASD requests comment on whether these 
provisions adequately address these concerns about undue influence and 
whether any alternative provisions would be equally effective. In 
addition, NASD requests comment on whether the gate-keeper approach 
that the proposed rule change would impose with respect to contact with 
the subject company also should apply to contacts with the investment 
banking department?

[[Page 11534]]

(2) Research Analyst's or Member's Investment Banking Compensation

    The NASD's proposed rule change would prohibit a member from tying 
analyst compensation to specific investment banking transactions. The 
NASD requests comment on whether this provision might impose 
unnecessary burdens on smaller members that may have the same employee 
perform investment banking and research services. To the extent that 
this provision might impose such unnecessary burdens, the NASD requests 
comment on how widespread this problem would be? Further, NASD requests 
comment on what, if any, alternative measure would respond to the 
concerns that this provision is intended to address without imposing 
these burdens?
    Since research analysts, as part of their job responsibilities, 
advise investment banking departments concerning such matters as 
whether a potential underwriting client is financially or operationally 
prepared for an initial public offering, the NASD's proposed rule 
change would permit a member to compensate its research analysts based 
on their overall performance, which may include these services to the 
investment banking department. However, a member would have to disclose 
in research reports if a research analyst received compensation based 
in whole or in part on the member's investment banking revenues.
    The NASD's proposed rule change also would require a member to 
disclose in research reports if the member or its affiliates received 
compensation from the subject company within the last 12 months, or 
expected to receive compensation within the next three months following 
publication of the report. This disclosure requirement, like all of the 
other disclosure requirements of the proposed rule change, would 
mandate definitive disclosure. Ambiguous or conditional language, such 
as disclosure that the member ``may have'' received compensation from 
the subject company, would not comply with the disclosure requirements 
of the proposed rule change.
    The NASD recognizes the possibility that this requirement might 
necessitate disclosure of compensation related to non-public 
transactions. The NASD believes that this type of compensation presents 
the same conflicts as the receipt of compensation related to 
transactions that have been publicly disclosed. Moreover, the NASD does 
not believe that the proposed rule change would alert the research 
department or the investing public concerning non-public transactions, 
for at least two reasons. First, the proposed rule change would require 
only disclosure that compensation was received by the member or one of 
its affiliates. It would not require disclosure concerning the nature 
of the transaction, such as the fact that the member received the 
compensation in connection with non-public merger and acquisition 
services, or even that the compensation was received by the member (as 
opposed to one of its affiliates that is not engaged in investment 
banking). Second, the term ``compensation'' is to be broadly 
interpreted to include the receipt of any consideration from the 
subject company. Given the breadth of the meaning of ``compensation,'' 
the NASD believes that this disclosure requirement should not alert the 
research department whether the compensation related to a non-public 
transaction. Nevertheless, the NASD does request comment on the 
efficacy of this disclosure requirement, and whether any alternative, 
definitive disclosure would be effective.
    The NASD proposes that a research analyst would have to disclose in 
public appearances if the issuer of a recommended security is a client 
of the member or its affiliates, provided the analyst knows or has 
reason to know this fact. For purposes of this provision, the NASD 
proposes that an issuer would be deemed a ``client'' of the member if 
the member or its affiliates received compensation from the issuer 
within the previous twelve months, or reasonably expects to receive 
compensation from the issuer within the next three months. This 
disclosure requirement thus would not apply with regard to a non-public 
transaction in which the issuer is a client of the member or its 
affiliates and the research analyst does not know and has no reason to 
know of this fact due to an information barrier imposed by the member.

c. Promises of Favorable Research

    The proposed rule change would include a provision that expressly 
prohibits a member from offering or threatening to change favorable 
research, a specific research rating or a specific price target as 
consideration or inducement for the receipt of business or 
compensation. According to the NASD, such behavior already constitutes 
a violation of just and equitable principles of trade (NASD Rule 2110) 
and could violate the anti-fraud provisions of the federal securities 
laws. The proposed rule change would make this prohibition explicit. A 
member would violate this provision simply by making such an offer or 
threat, whether or not the member provided any service to or received 
any compensation or business from the issuer.

d. Quiet Periods

    The NASD's proposed rule change would impose two ``quiet periods'' 
on the issuance of research reports. The proposed rule change would 
prohibit a member from issuing a research report regarding a subject 
company for which the member acted as an underwriting manager or co-
manager for 40 days following the date of an initial public offering 
and 10 days following the date of a secondary offering. For purposes of 
this provision, the ``date'' of an IPO is proposed to be the date on 
which the IPO's registration statement becomes effective. The ``date'' 
of a secondary offering is proposed to be the date on which a member 
commences sales on behalf of an issuer or selling security holders 
pursuant to an underwriting agreement or similar agreement that governs 
the transaction.
    According to the NASD, the quiet periods are intended to reduce a 
manager's ability to improperly reward the subject company for its 
underwriting business by publishing favorable research after completion 
of the offering. The NASD's proposed rule change would not prohibit a 
manager or co-manager from issuing a research report during these quiet 
periods due to significant news or a significant event concerning the 
subject company. In general, NASD proposes that a ``significant'' news 
item or event would constitute a news item or event that is expected to 
have a material impact on, or that reflects a material change to, the 
subject company's earnings, operations or financial condition.
    The NASD specifically seeks comment on the proposed quiet period 
after secondary offerings. In addition, the NASD seeks comment on the 
following: (1) How significant is a manager's opportunity to engage in 
this behavior with respect to a public company that conducts a 
secondary offering?; (2) Should the NASD adopt an exception to this 
provision for seasoned companies qualified to issue their securities in 
an initial public offering under Form S-3?; (3) Would the $75 million 
public float and one-year reporting requirements applicable to S-3 
companies provide a sufficiently high threshold to ensure that the 
quiet period for secondary offerings is effective?; (4) Would an 
alternative standard, such as the $150 million public float value for 
actively traded securities under Regulation M, be more appropriate?

