[Federal Register Volume 68, Number 39 (Thursday, February 27, 2003)]
[Rules and Regulations]
[Pages 9482-9493]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-4576]
[[Page 9481]]
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Part III
Securities and Exchange Commission
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17 CFR Part 242
Regulation Analyst Certification; Final Rule
Federal Register / Vol. 68, No. 39 / Thursday, February 27, 2003 /
Rules and Regulations
[[Page 9482]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR PART 242
[Release Nos. 33-8193; 34-47384; File No. S7-30-02]
RIN 3235-AI60
Regulation Analyst Certification
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'' ``SEC''
or ``we'') is adopting new Regulation Analyst Certification
(``Regulation AC''). Regulation AC requires that brokers, dealers, and
certain persons associated with a broker or dealer include in research
reports certifications by the research analyst that the views expressed
in the report accurately reflect his or her personal views, and
disclose whether or not the analyst received compensation or other
payments in connection with his or her specific recommendations or
views. Broker-dealers would also be required to obtain periodic
certifications by research analysts in connection with the analyst's
public appearances. By requiring these certifications and disclosures,
Regulation AC should promote the integrity of research reports and
investor confidence in those reports.
EFFECTIVE DATE: April 14, 2003.
FOR FURTHER INFORMATION CONTACT: James Brigagliano, Thomas Eidt, or
Racquel Russell in the Office of Risk Management and Control, Division
of Market Regulation, at (202) 942-0772.
SUPPLEMENTARY INFORMATION: We are adopting new Regulation Analyst
Certification \1\ under the Securities Act of 1933 (``Securities Act'')
and the Securities Exchange Act of 1934 (``Exchange Act'').
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\1\ 17 CFR 242.500 through 505.
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I. Introduction and Summary of Regulation Analyst Certification
During 1999, the Commission and Congress began to closely examine
research analysts' conflicts of interest. We were particularly
concerned that many investors who rely on analysts' recommendations may
not know, among other things, that favorable research coverage could be
used to market the investment banking services provided by an analyst's
firm, and that an analyst's compensation may be based significantly on
generating investment banking business. Moreover, news reports stated
that some analysts had issued reports that did not reflect their true
beliefs and communicated to institutional investors views that differed
materially from those expressed in their research reports.\2\
Regulation AC, together with other efforts, is intended to address
these issues.\3\
On May 10, 2002, we approved rule changes filed by the NYSE and
NASD governing analyst conflicts of interest.\4\ On December 31, 2002,
we noticed for comment a second set of proposed rules filed by the NYSE
and NASD to further address research analyst conflicts of interest.\5\
These self-regulatory organization rules are part of an ongoing process
on our part and that of the NYSE and NASD to address conflicts of
interest affecting the integrity and objectivity of research by
securities firms. Regulation AC is intended to complement other rules
governing conflicts of interest disclosure by research analysts,
including NYSE Rule 472, NASD Rule 2711, and the anti-fraud provisions
of the federal securities law.
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\2\ See, e.g., Gretchen Morgenson, ``NASD Sues Star Analyst Over
Research,'' The New York Times at A1 (September 24, 2002).
\3\ On December 20, 2002, the Commission, New York Attorney
General, North American Securities Administrators Association, New
York Stock Exchange (``NYSE''), National Association of Securities
Dealers (``NASD''), and state securities regulators announced an
agreement in principle that, if approved by the Commission, would
result in a settlement with major investment firms to resolve issues
of conflicts of interest relating to the production of research
reports. Securities and Exchange Commission Press Release No. 2002-
179 (December 20, 2002).
\4\ Securities Exchange Act Release No. 45908 (May 10, 2002), 67
FR 34968 (May 16, 2002).
\5\ Securities Exchange Act Release No. 47110 (December 31,
2002), 68 FR 826 (January 7, 2003). The Commission will consider
action on these proposed rules after the close of the comment
period, which is March 10, 2003.
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On July 30, 2002, President Bush signed into law the Sarbanes-Oxley
Act of 2002 (``SOA'').\6\ Section 501 of the SOA requires that rules
governing analyst conflicts be adopted within a year of enactment,
including rules: limiting the supervision and compensatory evaluation
of securities analysts; defining periods in which brokers or dealers
engaged in a public offering of a security as underwriter or dealer may
not publish research on such security; and requiring securities
analysts and brokers or dealers to disclose specified conflicts of
interest. The Commission voted to propose Regulation AC on July 24,
2002, before the passage of the SOA.\7\ In the Proposing Release, the
Commission noted that it would abide by the directives of the SOA as it
continues to address analyst conflicts of interest issues, including
with respect to the possible adoption of Regulation AC.
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\6\ Pub. L. 107-204 (2002).
\7\ Securities Exchange Act Release No. 46301 (August 2, 2002),
67 FR 51510 (August 8, 2002) (``Proposing Release'').
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The Commission received twenty-one comment letters in response to
the Proposing Release,\8\ which generally supported the proposed
regulation. After considering the comments, we are adopting Regulation
AC with modifications to the rule to reflect commenters' concerns and
to clarify and limit certain provisions. We are also providing
interpretive guidance requested by commenters.
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\8\ See Letters to Jonathan G. Katz, Secretary, Commission,
from: The Alliance in Support of Independent Research, dated
September 20, 2002 (``Alliance''); Association for Investment
Management and Research, dated September 30, 2002 (``AIMR''); The
Bond Market Association, dated September 23, 2002 (``TBMA'');
Charles Schwab &Co., Inc., dated September 23, 2002 (``Schwab'');
Cleary, Gottlieb, Steen & Hamilton, dated September 12, 2002
(``Cleary''); Credit Suisse First Boston, dated September 23, 2002
(``CSFB''); David Norr Inc., dated August 16, 2002 (``David Norr'');
Goldman Sachs, dated September 23, 2002 (``Goldman''); Investment
Company Institute, dated September 23, 2002 (``ICI''); Investment
Counsel Association of America, letters dated September 23, 2002 and
January 13, 2003 (``ICAA''); Investorside Research Association,
dated September 20, 2002 (``Investorside''); Karr Tuttle Campbell,
dated September 27, 2002 (``Karr Tuttle''); Rupert Kenna, dated
October 10, 2002; Merrill Lynch, dated September 18, 2002
(``Merrill''); North American Securities Administrators Association,
Inc., dated September 23, 2002 (``NASAA''); Salomon Smith Barney,
dated September 27, 2002 (``SSB''); Securities Industry Association,
dated September 23, 2002 (``SIA''); Sullivan & Cromwell, dated
September 23, 2002 (``Sullivan''); Thomson Financial, dated
September 23, 2002; and Weiss Ratings, Inc., dated September 10,
2002 (``Weiss'').
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A. Certifications in Connection With Research Reports
As adopted, Regulation Analyst Certification requires that brokers,
dealers, and their associated persons that are ``covered persons'' \9\
that publish,\10\ circulate, or provide research reports include in
those research reports:
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\9\ ``Covered person'' is defined in Rule 500 of Regulation AC,
and is discussed in detail below at II.A.2.
\10\ Publish means to disseminate by any means, including
through any third party.
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(A) A statement by the research analyst (or analysts) certifying
that the views expressed in the research report accurately reflect such
research analyst's personal views about the subject securities and
issuers; and
(B) A statement by the research analyst (or analysts) certifying
either:
(1) That no part of his or her compensation was, is, or will be
directly or indirectly related to the specific recommendations or views
contained in the research report; or
[[Page 9483]]
(2) That part or all of his or her compensation was, is, or will be
directly or indirectly related to the specific recommendations or views
contained in the research report. If the analyst's compensation was,
is, or will be directly or indirectly related to the specific
recommendations or views contained in the research report, the
statement must include the source, amount, and purpose of such
compensation, and further disclose that it may influence the
recommendation in the research report.
All certifications must be clear and prominent.\11\ If the analyst
is unable to certify that the report accurately reflects his or her
personal views, distribution of the report by the broker-dealer or
covered person would be in violation of Regulation AC. Similarly, if
the report does not contain one of the two alternative compensation
certifications, distribution of the report by the broker-dealer or
covered person would be in violation of Regulation AC.\12\
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\11\ Regulation AC, 17 CFR 242.501(a). The Commission expects
that the certifications will be included on the front page of the
research report, or that the front page will specify the page or
pages on which each certification is found. Disclosures and
references to disclosures must be clear and prominent. Electronic
research reports may utilize hyperlinks to this disclosure, provided
that the first screen that the investor sees clearly and prominently
labels the hyperlinks to the required disclosures. When hyperlinks
are not possible (such as a report in PDF format), firms should
follow the requirements for paper reports. See NYSE Information Memo
No. 02-26 (June 26, 2002), and NASD Notice to Members 02-39 (July
2002).
\12\ Communications relating to the certifications should be
treated as being within the purview of Exchange Act Rule 17a-
4(b)(4). See Exchange Act Rule 17a-4(b)(4), 17 CFR 240.17a-4(b)(4).
