[Federal Register Volume 68, Number 4 (Tuesday, January 7, 2003)]
[Notices]
[Pages 826-836]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-223]



[[Page 826]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47110; File No. SR-NYSE-2002-49; SR-NASD-2002-154]


Self-Regulatory Organizations: Notice of Filing of Proposed Rule 
Changes by the New York Stock Exchange, Inc. Relating to Exchange Rules 
344 (``Supervisory Analysts''), 345A (``Continuing Education for 
Registered Persons''), 351 (``Reporting Requirements'') and 472 
(``Communications With the Public'') and by the National Association of 
Securities Dealers, Inc. Relating to Research Analyst Conflicts of 
Interest

December 31, 2002.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Exchange Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is 
hereby given that on October 9, 2002, the New York Stock Exchange, Inc. 
(``NYSE'' or the ``Exchange''), and on October 25, 2002, National 
Association of Securities Dealers (``NASD''), filed with the Securities 
and Exchange Commission (``SEC'' or ``Commission'') the proposed rule 
changes as described in Items I, II, and III below, which Items have 
been prepared by the respective self-regulatory organizations 
(``SROs''). On December 4, 2002, NYSE submitted Amendment No. 1 to its 
proposed rule change.\3\ On December 18, 2002, NASD submitted Amendment 
No. 1 to its proposed rule change.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from Darla Stuckey, Corporate Secretary, New York 
Stock Exchange, Inc., to James A. Brigagliano, Assistant Director, 
Division of Market Regulation (``Division''), Commission (December 
4, 2002) (``NYSE Amendment No. 1''). NYSE Amendment No. 1 conformed 
aspects of the proposed NYSE rules to those of NASD (See SR-NASD-
2002-154), and proposed effective dates for the various rule 
provisions.
    \4\ See Letter from Philip Shaikun, Assistant General Counsel, 
NASD, to Katherine A. England, Assistant Director, Division of 
Market Regulation, Commission (December 18, 2002) (``NASD Amendment 
No. 1''). NASD Amendment No. 1 inserted language in proposed Rule 
1050 to clarify that only research analysts who are directly 
responsible for the preparation of research reports (as opposed to 
indirect supervisors or others who are not directly responsible) 
would be required to register with NASD and pass a qualification 
examination. NASD Amendment No. 1 also conformed NASD's proposed 
research analyst compensation provisions to comparable provisions in 
the NYSE's research analyst rule amendments. NASD Amendment No. 1 
also amended the definition of ``research report'' to conform it to 
the requirements of the Sarbanes-Oxley Act of 2002. NASD Amendment 
No. 1 also revised certain language that was contained in the 
discussion of the proposed amendment concerning print media 
interviews and articles.
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    The Commission is publishing this notice to solicit comments on the 
proposed rule changes from interested persons.

I. Self-Regulatory Organizations' Statement of the Terms of Substance 
of the Proposed Rule Changes

    The SROs propose to amend their rules to address research analyst 
conflicts of interest. NYSE filed with the Commission proposed 
amendments to Rule 472 (``Communications with the Public''). The 
proposed amendments expand upon recently approved amendments to Rule 
472 \5\ and will place further restrictions on associated persons' 
(hereinafter referred to as research analysts) preparing research 
reports, compensation and trading activities, as well as additional 
disclosure requirements on research reports issued by members and 
member organizations.
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    \5\ See Securities Exchange Act Release No. 45908 (May 10, 
2002), 67 FR 34968 (May 16, 2002).
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    Proposed amendments to Rule 351 (``Reporting Requirements''), will 
require members and member organizations to document the basis and 
approval of a research analyst's compensation as required by Rule 
472(h)(2) and include it in the annual written attestation that they 
are required to submit to the Exchange.
    Proposed amendments to Rule 344 (``Supervisory Analysts''), will 
require a new registration category and qualification examination for 
research analysts. Proposed amendments to Rule 345A (``Continuing 
Education for Registered Persons''), will include research analysts and 
supervisory analysts as covered persons subject to the Firm Element of 
the Continuing Education Program to address applicable rules, 
regulations, ethics and professional responsibility.
    NASD filed with the Commission proposed amendments to NASD Rules 
1120 and 2711, and a proposed rule change to create a new NASD Rule 
1050, to expand upon recently approved rules that govern research 
analyst conflicts of interest.
    Below is the text of the proposed rule changes. Proposed new 
language is in italics; proposed deletions are in [brackets].

A. NYSE's Proposed Rule Text

Rule 472 Communications With the Public

Approval of Communications and Research Reports
    (a)(1) Each advertisement, market letter, sales literature or other 
similar type of communication which is generally distributed or made 
available by a member or member organization to customers or the public 
must be approved in advance by a member, allied member, supervisory 
analyst, or qualified person designated under the provisions of Rule 
342(b)(1).
    (2) Research reports must be [prepared or] approved, in advance, by 
a supervisory analyst acceptable to the Exchange under the provisions 
of Rule 344. Where a supervisory analyst does not have technical 
expertise in a particular product area, the basic analysis contained in 
such report may be co-approved by a product specialist designated by 
the organization. In the event that the member organization has no 
principal or employee qualified with the Exchange to approve such 
material, it must be approved by a qualified supervisory analyst in 
another member organization by arrangement between the two member 
organizations.
Investment Banking, Research Department and Subject Company 
Relationships and Communications
    (b)(1) Research Department personnel or any associated person(s) 
engaged in the preparation of research reports may not be subject to 
the supervision or control of the Investment Banking Department of the 
member or member organization. Research reports may not be subject to 
review or approval prior to distribution by the Investment Banking 
Department.
    (2) Investment Banking personnel may check research reports prior 
to distribution only to verify the accuracy of information and to 
identify or to review for any potential conflicts of interest that may 
exist, provided that:
    (i) Any such written communication concerning the accuracy of 
research reports between the Investment Banking and Research 
Departments must be made either through the Legal or Compliance 
Department or in a transmission copied to Legal or Compliance; and
    (ii) Any such oral communication concerning the accuracy of 
research reports between the Investment Banking and Research 
Departments must be documented and made either with Legal or Compliance 
personnel acting as intermediary or in a conversation conducted in the 
presence of Legal or Compliance personnel.
    (3) A member or member organization may not submit a research 
report to the subject company prior to distribution, except for the 
review of sections of a draft of the research report solely to verify 
facts. Members and member organizations may not, under any 
circumstances, provide the subject company sections of research reports