[[Page 11535]]

    NASD also requests comment on whether the proposed quiet periods 
should apply not only to the issuance of research reports, but also to 
any public appearance by a research analyst employed by the manager or 
co-manager of the underwriting.

e. Research Analysts' Personal Trading

    The NASD's proposed rule change would impose certain restrictions 
on an analyst's personal trading activities to help ensure that 
research reports and recommendations are not influenced by the prospect 
of personal enrichment and to ensure that analysts do not profit from 
the issuance of a research report or change in a rating or price 
target. The NASD's proposed rule change would prohibit a research 
analyst account (which would include any account of the research 
analyst or member of the analyst's household, and any account over 
which the analyst or household member has discretion or control) from 
purchasing or receiving securities of a company in the industry the 
analyst covers before that company's initial public offering. According 
to the NASD, this provision is designed to prevent a research analyst 
from receiving ``cheap stock'' before the initial public offering of a 
company that the analyst may subsequently cover.
    The NASD's proposed rule change also would prohibit a research 
analyst account from trading a subject company's securities during a 
``blackout'' period beginning 30 calendar days before, and ending five 
calendar days after, the issuance of a research report or change in the 
research rating or price target for the subject company's securities. 
This prohibition would apply not only to transactions in the subject 
company's securities themselves (including short sales), but also any 
derivative security, such as an option, right, warrant or future. 
Furthermore, the NASD's proposed rule change would prohibit a research 
analyst account from trading in a manner inconsistent with the 
analyst's most current recommendation concerning a security. Thus, for 
example, the proposed rule change would prohibit a research analyst 
from selling or effecting a short sale in a security while maintaining 
a ``buy,'' ``hold'' or ``neutral'' recommendation.
    The NASD's proposed rule change would permit members to adopt 
certain exceptions to these prohibitions that are reasonable in light 
of the purposes of the personal trading restrictions. For example, the 
proposed rule change would permit a transaction within 30 calendar days 
before the member publishes a research report or changes a rating or 
price target due to significant news or a significant event concerning 
the subject company. This exception is designed to ensure that the 30-
day blackout provision does not impede the member's ability to publish 
a research report or change a rating or price target in these 
circumstances. The exception would require that the member's legal or 
compliance department pre-approve any research report or change in a 
rating or price target made in connection with a significant news item 
or event. The legal or compliance department should consider, among 
other factors, whether the research analyst knew or had reason to know 
of the significant news or event before the research analyst account 
entered into the transaction that occurred less than 30 days prior to 
the new research report, rating or price target.
    The NASD's proposed rule change would permit members to authorize 
an exception to the blackout period and prohibition of trading against 
recommendations to allow a research analyst account to trade securities 
due to significant personal financial circumstances, provided certain 
conditions are met. Reliance on this provision should be rare. In most 
cases, a research analyst account should not hold such a significant 
interest in a subject company's securities as to necessitate reliance 
on this provision. Moreover, this provision is meant to be narrowly 
construed to permit an exception in extremely limited circumstances 
such as when the beneficial owner of a research analyst account must 
liquidate securities holdings in order to have funds available for an 
unforeseen medical emergency.
    According to the NASD, the restrictions on personal trading would 
not apply to transactions in shares of registered diversified 
investment companies as defined under Section 5(b)(1) of the Investment 
Company Act of 1940, even if the diversified investment company held 
shares of a subject company.\4\ NASD also proposes that the 
restrictions would not apply to transactions in holdings of any other 
investment fund (including a non-diversified investment company) over 
which neither the research analyst nor a household member has any 
investment discretion or control, provided that the fund meets certain 
conditions. First, the research analyst account could not own more than 
one percent of the fund's assets. Second, the fund could not invest 
more than 20 percent of its assets in securities of issuers principally 
engaged in the same types of business as companies that the research 
analyst covers. Third, the fund could not distribute securities in kind 
to the research analyst or household member before the issuer's initial 
public offering. The NASD requests comment on whether this investment 
fund exception would create a regulatory gap that could undermine the 
effectiveness of the personal trading restrictions or, would it impose 
any unnecessary restrictions on a research analyst's ability to invest 
appropriately in certain investment funds?
---------------------------------------------------------------------------