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Research reports generally contain an analyst's summary rating of
the security based on his or her particular firm's rating system, as
well as an analysis. The summary rating or recommendation is often one
word (e.g., buy, sell, overweight), while the analysis may be very
detailed and lengthy. Generally, the analysis explains the basis for
the rating and provides extensive supplementary information, which, in
some instances, significantly qualifies or conditions the stated
rating. The Regulation AC certification that the views in the report
accurately reflect the analyst's personal views applies to the analysis
as reflected in the rating as well as the substance of a research
report.
A rating is designed to be a severable summary statement of the
analysis in the report. In situations where the analysis significantly
qualifies or conditions the stated rating, a communication by the firm
or the analyst of only the rating to an investor as representing the
analyst's views about the security could be misleading.\13\ Further,
where the analysis contradicts the stated rating, an analyst and the
firm could be in violation of the anti-fraud provisions of the federal
securities laws. A rating that contradicts the analysis could also
render false the analyst's certification, because the analyst's
certification reflects both the analysis as well as the rating.
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\13\ Cf. Hanly v. SEC, 415 F.2d 589, 597 (2d Cir. 1969).
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B. Certifications in Connection With Public Appearances
Under Regulation AC, broker-dealers must make and keep records
related to public appearances by research analysts. Specifically, if a
broker-dealer publishes, circulates, or provides a research report
prepared by a research analyst employed by the broker-dealer or a
covered person, the broker-dealer is required to make a record within
thirty days after each calendar quarter in which the research analyst
made any public appearance, that includes:
[sbull] A statement by the research analyst attesting that the
views expressed by the research analyst in all public appearances
during the calendar quarter accurately reflected the research analyst's
personal views at that time about any and all of the subject securities
or issuers; and
[sbull] A written statement by the research analyst certifying that
no part of such research analyst's compensation was, is, or will be
directly or indirectly related to any specific recommendations or views
expressed in any such public appearance.
In cases where the broker-dealer does not obtain a statement by the
research analyst in connection with public appearances as described
above, the broker-dealer must promptly notify its examining authority,
designated pursuant to section 17(d) of the Exchange Act and Rule 17d-2
thereunder, that the analyst did not provide certification in
connection with public appearances. In addition, for 120 days following
such notification, the broker-dealer must disclose in any research
report it distributes authored by that analyst that the analyst did not
provide certification specified in Rule 502(a) of Regulation AC.
Further, broker-dealers must keep and maintain these records pursuant
to Rule 17a-4.
II. Response to Comments on Regulation Analyst Certification
In the Proposing Release, the Commission sought comment on specific
aspects of the proposed regulation, as well as general comments. We
received twenty-one comment letters in response to the release. Many
commenters expressed support for Regulation AC, although a number also
expressed concerns regarding one or more aspects of the proposal, and
some suggested alternatives for addressing particular issues. We are
adopting Regulation AC with modifications from the proposal that
clarify or limit provisions or reflect commenters' views.
A. Defined Terms
We requested comment on whether the proposed definitions of
``research report,'' ``research analyst,'' or ``public appearance''
should be broader or narrower than proposed. Eleven commenters
discussed the scope of the definitions proposed in Regulation AC and
noted differences in certain respects compared to definitions contained
in the self-regulatory organization (``SRO'') rules and the SOA.\14\
Generally, commenters believed that compliance efforts would be
significantly enhanced by the use of consistent terminology throughout
the rules wherever possible.\15\ The Commission has conformed the
terminology and definitions of Regulation AC to the SRO rules and the
SOA wherever appropriate.
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\14\ See Alliance, AIMR, Cleary, Goldman, ICI, ICAA, SIA, SSB,
Schwab, Sullivan, and Thomson Financial.
\15\ See, e.g., Cleary and SIA.
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1. Definition of ``Research Analyst''
Commenters noted that Regulation AC defines ``research analyst''
more broadly than do the current SRO analyst rules and the SOA.
Specifically, the Regulation AC definition as proposed covers ``any
natural person,'' rather than only ``associated persons of a member''
(in the case of the SRO rules) or ``associated persons of a registered
broker or dealer'' (in the case of the SOA). Commenters argued that
Regulation AC applies to any person, including employees of investment
advisers, foreign entities, or any other third party that prepares a
research report that is circulated by a broker-dealer or associated
persons.\16\
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\16\ See, e.g., Cleary, ICAA, SSB, Sullivan, and Thomson
Financial.
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In this regard, Regulation AC is designed to be broader than the
SRO rules and the SOA in that it applies to brokers, dealers, and
certain associated persons,\17\ which may also include investment
advisers and others that prepare research reports. We believe that the
broad scope of Regulation AC
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is warranted because Regulation AC imposes core standards of integrity
that should pertain to all research distributed by broker-dealers and
covered persons. On the other hand, we note that Regulation AC is
narrower than the SRO rules and the SOA in that its certification
requirements apply only to the research analyst or analysts primarily
responsible for the content of a research report; junior analysts are
not required to certify.\18\ This distinction is reasonable because the
core integrity standards promoted by Regulation AC are achieved where
the analysts primarily responsible for the views expressed in the
research report are required to certify. In comparison, the coverage of
junior analysts by the SRO rules is appropriate because the concerns
those provisions seek to address (for example, trading ahead of
research reports) exist with respect to all analysts associated with a
member firm and those persons who report to analysts.
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\17\ See Rule 500 of Regulation AC (definition of ``covered
person'').
\18\ The proposed definition of ``research analyst'' referred to
any natural person ``principally'' responsible for research reports;
the adopted definition refers to any natural person ``primarily''
responsible. This modification clarifies that, whether or not a
natural person is considered to be principally responsible for
research reports as a job description, any natural person who is
primarily responsible for the preparation of the content of any
research report is a research analyst for the purposes of Regulation
AC unless otherwise exempted.
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2. Definition of ``Covered Person''
In response to comments, we have added the definition of ``covered
person'' to narrow the scope of persons to which Regulation AC applies.
Covered person means persons associated with a broker or dealer,\19\
but not including an associated person that has no officers or
employees in common with the broker or dealer and where the broker or
dealer maintains and enforces written policies and procedures
reasonably designed to prevent the broker or dealer or any of its
controlling persons, officers, or employees from influencing the
activities of research analysts and the content of research reports
prepared by the associated person. In adopting Regulation AC, we have
sought to focus the rule on research that appears to be most
susceptible to pressures that might compromise its integrity, for
example pressures to generate investment banking business.
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\19\ The term ``person associated with a broker or dealer'' is
defined in Exchange Act section 3(a)(18), 15 U.S.C. 78c(a)(18).
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We believe that it is unnecessary to apply Regulation AC to
research published, circulated, or provided by associated persons who
have a sufficient level of independence from the broker or dealer with
which they are associated. Associated persons who meet the independence
criteria in this definition should have a sufficient level of
independence so that pressures from the broker-dealer with which they
are associated should not compromise their research. In order to avoid
the possibility that an associated person might incorrectly believe
that the broker-dealer had policies and procedures to prevent
influencing the research of the associated person and, therefore, fail
to certify when certification was required, we have added a provision
to Regulation AC (Rule 504) that requires a broker or dealer to notify
its associated persons that issue research reports as to whether the
broker or dealer maintains and enforces such written policies and
procedures and whether the associated person has any officers (or
persons performing similar functions) or employees in common with the
broker or dealer who can influence the activities of research analysts
or the content of research reports and, if so, the identity of those
persons.\20\ We also would not expect that such policies and procedures
would interfere with other communications between the associated person
and the broker-dealer made in the ordinary course of business and not
in violation of any other provision of the securities laws.
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\20\ Associated persons of a member are required under SRO rules
to provide prompt notice to his or her employer of employment with
any other persons as a result of a business activity. See NASD Rule
3030.
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We have also excluded from the rule investment advisers that are
prohibited under section 203A of the Investment Advisers Act of 1940
\21\ (``Advisers Act'') from registering with the Commission as
investment advisers and not otherwise registered or required to be
registered as a broker-dealer. Section 203A was added to the Advisers
Act by the National Securities Markets Improvement Act of 1996
(``NSMIA''), which amended the Advisers Act to divide responsibility
for regulating investment advisers between the Commission and state
securities authorities.\22\ Section 203A of the Advisers Act effects
this division by generally prohibiting investment advisers from
registering with us unless they have at least $25 million of assets
under management or advise a registered investment company.\23\
Advisers prohibited from registering with us are subject to the
regulation of state securities authorities, but also continue to be
subject to the federal securities laws, including the anti-fraud
provisions of the federal securities laws.
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\21\ 15 U.S.C. 80b-3a.
\22\ Pub. L. No. 104-290, 110 Stat. 3416 (1996) (codified in
scattered sections of the United States Code). Section 203A was
designed to allow the Commission to better use its limited resources
by concentrating its regulatory responsibilities on advisers with
national businesses, and to reduce the burden to investment advisers
of the overlapping and duplicative regulation existing prior to the
enactment of NSMIA. See S. Rep. No. 293, 104th Cong., 2d Sess. 2-4
(1996). In conjunction with implementing NSMIA, the Commission
amended several ``prophylactic'' anti-fraud rules under the Advisers
Act to make them inapplicable to state-registered advisers because
``application of these provisions to state-registered advisers is
more appropriately a matter for state law.'' Investment Advisers Act
Release No. 1633 (May 15, 1997), 62 FR 28112 (May 22, 1997).