[[Page 827]]

that include the research summary, the research rating or the price 
target.
    (i) Prior to submitting any sections of the research report to the 
subject company, the Research Department must provide a complete draft 
of the research report to the Legal or Compliance Department.
    (ii) If after submission to the subject company, the Research 
Department intends to change the proposed rating or price target, the 
Research Department must provide written justification to, and receive 
prior written authorization from, the Legal or Compliance Department 
for any change. The Legal or Compliance Department must retain copies 
of any drafts and changes thereto of the research reports provided to 
the subject company.
    (iii) The member or member organization may not notify a subject 
company that a rating will be changed until after the close of trading 
in the principal market of the subject company one business day prior 
to the announcement of the change.
    (4) No associated person may issue a research report or make a 
public appearance concerning a subject company if the associated person 
engaged in any communication with the subject company in furtherance of 
obtaining investment banking business prior to the time the subject 
company entered into a letter of intent or other written agreement with 
the member or member organization designating the member or member 
organization as an underwriter of an initial public offering by the 
subject company. This provision shall not apply to any due diligence 
communication between the associated person and the subject company, 
the sole purpose of which was to analyze the financial condition and 
business operations of the subject company.
Written Procedures
    (c) Each member and member organization must establish written 
procedures reasonably designed to ensure that members, member 
organizations and their associated persons are in compliance with this 
Rule (see Rule 351(f) and Rule 472(h)(2) for attestations to the 
Exchange regarding compliance).
Retention of Communications
    (d) Communications with the public prepared or issued by a member 
or member organization must be retained in accordance with Rule 440 
(``Books and Records''). The names of the persons who prepared and who 
reviewed and approved the material must be ascertainable from the 
retained records and the records retained must be readily available to 
the Exchange, upon request.
Restrictions on Trading Securities by Associated Persons
    (e)(1) No associated person or member of the associated person's 
household may purchase or receive an issuer's securities prior to its 
initial public offering (e.g., so-called pre-IPO shares), if the issuer 
is principally engaged in the same types of business as companies (or 
in the same industry classification) which the associated person 
usually covers in research reports.
    (2) No associated person or member of the associated person's 
household may trade in any recommended subject company's securities or 
derivatives of such securities for a period of thirty (30) calendar 
days prior to and five (5) calendar days after the member's or member 
organization's issuance of research reports concerning such security or 
a change in rating or price target of a subject company's securities.
    (3) No associated person or member of the associated person's 
household may effect trades contrary to the member's or member 
organization's most current recommendations (i.e., sell securities 
while maintaining a ``buy'' or ``hold'' recommendation, buy securities 
while maintaining a ``sell'' recommendation, or effecting a ``short 
sale'' in a security while maintaining a ``buy'' or ``hold'' 
recommendation on such security).
    (4) The following are exceptions to the prohibitions contained in 
paragraphs (1), (2), and (3):
    (i) Transactions by associated persons and household members that 
have been pre-approved in writing by the Legal or Compliance Department 
that are made due to an unanticipated significant change in their 
personal financial circumstances;
    (ii) A member or member organization may permit the issuance of 
research reports or permit a change to the rating or price target on a 
subject company, regardless of whether an associated person and/or 
household members traded the subject company's securities or 
derivatives of such securities, within the thirty (30) calendar day 
period described in paragraph (e)(2), when the issuance of such 
research reports, or change in such rating or price target is 
attributable to some significant news or events regarding the subject 
company, provided that the issuance of such research reports, or change 
in rating or price target on such subject company has been pre-approved 
in writing by the Legal or Compliance Department;
    (iii) Sale transactions by an associated person and/or household 
member who is new to the member or member organization within thirty 
(30) calendar days of such associated person's employment with the 
member or member organization when such associated person and/or 
household member had previously purchased such security or derivatives 
of such security prior to the associated person's employment with the 
member or member organization;
    (iv) Sale transactions by an associated person and/or household 
member within thirty (30) calendar days from the date of the member's 
or member organization's issuance of research reports or changes to the 
rating or price target on a subject company when such associated person 
and/or household member had previously purchased the subject company's 
securities or derivatives of such securities prior to initiation of 
coverage of the subject company by the associated person;
    (v) Transactions in accounts not controlled by the associated 
person and for investment funds in which an associated person or 
household member participates as a passive investor, provided the 
interest of the associated person or household member in the assets of 
the fund does not exceed 1% of the fund's assets, and the fund does not 
invest more than 20% of its assets in securities of issuers principally 
engaged in the same types of business as companies (or in the same 
industry classification) which the associated person usually covers in 
research reports. If an investment fund distributes securities in kind 
to an associated person before the issuer's initial public offering, 
the associated person must either divest those securities immediately 
or refrain from participating in the preparation of research reports 
concerning that issuer;
    (vi) Transactions in a registered diversified investment company as 
defined under Section 5(b)(1) of the Investment Company Act of 1940.
Restrictions on Member's or Member Organization's Issuance of Research 
Reports and Participation in Public Appearances
    (f)(1) A member or member organization may not issue research 
reports regarding an issuer or recommend an issuer's securities in a 
public appearance, for which the member or member organization acted as 
manager or co-manager of an initial public offering within forty (40) 
calendar days following the effective date of the offering.
    (2) A member or member organization may not issue research reports 
regarding an issuer or recommend an issuer's securities in a public 
appearance, for

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which the member or member organization acted as manager or co-manager 
of a secondary offering within ten (10) calendar days following the 
effective date of the offering. This prohibition shall not apply to 
research reports issued under Securities Act Rule 139 regarding issuers 
whose securities are actively traded, as defined in Securities Exchange 
Act Rule 101(c)(1) of Regulation M.
    (3) A member or member organization may permit exceptions to the 
prohibitions in paragraphs (f)(1) and (2) (consistent with other 
securities laws and rules) for research reports that are issued due to 
significant news or events, provided that such research reports are 
pre-approved in writing by the member's or member's organization's 
Legal or Compliance Department.
    (4) No member or member organization which has acted as a manager 
or co-manager of a securities offering may issue a research report or 
make a public appearance within fifteen (15) days prior to or after the 
expiration, waiver or termination of a lock-up agreement or any other 
agreement that the member or member organization has entered into with 
a subject company and its shareholders that restricts or prohibits the 
sale of the subject company's or its shareholder's securities after the 
completion of a securities offering. A member or member organization 
may permit exceptions to the prohibitions in paragraph (f)(4) 
(consistent with other securities laws and rules) for research reports 
that are issued as a result of the development of significant news or 
events, provided that such research reports are pre-approved in writing 
by the member's or member organization's Legal or Compliance 
Department.
    (5) If a member or member organization withdraws its research 
coverage of a subject company, notice of this withdrawal must be made. 
Such notice must be made in the same manner as when research coverage 
was first initiated by the member or member organization and must 
include the member's or member organization's final recommendation or 
rating.
Prohibition of Offering Favorable Research for Business
    (g) No member or member organization may directly or indirectly 
offer a favorable research rating or specific price target, or offer to 
change a rating or price target, to a subject company as consideration 
or inducement for the receipt of business or for compensation.
Restrictions on Compensation to Associated Persons
    (h)(1) No member or member organization may compensate an 
associated person(s) for specific investment banking services 
transactions. An associated person may not receive an incentive or 
bonus that is based on a specific investment banking services 
transaction. However, a member or member organization is not prohibited 
from compensating an associated person based upon such member's or 
member organization's [person's] overall performance, including 
[services provided to] the performance of the Investment Banking 
Department (see Rule 472(k)(2) for disclosure of such compensation).
    (2) An associated person's compensation must be reviewed and 
approved at least annually by a committee which reports to the Board of 
Directors or where the member or member organization has no Board of 
Directors to a senior executive officer of the member or member 
organization. Such committee may not include representatives from the 
member's or member organization's Investment Banking Department. The 
committee must, among other things, consider the following factors, if 
applicable, when reviewing an associated person's compensation:
    i. The associated person's individual performance, (e.g., 
productivity, and quality of research product);
    ii. The correlation between the associated person's recommendations 
and stock price performance;
    iii. The overall ratings received from clients, sales force, and 
peers independent of the Investment Banking Department, and other 
independent rating services.
    The committee may not consider as a factor in determining the 
associated person's compensation, his or her contributions to the 
member's or member organization's investment banking business.
    The committee must document the basis upon which each associated 
person's compensation was established. The annual attestation required 
by Rule 351(f) must certify that the committee reviewed and approved 
each associated person's compensation and has documented the basis upon 
which such compensation was established.
General Standards for All Communications
(Formerly positioned at Supplementary Material .30)

    (i) No change
Specific Standards for Communications
(Formerly positioned at Supplementary Material .40)

    (j) No change (except for deletion of .40(2)).

