[Federal Register Volume 67, Number 135 (Monday, July 15, 2002)]
[Notices]
[Pages 46555-46558]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-17682]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46165; File No. SR-NASD-2002-87]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change and Amendment No. 1 Thereto by 
the National Association of Securities Dealers, Inc. Relating to 
Establishing Effective Dates for NASD Rule 2711, Research Analysts and 
Research Reports

July 3, 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 July 1, 2002, the National Association of Securities Dealers, Inc. 
(``NASD'') submitted to the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by the NASD. On July 3, 
2002, the NASD filed Amendment No. 1 to the proposed rules change.\3\ 
The NASD has designated the proposed rule change as constituting a 
stated policy, practice, or interpretation with respect to the meaning, 
administration, or enforcement of an existing rule series under 
paragraph (f)(1) of Rule 19b-4 under the Act,\4\ which renders the 
proposal effective upon filing Amendment No. 1 with the Commission. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, NASD established a further condition for 
delaying the implementation of Rules 2711(b) and (c) until November 
6, 2002 for members that over the previous three years, on average, 
have participated in 10 or fewer investment banking transactions on 
underwritings as manager or co-manager and generated $5 million or 
less in gross investment banking revenues from those transactions. 
Amendment No. 1 requires that those firms that meet the eligibility 
requirements outlined above must maintain records of communications 
that would otherwise be subject to the gatekeeper provisions of 
Rules 2711(b) and (c). In Amendment No. 1, NASD also corrected 
several technical errors that appeared in its original filing. See 
letter from Marc Menchel, Senior Vice President and General Counsel, 
NASD, to Katherine A. England, Assistant Director, Division of 
Market Regulation, Commission, dated July 2, 2002 (``Amendment No. 
1'').
    \4\ 17 CFR 240.19b-4(f)(1).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Pursuant to the provisions of Section 19(b)(1) of the Act,\5\ the 
NASD is filing with the Commission a proposed rule change to establish 
November 6, 2002 as the effective date for certain provisions of NASD 
Rule 2711. First, the proposed rule change would establish November 6, 
2002 as the effective date for Rules 2711(b) and (c) for members that 
over the previous three years, on average, have participated in 10 or 
fewer investment banking transactions on underwritings as manager or 
co-manager and generated $5 million or less in gross investment banking 
revenues from those transactions. Rules 2711(b) and (c), when 
effective, will prohibit a research analyst from being subject to the 
supervision or control of any employee of a member's investment banking 
department, and will further require legal or compliance personnel to 
intermediate certain communications between the research department and 
either the investment banking department or the company that is the 
subject of a research report or recommendation (``subject company'').
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    \5\ 15 U.S.C. 78s(b)(1).
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    Second, the proposed rule change would also establish November 6, 
2002 as the effective date for Rule 2711(h)(2) as applied to the 
receipt of compensation by a member's foreign affiliates from a subject 
company. Rule 2711(h)(2), when effective, will require a member to 
disclose in research reports all compensation received by it or its 
affiliates from a subject company for investment banking services in 
the past 12 months, or expected to be received in the next 3 months.\6\
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    \6\ See Amendment No. 1, supra note 3.
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    Third, the proposed rule change would establish November 6, 2002, 
subject to certain conditions, as the effective date for Rule 
2711(g)(3) for those research analysts who must divest holdings to 
comply with their firm's more restrictive policy that prohibits analyst 
ownership of securities they cover. Rule 2711(g)(3), when effective, 
will prohibit a ``research analyst account'' from purchasing or selling 
a security or option or derivative of that security, in a manner 
contrary to the analyst's most recent published recommendation 
reflected in the member's research report.

[[Page 46556]]