\23\ Pursuant to authority under Advisers Act section
203(a)(1)(A) the Commission adopted Advisers Act Rule 203A-1, which
made SEC registration optional for certain investment advisers that
have between $25 and $30 million of assets under management. See
Advisers Act Rule 203A-1(a)(1), 17 CFR 275.203A-1(a)(1).
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We also make clear that no provision of the regulation shall apply
to the publisher of any newspaper, news magazine, or business or
financial publication of general and regular circulation that is not
registered or required to be registered with the Commission as a broker
or dealer or investment adviser. Regulation AC was never intended to
govern media coverage of issuers.\24\
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\24\ It is possible that a broker or dealer or covered person
could provide a research report to a media entity intending that it
be published. In that case, the report must be certified by the
research analyst.
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3. Definition of ``Research Report''
The Commission requested comment on whether the definition of
``research report'' should be broader or narrower than proposed.
Commenters discussed several aspects of the proposed definition,
including whether it should cover debt securities, whether it should
include electronic communications, and guidance concerning what will
and will not be considered a research report.
a. Application to Debt Securities
We specifically requested comment on whether the proposed
definition of ``research report'' should be limited to cover only
equity securities. Five commenters discussed the application of
Regulation AC to fixed income and all supported the application to debt
to some extent.\25\
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\25\ See CSFB, Goldman, NASAA, SSB, and TBMA. We note that the
SOA and the SRO rules apply only to equity securities.
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The Commission has determined that applying the requirements of
Regulation AC to debt securities as well as equity securities would
benefit investors because it would provide to debt investors the same
benefits as equity
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investors by promoting the integrity of research reports and confidence
in research analyst recommendations.
b. Electronic Communications
Commenters noted that, unlike the SRO rules, the proposed
definition of ``research report'' in Regulation AC did not explicitly
include ``electronic communications,'' and requested that the
Commission clarify that the regulation would apply to research reports
transmitted electronically.
The Commission believes that electronic communications were
included under proposed Regulation AC's definition of ``research
report.'' However, in response to commenters' concerns, the Commission
has modified the proposed definition of ``research report'' to
explicitly include written communications in electronic form.
c. What Constitutes a Research Report?
The Commission has deleted the ``recommendation'' element from
Regulation AC's proposed definition of ``research report'' to conform
to the definition in the SOA. Therefore, ``research report'' is defined
as ``a written communication (including an electronic communication)
that includes an analysis of a security or an issuer and provides
information reasonably sufficient upon which to base an investment
decision.''
Commenters requested that the Commission provide guidance
concerning what types of communications the rule is not intended to
cover.\26\ Commenters also requested clarification that Regulation AC
would not apply to internal communications.
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\26\ See SIA and Schwab.
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It is not possible to provide a complete list of all types of
communications that would or would not fall within the definition of
``research report.'' Whether a particular communication constitutes a
research report for the purposes of Regulation AC will turn on the
individual facts and circumstances surrounding that communication. In
general, however, the following communications would not be research
reports if they do not include an analysis of, or recommend or rate,
individual securities or companies:
[sbull] Reports discussing broad-based indices, such as the Russell
2000 or S&P 500 index.
[sbull] Reports commenting on economic, political, or market
conditions.
[sbull] Reports commenting on or analyzing particular types of debt
securities or characteristics of debt securities.
[sbull] Technical analysis concerning the demand and supply for a
sector, index, or industry based on trading volume and price.
[sbull] Reports that recommend increasing or decreasing holdings in
particular industries or sectors or types of securities.
The following communications would generally not be research
reports even if they recommend or rate individual securities or
companies:
[sbull] Statistical summaries of multiple companies' financial data
(including listings of current ratings) that do not include any
analysis of individual companies' data.
[sbull] An analysis prepared for a specific person or a limited
group of fewer than fifteen persons.\27\
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\27\ We have focused on a group of fewer than fifteen persons in
part because Congress made a determination that an investment
adviser who, during the course of the preceding twelve months, has
had fewer than fifteen clients and who, among other things, does not
hold themselves out generally to the public as an investment
adviser, does not have to register with the Commission as an
investment adviser. See Advisers Act Rule 203(b)(3), 15 U.S.C. 80b-
3(b)(3).
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[sbull] Periodic reports or other communications prepared for
investment company shareholders or discretionary investment account
clients discussing past performance or the basis for previously made
discretionary investment decisions.
[sbull] Internal communications that are not given to customers.
4. Definition of ``Third Party Research Analyst''
In response to commenters'' concerns, we have added a definition of
``third party research analyst'' in order to refine the scope of
Regulation AC. A ``third party research analyst'' is, with respect to a
particular broker or dealer, any research analyst not employed by that
broker or dealer or any associated person of that broker or dealer.
With respect to a covered person, a ``third party research analyst'' is
any research analyst not employed by that covered person, by the broker
or dealer with whom that covered person is associated, or by any other
associated person of the broker or dealer with whom that covered person
is associated. We believe that research prepared by third party
research analysts will not be susceptible to pressures from broker-
dealers who distribute their research provided that the analyst's
employer meets certain independence criteria.
B. Discussion of Certification Requirements
1. Certification by the Primarily Responsible Analyst
Commenters requested clarification on identifying the research
analyst that would be required to make the certifications. Commenters
argued that multiple certifications would likely be confusing or have
other undesirable effects.\28\
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\28\ See, e.g., SIA and SSB.
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Regulation AC requires that the analyst or analysts primarily
responsible for the preparation of the content of a research report
comply with the certification requirements. Thus, certification by
junior analysts involved in the preparation of a research report is not
necessary.\29\ In some cases, however, there may be more than one
research analyst primarily responsible for the content of a research
report. In such instances, all analysts who are primarily responsible
for the views expressed in the report must provide the certifications.
Removing the names of all analysts from a report would not allow the
firm to avoid including the required certifications and disclosures;
the analyst or analysts primarily responsible for the report must
certify.
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\29\ The Commission notes that any person not required to comply
with the certification requirements of Regulation AC (e.g., junior
analysts) would nonetheless be subject to the antifraud provisions
of the federal securities laws.
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2. Quantitative and Technical Research
Commenters argued that research based on quantitative and technical
models may not be attributed to a particular analyst, may not reflect
an analyst's views, and therefore, requested that the Commission
provide guidance that these types of research would not be covered.\30\
One commenter suggested, as an alternative, that Regulation AC should
require a certification by the firm that the views expressed in the
report are derived from the firm's systematic quantitative research
model.\31\
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\30\ See Schwab and SIA.
\31\ See Schwab.
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The Commission has determined that, in cases where there is no
identified analyst because the report is based on the firm's
quantitative or technical model, the firm itself may provide the
certifications that the views expressed in the research report
accurately reflect the firm's quantitative research model, and that no
part of the firm's compensation was, is, or will be, directly or
indirectly, related to the specific recommendations or views disclosed
in the research report.
[[Page 9486]]
However, tying an analyst's compensation to the performance of a
quantitative or technical model would indicate that the report is the
product of the analyst's subjective views (reflected by the design of
the model employed). In that case, that analyst must certify the report
containing the model's results in accordance with Rule 501 of
Regulation AC.
C. Certifications or Disclosures During Public Appearances
We requested comment on what, if any, disclosures should be
required during public appearances by analysts. The four commenters
that addressed this issue generally were opposed to requiring
certifications during analyst public appearances.\32\ We have
determined not to require certifications during public appearances by
analysts.
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\32\ See AIMR, Goldman, SIA, and SSB.
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The Commission believes that the proposed quarterly certification
requirements in connection with analyst public appearances are
sufficient. If the analyst does not provide a certification in
connection with public appearances, Rule 502 of Regulation AC requires
the broker-dealer to provide readers of research reports that it
distributes, as well as the broker-dealer's designated examining
authority, with notice that the analyst did not provide the
certifications.\33\ A Rule 502(b) notice in a research report must be
in plain English.
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\33\ The Commission believes that merely citing to the rule
provision would not constitute an adequate notice.
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D. Compendium Reports
The Commission requested comment on whether Regulation AC should
make allowances for compendium research reports covering six or more
securities. Commenters that discussed the treatment of certifications
in compendium research reports believed that Regulation AC should
permit the required disclosures to appear in a place other than the
report itself.\34\ Most of these commenters specifically supported
treatment of compendium reports for the purpose of Regulation AC
similar to the treatment allowed under SRO rules. Under SRO rules,
members are not obligated to include disclosures in compendiums if the
report directs readers to a toll-free number or postal address to write
for required disclosures.\35\ Electronic compendiums may instead
include a hyperlink and paper compendiums may also include a web
address where disclosures are located. Two commenters suggested the use
of a combined certification that each analyst referenced in the report
certifies that the analysis attributed to him or her accurately
reflects his or her views.\36\
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\34\ See CSFB, Cleary, Goldman, SIA, SSB, and Schwab.