Disclosure

(k)(1)Disclosures Required in Research Reports and Public Appearances
Disclosure of Member's, Member Organization's and Associated Person's 
Ownership of Securities
    (i) A member or member organization must disclose in research 
reports and an associated person must disclose in public appearances:
    a. If, as of the last day of the month before the publication or 
appearance (or the end of the second most recent month if the 
publication or appearance is less than ten (10) calendar days after the 
end of the most recent month), the member or member organization or its 
affiliates beneficially own 1% or more of any class of common equity 
securities of the subject company. The member or member organization 
must make the required beneficial ownership computation no later than 
ten (10) calendar days after the end of the prior month. Computation of 
beneficial ownership of securities must be based upon the same 
standards used to compute ownership for purposes of the reporting 
requirements under Section 13(d) of the Securities Exchange Act of 
1934,
    b. If the associated person or a household member has a financial 
interest in the securities of the subject company, and the nature of 
the financial interest, including, without limitation, whether it 
consists of any option, right, warrant, futures contract, long or short 
position, or
    c. Any other actual, material conflict of interest of the member or 
member organization, which the associated person knows, or has reason 
to know, at the time the research report is issued or at the time the 
public appearance is made.
Member, Member Organization and Affiliate Compensation
    (ii) A member or member organization must disclose in research 
reports if the member or member organization or its affiliates: a) Has 
managed or co-managed a public offering of equity securities for the 
subject company in the past twelve (12) months; b) has received 
compensation for investment banking services from the subject company 
in the past twelve (12) months; or c) expects to receive or intends to 
seek compensation for investment banking

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services from the subject company in the next three (3) months.
    When an associated person recommends securities in a public 
appearance, the associated person must disclose if the subject company 
is an investment banking services client of the member, member 
organization, or one of its affiliates; when the associated person 
knows or has reason to know of this relationship.
Disclosure of Associated Person's Affiliations With Subject Company
    (iii) A member or member organization must disclose in research 
reports, and an associated person must disclose in public appearances, 
whether the associated person or member of the associated person's 
household is an officer, director or advisory board member of the 
recommended issuer.
(k)(2) Disclosures Specific to Research Reports
    The front page of a research report either must include the 
disclosures required under this Rule or must refer the reader to the 
page(s) on which each such disclosure is found. Disclosures, and 
references to disclosures, must be clear, comprehensive and prominent.
    A member or member organization must disclose in research reports 
if the associated person preparing such reports received compensation 
that is based upon (among other factors) the member's or member 
organization's overall investment banking revenues.
    A member or member organization must disclose in research reports 
that recommend securities:
    (i) If it is making a market in the subject company's securities at 
the time the research report is issued.
    (i) The valuation methods used, and any price objectives must have 
a reasonable basis and include a discussion of risks.
    (iii) The meanings of all ratings used by the member or member 
organization in its ratings system. (For example, a member or member 
organization might disclose that a ``strong buy'' rating means that the 
rated security's price is expected to appreciate at least 10% faster 
than other securities in its sector over the next 12-month period). 
Definitions of ratings terms also must be consistent with their plain 
meaning. Therefore, for example, a ``hold'' rating should not mean or 
imply that an investor should sell a security.
    (iv) The percentage of all securities that the member or member 
organization recommends an investor ``buy,'' ``hold,'' or ``sell.'' 
Within each of the three categories, a member or member organization 
must also disclose the percentage of subject companies that are 
investment banking services clients of the member or member 
organization within the previous twelve (12) months. (See Rule 472.70 
for further information.).
    (v) A chart that depicts the price of the subject company's stock 
over time and indicates points at which a member or member organization 
assigned or changed a rating or price target. This provision would 
apply only to securities that have been assigned a rating for at least 
one year, and need not extend more than three years prior to the date 
of the research report. The information in the price chart must be 
current as of the end of the most recent calendar quarter (or the 
second most recent calendar quarter if the publication date is less 
than fifteen (15) calendar days after the most recent calendar 
quarter).
    When a member or member organization distributes a research report 
covering six (6) or more subject companies for purposes of the 
disclosures required in paragraph (k) of this Rule, such research 
report may direct the reader in a clear and prominent manner as to 
where they may obtain applicable current disclosures in written or 
electronic format.

Other Communications Activities

    (l) Other communications activities are deemed to include, but are 
not limited to, conducting interviews with the media, writing books, 
conducting seminars or lecture courses, writing newspaper or magazine 
articles or making radio/TV appearances.
    Members and member organizations must establish specific written 
supervisory procedures applicable to members, allied members and 
employees who engage in these types of communications activities. These 
procedures must include provisions that require prior approval of such 
activity by a person designated under the provisions of Rule 342(b)(1). 
These types of activities are subject to the general standards set 
forth in paragraph (i). In addition, any activity which includes 
discussion of specific securities and/or industries is subject to the 
specific standards in paragraph (j) and the disclosure requirements of 
paragraphs (k)(1) and (k)(2)(i).
.10 Definitions
    (1) Communication--The term ``Communication'' is deemed to include, 
but is not limited to, advertisements, market letters, research 
reports, sales literature, electronic communications, communications in 
and with the press and wires and memoranda to branch offices or 
correspondent firms which are shown or distributed to customers or the 
public.
    (2) Research Report--``Research report'' is generally defined as a 
written or electronic communication which includes an analysis of 
equity securities of individual companies or industries, and provides 
information reasonably sufficient upon which to base an investment 
decision. [and includes a recommendation].
    For purposes of approval by a supervisory analyst pursuant to Rule 
472(a)(2), research report includes, but is not limited to, reports 
which recommend equity securities, derivatives of such securities, 
including options, debt and other types of fixed income securities, 
single stock futures products, and other investment vehicles subject to 
market risk.
    (3) Advertisement--``Advertisement'' is defined to include, but is 
not limited to, any sales communications that is published, or designed 
for use in any print, electronic or other public media such as 
newspapers, periodicals, magazines, radio, television, telephone 
recording, web sites, motion pictures, audio or video device, 
telecommunications device, billboards or signs.
    (4) Market letters--``Market letters'' are defined as, but are not 
limited to, any written comments on market conditions, individual 
securities, or other investment vehicles that are not defined as 
research reports. They also may include ``follow-ups'' to research 
reports and articles prepared by members or member organizations which 
appear in newspapers and periodicals.
    (5) Sales literature--``Sales literature'' is defined as, but is 
not limited to, written or electronic communications including, but not 
limited to, telemarketing scripts, performance reports or summaries, 
form letters, seminar texts, and press releases discussing or promoting 
the products, services and facilities offered by a member or member 
organization, the role of investment in an individual's overall 
financial plan, or other material calling attention to any other 
communication.
    .20 For purposes of this Rule, ``investment banking services'' 
includes, without limitation, acting as an underwriter in an offering 
for the issuer; acting as a financial adviser in a merger or 
acquisition; providing venture capital, equity lines of credit, PIPEs 
(private investment, public equity transaction), or similar 
investments; or serving as placement agent for the issuer.