    \4\ According to the NASD, under Section 5(b)(1) of the 
Investment Company Act of 1940, a ``diversified'' investment 
company's assets are divided into two baskets, one representing 75% 
of its assets and one representing 25% of its assets. The 
restrictions focus on the 75% basket: its assets must consist of 
cash, government securities, securities of other investment 
companies, and ``other securities.'' The ``other securities'' of a 
single issuer may not account for more than 5% of the fund's assets, 
and the fund may not hold more than 10% of a single issuer's voting 
securities. The 25% basket is not subject to these restrictions. 15 
U.S.C. 80a-5 (b)(1).
---------------------------------------------------------------------------

f. Members' or Research Analysts' Financial Interests

    The NASD's proposed rule change would impose several disclosure 
requirements on members and research analysts concerning their 
financial interest in a subject company's securities. First, the NASD's 
proposed rule change would require members and research analysts to 
disclose in research reports and public appearances if the research 
analyst (or a member of the research analyst's household) has a 
financial interest in a subject company, and the nature of the 
financial interest. According to the NASD, this ``financial interest'' 
could include any option, right, warrant, future, long or short 
position in the subject company's securities. The NASD requests comment 
on whether members and research analysts also should be required to 
disclose if any discretionary account managed by the research analyst 
or a member of the analyst's household (other than a registered 
investment company) has a financial interest in a subject company, and 
the nature of this interest.
    Second, the NASD's proposed rule change would require members and 
analysts to disclose if the member or its affiliates beneficially own 
1% or more of any class of a subject company's common equity 
securities. Members could determine whether they or their affiliates 
``beneficially own'' a security by relying upon the standards set forth

[[Page 11536]]

in Section 13(d) \5\ and section 13(g) \6\ of the Act, and the rules 
thereunder.
---------------------------------------------------------------------------

    \5\ 15 U.S.C. 78m(d).
    \6\ 15 U.S.C. 78m(g).
---------------------------------------------------------------------------

    Finally, the NASD's proposed rule change contains a provision that 
would require disclosure in research reports and public appearances of 
any other actual, material conflict of interest of which the analyst 
knows or has reason to know. The NASD requests comment on this 
provision. Specifically, the NASD solicits comment on what types of 
guidance would members need in order to know when this disclosure is 
necessary? The NASD's proposed rule change would explicitly require 
that members and their research analysts comply with the disclosure 
requirements of other applicable laws and regulations, including NASD 
Rule 2210 and the anti-fraud provisions of the federal securities laws. 
In light of this explicit requirement, the NASD requests comment on 
whether the general admonishment to disclose ``other, actual material 
conflicts of interest'' is necessary.

g. Other Disclosures

    The NASD's proposed rule change would require additional 
disclosures in research reports to clarify the meaning of a member's 
ratings system and provide investors with better information to 
evaluate and compare the quality of a firm's research and the influence 
of possible conflicts on the assignment of ratings.
    First, the NASD's proposed rule change would require that research 
reports disclose the meaning of all ratings used in the member's rating 
system. The NASD's proposed rule change also would require that the 
definition of each rating be consistent with its plain meaning. For 
example, a ``hold'' rating could not mean that an investor should sell 
the security.
    Second, the NASD's proposed rule change would require a member to 
disclose in its research reports the percentage of all securities rated 
by the member to which the member would assign a ``buy,'' ``hold/
neutral'' or ``sell'' rating, regardless of whether the member's rating 
system uses other categories. The NASD's proposed rule change would 
require a member to determine based on its own rating system into which 
of the three categories each securities rating falls. Thus, for 
example, a rating of ``market outperform'' or ``strong buy'' might 
constitute a ``buy'' under this requirement. The member then would 
provide the percentage of all of its ratings in each of these 
categories. For example, a research report might disclose that the 
member has assigned a ``buy'' rating to 70% of the securities that it 
follows, a ``hold'' rating to 25%, and a ``sell'' rating to 5% (even if 
the member employs a system that assigns five different ratings to the 
securities that it follows). NASD requests comment on whether another 
set of terms would be more appropriate than ``buy,'' ``hold/neutral'' 
or ``sell,'' such as a numerical rating system of ``one,'' ``two'' and 
``three.''
    Third, the NASD proposes that the member would have to disclose the 
percentage of subject companies within each of these three rating 
categories for which the member has provided investment banking 
services within the previous twelve months. For example, if 20 of the 
25 companies that a member categorizes with a ``buy'' rating are 
investment banking clients , the member would have to disclose that 80 
percent of the companies in the ``buy'' rating category are its 
investment banking clients. NASD proposes that all of this information 
would have to be current as of the most recent calendar quarter (or the 
second most recent calendar quarter if the publication date is less 
than 15 calendar days after the most recent calendar quarter).
    Fourth, the NASD's proposed rule change would require that research 
reports present a price chart that maps the historical price movements 
of the recommended security and indicates those points at which the 
member assigned or changed a research rating or price target. The NASD 
believes that such a chart could enable investors to compare the 
ratings and price targets that a member has assigned with the stock 
performance of the recommended security.\7\
---------------------------------------------------------------------------

    \7\ The NASD submitted a sample price chart that complies with 
this proposed rule provision as Exhibit 3 to its Form 19b-4, which 
is part of the public file and can be inspected at the Commission's 
Public Reference Room, as well as at the principal office of the 
NASD.
---------------------------------------------------------------------------