\35\ See CSFB, Cleary, SIA, SSB, and Schwab.
\36\ See SIA and SSB.
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The Commission has determined not to permit treatment of compendium
research reports in a manner similar to that permitted by the SROs
because, unlike the SRO rules, the certifications required by
Regulation AC are very concise. Nonetheless, when a research report
covers more than one company and each research analyst required to
certify with respect to the views expressed in a portion of the report
is able to certify that: (a) the views expressed in the research report
accurately reflect such research analyst's personal views about the
subject securities and companies; and (b) that no part of his or her
compensation was, is, or will be directly or indirectly related to the
specific recommendation or views contained in the research report, the
firm may comply with Regulation AC by including one clear and prominent
combined certification that, as to each company covered, the respective
research analyst (or analysts) certifies as to (a) and (b) above.\37\
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\37\ This certification must be in plain English. The Commission
would expect that broker-dealers would be able to demonstrate that
the combined certification in the report is accurate.
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E. Application of Regulation AC to Investment Advisers and Banks
Regulation AC is directed at brokers, dealers, and covered persons,
because we believe that these entities are subject to the greatest
conflicts. Therefore, investment advisers and banks, among others, may
be required to comply with the regulation if they are covered persons
of a broker-dealer. The Commission noted in the Proposing Release that
the term ``research analyst'' would not include personnel of an
investment adviser, such as a mutual fund portfolio manager, who are
not principally responsible for preparing research reports, even if the
individuals are registered persons of a broker-dealer (similar to the
guidance provided by the SROs in the joint interpretive
memorandum).\38\ The Commission requested comment on whether the
regulation should cover banks that are not associated persons and other
independent entities, and whether the rule should explicitly exclude
investment advisers.
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\38\ See NYSE Information Memo No. 02-26 (June 26, 2002), and
NASD Notice to Members 02-39 (July 2002).
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Commenters who addressed the application of Regulation AC to
investment advisers generally opposed the rule's coverage of investment
advisers and investment advisory personnel.\39\ Some commenters called
for the specific exclusion of investment advisers.\40\ Commenters who
addressed the application of Regulation AC to banks generally opposed
the rule's coverage of banks.\41\ One commenter favored the application
of Regulation AC to investment advisers and banks.\42\
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\39\ See Alliance, ICAA, ICI, Investorside, SIA, SSB, Sullivan,
and Thomson Financial.
\40\ See, e.g., ICAA and ICI.
\41\ See Investorside, SSB, Sullivan, and Thomson Financial.
\42\ See NASAA.
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The Commission has determined that Regulation AC should not exclude
all investment advisers or banks that are associated with broker-
dealers. However, as discussed above, the definition of ``covered
person'' substantially narrows the scope of persons associated with a
broker-dealer, such as investment advisers and banks, that are subject
to Regulation AC. Where the broker-dealer has informational and
structural separations from its associated person, the rule does not
apply to that associated person. Where the protections are lacking,
however, with respect to a person associated with a broker-dealer, that
person is a covered person.\43\ Accordingly, if an investment adviser
or bank is a covered person and publishes, circulates, or provides
research reports, the research report certification provisions of
Regulation AC will apply. We believe those investment advisers and
banks that do not meet the independence criteria that would exclude
them from the definition of ``covered person'' may be subject to
greater conflicts than are other investment advisers and banks.
Specifically, a broker-dealer's investment banking department could
pressure these investment adviser or bank affiliates to comment
favorably in a research report or public appearance about a client or
prospective client. Moreover, if associated persons that are covered
persons were not subject to the certification requirements of
Regulation AC, broker-dealers could attempt to funnel research through
them to avoid complying with Regulation AC.\44\
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\43\ As discussed above, Regulation AC requires a broker-dealer
to inform its associated persons as to whether or not it maintains
and enforces the informational barriers described in Regulation AC.
\44\ Regulation AC is directed at those regulated persons that
prepare research reports, as well as persons associated with
regulated persons who might be used if attempts were made to
improperly circumvent the rule. See also Exchange Act section 20(b),
15 U.S.C. 78t(b).
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[[Page 9487]]
F. Application of Regulation AC to Third Party Research
In Proposing Regulation AC, we did not propose to treat research
prepared by third parties but distributed by a broker-dealer
differently from research produced by the broker-dealer itself.
Commenters argued that broker-dealers should not be responsible for
certifying research by independent third parties. Moreover, they
pointed out practical problems, including the difficulty of tracking
analysts employed by third parties.\45\ They also cited increased
costs. They argued that firms would discontinue providing the valuable
service of making third party research available to customers.\46\
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\45\ See Alliance and Thomson Financial.
\46\ See, e.g., Schwab.
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We have determined not to apply Regulation AC where a broker-dealer
distributes research prepared by a third party research analyst whose
employer satisfies certain independence criteria. The independence
criteria require that the third party research analyst's employer does
not have officers or employees in common with the broker-dealer or
covered person distributing its research, and that the broker-dealer
has written policies and procedures designed to prevent the broker-
dealer, its controlling persons, officers, and employees from
influencing the activities of the third party research analyst and the
content of his or her research reports. We believe that research
analysts employed by these independent third parties will not be
sufficiently susceptible to pressures from distributing broker-dealers
to warrant certification. Where a broker-dealer distributes the
research of a third party that does not meet the independence criteria,
however, the broker-dealer must confirm that the research report
includes the same research analyst certification as required by
Regulation AC.
Commenters argued that it would be difficult to track analysts
employed by third parties, some of whom are overseas, in order to
monitor their public appearances and obtain written statements from
them. In response to commenters' concerns, we have determined that
broker-dealers who distribute third party research are not required to
obtain the public appearance certifications required by Rule 502 of
Regulation AC with respect to public appearances by third party
research analysts.
G. Application of Regulation AC to Foreign Research
In proposing Regulation Analyst Certification, the Commission did
not distinguish between research that was issued by a U.S. entity and
research that was issued by a non-U.S. entity. Several commenters
raised the issue of the Regulation's effect on research originating
from a foreign entity. These commenters generally opposed the proposed
scope of Regulation AC, which captured foreign entities (and their
associated persons) that issue research reports, including those who
are not required to be registered with the Commission under section 15
of the Exchange Act.\47\
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\47\ See, e.g., Cleary and Thomson Financial.
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In light of these comments, we have created a narrow exception for
foreign persons that are located outside of the United States and are
not associated with a registered broker-dealer that prepares and
provides research on foreign securities \48\ to major United States
institutions in the U.S. in accordance with the provisions of Rule 15a-
6(a)(2). In these instances, the foreign person is excepted from the
requirements of Regulation AC.
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\48\ As defined in the rule, for purposes of Regulation AC,
``foreign security'' means a security issued by a foreign company
for which a U.S. market is not the principal trading market.
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In addition, in the case of a research analyst employed outside the
United States by a foreign person located outside the United States,
Rule 502 of Regulation AC only applies to public appearances while the
research analyst is physically present in the United States.
H. Supervision and Oversight
Commenters requested that the Commission clarify that the
certification pertaining to the analyst's personal views is not
intended to prevent research supervisors or review committees from
seeking changes to the research product.\49\ One commenter argued that
Regulation AC should not impede the ability of a supervisor or a review
committee to require that a report follow a written firm policy on when
a research report can upgrade or downgrade a rating, or when it must
withhold a rating to prevent conflicts or for other reasons.\50\
Commenters argued that certification also should not preclude the
ability of an analyst or a firm to modify the report due to a change in
the analyst's opinion or to remove statements that create legal or
regulatory concerns.\51\
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\49\ See, e.g., SIA and SSB.
\50\ See SIA.
\51\ See SIA and SSB.
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The certification required by Rule 501 of Regulation AC does not
impede the oversight or review of research reports. If, at the end of
the revision process, the analyst still believes that the report
accurately reflects his or her personal views about the subject
securities or issuers, then that analyst may certify and the firm may
use the research report. If, however, after the review process the
research report no longer reflects the analyst's personal views, then
that analyst would be unable to certify and the firm would not be in
compliance with Regulation AC if it uses the research report without a
certification.
I. Regulation AC and Fraud Liability Under Federal Securities Laws
Several commenters requested that the Commission reiterate the
position stated in the Proposing Release that Regulation AC does not
impose new liability on analysts or their firms.\52\ Regulation AC
formalizes and potentially adds rigor to analysts' responsibilities to
express their views truthfully and without guile.\53\ Regulation AC
makes explicit the representations that are already implicit when an
analyst publishes his or her views--that the analysis of a security
published by the analyst reflects the analyst's honestly held
views.\54\
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\52\ See, e.g., Karr Tuttle, NASAA, SIA, and SSB.