[[Page 830]]

    .30 For purposes of this Rule, the term ``Investment Banking 
Department'' means any department or division of the member or member 
organization, whether or not identified as such, that performs any 
investment banking services on behalf of the member or member 
organization.
    .40 For purposes of this Rule, the term ``associated person'' 
includes a member, allied member, or employee of a member or member 
organization responsible for, and any person who reports directly or 
indirectly to such associated person in connection with, the 
preparation of [making of the recommendation to purchase, sell or hold 
an equity security in] research reports, or making recommendations or 
offering opinions in public appearances or establishing a rating or 
price target of a subject company's equity securities. For purposes of 
this Rule, the term ``household member'' means any individual whose 
principal residence is the same as the associated person's principal 
residence. Paragraphs (e)(1), (2), (3); (4)(i), (ii), (iii), (iv) and 
(v); (k)(1)(i)b., (k)(1)(iii) apply to any account in which an 
associated person has a financial interest, or over which the 
associated person exercises discretion or control, other than an 
investment company registered under the Investment Company Act of 1940.
    This term ``associated person'' also includes such ``other 
persons,'' e.g., Director of Research, Supervisory Analyst, or member 
of a committee, who have direct influence and/or control with respect 
to (1) preparing research reports, or (2) establishing or changing a 
rating or price target of a subject company's equity securities. Such 
other persons are subject to the provisions of paragraph (e)(1)--(4) of 
this Rule.
    .50 For purposes of this Rule, the term ``public appearance'' 
includes, without limitation, participation in a seminar, forum 
(including an interactive electronic forum), radio, [or] television or 
print media interview, or other public appearance or public speaking 
activity, or the writing of a newspaper article or other type of public 
written medium in which an associated person makes a recommendation or 
offers an opinion concerning any equity securities and/or industries.
    .60 For purposes of this Rule, ``subject company'' is the company 
whose equity securities are the subject of research reports.
    .70 For purposes of Rule 472(k)(2)(iv), a member or member 
organization must determine, based on its own ratings system, into 
which of the three categories each of their securities ratings utilized 
falls. This information must be current as of the end of the most 
recent calendar quarter (or the second most recent calendar quarter if 
the publication date is less than fifteen (15) calendar days after the 
most recent calendar quarter). For example, a research report might 
disclose that the member or member organization has assigned a ``buy'' 
rating to 58% of the securities that it follows, a ``hold'' rating to 
15%, and a ``sell'' rating to 27%.
    Rule 472(k)(2)(iv) requires members or member organizations to 
disclose the percentage of companies that are investment banking 
services clients for each of the three ratings categories within the 
previous twelve (12) months. For example, if 20 of the 25 companies to 
which a member or member organization has assigned a ``buy'' rating are 
investment banking clients of the member or member organization, the 
member or member organization would have to disclose that 80% of the 
companies that received a ``buy'' rating are its investment banking 
clients. Such disclosure must be made for the ``buy,'' ``hold'' and 
``sell'' ratings categories as appropriate.
    .80 For purposes of this Rule, the term ``Legal or Compliance 
Department'' also includes, but is not limited to, any department of 
the member or member organization which performs a similar function.
    .90 For purposes of Rule 472(a), a qualified person is one who has 
passed an examination acceptable to the Exchange.
    .100 For purposes of this Rule, the term ``initial public 
offering'' refers to the initial registered equity security offering by 
an issuer, regardless of whether such issuer is subject to the 
reporting requirements of Section 13 or 15(d) of the Securities 
Exchange Act of 1934, prior to the time of the filing of such issuer's 
registration statement.
    .110 For purposes of this Rule, a secondary offering shall include 
a registered follow-on offering by an issuer or a registered offering 
by persons other than the issuer involving the distribution of 
securities subject to Regulation M of the Securities Exchange Act of 
1934.

Reporting Requirements

Rule 351
    (a)-(e) No change.
    (f) Each member and member organization that prepares, issues or 
distributes [communications to the public, (including but not limited 
to,] research reports and whose associated persons make public 
appearances [, media presentations and interviews]), is required to 
submit to the Exchange annually, a letter of attestation signed by a 
senior officer or partner that the member or member organization has 
established and implemented procedures reasonably designed to comply 
with the provisions of Rule 472. The attestation must also specifically 
certify that each associated person's compensation was reviewed and 
approved in accordance with the requirements of Rule 472(h)(2) and that 
the basis for such approval has been documented.
* * * * *
    .11 For purposes of Rule 351(f), the attestation must be submitted 
by April 1 of each year.
    .12 The term ``research report'' is defined in Rule 472.10 and the 
term ``public appearance'' is defined in Rule 472.50.
Securities Analysts and Supervisory Analysts
    Rule 344. Securities analysts and supervisory analysts must be 
registered with, qualified by, and approved by the Exchange.
    [Supervisory analysts required under Rule 472 shall be acceptable 
to, and approved by, the Exchange.]
    .10 For purposes of this Rule, the term ``securities analyst'' 
includes a member, allied member or employee who is directly 
responsible for the preparation of research reports. Securities analyst 
candidates must pass a qualification examination acceptable to the 
Exchange.
    .11 [.10] For purposes of this rule, the term ``supervisory 
analyst'' includes a member, allied member or employee who is 
responsible for approving research reports under Rule 472(a)(2). In 
order to show evidence of acceptability to the Exchange as a 
supervisory analyst, a member, allied member or employee may do one of 
the following:
    (1) Present evidence of appropriate experience and pass an Exchange 
Supervisory Analysts Examination.
    (2) Present evidence of appropriate experience and successful 
completion of a specified level of the Chartered Financial Analysts 
Examination prescribed by the Exchange and pass only that portion of 
the Exchange Supervisory Analysts Examination dealing with Exchange 
rules on research standards and related matters.
    [In addition, if not a member, allied member or registered 
representative, the candidate is subject to Exchange investigation of 
character and conduct and should submit personal information on Form U-
4 for this purpose.]
    The Exchange publishes a Study Outline for the Securities Analyst 
Examination and the Supervisory

[[Page 831]]

Analysts Examination. [Examinations are requested and given under the 
procedures described in Para. of 2345.15 for registered representative 
examinations.]

Continuing Education for Registered Persons

    Rule 345A.(a) Regulatory Element--No change.
(b) Firm Element
    (1) Persons Subject to the Firm Element--The requirements of 
Section (b) of this Rule shall apply to any registered person who has 
direct contact with customers in the conduct of the member's or member 
organization's securities sales, trading or investment banking 
activities, and to the immediate supervisors of such persons, and to 
registered persons who function as supervisory analysts, and securities 
analysts as defined in Rule 344 (collectively, ``covered registered 
persons'').
    (2) Standards--No Change.
    (3) Participation in the Firm Element--No Change.
    (4) Specific Training Requirements--The Exchange may require a 
member or member organization, either individually or as part of a 
larger group, to provide specific training to its covered registered 
persons in such areas the Exchange deems appropriate. Such a 
requirement may stipulate the class of covered registered persons for 
which it is applicable, the time period in which the requirement must 
be satisfied and, where appropriate, the actual training content.
    .10 For purposes of this Rule, the term ``registered person'' means 
any member, allied member, registered representative or other person 
registered or required to be registered under Exchange rules, but does 
not include any such person whose activities are limited solely to the 
transaction of business on the Floor with members or registered broker-
dealers. For purposes of the Regulatory Element required under Rule 
345A(a), the term does not include persons registered as securities 
analysts or supervisory analysts pursuant to Rule 344.
    .20-.40 No Change.
    .50 Pursuant to Rule 345A(b)(1), all persons registered as 
securities analysts and supervisory analysts pursuant to Rule 344 must 
participate in a Firm Element Continuing Education program that 
includes training in applicable rules and regulations, ethics and 
professional responsibility.
* * * * *
    The Exchange is requesting the following implementation schedule 
for the proposed amendments (all time periods are from the date that 
the Commission approves the filing) in order to provide reasonable time 
periods for members and member organizations to develop and implement 
policies, procedures and systems to comply with the new requirements:
    [sbull] NYSE Rule 345A(b) and .50--Implementation of a Firm Element 
Continuing Education Program for Research Analysts--90 calendar days.
    [sbull] All other provisions--60 calendar days.
    In addition, the Exchange is proposing an effective date of 180 
days after approval of the amendments to NYSE Rule 344.10 to provide 
sufficient time for the Exchange to develop and implement a 
qualification examination for research analysts.
B. NASD's Proposed Rule Text