    The NASD proposes that this disclosure requirement would apply only 
to securities on which the member has assigned a rating for at least 
one year, in recognition of the long-term nature of many ratings. The 
NASD proposes that the provision also would require that the price 
chart cover the period that the member has rated the security or three 
years, whichever is shorter. The NASD proposes that the price chart 
would have to 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 15 calendar days after the most recent calendar 
quarter).
    Fifth, the NASD's proposed rule change would require disclosure in 
research reports of the valuation methods used in developing the 
research rating price target. The price target must have a reasonable 
basis and must be accompanied by a disclosure concerning the risks that 
may impede achievement of the price target. The requirement that the 
price target have a reasonable basis is based upon the current 
requirement in NASD Rule 2210(d)(2)(B)(i) that any member securities 
recommendation in an advertisement or item of sales literature have a 
reasonable basis.
    Sixth, the NASD's proposed rule change would require the member to 
disclose if it makes a market in the subject company's securities. 
According to the NASD, the market-making provisions are similar to 
requirements that exist under NASD Rule 2210. Ambiguous or conditional 
language, such as the fact that a member ``may'' make a market, or 
``usually'' makes a market in the security, would not comply with this 
disclosure requirement.\8\
---------------------------------------------------------------------------

    \8\ To the extent that there are differences in the disclosure 
requirements regarding market making between the proposed rule 
change and current NASD Rule 2210, the proposed rule change 
provisions would govern.
---------------------------------------------------------------------------

    Seventh, the NASD proposed rule change would require disclosure in 
research reports and public appearances of whether a research analyst 
or a member of the research analyst's household is an officer, director 
or advisory board member of the subject company. The NASD requests 
comment as to whether this disclosure requirement should extend to any 
employment with the subject company, including recent past employment.
    Finally, in addition to the disclosure required by this proposed 
rule change, members and research analysts would be required to provide 
disclosure in research reports and public appearances that is required 
by applicable law or regulation, including NASD Rule 2210 and the anti-
fraud provisions of the federal securities laws. In particular, NASD 
Rule 2210(d)(2)(B)(i) provides that, in making a recommendation in 
advertisements and sales literature, a member must disclose, as 
applicable:
     That the member usually makes a market in the recommended 
security, or that the member or associated persons will sell to or buy 
from customers on a principal basis;
     That the member and/or its officers or partners own 
options, rights or warrants to purchase any of the securities of the 
recommended issuer,

[[Page 11537]]

unless the extent of such ownership is nominal; and
     That the member was manager or co-manager of a public 
offering of any securities of the recommended issuer within the last 
three years.
    To the extent that the proposed rule change's disclosure 
requirements regarding market-making activities differ from those in 
Rule 2210(d)(2)(B)(i), the proposed rule change provisions would 
govern. However, the other disclosure requirements of Rule 
2210(d)(2)(B)(i) would continue to apply to advertisements and sales 
literature (including research reports) in addition to the proposed 
rule change's disclosure requirements. Thus, a member would continue to 
be required to disclose in research reports if the member buys the 
recommended securities from, or sells them to, customers on a principal 
basis; if the member or its officers or partners own options, rights or 
warrants to purchase any securities of the recommended issuer in any 
amount (unless the extent of such ownership is nominal); and if the 
member was a manager or co-manager of a public offering of the 
recommended issuer's securities within the last three years.
    The NASD proposes that disclosures required by the proposed rule 
change either would have to be presented on the front page of a 
research report, or the report's front page would have to refer to the 
page on which the disclosures are found. The NASD's proposed rule 
change would require disclosures to be clear, comprehensive and 
prominent. Ambiguous or conditional disclosures would not meet this 
standard.

h. Supervisory Procedures/Reporting Requirements

    The NASD's proposed rule change would require each member that is 
subject to the proposed rule to adopt written supervisory procedures 
reasonably designed to ensure that the member and its employees comply 
with the rule. The NASD also proposes that a member's senior officer 
also would have to attest annually to the NASD that the member has 
established and implemented procedures reasonably designed to comply 
with the rule. The NASD believes that this provision is similar to NYSE 
Rule 351, which requires NYSE members to submit to the NYSE annually a 
letter signed by a senior officer of a member that the member has met 
certain supervisory requirements. The NASD requests comment on whether 
attestation to the NASD is necessary, or whether this provision should 
simply require members to maintain records of such annual attestations. 
The NASD also requests comment as to whether this attestation should be 
submitted only to a member's designated examining authority (generally 
the NYSE or the NASD).
2. NASD's Statutory Basis
    NASD believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) \9\ 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 will 
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.
---------------------------------------------------------------------------

    \9\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

3. NYSE's Purpose
    According to the NYSE, its Rule 472 establishes standards governing 
member and member organization communications with the public. In 
particular, NYSE Rule 472.40(2) requires disclosure by member 
organizations as to certain relationships with recommended issuers, 
e.g., if the member organization participates in a public offering, 
makes a market or has positions in the securities of a company that is 
recommended in a communication to the public.