\53\ As the Commission stated in the Proposing Release,
Regulation AC is not intended to create new duties under section
10(b) of the Exchange Act. As a result, no private liability will
arise from a broker, dealer, or associated person's failure to make
the required disclosure, or make, keep, and maintain required
records. However, Regulation AC is subject to the full range of the
Commission's enforcement authority. With regard to the enforcement
of Regulation AC by the SROs, nothing in Regulation AC is
inconsistent with Exchange Act Rule 19g2-1. See 17 CFR 240.19g2-1.
\54\ The use of a certification process echoes and is consistent
with one approach employed in the Sarbanes-Oxley Act of 2002, which
requires certifications by officers of corporations relating to
issuers' financial statements. See Sarbanes-Oxley Act sections 302
and 906, Pub. L. 107-204 (2002).
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Regulation AC does not alter any other existing obligation under
the federal securities laws for research analysts or broker-
dealers.\55\ A research report contains an inherent representation that
the views expressed in the report are not knowingly false and do not
omit material facts necessary in order to make statements made not
misleading.\56\ Thus, even without
[[Page 9488]]
Regulation AC, analysts may be found to have violated the anti-fraud
provisions of the federal securities laws if they make baseless
recommendations or recommendations that they disbelieve.\57\
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\55\ See, e.g., Securities Act sections 17(a) and 17(b), 15
U.S.C. 77q; Exchange Act section 10(b), 15 U.S.C. 78j(b), and Rule
10b-5, 17 CFR 240.10b-5.
\56\ See, e.g., Securities Act section 17(a), 15 U.S.C. 77q(a);
Exchange Act Rule 10b-5, 17 CFR 240.10b-5; Exchange Act section
15(c)(1)(A), 15 U.S.C. 78o(c)(1)(A); and Exchange Act Rule 15c1-
2(b), 17 CFR 240.15c1-2.
\57\ See Securities Exchange Act Release No. 45908 (May 10,
2002), 67 FR 34968, 34977 (May 16, 2002); Proposing Release at
51512; Cf. Hanly, supra, note 13, at 597. See also In the Matter of
Robertson Stephens, Inc., Administrative Proceeding File No. 3-11003
(January 9, 2003) (settled fraud action against broker-dealer where
Commission found that a research analyst employed by the broker-
dealer issued recommendations about a public company that were
inconsistent with his privately communicated beliefs about the
company.)
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J. Performance-Based Compensation
Commenters expressed concern that Regulation AC could be read to
require disclosure of analyst compensation arrangements based on the
accuracy or performance of the views expressed as to the subject
company's prospects.\58\ Commenters thought that the compensation
disclosure provision should be clarified to only require disclosure of
compensation that was intended to influence or induce the particular
view expressed in the research report.\59\
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\58\ See, e.g., Goldman and Merrill.
\59\ See, e.g., Cleary, SIA, SSB, and Sullivan.
---------------------------------------------------------------------------
In the Proposing Release, the Commission noted that Regulation AC
does not preclude an analyst from providing otherwise permissible
services to his or her firm's investment banking department, and it
does not prohibit analysts generally from receiving compensation for
covering issuers or for preparing research reports. Instead, Regulation
AC focuses on disclosure where the analyst compensation that is related
to the specific recommendations or views expressed by the research
analyst in the research report. Regulation AC is not intended to
address compensation based on the performance of the views expressed
regarding the securities discussed.
III. Paperwork Reduction Act
Regulation AC contains ``collection of information'' requirements
within the meaning of the Paperwork Reduction Act of 1995
(``PRA'').\60\ We have submitted the proposal to the Office of
Management and Budget (``OMB'') for review in accordance with the
PRA.\61\ An agency may not conduct or sponsor, and a person is not
required to respond to, an information collection unless it displays a
currently valid OMB control number.
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\60\ 44 U.S.C. section 3501 et seq.
\61\ 44 U.S.C. section 3507(d) and 5 CFR 1320.11.
---------------------------------------------------------------------------
In the Proposing Release, the Commission solicited comments on the
collection of information requirements. In response to comments, the
Commission has revised the estimates published in the Proposing Release
regarding the collection of information burdens associated with the new
rule.
A. Summary of Collection of Information
Regulation AC generally requires that research reports published,
circulated, or provided by a broker or dealer or covered person contain
a statement attesting that the views expressed in each research report
accurately reflect the analyst's personal views and whether or not the
research analyst received or will receive any compensation in
connection with the views or recommendations expressed in the research
report. Regulation AC also requires broker-dealers to, on a quarterly
basis, make, keep, and maintain records of research analyst statements
regarding whether the views expressed in public appearances accurately
reflected the analyst's personal views, and whether any part of the
analyst's compensation is related to the specific recommendations or
views expressed in the public appearance.
B. Reporting and Cost Burden Estimates
Regulation AC provides that brokers, dealers, and covered persons
must include in research reports they publish, circulate, or provide
certain certifications and disclosures about the analyst's views
expressed in the research reports and any relationship between the
analyst's compensation and the specific recommendations or views
expressed. The regulation also requires broker-dealers to periodically
make, keep, and maintain records of research analyst certifications and
disclosures in connection with public appearances.
The staff of the Commission believes that the average amount of
time it would take to include the required certifications and
disclosures in each research report is one minute per report. In the
Proposing Release, the Commission staff estimated that broker-dealers
publish approximately 657,000 research reports per year. One commenter
provided the Commission with data in response to the Proposing
Release.\62\ After considering this additional information, the staff
of the Commission believes that broker-dealers publish approximately
1,375,865 research reports per year.\63\ Therefore, the Commission
estimates that the total annual burden in hours for broker-dealers to
comply with the research report certification and disclosure
requirements is approximately 22,930 hours per year ((1 minute x
1,375,865 reports)/60 minutes).
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\62\ Thomson Financial asserted in its comment letter that the
Commission's cost estimate in the Proposing Release was too low.
Thomson Financial noted that the Commission cited data from Thomson
Financial First Call and estimated that broker-dealers publish
657,000 research reports per year. Thomson Financial asserted that,
while this estimate may accurately reflect equity research on U.S.
securities transmitted via First Call Notes, it did not capture
fixed-income research, research on non-U.S. equities or full-text
reports transmitted through First Call Research Direct. Thomson
Financial asserted that, when these additional sell-side reports are
accounted for, the total exceeds 2 million reports a year. Thomson
Financial suggested that the compliance costs for sell-side firms
could run as high as $4,116,784.50.
\63\ After further consultation with Thomson Financial, they
have revised their total estimated number of research reports per
year for 2001 to range between 1,375,865 and 1,540,150. The staff
believes that the overall calculations are over-inclusive and
possibly duplicative. As a result, we are basing our estimates on
the lower-end of the range of the number of research reports per
year. The staff believes that this estimate continues to be
conservative.
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The Commission staff expects that research analysts will likely be
the employees primarily charged with executing certifications and
including them in research reports. According to industry sources,
research analysts, on average, earn $189,250 per year, for an hourly
pay rate of approximately $90. Including 35% overhead, Commission staff
estimates that the hourly pay rate for a research analyst would be
approximately $121.50. Therefore, the Commission estimates that the
total annual burden in dollars for broker-dealers to comply with the
research report certification and disclosure requirements is
approximately $2,785,995.00 \64\ per year (22,930 hours x $121.50 per
hour).
---------------------------------------------------------------------------
\64\ The estimated total annual burden in dollars for broker-
dealers to comply with the research report certification and
disclosure requirements would be approximately $3,118,642.00 if
calculated using the high-end of the estimated range for the number
of research reports.
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Rule 501 of Regulation AC, which applies to research reports, may
also impose requirements on certain entities if they are associated
with a broker-dealer and meet the definition of ``covered person.''
However, ``covered persons'' are not subject to Rule 502 of Regulation
AC, which addresses pubic appearances. The Commission estimates that
approximately 2,650 SEC registered investment advisers are associated
with a broker-dealer. We believe that not all of these entities write
research reports, and that those who do write research reports write
relatively few. Of those investment advisers that are associated with a
broker-dealer and that write research reports, we do not believe that
all of them will meet the definition of a ``covered person,'' as
defined by
[[Page 9489]]
Regulation AC. As a conservative estimate, however, if all SEC
registered investment advisers are covered persons and on average
publish as many research reports per year as the average broker-dealer
(250 research reports), the estimated total number of research reports
published by SEC registered investment advisers who are associated with
a broker-dealer would be approximately 662,500 (250 x 2,650).\65\
Therefore, the Commission estimates that the total annual analyst
certification burden in hours for these investment advisers would be
11,040 hours ((1 minute x 662,500 research reports)/60 minutes). The
Commission estimates that the annual burden in dollars of complying
with the research report certification and disclosure requirements for
SEC registered investment advisers is approximately $1,341,360 per year
\66\ (11,040 x $121.50). Unlike Rule 501, Rule 502 of Regulation AC
(public appearances) does not apply to covered persons. We note,
however, that we believe that a significant number of associated
persons would not be ``covered person(s),'' as defined in Rule 500 of
Regulation AC and, as a result, the aggregate burden for persons
associated with broker-dealers to comply with the research report
certification and disclosure requirements will be significantly lower.