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its original rule filing with the Commission, the NASD included 
statements concerning the purpose of and basis for the proposed rule 
change and discussed any comments it received on the proposed rule 
change. The text of these statements may be examined at the places 
specified in Item IV below. The NASD has prepared summaries, set forth 
in Sections A, B, and C below, of the most significant aspects of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The NASD is filing the proposed rule change to establish November 
6, 2002 as the effective date for the following provisions of NASD Rule 
2711: (a) Rules 2711(b) and (c) for members that over the previous 
three years, on average, have participated in 10 or fewer investment 
banking transactions on underwritings as manager or co-manager and 
generated $5 million or less in gross investment banking revenues from 
those transactions; (b) Rule 2711(h)(2) as applied to the receipt of 
compensation by a member's foreign affiliates from a subject company; 
and (c) Rule 2711(g)(3), subject to certain conditions, for those 
research analysts who must divest certain holdings to comply with their 
firm's more restrictive policy that prohibits analyst ownership of 
securities they cover.
    On May 10, 2002, the Commission approved new NASD Rule 2711, which 
governs conflicts of interest when research analysts recommend equity 
securities in research reports and during public appearances.\7\ The 
Commission approved a staggered implementation period for the rule. 
Most provisions of the rule become effective on July 9, 2002, including 
those that restrict supervision and control of research analysts by the 
investment banking department and those that require disclosure of 
investment banking compensation received from a subject company. The 
``gatekeeper'' provisions, described below, become effective September 
9, 2002, and Rule 2711(h)(1)(B)--a requirement to disclose firm 
ownership of subject company securities--becomes effective on November 
6, 2002.
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    \7\ See Securities Exchange Act Release No. 45908 (May 10, 
2002), 67 FR 34968 (May 16, 2002) (``May 10th order'').
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Small Firms and ``Gatekeeper'' Provisions
    Rule 2711 contains provisions that generally restrict the 
relationship between the research and investment banking departments, 
including ``gatekeeper'' provisions that require a legal or compliance 
person to intermediate certain communications between the research and 
investment banking departments. Rule 2711(b)(1) prohibits a research 
analyst from being under the control or supervision of any employee of 
the investment banking department. Rule 2711(b)(2) prohibits employees 
in the investment banking department from reviewing or approving any 
research reports prior to publication. Rule 2711(b)(3) creates an 
exception to (b)(2) to allow investment banking personnel to review a 
research report prior to publication to verify the factual information 
contained therein and to screen for potential conflicts of interest. 
Any permissible written communications must be made through an 
authorized legal or compliance official or copied to such official. 
Oral communications must be made through, or in the presence of, an 
authorized legal or compliance official and must be documented.
    Similarly, Rule 2711(c) restricts communications between a member 
and the subject company of a research report, except that a member may 
submit sections of the research report to the company to verify factual 
accuracy and may notify the subject company of a ratings change after 
the ``close of trading'' on the business day preceding the announcement 
of the ratings change. Submissions to the subject company may not 
include the research summary, the rating or the price target, and a 
complete draft of the report must be provided beforehand to legal or 
compliance personnel. Finally, any change to a rating or price target 
after review by the subject company must first receive written 
authorization from legal or compliance.
    As the Commission noted in its May 10th order, several commenters 
argued that the gatekeeper provisions would impose significant costs, 
especially for smaller firms that would have to hire additional 
personnel. Commenters also noted that personnel often wear multiple 
hats in smaller firms, thereby causing a greater burden to comply with 
the restriction on supervision and control by investment banking 
personnel over research analysts. These comments raised the prospect 
that the rules might force some firms out of business and/or reduce the 
research coverage of smaller companies.
    The NASD is sensitive to the burdens on small firms and, as the 
Commission's May 10th order noted, is reviewing the issue to explore 
possible exemptions or accommodations that can be made while preserving 
the purposes of the rule. To that end, the NASD is proposing to delay 
implementation of Rules 2711(b) and (c) until November 6, 2002 for 
members that over the previous three years, on average, have 
participated in 10 or fewer investment banking transactions on 
underwritings as manager or co-manager and generated $5 million or less 
in gross investment banking revenues from those transactions.
    As a further condition for the delayed implementation date, those 
firms that meet the eligibility requirements outlined above would be 
required to maintain records of communications that would otherwise be 
subject to the gatekeeper provisions of Rules 2711(b) and (c). The NASD 
believes that for these members, provided they comply with the 
conditions described, the burdens of the specific provisions outweigh 
the benefits to the investing public. Moreover, relief from these 
provisions will preserve these firms' roles as sources for capital and 
research for smaller local and regional issuers.\8\
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    \8\ See Amendment No. 1, supra note 3.
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Receipt of Investment Banking Compensation by Foreign Affiliates
    Rule 2711(h)(2)(A)(ii) requires a member to disclose in research 
reports if the member or its affiliates: (a) Managed or co-managed a 
public offering of the subject company's securities in the past 12 
months; (b) received compensation for investment banking services from 
the subject company in the past 12 months; or (c) expects to receive or 
intends to seek compensation for investment banking services from the 
subject company in the next 3 months. The NASD understands that members 
are setting up systems that can readily track the information required 
by this provision of the rule. However, certain members, particularly 
those with global operations and several foreign affiliates, have 
informed the NASD that the scope of their operations make it impossible 
to have systems in place by July 9, 2002, to track all investment 
banking compensation received by their foreign affiliates. For example, 
one firm has informed the NASD that it generates over 300 global 
research products per day and that each of its foreign divisions are 
separately automated. According to