a. Background

    According to the NYSE, during 2000 and 2001, the stock market 
decline and negative news reports brought attention to the issue of 
research analysts' conflicts of interest as well as to the adequacy of 
disclosure in communications with the public that recommend securities. 
According to the NYSE, the SEC expressed particular concern about 
analysts and others who make stock recommendations during TV interviews 
and had additional concerns about written communications in which 
disclosures were vague and buried in hedge clauses or footnotes.
    According to the NYSE, in 2000, the NYSE and NASDR began working on 
proposed amendments to NYSE and NASDR rules governing communications 
with the public (NYSE Rule 472 and NASDR Rule 2210) to strengthen the 
disclosure requirements.
    In June 2001, the Securities Industry Association's (``SIA'') Ad 
Hoc Committee on Analyst Integrity issued new guidelines for research 
analysts entitled ``Best Practices for Research.'' These best 
practices, which do not have the effect of rules of the SEC or SROs, 
suggested prohibitions on linking analysts' compensation to investment 
banking deals; on analysts' trading against their own securities 
recommendations; and on approving research by investment banking 
departments and subject companies. The guidelines also recommended 
disclosure of ownership positions in securities of companies that 
research analysts cover.
    In July 2001, the Association for Investment Management and 
Research (``AIMR'') published for comment an issues paper, ``Preserving 
the Integrity of Research,'' in which it identified conflicts of 
interest and pressures on research analysts that may bias research and 
recommendations.
    In addition, during the second half of 2001, several broker-dealers 
announced that they would either prohibit analysts from owning shares 
in companies they cover or require their analysts to disclose ownership 
stakes in such companies.
    During June and July 2001, the House Committee on Financial 
Service's Subcommittee on Capital Markets, Insurance and Government 
Sponsored Enterprises (the ``Subcommittee'') held hearings on the 
sources and ramifications of analysts'' conflicts of interest and on 
the adequacy of disclosures in communications to the public.
    During these hearings, according to the NYSE, the following 
industry issues were addressed: \10\ research analysts were ``subject 
to several influences that may affect the integrity and the quality of 
their analysis and recommendations;'' analysts provide assistance to 
investment banking by ``initiating research coverage on prospective 
investment banking clients;'' ``many firms pay their analysts largely 
based upon the profitability of their investment banking unit;'' 
``investment bankers at some firms are involved in evaluating the 
firm's research analysts to determine their compensation;'' and several 
``firms reported that investment banking had input into research 
analysts' bonuses.''
---------------------------------------------------------------------------

    \10\ July 31, 2001 testimony given by then SEC Acting Chairman 
Laura Unger, before the Subcommittee.
---------------------------------------------------------------------------

    Further, according to the NYSE, it was found that ``analysts were 
invited to invest'' in ``companies' private

[[Page 11538]]

placements, which were not available to the public generally,'' and 
``if the company went public and the analyst's firm underwrote the IPO, 
the analyst always issued positive research on the company.'' Also, 
``firms did not always know whether their research analysts owned stock 
in companies they underwrote and upon which their analysts then issued 
research reports.''
    Additionally, ``analysts sometimes provided investment bankers with 
prior notice of changes in recommendation,'' and in some instances, 
``analysts provided investment bankers and client management with 
advance notice of a pending change in the analyst's recommendations.''
    According to the NYSE, it was also found that some research 
analysts issued ``booster-shot'' research reports, whereby they 
reiterated ``buy recommendations shortly before, or just after, the 
lock-up period expired.'' Further, it was noted that some analysts 
``executed trades for their personal accounts that were contrary to 
their recommendations in their research reports.'' In some instances, 
``analysts'' ownership in stock of the covered company was not 
disclosed in the research report at all.''
    In addition, according to the NYSE, it was found that ``sell-side 
analysts routinely recommend securities during public appearances in 
the media (such as on financial television and radio programs), but 
rarely reveal any conflicts of interest to investors.'' Finally, 
ratings categories used by firms in their research reports ``may be 
unclear to investors'' and that ``full-service broker-dealers use a 
variety of undefined terms to describe their investment 
recommendations,'' and that ``the wide variety of terms may confuse 
investors.''
    The report of these hearings deemed the SIA best practices to be 
inadequate as a means of eliminating and/or mitigating the systemic 
conflicts of interest confronting analysts and the biased research 
attributable to such conflicts. According to NYSE, the Subcommittee 
concluded that rulemaking would be a more effective way to deal with 
these issues.
    In November 2001, the NYSE and NASDR established a joint SRO/
industry committee to elicit industry comment on the proposal on 
communications with the public developed to address Congress' concerns. 
The proposal also incorporates as rules many of the SIA best practices, 
and recommendations from the AIMR issues paper.