Rule 1050. Registration of Research Analysts

    All persons associated with a member who are to function as 
research analysts shall be registered with NASD. Before their 
registrations can become effective, they shall pass a Qualification 
Examination for Research Analysts as specified by the Board of 
Governors. For the purposes of this Rule 1050, ``research analyst'' 
shall mean an associated person who is directly responsible for the 
preparation of research reports.
* * * * *
Rule 1120. Continuing Education Requirements
    This Rule prescribes requirements regarding the continuing 
education of certain registered persons subsequent to their initial 
qualification and registration with the Association. The requirements 
shall consist of a Regulatory Element and a Firm Element as set forth 
below.
(a) Regulatory Element
    (1)-(4) (No change.)
(5) Definition of Registered Person
    For purposes of this Rule, the term ``registered person'' means any 
person registered with [the Association] NASD as a representative, 
principal, [or] assistant representative or research analyst pursuant 
to Rule 1020, 1030, 1040, 1050 and 1110 Series.
    (6) (No change.)
(b) Firm Element
(1) Persons Subject to the Firm Element
    The requirements of this subparagraph shall apply to any person 
registered with the member who has direct contact with customers in the 
conduct of the member's securities sales, trading and investment 
banking activities, and to the immediate supervisors of such persons, 
and to any person registered as a research analyst pursuant to Rule 
1050 (collectively, ``covered registered persons''). ``Customer'' shall 
mean any natural person and any organization, other than another broker 
or dealer, executing securities transactions with or through or 
receiving investment banking services from a member.
(2) Standards for the Firm Element
    (A) (No change.)
    (B) Minimum Standards for Training Programs--Programs used to 
implement a member's training plan must be appropriate for the business 
of the member and, at a minimum must cover the following matters 
concerning securities products, services, and strategies offered by the 
member:
    (i) General investment features and associated risk factors;
    (ii) Suitability and sales practice considerations; [and]
    (iii) Applicable regulatory requirements[.]; and
    (iv) With respect to registered research analysts, training in 
ethics, professional responsibility and the requirements of Rule 2711.
    (3)-(4) (No change.)
* * * * *
Rule 2711. Research Analysts and Research Reports
(a) Definitions
    For purposes of this rule, the following terms shall be defined as 
provided.
    (1)-(3) (No change.)
    (4) ``Public appearance'' means any participation in a seminar, 
forum (including an interactive electronic forum), radio, [or] 
television or print media interview, or other public speaking activity, 
or the writing of a print media article, in which a research analyst 
makes a recommendation or offers an opinion concerning an equity 
security.
    (5) ``Research analyst'' means the associated person who is 
principally responsible for, and any associated person who reports 
directly or indirectly to such a research analyst in connection with, 
preparation of the substance of a research report, whether or not any 
such person has the job title of ``research analyst.'' Solely for 
purposes of paragraph (g), the term ``research analyst'' also includes 
such other persons as the director of research, supervisory analyst, or

[[Page 832]]

member of a committee who have direct influence or control with respect 
to (A) the preparation of research reports, or (B) establishing or 
changing a rating or price target of a subject company's equity 
securities.
    (6)-(7) (No change.)
    (8) ``Research report'' means a written or electronic communication 
which includes an analysis of equity securities or individual companies 
or industries, and which provides information reasonably sufficient 
upon which to base an investment decision [and includes a 
recommendation].
    (9) (No change.)
    (b) (No change.)
(c) Restrictions on Review of a Research Report by the Subject Company
    (1)-(3) (No change.)
    (4) No research analyst may issue a research report or make a 
public appearance concerning a subject company if the research analyst 
engaged in any communication with the subject company in furtherance of 
obtaining investment banking business prior to the time the subject 
company entered into a letter of intent or other written agreement with 
the member designating the member as an underwriter of an initial 
public offering by the subject company. This provision shall not apply 
to any due diligence communication between the research analyst and the 
subject company, the sole purpose of which was to analyze the financial 
condition and business operations of the subject company.
(d) [Prohibition of Certain Forms of] Restrictions on Research Analyst 
Compensation
    (1) No member may pay any bonus, salary or other form of 
compensation to a research analyst that is based upon a specific 
investment banking services transaction.
    (2) A research analyst's compensation must be reviewed and approved 
at least annually by a committee that reports to the member's board of 
directors, or when the member has no board of directors, to a senior 
executive officer of the member. This committee may not have 
representation from the member's investment banking department. The 
committee must consider the following factors when reviewing a research 
analyst's compensation, if applicable:
    (A) the research analyst's individual performance, including the 
analyst's productivity and the quality of the analyst's research;
    (B) the correlation between the research analyst's recommendations 
and the stock price performance; and
    (C) the overall ratings received from clients, sales force, and 
peers independent of the member's investment banking department, and 
other independent ratings services.

The committee may not consider as a factor in determining the research 
analyst's compensation his or her contributions to the member's 
investment banking business. The committee must document the basis upon 
which each research analyst's compensation was established. The annual 
attestation required by Rule 2711(i) must certify that the committee 
reviewed and approved each research analyst's compensation and 
documented the basis upon which this compensation was established.
    (e) (No change.)
(f) [Imposition of Quiet Periods] Restrictions on Publishing Research 
Reports and Public Appearances; Termination of Coverage
    (1) No member may publish a research report regarding a subject 
company or recommend a subject company's securities in a public 
appearance for which the member acted as manager or co-manager of:
    [(1)](A) an initial public offering, for 40 calendar days following 
the date of the offering; or
    [(2)](B) a secondary offering, for 10 calendar days following the 
date of the offering; provided that:
    [(A)](i) paragraphs (f)(1)(A) and (f)[(2)](1)(B) will not prevent a 
member from publishing a research report concerning the effects of 
significant news or a significant event on the subject company within 
such 40- and 10-day periods, and provided further that the legal and 
compliance department authorizes publication of that research report 
before it is issued; and
    [(B)](ii) paragraph (f)[(2)](1)(B) will not prevent a member from 
publishing a research report pursuant to SEC Rule 139 regarding a 
subject company with ``actively-traded securities,'' as defined in 
Regulation M, 17 CFR 242.101(c)(1).
    (3) No member that has acted as a manager or co-manager of a 
securities offering may publish a research report or make a public 
appearance concerning a subject company 15 days prior to and after the 
expiration, waiver or termination of a lock-up agreement or any other 
agreement that the member has entered into with a subject company or 
its shareholders that restricts or prohibits the sale of securities 
held by the subject company or its shareholders after the completion of 
a securities offering. This paragraph will not prevent a member from 
publishing a research report concerning the effects of significant news 
or a significant event on the subject company within such period, 
provided that the legal and compliance department authorized 
publication of that research report before it is issued.
    (4) If a member intends to discontinue its research coverage of a 
subject company, notice of this withdrawal must be made in the same 
manner as when research coverage was first initiated by the member and 
must include the member's final recommendation or rating.
    (g)-(i) (No change.)