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\65\ We believe that including all SEC registered investment
advisers in calculating the paperwork burden as to covered persons
is over-inclusive as to investment advisers, and that this estimate
is therefore sufficient to account for other types of entities who
would meet the definition of ``covered person.''
\66\ The estimated total annual burden in dollars for SEC
registered investment advisers to comply with the research report
certification and disclosure requirements would be approximately
$1,501,518.00 if calculated using the high-end of the estimated
range for the number of research reports.
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The staff of the Commission believes that the research analyst will
prepare the quarterly statement required for public appearances. The
staff estimates that the average amount of time it would take a
research analyst to prepare the quarterly statements regarding public
appearances as required by the regulation is ten minutes per analyst.
The staff of the Commission believes that, on average, approximately
519 public appearances by research analysts occur per quarter,\67\ or
about 2,076 per year. Therefore, the Commission believes that the total
annual burden for broker-dealers in hours of complying with the public
appearance certification and disclosure requirements would be
approximately 346 hours per year ((10 minutes x 2076 appearances) / 60
minutes).
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\67\ 519 is approximately 10% of the estimated 5,186 research
analysts employed in the U.S., which is based on information
provided by Nelson Information. One commenter believes that this
estimate is low, but did not provide specific data in support of its
views. See Thomson Financial.
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In cases where the broker or dealer does not obtain a statement by
the research analyst in connection with public appearances as described
above, the broker-dealer must promptly notify its examining authority,
designated pursuant to section 17(d) of the Exchange Act and Rule 17d-2
thereunder, that the analyst did not provide certification in
connection with public appearances. In addition, for 120 days following
such notification, the broker-dealer must disclose in any research
report it distributes authored by that analyst that the analyst did not
provide certification specified in Rule 502(a) of Regulation AC.
Further, broker-dealers must keep and maintain these records pursuant
to Rule 17a-4(b)(4). Broker-dealers are also expected to have records
that document the process they followed in producing each research
analyst certification. The staff of the Commission believes that there
will be few, if any, instances where a broker-dealer will provide
notification to their examining authority, as analysts and their firms
will have strong incentives to avoid having to make the type of
disclosures required to be provided to their examining authority.
Therefore, the total annual burden, in dollars, of complying with the
public appearance certification requirements would be approximately
$42,039 (346 hours x $121.50).
The regulation requires that the records of statements regarding
public appearances be preserved in accordance with Exchange Act Rule
17a-4(b)(4). Exchange Act Rule 17a-4(b)(4) requires that any
communication relating to a broker-dealer's business, including inter-
office communications, must be kept for at least three years. In light
of the existing record preservation requirement for brokers and dealers
under Exchange Act Rule 17a-4(b)(4),\68\ the staff of the Commission
believes that any additional costs to preserve the records of the
certifications required by the regulation would be minimal.
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\68\ OMB Control No. 3235-0279.
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Rule 500 of Regulation AC includes a definition of ``covered
person,'' which limits the scope of the regulation's application. Rule
504 of Regulation AC requires a broker-dealer to notify its associated
persons that issue research reports as to whether associated persons
would meet the definition of ``covered persons'' under Regulation AC,
and, therefore, be subject to the rule. Specifically, the broker-dealer
must inform its associated persons whether the broker or dealer
maintains and enforces written policies and procedures reasonably
designed to prevent the broker or dealer or any of its controlling
persons, officers, or employees from influencing the activities of
research analysts and the content of research reports prepared by
associated persons. Broker-dealers must also inform its associated
persons whether associated persons have any officers or employees in
common with the broker or dealer who can influence the activities of
research analysts or the content of research reports and, if so, the
identity of those persons.
The staff has not obtained data on the amount of time it would take
for broker-dealers to make the necessary determinations and to draft
and provide the notification required under Rule 504 of Regulation AC.
For PRA purposes, the below calculations represent the staff's
estimates of the amount of time that would be required for broker-
dealers to comply with Rule 504. The staff estimates that there are
approximately 2,650 investment advisers that are associated with at
least one broker-dealer. The staff estimates that it would take
approximately one hour per year for each of the approximately 2,650
broker-dealers to determine whether it maintains and enforces written
policies and procedures reasonably designed to prevent the broker or
dealer or any of its controlling persons, officers, or employees from
influencing the activities of research analysts and the content of
research reports prepared by associated persons. The staff estimates
that it would take approximately thirty minutes per year for each
broker-dealer to determine whether its associated persons have any
officers or employees in common with the broker or dealer who can
influence the activities of research analysts or the content of
research reports and, if so, the identity of those persons.\69\
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\69\ Broker-dealers should already have mechanisms in place to
determine whether such persons exist and, if so, the identity of
those persons because of NASD Rule 3030. See NASD Rule 3030.
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The staff estimates that it would take fifteen minutes per year for
each broker-dealer to draft and provide the required notification to
its associated persons. The Commission staff expects that a compliance
officer will likely be the employee primarily charged with making the
necessary determinations, and drafting and providing the required
notification. According to industry sources, in 2002, compliance
officers,
[[Page 9490]]
on average, earned approximately $82.00/per hour. Including 35%
overhead, Commission staff estimates that the hourly pay rate for a
compliance officer would be $110.70 per hour. Therefore, the Commission
estimates that the annual burden for broker-dealers in hours of
complying with the notification requirements would be approximately
4,638 hours ([2,650 x 105 minutes)/60]. The staff estimates that the
annual burden for broker-dealers of complying with the notification
requirements in dollars would be approximately $513,427.00 (4,638 hours
x $110.70).
Therefore, the Commission estimates that the regulation would
result in a total annual burden in hours of approximately 38,954 hours
(22,930 hours for broker-dealers to comply with the research report
requirements + 11,040 hours for investment advisers to comply with the
research report requirements + 346 hours for broker-dealers to comply
with the public appearance requirements + 4,638 hours for broker-
dealers to comply with the notification requirements), for a total
annual cost in dollars of approximately $4,682,821 ($2,785,995 for
broker-dealers to comply with the research report requirements +
$1,341,360 for investment advisers to comply with research the report
requirements + $42,039 for broker-dealers to comply with the public
appearance requirements + $513,427 for broker-dealers to comply with
the notification requirements).
IV. Costs and Benefits of Adopted Regulation Analyst Certification
To assist the Commission in evaluating the costs and benefits that
may result from adopting Regulation AC, the Commission sought comment
on any potential costs, as well as any potential benefits, resulting
from the proposal for investors, issuers, broker-dealers, other
securities industry professionals, SROs, or others. The Commission also
requested that commenters provide analysis and data to support their
views. Regulation AC is part of an ongoing process by the Commission to
address conflicts of interest affecting the production and
dissemination of research by securities firms, and to provide increased
disclosure to investors. Regulation AC includes a requirement that
broker-dealers and covered persons include in research reports they
publish certain certifications and disclosures about the analyst's
views expressed in the research reports and any relationship between
the analyst's compensation and the specific recommendations or views
expressed. Regulation AC would also require broker-dealers to make,
keep, and maintain records of research analyst certifications and
disclosures in connection with public appearances. We are sensitive to
the costs and benefits that result from our rules. The Commission
initially identified certain costs and benefits relating to the
proposals and encouraged commenters to discuss any additional costs or
benefits. We discuss these costs and benefits below.
A. Costs
The Commission received letters from twenty-one commenters
concerning Regulation AC. Only one commenter provided actual data to
quantify the costs identified. This commenter believed that the
estimates set forth in the proposing release were low primarily because
the estimated number of research reports per year did not capture,
among other things, reports by investment advisers and certain full-
text reports.\70\ The Commission modified its estimates in response to
these comments.
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\70\ See Thomson Financial.
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The Commission also requested comment on how many public appearance
certifications would likely be submitted to brokerage firms per
quarter, and how many of those statements would be required to be
provided to the firm's examining authority. One commenter believed that
the estimate of the number of public appearances was too low, but did
not provide specific data in support of its views.\71\
---------------------------------------------------------------------------
\71\ Id.
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While Regulation AC may lead to some additional costs for brokers,
dealers, and covered persons, we continue to believe that any costs
should not be significant. In light of current requirements for broker-
dealers under SRO rules, the Commission estimates that, beyond the
paperwork costs described above, any additional costs to broker-dealers
that would result from the required certifications and disclosures
would be minimal. In the Proposing Release, the staff estimated that
broker-dealers publish approximately 657,000 research reports per year.
One commenter provided information that suggests that broker-dealers
publish as many as 1,375,865 research reports per year.\72\ Given the
refined scope of Regulation AC, the staff believes that these two
estimates represent a reasonable range with which to estimate research
reports affected by the rule. Accordingly, the Commission estimates the
total direct costs to be approximately $2.5 million to $4.7
million.\73\ In addition, because the rule is minimally burdensome, the
Commission believes that, beyond the paperwork costs described above,
any additional costs to associated persons that would result from
certifications and disclosures would be minimal.
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\72\ See Thomson Financial and footnote 63 for a discussion of
revisions to the original estimate.