b. Proposed Amendments to NYSE Rule 472

    As proposed, the NYSE Rule amendments will address and remediate 
the issues discussed above in regard to analysts' conflicts of interest 
and lack of adequate disclosure.
    NYSE's proposed rules are intended to reinforce the integrity of 
the process and help rebuild investors' faith in research and in the 
equities markets as a whole. The amendments should impact the way 
research analysts work within their firms and with subject companies. 
As an unavoidable consequence, NYSE believes that this will add to the 
firms' costs and administrative burden of operating and overseeing the 
research process.
    The most significant changes are as follows:
    (1) Proposed amendments to NYSE Rule 472 would place the following 
prohibitions and/or restrictions on Investment Banking Department, 
Research Department and Subject Company Relationships and 
Communications:
     Research Department personnel or others engaged in the 
preparation of research reports may not be subject to the supervision 
or control of the Investment Banking Department (Proposed NYSE Rule 
472(b)(1)).
     Research reports may not be subject to review or approval 
prior to distribution by the Investment Banking Department (Proposed 
NYSE Rule 472(b)(1)).
     The NYSE believes that analyst's responsibility to provide 
fair, objective and unbiased research may be compromised if, at the 
same time, the analyst is involved with and/or supervised by the member 
or member organization's Investment Banking Department responsible for 
taking a company public or participating in other types of equity 
underwritings.
    The NYSE's proposed rule change would address this potential 
conflict by prohibiting investment banking supervision and control, and 
thus should protect research analysts from undue influence by the 
Investment Banking Department. Further, NYSE believes that this 
prohibition would be a codification of one of the SIA's Best Practices 
recommendations.
     An exception is provided for written and oral 
communications, intermediated through the Legal or Compliance 
Department, to verify the accuracy of information and to identify 
potential conflicts of interest (Proposed NYSE Rule 472(b)(2)(i) and 
(ii)).
     This limited exception would further the purpose of the 
NYSE's proposed rule change in that research analysts will be shielded 
from pressure and influences of investment banking, while providing for 
the issuance of factually accurate research reports. Moreover, NYSE 
believes that the Legal or Compliance Department intermediation 
requirement is consistent with and furthers the purpose of both Federal 
securities laws and NYSE rules governing information barriers.\11\
---------------------------------------------------------------------------

    \11\ According to NYSE, Section 15(f) of the Act provides, in 
part, that every registered broker or dealer shall establish, 
maintain, and enforce written policies and procedures designed to 
prevent the misuse of material non-public information. 15 U.S.C. 
78o(f). See also NYSE Rules 98, 342, and 351.
---------------------------------------------------------------------------

     The subject company may not review or approve a research 
report prior to its distribution (Proposed NYSE Rule 472(b)(3)).
     However, the subject company may review sections of draft 
research reports excluding the research summary, research rating or 
price target to verify facts, provided the Legal or Compliance 
Department receives a complete draft prior to submission to the subject 
company (Proposed NYSE Rule 472(b)(3)(i)).
     After submission of the draft research report to the 
subject company, any changes in the proposed rating or price target 
must be justified by the Research Department, and receive prior written 
authorization from the Legal or Compliance Department (Proposed NYSE 
Rule 472(b)(3)(ii)).
    The NYSE believes that its proposed rule change addresses concerns 
raised by AIMR in its issues paper that a subject company may attempt 
to pressure an analyst to issue a favorable research recommendation 
provided in a research report. Moreover, should an analyst change a 
recommendation on a subject company, after limited review by the 
subject company, such change would have to be justified to, and 
approved by, the Legal or Compliance Department.
    The NYSE recognizes that the proposed rule amendment may require 
members and member organizations to make additions to their Legal or 
Compliance Departments, with concomitant financial costs to the members 
and member organizations.
     The subject company may not be notified of a ratings 
change until after the close of trading in the principal market one 
business day prior to the announcement of the change (Proposed NYSE 
Rule 472(b)(3)(iii)).
    The NYSE believes that limiting advance notification of the ratings 
change should substantially reduce the

[[Page 11539]]