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

    In their filings with the Commission, the NYSE and NASD included 
statements concerning the purpose of and basis for the proposed rule 
changes. The text of these statements may be examined at the places 
specified in Item IV below. The NYSE and NASD have prepared summaries, 
set forth in Sections A, B, and C below.

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

1. NYSE's Purpose
Background
    NYSE believes that allegations regarding improprieties in 
solicitation of investment banking business impugn the objectivity and 
integrity of research analysts and the reports they prepare and have 
continued to undermine investor confidence in the equity markets. 
According to the NYSE, in discharging their duties as SROs, the NYSE 
and NASD have been proactive in this regard and have passed sweeping 
changes, described below, to their rules governing research analysts, 
their member organizations and their communications with the public. 
The proposed amendments described below are a continuation of this 
process to restore integrity to the public equity markets.
Prior Amendments
    On May 10, 2002, the SEC approved amendments to Exchange Rules 472 
and 351 which significantly changed the manner in which members and 
member organizations, their investment-banking departments and their 
research analysts manage and disclose conflicts of interest between 
their investment banking and research activities. The SEC also

[[Page 833]]

simultaneously approved comparable changes to NASD rules (new NASD Rule 
2711--``Research Analysts and Research Reports''). NYSE believes that 
these rule amendments are the result of the SROs working to develop 
uniform industry rules.
    The rule amendments generally restrict the relationship between 
research and investment banking departments and the companies that are 
the subject of research reports; require disclosure of a financial 
interest in a subject company by an analyst or a member or member 
organization; require disclosure of existing and potential investment 
banking relationships with a subject company; impose quiet periods for 
the issuance of research reports following the completion of a 
company's securities offering; restrict personal trading by research 
analysts in the stock of the companies covered by such analysts; and 
generally require extensive disclosure in research reports of certain 
important information to help customers monitor the correlation between 
an analyst's rating and the stock's price movements.
    The rule amendments have been phased-in incrementally to provide 
members and member organizations time to develop and implement 
policies, procedures and systems and hire additional personnel to 
comply with the new requirements. The staggered implementation of the 
Rules began July 9, 2002, with September 9, 2002 and November 6, 2002 
as the effective dates for certain specified provisions. Implementation 
dates for certain of the SRO rules have also been delayed for small 
firms. As a result of numerous interpretive requests, on June 26, 2002, 
the Exchange and the NASD issued a Joint Memo providing interpretive 
guidance to certain rule provisions.\6\
---------------------------------------------------------------------------

    \6\ NYSE Information Memo No. 02-26 (June 26, 2002), and NASD 
Notice to Members 02-39 (July 2002).
---------------------------------------------------------------------------

    According to NYSE, the Exchange, together with other regulatory 
organizations and SROs, is currently examining members' and member 
organizations' research practices to determine compliance with the new 
SRO Rules.
    According to the NYSE, some of the interpretive issues raised by 
the industry and the preliminary findings from the recent examinations 
have highlighted the need for certain additional changes to the 
existing SRO Rules. NYSE believes that further amendments to the SRO 
rules will also be required to comply with the mandate of the Sarbanes-
Oxley Act of 2002 (``SOA''), which requires the SEC, either directly or 
indirectly through SROs, to adopt not later than one year after the 
date of enactment of the Act (July 24, 2002), ``rules reasonably 
designed to address conflicts of interest that can arise when 
securities analysts recommend equity securities in research reports and 
public appearances, in order to improve the objectivity of research and 
provide investors with more useful and reliable information.''
    According to the NYSE, certain of the disclosure requirements and 
prohibitions that the SOA mandates have already been adopted in the new 
NYSE Rules. In some cases, the SOA appears to impose more stringent 
requirements. The NYSE is currently analyzing the differences between 
the SOA and NYSE Rules, to determine the extent of additional 
amendments to be made.

Proposed Amendments Regarding Research Analysts

    The following proposed amendments to Exchange rules governing 
communications with the public expand upon the recently approved rule 
changes. The amendments generally provide for further restrictions on 
research analysts' compensation and trading activities, and impose 
additional disclosure requirements for research reports and associated 
persons.
    Proposed amendments to Rule 472 would further separate an analyst's 
compensation from investment banking influence by requiring procedures 
for review and approval of research analysts' compensation by a 
Committee that reports to the Board of Directors or a senior executive. 
Recently approved amendments prohibit an associated person from being 
compensated for specific investment services transactions.
    Such a Committee, at a minimum, would consider the following 
factors: the associated person's individual performance (e.g., quality 
of research product), correlation between a research analyst's 
recommendations and stock prices, and overall ratings from various 
internal or external parties exclusive of member or member organization 
investment banking personnel.
    Further, in determining an individual research analyst's 
compensation, the Committee may not consider his or her contribution to 
the firm's overall investment banking business. The basis for a 
research analyst's compensation would have to be documented and an 
annual attestation to the Exchange would certify that the Committee 
reviewed and approved each associated person's compensation and 
documented the basis for such approval (Rule 472(h)(1) and (2)).
    Proposed Rule 472(b)(4) will prohibit a research analyst from 
issuing a research report or making a public appearance concerning a 
subject company if the research analyst engaged in any communication 
with the subject company in furtherance of obtaining investment banking 
business prior to the time the subject company entered into a letter of 
intent or other written agreement with the member or member 
organization designating the member or member rganization as an 
underwriter of an initial public offering by the subject company.\7\ 
Prohibiting research analysts from issuing research reports or making 
public appearances after participating in ``pitch'' meetings is 
intended to prevent the use or promise of research as an influence or a 
sales and marketing tool with prospective investment banking clients of 
the member or member organization, and would cause subject companies to 
choose a prospective investment banking firm based on the merits of its 
underwriting capabilities, rather than its research coverage.\8\
---------------------------------------------------------------------------

    \7\ Telephone conversation between NYSE and Division Staff on 
December 30, 2002.
    \8\ Telephone conversation between NYSE and Division Staff on 
December 30, 2002.
---------------------------------------------------------------------------

    Due diligence communications between the research analyst and the 
subject company, the sole purpose of which is to analyze the financial 
condition and business operations of the subject company, is not 
subject to the prohibition. Recognizing the need for critical financial 
analysis of a subject company during the period an issuer is preparing 
to engage in a securities offering with the public, the rule allows 
research analysts to participate in due diligence communications. In 
doing so, the rule is intended to segregate legitimate research analyst 
duties/functions, traditionally associated with their profession, from 
the sales/marketing duties that they may have been called upon recently 
to do by their firms.
    Proposed amendments to Rule 472 would prohibit the issuance of 
research reports by the manager or co-manager of a securities offering 
for fifteen (15) days prior to and after the expiration time of any 
``lock-up agreement'' (Rule 472(f)(4)). This provision is intended to 
address situations where research analysts may issue positive research 
reports or reiterated ``buy'' recommendations shortly before or just 
after the expiration of a lock-up agreement. Through issuance or 
reiteration of ``buy'' recommendations,