\73\ The total burden range of approximately $2.5 million to
$4.7 million is obtained by applying both the low and the high
research report estimates. Costs are proportionate to the number of
research reports assumed to be issued each year. For purposes of the
Paperwork Reduction Act analysis, we used the estimate of 1,375,865
research reports to obtain the high end of the burden range. If we
instead substitute the low estimate of 657,000 research reports in
place of the high estimate, the low end of the burden range is
approximately $2.5 million. The low research report estimate is
approximately 48% of the high estimate and the resulting total
annual cost burden is approximately $2.5 million ($1,337,278 for
broker-dealers to comply with the research report requirements +
$643,853 for investment advisers to comply with the research report
requirements + $42,039 for broker-dealers to comply with the public
appearance requirements + $513,427 for broker-dealers to comply with
the notification requirements = $2,536,596).
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Moreover, with respect to the compensation certifications and
disclosures that are required by Regulation AC, broker-dealers are
already required to make certain disclosures regarding research analyst
compensation under SRO rules. For example, SRO rules currently require
that firms disclose in research reports if the associated person
preparing the report received compensation that is based upon (among
other factors) the member's overall investment banking revenues.\74\
Further, SRO rules prohibit members from offering favorable research to
a company as consideration or inducement for the receipt of business or
for compensation.\75\ Additionally, Exchange Act Rule 17a-3(a)(19)
currently requires broker-dealers to maintain a record of all
agreements pertaining to the relationship between each associated
person and the broker-dealer, including a summary of each associated
person's compensation arrangement or plan.
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\74\ NASD 2711(h)(2)(A)(i); NYSE 472(k)(2).
\75\ NASD Rule 2711(e); NYSE Rule 472(g).
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In response to commenters' concerns, we modified the proposed rule
text to include a definition of ``covered person,'' which limits the
scope of the regulation's application. Rule 504 of Regulation AC
requires broker-dealers to notify its associated persons that issue
research reports as to whether the broker-dealer maintains and enforces
written policies and procedures reasonably designed to prevent the
broker or dealer or any of its controlling
[[Page 9491]]
persons, officers, or employees from influencing the activities of
research analysts and the content of research reports prepared by the
associated person, and to inform associated persons as to whether the
associated person has any officers (or persons performing similar
functions) or employees in common with the broker or dealer who can
influence the activities of research analysts or the content of
research reports and, if so, the identity of those persons. Broker-
dealers may incur costs in providing this notification to each of its
associated persons. As noted previously, the staff estimates that the
paperwork costs for broker-dealers of complying with the notification
requirements in dollars would be approximately $513,427.00. Any
additional costs should not be significant in part because associated
persons of an SRO member are required under SRO rules to provide prompt
notice to his or her employer of employment with any other persons as a
result of a business activity.\76\
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\76\ See NASD Rule 3030.
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With respect to public appearances, current SRO rules require
analysts to make certain disclosures during public appearances, such as
the member's or the analyst's ownership interests in the subject
company. SRO rules also require analysts to disclose any other actual,
material conflict of interest of which the research analyst knows, or
has reason to know, at the time of the public appearance.\77\
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\77\ NASD Rule 2711(h); NYSE 472(k)(1).
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Broker-dealers should already have in place procedures necessary to
comply with many components of Regulation AC due to existing
obligations under SRO rules, although these procedures might require
some minor modifications to conform with Regulation AC. As noted
previously, the Commission estimates that the annual paperwork costs in
dollars of complying with the regulation would be approximately
$4,682,821.
B. Benefits
We believe that investor confidence in the integrity of research
has suffered because there is evidence that, in some cases, research
analyst objectivity has been compromised due to, among other things,
analysts' personal compensation and firms' investment banking
relationships with issuers that are the subjects of research reports.
Requiring research analysts to certify that the views expressed in
research reports reflect their personal views, and requiring disclosure
of information regarding whether analyst compensation is related to the
specific recommendations made, should help bolster investor confidence
in the quality of research. This, in turn, should help increase
investor confidence in the securities markets.
The Commission requested comment on whether the certification and
disclosure requirements, if adopted, would promote investor confidence
in the views expressed by research analysts and provide investors with
useful information with which to evaluate potential biases. Ten
commenters expressed support for Regulation AC. Generally, these
commenters were of the view that Regulation AC would promote the
integrity of research and investor confidence.\78\ Three commenters did
not agree that Regulation AC would advance investor protection and/or
investor confidence to any significant degree.\79\
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\78\ See AIMR, CSFB, Goldman, ICAA, ICI, Merrill, SIA, SSB,
Schwab, and TBMA.
\79\ See David Norr, NASAA, and Thomson Financial.
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Regulation AC requires that broker-dealers and covered persons
include certifications in research reports regarding the truthfulness
of the views expressed in research reports and whether or not the
analyst received compensation in connection with his or her specific
recommendations or views. Many investors rely on the research reports
and recommendations provided by their brokers and covered persons. To
the extent that the Regulation AC requires disclosures that provide
more transparency than provided by current regulation, these
disclosures should provide investors with important information with
which to determine the value of the research available to them.\80\
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\80\ See Securities Exchange Act Release No. 45908 (May 10,
2002), 67 FR 34968 (May 16, 2002).
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Regulation AC may result in an increase in the overall quality of
the research available to the public because broker-dealers and covered
persons would be in violation of Regulation AC when issuing research
reports unless the reports include the required certifications and
disclosures. The requirement that the research analyst (or analysts)
primarily responsible for preparing the research report personally
certify that the views expressed in the report accurately reflect his
or her personal views creates an incentive for analysts to examine,
even more carefully, the basis and foundations for his or her
recommendations in preparing research reports.
Regulation AC may also result in an increase in the quality of
research because of competitive reasons. Firms that publish research
reports that do not contain certain analyst certifications will be in
violation of the regulation, and firms whose research analysts'
compensation is related to the specific recommendations or views
provided in research reports (to the extent allowed by SRO rules) may
lose some business to firms that are less conflicted. Regulation AC is
intended to enhance investor confidence in the integrity of the
research available to them. We believe that by requiring research
analysts to certify as to the truthfulness of the views expressed in
research reports, investor confidence in the securities markets should
be enhanced, thereby leading to the benefit of more liquid and
efficient markets. The Commission does not have data to quantify the
value of the benefits described above. The Commission requested, but
did not receive, comment on how it may quantify these benefits. The
Commission also requested, but did not receive, comment concerning any
benefits, not already identified, that may result from the adoption of
Regulation AC.
V. Regulatory Flexibility Act Certification
Pursuant to section 605(b) of the Regulatory Flexibility Act,\81\
the Commission certified that Regulation AC will not have a significant
economic impact on a substantial number of small entities. This
certification, including the reasons supporting the certification, were
set forth in the Proposing Release.
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\81\ 5 U.S.C. 605(b).
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The Commission solicited comments on the potential impact of
Regulation AC on small entities in the Proposal. No comments were
received that discussed the Regulatory Flexibility Act Certification.
However, in response to other comments, the Commission has revised its
estimates and believes that the total burden in hours required to
comply with proposed Regulation AC would be approximately 5.78 hours
per year, per small firm, as compared to the original estimate of two
hours and two minutes per year, per small firm.
VI. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition and Capital Formation
Section 3(f) of the Exchange Act \82\ requires us, when engaging in
rulemaking where we are required to consider or determine whether an
action is necessary or appropriate in the public interest, to consider
whether the action will promote efficiency, competition,
[[Page 9492]]
and capital formation. In addition, section 23(a)(2) \83\ of the
Exchange Act requires the Commission to consider the impact any rule
would have on competition. Further, the law requires that the
Commission not adopt any rule that would impose a burden on competition
not necessary or appropriate in furtherance of the purposes of the
Exchange Act.
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\82\ 15 U.S.C. section 78c(f).
\83\ 15 U.S.C. section 78w(a)(2).
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In the Proposing Release, the Commission solicited comment on the
proposal's effect on competition, efficiency, and capital formation.
Three commenters believed that Regulation AC would impose an
inappropriate burden on competition.\84\ One commenter asserted that
the scope of Regulation AC was overly broad and would apply
unnecessarily to, and be an onerous burden on, broker-dealer firms that
are not subject to the conflicts the regulation is designed to
address.\85\ Another commenter asserted that Regulation AC may serve as
a barrier to entry and an impediment to competition for firms seeking
to provide an alternative to sell-side research.\86\
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\84\ See Alliance, Investorside, and Thomson Financial.
\85\ See Alliance.
\86\ See Investorside.
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Regulation AC is intended to enhance investor confidence in the
integrity of the research available to them. Further, we have modified
the rule from the proposal and have limited the scope of its
application. We believe that requiring broker-dealers and covered
persons to include analyst certifications in research reports, as well
as the other disclosures required by Regulation AC, should enhance
investor confidence in the securities markets, thereby leading to a
more efficient market.