possibility of the subject company and its insiders from taking 
advantage of such knowledge to their benefit, and to the detriment of 
its shareholders.
    (2) Proposed amendments to NYSE Rule 472 prohibit and/or restrict 
the following in connection with associated persons and/or their 
household members and to any account in which an associated person has 
a financial interest or over which the associated person exercises 
discretion or control, in preparing research reports:
     Prohibits compensation linked to specific investment 
banking services transactions (Proposed NYSE Rule 472(h)).
     Prohibits ownership positions (including purchasing or 
receiving pre-IPO shares) if the issuer is principally engaged in the 
same type of business or industry classification as companies which the 
associated person covers in research reports (Proposed NYSE Rule 
472(e)(1)).
     Prohibits trading in recommended securities thirty (30) 
days prior to and five (5) days after the issuance of research reports, 
changes in rating or price target (Proposed NYSE Rule 472(e)(2)).
     Prohibits trades contrary to the analyst's current 
recommendation (Proposed NYSE Rule 472(e)(3)).
    The proposed amendments include exceptions to the above 
prohibitions for:
     A significant unanticipated change in the personal 
financial circumstances which is pre-approved by the Legal or 
Compliance Department (Proposed NYSE Rule 472(e)(4)(i));
     Thirty (30) and five (5) day blackout period for the 
issuance of research reports, change in rating or price target 
attributable to significant news or events regarding the subject 
company which are pre-approved by the Legal or Compliance Department 
(Proposed NYSE Rule 472(e)(4)(ii));
     Sale transactions for associated persons new to the member 
or member organization within thirty (30) days of employment (Proposed 
NYSE Rule 472(e)(4)(iii)) or being assigned the responsibility of 
preparing research reports with respect to a subject company (Proposed 
NYSE Rule 472(e)(4)(iv)); and
     Transactions in accounts not controlled by the associated 
person, e.g., certain investment funds (Proposed NYSE Rule 
472(e)(4)(v)), or registered investment company (Proposed NYSE Rule 
472(e)(4)(vi)).
    The NYSE believes that prohibitions on tying analyst compensation 
to specific investment banking deals, or on analyst ownership of pre-
IPO shares in subject companies would help eliminate incentives 
analysts and members or member organizations may have to publish 
favorable research on such subject companies.
    The NYSE believes that the proposed rule change would also impose 
certain restrictions on an analyst's personal trading activities to 
help ensure that research reports and recommendations are not 
influenced by the prospect of personal enrichment.
    Further, the NYSE proposed rule change would prohibit a research 
analyst from trading in a manner contrary to the analyst's most current 
recommendation concerning a security. Thus, for example, the NYSE 
proposed rule change would prohibit a research analyst from selling a 
security while maintaining a ``buy'' recommendation.
    (3) Proposed amendments to NYSE Rule 472 place the following 
prohibitions and/or restrictions on members or member organizations:
     The publishing of research reports within forty (40) 
calendar days of the completion of an initial public offering and ten 
(10) calendar days of the completion of a secondary offering in which a 
member or member organization acted as a manager or co-manager 
(Proposed NYSE Rule 472(f)(1) and (2)).
     An exception to the forty (40) and ten (10) day quiet 
period for a research report issued due to significant news or events 
about the issuer, provided it is pre-approved by the Legal or 
Compliance Department (Proposed NYSE Rule 472(f)(3)).
     Offering favorable research to companies as consideration 
or inducement for their business is prohibited (Proposed NYSE Rule 
472(g)).
    While NYSE recognizes that efficient markets require the 
dissemination of information on publicly traded companies, the proposed 
quiet periods are intended to minimize the concern that a managing 
underwriter has the ability to reward the subject company for its 
underwriting business by publishing favorable research soon after 
completion of the offering.
    As proposed, the forty (40) and ten (10) calendar day quiet periods 
exceed those provided for under the federal securities laws.\12\ 
Although the proposed quiet periods are longer than what is currently 
mandated, NYSE believes that they are warranted.
---------------------------------------------------------------------------

    \12\ According to NYSE, currently Rule 174(d) of the Securities 
Act of 1933 provides for a twenty-five (25) day prospectus delivery 
requirement for an issuer's IPO if the security is to be listed on 
an exchange or authorized for inclusion in an interdealer quotation 
system such as Nasdaq. The twenty-five (25) day quiet period 
coincides with the twenty-five (25) day prospectus delivery 
requirement under this rule. In addition, according to NYSE, the 
restrictions regarding publication of research reports in Rule 101 
of Regulation M do not apply to research reports that comply with 
Rules 138 or 139 (available to S-2 and/or S-3 issuers) of the 
Securities Act.
---------------------------------------------------------------------------

    Recognizing that markets may be volatile, the proposed rule change 
would not prohibit a manager or co-manager from issuing a research 
report during these quiet periods due to significant news or a 
significant event concerning the subject company. In general, a 
``significant'' news item or event is one that is expected to have a 
material impact on, or that reflects a material change to, the subject 
company's earnings, operations or financial condition.
    The NYSE proposed rule change would include a provision that 
expressly prohibits a member or member organization from offering 
favorable research, a specific research rating or a specific price 
target as consideration or inducement for the receipt of business or 
compensation. While, according to NYSE, such action constitutes a 
violation of existing just and equitable principles of trade, the NYSE 
proposed rule change makes this prohibition explicit.
    (4) Proposed amendments to NYSE Rule 472 impose requirements on 
members, member organizations, and associated persons preparing 
research reports to disclose the following in written communications 
and public appearances:
     whether, as of five (5) days prior to the publication of a 
research report, a member or member organization owns a position in 
excess of 1% of any class of common equity securities of the subject 
company (Proposed NYSE Rule 472 (k)(1)(i)(a));
     the associated person's or household member's financial 
interest in the subject company (Proposed NYSE Rule 472(k)(1)(i)(b));
     any actual, material conflict of interest of the member or 
member organization which the associated person knows or has reason to 
know exists at the time of the issuance of a research report or public 
appearance (Proposed NYSE Rule 472(k)(1)(i)(c));
     whether the member or member organization received 
compensation from subject companies within the past twelve (12) months 
or reasonably expects to receive compensation in the next three (3) 
months (Proposed NYSE Rule 472(k)(1)(ii)); and
     whether the associated person or household member is an 
officer, director, or advisory board member of the recommended issuer 
(Proposed NYSE Rule 472(k)(1)(iii)).