[[Page 834]]

shareholders of the subject company which were precluded from selling 
shares in the immediate aftermarket for specified periods of time, may 
be able to sell their shares at higher prices. Imposition of this 
fifteen (15) day blackout period around the expirations of lockups is 
intended to mitigate and/or eliminate the incentive for a research 
analyst to issue positive research reports, and should permit real 
market forces to determine the price at which such securities can be 
sold after the expiration of such agreements.
    Proposed amendments to Rule 472 would require notification to 
customers when a member or member organization terminates research 
coverage of a subject company and require that the final report include 
a final recommendation or rating \9\ (assuming the member or member 
organization had issued a prior rating or recommendation) \10\ (Rule 
472(f)(5)). This provision is intended to address situations where 
research analysts have discontinued following subject companies without 
changing their ratings of such companies, even though ratings changes, 
may have in many instances, been warranted. Thus, investors held the 
securities of such companies, often while these companies were 
deteriorating financially, without the benefit of guidance from the 
firms from which they had purchased them. The recently approved 
amendments to Rule 472 also address this issue, in part, by requiring 
the disclosure of a price chart versus changes in ratings in order to 
help investors track the correlation between a research analyst's 
rating/recommendation and the stock's price performance. NYSE believes 
that the proposed amendments would enhance this required disclosure by 
providing investors with notice of termination of coverage as well as 
any final rating the member or member organization has issued on the 
subject company.
---------------------------------------------------------------------------

    \9\ The Exchange requested that Commission Staff delete the 
reference to a final recommendation or rating ``if any'' in order to 
conform to changes made by NYSE Amendment No. 1.
    \10\ Telephone conversation between NYSE and Division Staff on 
December 30, 2002.
---------------------------------------------------------------------------

    As proposed, the definition of research analyst (associated person) 
would be amended to include research directors, supervisory analysts 
and others e.g., committee members, who have direct influence, or 
control the preparation of research reports and establishment or change 
in ratings or price targets and thereby subject them to the trading and 
ownership prohibitions of the Rule (Rule 472.40) as research analysts.
    As proposed, the current ten (10) and forty (40) day quiet periods 
for research analysts' issuance of research reports by managers and co-
managers of initial and secondary offerings would be extended to 
include public appearances (Rule 472(f)(1) and (2)). Extending the 
quiet periods to public appearances would preclude members and member 
organizations from engaging in communications through public 
appearances that they are otherwise prohibited from making in written 
communications to the same standards. NYSE believes that subjecting all 
types of appearances and written communications should further remove 
any incentives for biased research recommendations in any potential 
type of medium.
    The definition of ``public appearance'' would be amended to include 
research analysts'' making a recommendation in a newspaper article or 
similar public medium (Rule 472.50). Extending the definition of public 
appearance to recommendations in a newspaper article would require 
research analysts to make the same disclosures that they are required 
to make in other public appearances.\11\
---------------------------------------------------------------------------

    \11\ The Exchange requested that Commission Staff delete the 
reference to ``research reports.'' Telephone conversation between 
NYSE and Division Staff on December 30, 2002.
---------------------------------------------------------------------------

    Proposed amendments to Rule 344 (``Supervisory Analysts'') would 
establish a new registration category and require a qualification 
examination for research analysts (Rule 344). In addition, Rule 345A 
(``Continuing Education for Registered Persons'') would be amended to 
include research analysts and supervisory analysts as covered persons 
subject to the Firm Element of the Continuing Education Program to 
address applicable rules and regulations, ethics, and professional 
responsibility (Rule 345A(b) and .50).
    NYSE believes that research analysts as securities professionals 
perform vital functions for their members or member organizations in 
the public equity markets. As such, they should be subject to the 
highest ethical and professional competency standards. Accordingly, 
NYSE believes that establishing a new registration category with a 
corresponding qualifying examination will raise such standards. 
Further, including research and supervisory analysts as covered persons 
in the Firm Element component of Continuing Education Programs would 
place an obligation on members and member organizations to ensure that 
they are receiving the requisite ethics and professional responsibility 
training that NYSE believes they will require to properly conduct their 
duties as research analysts.
    The Exchange is making certain clarifying amendments to Rule 472 
that would make it more uniform with the NASD rule and would bring it 
into conformity with certain of the new requirements of the Act.
    Rule 472 is being amended to require that the nature of a research 
analyst's financial interest in a subject company's securities be 
disclosed in research reports and public appearances, including whether 
the interest consists of any option, right, warrant, futures contract, 
or long or short position, etc. This would make NASD and NYSE rule 
texts consistent with each other (Rule 472(k)(1)(i)(b).
    Proposed amendments to Rule 472(l) with respect to specified 
communications activities, including, interviews with the media, 
writing books and newspaper/periodical articles etc., engaged in by 
members, allied members or employees, would clarify the approval and 
supervisory requirements for such activities.
    As proposed, the term ``research report'' as it is currently 
defined in the Rule 472 is being amended to conform to the Act's 
definition by deleting the criterion of providing a recommendation from 
the criteria that determines what constitutes a research report (Rule 
472.10(2)). NYSE believes conforming the definition to the one required 
by the SOA would help facilitate members' and member organizations' 
future compliance with the SOA in the least disruptive manner.
2. NYSE's Statutory Basis
    The NYSE believes that the proposed rule change is consistent with 
Section 6(b)(5) of the Exchange Act \12\ which requires, among other 
things, that the rules of the Exchange are designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade and in general to protect investors and 
the public interests.
---------------------------------------------------------------------------

    \12\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

3. NASD's Purpose
Background
    In May 2002, the SEC approved new NASD Rule 2711 and similar 
amendments to existing New York Stock Exchange (``NYSE'') rules that 
increased the regulation of research analysts and research reports.\13\ 
The new rules are intended to improve the objectivity of

[[Page 835]]

research and provide investors with more useful and reliable 
information when making investment decisions. Most of the new rules' 
provisions became effective on July 9, 2002, although some provisions 
took effect on September 9, 2002, and one provision took effect on 
November 6, 2002. Additionally, in July 2002, the SEC approved an NASD 
rule proposal to delay until November 6, 2002 the effectiveness of 
certain provisions for certain members with foreign affiliates, certain 
research analysts that are divesting the securities of all subject 
companies that they cover, and certain defined small firms.\14\
---------------------------------------------------------------------------

    \13\ Supra note 5,m See also Securities Exchange Act Release No. 
46402 (June 6, 2002), 67 FR 40361 (June 12, 2002)(correcting 
language contained in rule 2711(h)).
    \14\ See Securities Exchange Act Release No. 46165 (July 3, 
2002), 67 FR 46555 (July 15, 2002).
---------------------------------------------------------------------------

    In June 2002, NASD and the NYSE issued a joint memorandum that 
provided members with the new rule language, as well as interpretive 
guidance on a number of Rule 2711's provisions.\15\ NASD and the NYSE 
also have been examining members' research practices to determine 
compliance with the new research analyst rules.
---------------------------------------------------------------------------

    \15\ See Notice to Members 02-39 (July 2002).
---------------------------------------------------------------------------