[[Page 46557]]

this firm, mapping revenues from one division to another would require 
manual matching of identification numbers. The firm has undertaken to 
do so with respect to its United States-based affiliates, but has told 
the NASD it requires more time to aggregate compensation from all of 
its foreign affiliates. The NASD further understands that other members 
with global operations have similar challenges.
    The NASD recognizes that the tracking of investment banking 
compensation received from foreign affiliates requires significant 
resources and therefore believes it is appropriate to allow members 
additional time to set up systems to enable compliance with the rule. 
Accordingly, the NASD is proposing to delay the implementation date for 
Rule 2711(h)(2)(A)(ii) until November 6, 2002, only as it relates to 
investment banking compensation received by members' foreign 
affiliates. Members would remain responsible for complying with the 
rule's provisions for investment banking compensation received by the 
member and those affiliates based in the United States. Members who 
delay implementation would have to disclose that their foreign 
affiliates may (a) have managed or co-managed a public offering of the 
subject company's securities in the past 12 months; (b) have received 
compensation for investment banking services from the subject company 
in the past 12 months; or (c) expect to receive or intend to seek 
compensation for investment banking services from the subject company 
in the next 3 months. Members that delay implementation of Rule 
2711(h)(2)(A)(ii) must notify NASD's Corporate Financing Department in 
writing at 9509 Key West Avenue, Rockville, MD 20850.
Trading Against Recommendations
    Rule 2711 contains provisions that restrict personal trading by 
research analysts, but it does not completely prohibit ownership of 
securities that the analyst covers. One such restriction is found in 
Rule 2711(g)(3), which becomes effective on July 9, 2002. That 
provision prohibits a ``research analyst account'' from purchasing or 
selling a security or option or derivative of that security, in a 
manner contrary to the analyst's most recent published recommendation 
reflected in the member's research report. The rule defines ``research 
analyst account'' as any account in which a research analyst or member 
of the research analyst's household has a financial interest, or over 
which the analyst has discretion or control, except for an investment 
company registered under the Investment Company Act of 1940.
    Several members have gone beyond the requirements of the rule and 
instituted internal policies that prohibit research analysts from 
owning securities that they cover. Most of these firms require that 
analysts divest themselves, over a certain period of time, of any 
existing holdings in securities they cover. Consequently, analysts 
could face the predicament of violating Rule 2711(g)(3) to comply with 
their firm's more restrictive policy because they could be required by 
their firm to divest their holdings in a security even as they 
maintained a buy recommendation in that security. Absent some relief 
from the rule, analysts would have to divest all holdings in securities 
they cover by July 9, 2002, or cease coverage in those securities in 
which they held positions.
    To alleviate the described dilemma, and to allow an orderly 
liquidation of holdings, the NASD is proposing to delay implementation 
of Rule 2711(g)(3) until November 6, 2002, only for analysts that meet 
the following conditions: (a) They are employed by a member firm that, 
as of July 9, 2002, has adopted a policy that bans analyst ownership of 
securities they cover and further requires complete divestiture of 
existing holdings in those securities; (b) they abide by a reasonable 
plan of liquidation under which all shares are to be sold by November 
6, 2002 and file that plan with their firm's legal or compliance 
department no later than July 9, 2002; (c) they receive written 
approval of the liquidation plan from their firm's legal or compliance 
department; and (d) they notify NASD's Corporate Financing Department 
of their delayed implementation of the provision in writing at 9509 Key 
West Avenue, Rockville, MD 20850.
2. Statutory Basis
    The NASD believes that the proposed rule change is consistent with 
the provisions of section 15A(b)(6) of the Act,\9\ which requires, 
among other things, that the NASD's rules must be designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, and, in general, to protect investors 
and the public interest. The NASD believes that this proposed rule 
change would reduce or expose conflicts of interest and thereby 
significantly curtail the potential for fraudulent and manipulative 
acts. The NASD further believes that the proposed rule change will 
provide investors with better and more reliable information with which 
to make investment decisions.
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    \9\ 15 U.S.C. 78o-3 (b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The NASD does not believe that the proposed rule change 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 Organization's Statement on Comments on the Proposed 
Rule Change Received from Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    The proposed rule change has been filed by the NASD as a stated 
policy, practice, or interpretation with respect to the meaning, 
administration, or enforcement of an existing rule under Rule 19b-
4(f)(1) under the Act.\10\ Consequently, it has become effective 
pursuant to Section 19(b)(3)(A) of the Act and Rule 19b-4(f)(1) 
thereunder.
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    \10\ 17 CFR 240.19b-4(f)(1).
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    At any time within 60 days of this filing, the Commission may 
summarily abrogate this proposal if it appears to the Commission that 
such action is necessary or appropriate in the public interest, for the 
protection of investors, or otherwise in furtherance of the purposes of 
the Act.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW, Washington, 
DC 20549-0609. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule 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 office of the NASD. All submissions should refer to the file

[[Page 46558]]

number SR-NASD-2002-87 and should be submitted by August 5, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-17682 Filed 7-12-02; 8:45 am]
BILLING CODE 8010-01-P