[[Page 11540]]

    NYSE proposes that all required disclosures must be clear, 
comprehensive and on the first page of a research report or must 
reference the reader to the page in which it is found (Proposed NYSE 
Rule 472(k)(2)).
    As noted above, the NYSE proposed rule change would require a 
member or member organization to disclose in research reports whether 
the member, member organization or its affiliates received compensation 
from the subject company within the last 12 months, or reasonably 
expects to receive compensation within the next three months following 
publication of the research report. According to NYSE, this requirement 
would mandate definitive disclosure. Ambiguous or conditional language, 
such as disclosure that the member or member organization ``may have'' 
received compensation from the subject company, would not comply with 
the disclosure requirements of the proposed rule change.
    The NYSE recognizes the possibility that this requirement might 
include compensation related to non-publicly announced transactions. 
However, both publicly announced and non-publicly announced related 
compensation present the potential for conflicts. Moreover, the NYSE 
does not believe that the proposed rule change would alert the Research 
Department or the investing public concerning non-public transactions, 
for at least two reasons.
    First, the NYSE proposed rule change would require only disclosure 
that compensation was received by the member, member organization or 
its affiliates. It would not require disclosure concerning the specific 
amount received or expected to be received or the nature of the 
transaction, such as the fact that the member, member organization or 
its affiliates received the compensation in connection with non-public 
merger and acquisition services, or even that the compensation was 
received by the member or member organization (as opposed to one of its 
affiliates that is not engaged in investment banking). Second, 
according to NYSE, the term ``compensation'' is to be broadly 
interpreted to include the receipt of any consideration from the 
subject company. Given the breadth of the meaning of ``compensation,'' 
this disclosure requirement should not alert the Research Department 
whether the compensation is related to a non-public transaction.
    According to the NYSE, research analysts would have to disclose in 
public appearances if the issuer of a recommended security is a client 
of the member, member organization or its affiliates, provided the 
analyst knows or has reason to know this fact. For purposes of this 
provision, an issuer would be deemed a ``client'' of the member, member 
organization or its affiliates, if the member, member organization or 
its affiliates received compensation from the issuer within the 
previous twelve months, or reasonably expects to receive compensation 
from the issuer within the next three months. This disclosure 
requirement thus would not apply with regard to a non-public 
transaction in which the issuer is a client of the member, member 
organization or its affiliates and the research analyst does not know 
and has no reason to know of this fact due to an information barrier 
imposed by the member or member organization.
    (5) The proposed rule change would require additional disclosures 
in research reports to clarify the meaning of a member's or member 
organization's ratings system and provide investors with better 
information to evaluate and compare the quality of a member or member 
organization's research and the influence of possible conflicts in the 
assignment of ratings (Proposed NYSE Rule 472(k)(2)(iv)).
    (6) Proposed amendments to NYSE Rule 351 would require members and 
member organizations to submit to NYSE, annually, a letter of 
attestation signed by a senior officer or partner, that the member or 
member organization has established and implemented written procedures 
reasonably designed to comply with the provisions of NYSE Rule 472 
(Proposed NYSE Rule 351(f)). See also NYSE Rule 472(c) for the 
requirement to establish written procedures.
    According to the NYSE, the scope of sales practice examinations 
conducted by NYSE will be expanded to ensure compliance with the new 
rule amendments.
4. NYSE's Statutory Basis
    The Exchange believes that the proposed rule change furthers the 
objectives of Section 6(b)(5)\13\ of the Act in that it is 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.
---------------------------------------------------------------------------

    \13\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

B. Self-Regulatory Organizations' Statements on Burden on Competition

    NASDR and the NYSE do not believe that the proposed rule changes 
will result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act, as amended.

C. Self-Regulatory Organizations' Statements on Comments on the 
Proposed Rule Change Received From Members, Participants, or Others

1. NASD
    Written comments were neither solicited nor received for this 
proposed rule change. Previously, the NASD published for comment in 
NASD Notice to Members 01-45 (July 2, 2001) a more limited proposal to 
amend NASD Rule 2210, Communications With The Public. The NASD received 
850 comments in response to that Notice. The NASD has not included a 
discussion of the comments received on that proposal because the 
current proposed rule change is significantly different and more 
comprehensive.
2. NYSE
    The Exchange 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 changes, or
    B. institute proceedings to determine whether the proposed rule 
changes should be disapproved.

IV. Solicitation of Comments

    The Commission notes that the NASDR and NYSE have worked together 
to fashion these proposals. However, there are differences in the text 
of the proposals. The Commission specifically requests comment on the 
substance of proposed NASD Rule 2711, as amended; NYSE's proposed rule 
changes to NYSE Rule 472 and NYSE Rule 351; and whether there are any 
differences between the NYSE proposed Rule 472 and NASD proposed Rule 
2711 that present compliance or interpretive issues. The Commission 
also specifically seeks comment on whether the text or substance of 
proposed NASD Rule 2711 and current NASD Rule 2210 present compliance 
or interpretive issues.\14\ The Commission notes that, in

[[Page 11541]]

Section II above, the NASD has requested comment on several issues 
relating to proposed NASD Rule 2711.
---------------------------------------------------------------------------

    \14\ See, e.g., the discussion in Section II.A.1.g. above.
---------------------------------------------------------------------------

    Persons making written submissions should file six copies thereof 
with the Secretary, Securities and Exchange Commission, 450 Fifth 
Street, NW., Washington, DC 20549-0609. Copies of the submission, all 
subsequent amendments, all written statements with respect to the 
proposed rule 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 such filing will also be available for inspection and 
copying at the principal offices of the SROs. All submissions should 
refer to File Nos. SR-NASD-2002-21 and SR-NYSE-2002-09 and should be 
submitted by April 4, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
---------------------------------------------------------------------------

    \15\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-6159 Filed 3-13-02; 8:45 am]
BILLING CODE 8010-01-P