    According to NASD, as a result of the examinations and further 
discussions with the SEC staff, NASD and NYSE agreed that additional 
rules governing members' research activities are necessary to protect 
investors. This rule change proposal would effectuate those additional 
safeguards. Generally, the proposed amendments would further separate 
analyst compensation from investment banking influence, prohibit 
analysts from issuing ``booster shot'' research reports, prohibit 
analysts from participating in ``bake-off'' meetings with prospective 
investment banking clients, require members to publish a final research 
report when they terminate coverage of a subject company, impose 
registration, qualification and continuing education requirements on 
research analysts, and make certain other changes.
    NASD believes that these amendments do not implement all of the 
changes that may be required pursuant to the research analyst 
provisions of the SOA. NASD anticipates filing additional proposed 
amendments to Rule 2711 in the future to meet the requirements of SOA 
after further discussions with NYSE and SEC staff.
    A more detailed discussion of the proposed rule change follows.
1. Analyst Compensation
    The proposed amendments would require members to further separate 
analyst compensation from investment banking influence by imposing new 
restrictions on the manner in which research analysts may be 
compensated. The rule proposal would require members to employ a 
compensation committee that reports to the member's board of directors 
(or if the member does not have a board of directors, a senior 
executive officer of the member) responsible for reviewing and 
approving analyst compensation at least annually. The committee could 
not have representation from the member's investment banking 
department. In determining an analyst's compensation, the committee 
would have to consider, if applicable, the research analyst's 
individual performance, including the analyst's productivity and 
research quality, the correlation between the analyst's recommendations 
and stock price performance, and overall ratings of clients, sales 
force, and peers independent of the member's investment banking 
department. The committee could not consider the analyst's 
contributions to the member's investment banking business.
    The committee would be required to document the basis for 
establishing the analyst's compensation. The member also would have to 
attest annually to NASD that the committee reviewed and approved each 
analyst's compensation and documented the basis upon which the 
compensation was established.
2. Restrictions on Publishing Research Reports and Public Appearances
    The proposed amendments would make several changes to current Rule 
2711(f), which imposes ``quiet periods'' on members during which 
members may not publish research reports following an initial or 
secondary public offering of securities. First, the proposed amendments 
would extend the quiet period prohibitions to public appearances by 
research analysts as well as to the issuance of research reports.
    Second, the proposed amendments would prohibit ``booster shot'' 
research reports or public appearances around the time of the 
expiration, waiver or termination of a ``lock-up'' agreement. Members 
often enter into lock-up agreements with subject companies or their 
shareholders that restrict or prohibit the sale of a subject company's 
or its shareholder's securities for a defined period after the 
completion of a securities offering. This provision would prohibit 
members from publishing a research report or making a public appearance 
concerning a subject company for 15 days prior to or after the 
expiration, waiver or termination of a lock-up agreement, thus helping 
prevent members from publishing favorable research that is intended to 
benefit the shareholders whose lock-up agreement is no longer in effect 
by driving up the price of the issuer's shares. However, the rule 
proposal includes an exception that would allow members to publish 
research reports during this quiet period to comment on the effect of 
significant news or a significant event on the subject company, 
provided that the legal and compliance department authorizes the 
publication of the report before it is issued. A similar exception 
exists with respect to quiet periods in the current rule.
    Third, the proposed amendments would require a member that decides 
to terminate coverage of a subject company to publish a notice of this 
termination, and to publish its final rating or recommendation of the 
subject company's securities (assuming the member had issued a prior 
rating or recommendation). This provision is intended to eliminate the 
practice of dropping coverage of a subject company rather than lowering 
a rating or recommendation.
3. Bake-Offs
    The proposed amendments would prohibit a research analyst from 
issuing a research report or making a public appearance concerning a 
subject company if the research analyst communicated with the subject 
company in furtherance of obtaining investment banking business before 
the subject company had entered into a letter of intent or other 
written agreement designating the member as an underwriter of an 
initial public offering of the subject company. This provision would 
not apply to due diligence communications between an analyst and a 
subject company where the sole purpose is to analyze the financial 
condition and business operations of the subject company. The purpose 
of this provision is to prevent research analysts from attending 
``bake-off'' meetings or otherwise communicating with a subject company 
where the intention is to pitch the member's investment banking 
services.
4. Registration, Qualification and Continuing Education of Research 
Analysts
    The proposed amendments would create new NASD Rule 1050, which 
would require all persons associated with a member that function as 
research analysts to register with NASD. For purposes of Rule 1050, 
``research analyst'' would be defined as any associated person who is 
directly responsible for the preparation of

[[Page 836]]

research reports. Before these persons' registrations could become 
effective, they would be required to pass a qualification examination 
for research analysts specified by NASD. The proposed amendments also 
would amend Rule 1120 to require research analysts to participate in 
the regulatory element and firm element of a member's continuing 
education program. The firm element program would have to include 
research analysts' training and education in ethics, professional 
responsibility and the requirements of Rule 2711.
5. Definitions
    The proposed amendments would revise the definition of ``research 
analyst'' to include supervisors of research analysts, including 
directors of research and members of supervisory committees. The 
proposed expanded definition would apply only with respect to the 
personal trading restrictions of Rule 2711(g). NASD believes the 
amendment is necessary because these supervisory personnel review and 
often greatly influence the content of and recommendation contained in 
research reports and therefore should be subject to the same trading 
restrictions, such as the prohibition on trading against the member's 
recommendation. The other provisions of Rule 2711 that govern research 
analyst conduct and disclosures would not apply to supervisors of 
research analysts.
    Additionally, the definition of ``public appearance'' would be 
revised to include interviews with print media and the writing of a 
print media article by a research analyst. In NASD's experience, the 
opinions and recommendations by research analysts made in the print 
media, specifically in opinion pieces, have created some of the same 
concerns as those made in radio and television appearances, which are 
covered by the current definition. NASD is modifying the guidance 
discussed in NASD's Notice to Members 02-39 concerning the making of 
the required disclosures in public appearances with media outlets. An 
analyst would not violate the rule if the analyst makes the required 
disclosures to the print, radio or television media in good faith, even 
if the media outlet does not print or broadcast the information. NASD 
thus recognizes the independent editorial discretion of the print, 
radio and television media.
6. NASD's Statutory Basis
    NASD believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) \16\ of the Act, which require, among 
other things, that the NASD's rules be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. The NASD believes that this proposed rule change would 
eliminate or expose conflicts of interest and thereby significantly 
curtail the potential for fraudulent and manipulative acts. The NASD 
further believes that the proposed rule change will provide investors 
with better and more reliable information with which to make investment 
decisions.
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    \16\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organizations' Statements on Burden on Competition

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

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

    NYSE and NASD has neither solicited nor received written comments 
on the proposed rule change.

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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding, or (ii) as to 
which the SROs consent, the Commission will:
    A. By order approve such proposed rule change, or
    B. Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    The Commission notes that the NYSE and NASD have worked together to 
develop these proposals. The Commission specifically requests comment 
on the substance of the proposals, and whether there are any 
differences between the NYSE and NASD proposals that present compliance 
or interpretive issues. The Commission also specifically seeks comment 
on the practicalities of making the required disclosures in print media 
and other public appearances. The Commission requests comment on 
whether the SROs should consider whether there are other effective 
means (including abbreviated disclosures) to alert investors of 
conflicts in the context of public media appearances that would take 
into account possible space or time limitations.
    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposals, as 
amended, are consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW, Washington, 
DC 20549-0609. Comments also may be submitted electronically to the 
following e-mail address: [email protected]. Electronically 
submitted comments will be posted on the Commission's Web site (http://www.sec.gov). All submissions should refer to File Nos. SR-NASD-2002-
154 and SR-NYSE-2002-49 and should be submitted by March 10, 2003.
    Copies of the rule filings, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of the rule filings and 
amendments will also be available for inspection and copying at the 
principal offices of the SROs and on the SROs' respective Web sites 
(http://www.nyse.com and http://www.nasd.com).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-223 Filed 1-6-03; 8:45 am]
BILLING CODE 8010-01-P