The Commission has considered Regulation AC in light of the
standards in section 23(a)(2) and believes that it would not impose any
burden on competition not necessary or appropriate in furtherance of
the purposes of the Exchange Act. As discussed above in the Cost-
Benefit section, the Commission recognizes that Regulation AC may lead
to some additional costs for broker-dealers and covered persons. On
balance, we think that the application of Regulation AC is tailored to
those situations where the conflicts are most likely to affect
research. As such, we do not believe that the rule would create an
unreasonable burden on competition. Further, we believe that providing
the benefits that will result from the rule in those conflict-laden
situations will further the purposes of the rule, including enhancing
investor confidence in the market, thereby leading to a more efficient
market.
VII. Statutory Authority
Regulation AC is being adopted pursuant to sections 3, 15, 17, and
23 of the Exchange Act and pursuant to sections 17 and 19 of the
Securities Act.
Text of the Rule
List of Subjects in 17 CFR Part 242
Brokers, Securities.
For the reasons set out in the preamble, Title 17, Chapter II, of
the Code of Federal Regulations is amended as follows.
PART 242--REGULATIONS M, ATS, AND AC AND CUSTOMER MARGIN
REQUIREMENTS FOR SECURITY FUTURES
1. The authority citation for part 242 continues to be read as
follows:
Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2),
78i(a), 78j, 78k-1(c), 78l, 78m, 78mm, 78n, 78o(b), 78o(c), 78o(g),
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 80a-23, 80a-29, and 80a-37.
2. The part heading for part 242 is revised as set forth above.
3. Part 242 is amended by adding Regulation AC, Sec. Sec. 242.500
through 242.505 to read as follows:
Sec.
242.500 Definitions.
242.501 Certifications in connection with research reports.
242.502 Certifications in connection with public appearances.
242.503 Certain foreign research reports.
242.504 Notification to associated persons.
242.505 Exclusion for news media.
Regulation AC--Analyst Certification
Sec. 242.500 Definitions.
For purposes of Regulation AC (Sec. Sec. 242.500 through 242.505
of this chapter) the term:
Covered person of a broker or dealer means an associated person of
that broker or dealer but does not include:
(1) An associated person:
(i) If the associated person has no officers (or persons performing
similar functions) or employees in common with the broker or dealer who
can influence the activities of research analysts or the content of
research reports; and
(ii) If the broker or dealer maintains and enforces written
policies and procedures reasonably designed to prevent the broker or
dealer, any controlling persons, officers (or persons performing
similar functions), and employees of the broker or dealer from
influencing the activities of research analysts and the content of
research reports prepared by the associated person.
(2) An associated person who is an investment adviser:
(i) Not registered with the Commission as an investment adviser
because of the prohibition of section 203A of the Investment Advisers
Act of 1940 (15 U.S.C. 80b-3a); and
(ii) Not registered or required to be registered with the
Commission as a broker or dealer.
Note to definition of covered person: An associated person of a
broker or dealer who is not a covered person continues to be subject
to the federal securities laws, including the anti-fraud provisions
of the federal securities laws.
Foreign person means any person who is not a U.S. person.
Foreign security means a security issued by a foreign issuer for
which a U.S. market is not the principal trading market.
Public appearance means any participation by a research analyst in
a seminar, forum (including an interactive electronic forum), or radio
or television or other interview, in which the research analyst makes a
specific recommendation or provides information reasonably sufficient
upon which to base an investment decision about a security or an
issuer.
Registered broker or dealer means a broker or dealer registered or
required to register pursuant to section 15 or section 15B of the
Securities Exchange Act of 1934 (15 U.S.C. 78o or 78o-4) or a
government securities broker or government securities dealer registered
or required to register pursuant to section 15C(a)(1)(A) of the
Securities Exchange Act of 1934 (15 U.S.C. 78o-5(a)(1)(A)).
Research analyst means any natural person who is primarily
responsible for the preparation of the content of a research report.
Research report means a written communication (including an
electronic communication) that includes an analysis of a security or an
issuer and provides information reasonably sufficient upon which to
base an investment decision.
Third party research analyst means:
(1) With respect to a broker or dealer, any research analyst not
employed by that broker or dealer or any associated person of that
broker or dealer; and
(2) With respect to a covered person of a broker or dealer, any
research analyst not employed by that covered person, by the broker or
dealer with whom that covered person is associated,
[[Page 9493]]
or by any other associated person of the broker or dealer with whom
that covered person is associated.
United States has the meaning contained in Sec. 230.902(l) of this
chapter.
U.S. person has the meaning contained in Sec. 230.902(k) of this
chapter.
Sec. 242.501 Certifications in connection with research reports.
(a) A broker or dealer or covered person that publishes,
circulates, or provides a research report prepared by a research
analyst to a U.S. person in the United States shall include in that
research report a clear and prominent certification by the research
analyst containing the following:
(1) A statement attesting that all of the views expressed in the
research report accurately reflect the research analyst's personal
views about any and all of the subject securities or issuers; and
(2)(i) A statement attesting that no part of the research analyst's
compensation was, is, or will be, directly or indirectly, related to
the specific recommendations or views expressed by the research analyst
in the research report; or
(ii) A statement:
(A) Attesting that part or all of the research analyst's
compensation was, is, or will be, directly or indirectly, related to
the specific recommendations or views expressed by the research analyst
in the research report;
(B) Identifying the source, amount, and purpose of such
compensation; and
(C) Further disclosing that the compensation could influence the
recommendations or views expressed in the research report.
(b) A broker or dealer or covered person that publishes,
circulates, or provides a research report prepared by a third party
research analyst to a U.S. person in the United States shall be exempt
from the requirements of this section with respect to such research
report if the following conditions are satisfied:
(1) The employer of the third party research analyst has no
officers (or persons performing similar functions) or employees in
common with the broker or dealer or covered person; and
(2) The broker or dealer (or, with respect to a covered person, the
broker or dealer with whom the covered person is associated) maintains
and enforces written policies and procedures reasonably designed to
prevent the broker or dealer, any controlling persons, officers (or
persons performing similar functions), and employees of the broker or
dealer from influencing the activities of the third party research
analyst and the content of research reports prepared by the third party
research analyst.
Sec. 242.502 Certifications in connection with public appearances.
(a) If a broker or dealer publishes, circulates, or provides a
research report prepared by a research analyst employed by the broker
or dealer or covered person to a U.S. person in the United States, the
broker or dealer must make a record within 30 days after any calendar
quarter in which the research analyst made a public appearance that
contains the following:
(1) A statement by the research analyst attesting that the views
expressed by the research analyst in all public appearances during the
calendar quarter accurately reflected the research analyst's personal
views at that time about any and all of the subject securities or
issuers; and
(2) A statement by the research analyst attesting that no part of
the research analyst's compensation was, is, or will be, directly or
indirectly, related to the specific recommendations or views expressed
by the research analyst in such public appearances.
(b) If the broker or dealer does not obtain a statement by the
research analyst in accordance with paragraph (a) of this section:
(1) The broker or dealer shall promptly notify in writing its
examining authority, designated pursuant to section 17(d) of the
Securities Exchange Act of 1934 (15 U.S.C. 78q(d)) and Sec. 240.17d-2
of this chapter, that the research analyst did not provide the
certifications specified in paragraph (a) of this section; and
(2) For 120 days following notification pursuant to paragraph
(b)(1) of this section, the broker or dealer shall disclose in any
research report prepared by the research analyst and published,
circulated, or provided to a U.S. person in the United States that the
research analyst did not provide the certifications specified in
paragraph (a) of this section.
(c) In the case of a research analyst who is employed outside the
United States by a foreign person located outside the United States,
this section shall only apply to a public appearance while the research
analyst is physically present in the United States.
(d) A broker or dealer shall preserve the records specified in
paragraphs (a) and (b) of this section in accordance with Sec.
240.17a-4 of this chapter and for a period of not less than 3 years,
the first 2 years in an accessible place.
Sec. 242.503 Certain foreign research reports.
A foreign person, located outside the United States and not
associated with a registered broker or dealer, who prepares a research
report concerning a foreign security and provides it to a U.S. person
in the United States in accordance with the provisions of Sec.
240.15a-6(a)(2) of this chapter shall be exempt from the requirements
of this regulation.
Sec. 242.504 Notification to associated persons.
A broker or dealer shall notify any person with whom that broker or
dealer is associated who publishes, circulates, or provides research
reports:
(a) Whether the broker or dealer maintains and enforces written
policies and procedures reasonably designed to prevent the broker or
dealer, any controlling persons, officers (or persons performing
similar functions), or employees of the broker or dealer from
influencing the activities of research analysts and the content of
research reports prepared by the associated person; and
(b) Whether the associated person has any officers (or persons
performing similar functions) or employees in common with the broker or
dealer who can influence the activities of research analysts or the
content of research reports and, if so, the identity of those persons.
Sec. 242.505 Exclusion for news media.
No provision of this Regulation AC shall apply to any person who:
(a) Is the publisher of any bona fide newspaper, news magazine or
business or financial publication of general and regular circulation;
and
(b) Is not registered or required to be registered with the
Commission as a broker or dealer or investment adviser.
Dated: February 20, 2003.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-4576 Filed 2-26-03; 8:45 am]
BILLING CODE 8010-01-P