[Federal Register Volume 70, Number 81 (Thursday, April 28, 2005)]
[Notices]
[Pages 22168-22170]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-2002]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51593; File Nos. SR-NYSE-2004-24; SR-NASD-2004-141]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Changes by the New York Stock Exchange, Inc., and the National 
Association of Securities Dealers, Inc., To Prohibit Participation by a 
Research Analyst in a Road Show Related to an Investment Banking 
Services Transaction and To Require Certain Communications About an 
Investment Banking Services Transaction To Be Fair, Balanced and Not 
Misleading

April 21, 2005.

I. Introduction

    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'' or ``Act'') \1\ and Rule 19b-4 thereunder,\2\ on 
April 22, 2004 the New York Stock Exchange (``NYSE'' or the 
``Exchange''), and on September 20, 2004, the National Association of 
Securities Dealers, Inc. (``NASD''), filed with the Securities and 
Exchange Commission (``SEC'' or ``Commission'') proposed rule changes 
including proposals to prohibit participation by a research analyst in 
a road show related to an investment banking services transaction and 
to require certain communications about an investment banking services 
transaction to be fair, balanced and not misleading. On February 11, 
2005, NYSE filed Amendment No. 1 to its proposed rule change, which 
replaced the original rule filing in its entirety. On February 4, 2005, 
NASD filed Amendment No. 1 to its proposed rule change, which replaced 
the original rule filing in its entirety.\3\ The proposed rule changes, 
as amended, were published for comment in the Federal Register on March 
17, 2005.\4\ The comment period expired on April 7, 2005. The 
Commission received one comment letter in response to the Notice, which 
supported the proposed rule changes.\5\ This order approves the 
proposed rule changes, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ On March 9, 2005, NASD filed with the Commission Amendment 
No. 2 to its proposed rule change, which clarified that Amendment 
No. 1 replaced the original filing in its entirety.
    \4\ See Securities Exchange Act Release No. 51358 (March 10, 
2005), 70 FR 13061 (the ``Notice'').
    \5\ See Letter to Jonathan G. Katz, Secretary, Commission, from 
the Ohio Public Employees Retirement System (April 1, 2005).
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II. Background

    On May 10, 2002, the Commission approved rule changes filed by the 
NYSE and NASD (the ``SROs'') governing research analyst conflicts of 
interest.\6\ Those rules took considerable steps towards promoting 
greater independence of research analysts and significantly enhanced 
the disclosure of actual and potential conflicts of interest to 
investors.
    On July 30, 2002, President Bush signed into law the Sarbanes-Oxley 
Act of 2002 (``SOA''), which required, among other things, that the 
Commission, or upon authorization and direction of the Commission, a 
registered securities association or national securities exchange, 
adopt rules governing analyst conflicts.\7\ Certain of the SOA's 
mandates were satisfied by NASD and NYSE rule provisions existing at 
the time of the enactment of the SOA. Other of the SOA's mandates 
necessitated amendments to the then existing rules. Thus, the 
Commission directed the NASD and NYSE to amend their analyst conflicts 
rules to fulfill the mandates of the SOA.\8\ The Commission approved 
these rules on July 29, 2003.\9\
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    \6\ See Securities Exchange Act Release No. 45908, 67 FR 34968 
(May 16, 2002) (the ``Round I'' rules).
    \7\ See Pub. L. 107-204, 116 Stat. 745 (2002). The SOA amended 
the Exchange Act by adding Section 15D. See 15 U.S.C. 78a et seq.; 
15 U.S.C. 78o-6.
    \8\ See Letter from Annette Nazareth, Director, Division of 
Market Regulation, Commission, to Mary Schapiro, Vice Chairman and 
President, Regulatory Policy and Oversight, NASD, and Richard 
Grasso, Chairman and Chief Executive Officer, NYSE (March 13, 2003).
    \9\ See Securities Exchange Act Release No. 48252, 68 FR 45875 
(August 4, 2003) (the ``Round II'' rules).
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    In the order approving the Round I rules, the Commission directed 
the SROs to prepare a report on the operation and effectiveness of the 
rules by November, 2003. The Commission later postponed requiring the 
SROs to submit the report in light of the SOA and the approval of the 
Round II rules.\10\ The Round II rules have now been fully implemented 
since April 26, 2004 and the SROs have been instructed to jointly 
submit a report on the operation and effectiveness of all of the 
analyst rules by November 4, 2005.\11\ It is possible that the report 
may indicate additional areas for rulemaking.
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    \10\ Id.
    \11\ See Letter from Annette Nazareth, Director, Division of 
Market Regulation, Commission, to Mary Schapiro, Vice Chairman and 
President, Regulatory Policy and Oversight, NASD, and Richard 
Ketchum, Chief Regulatory Officer, NYSE (April 8, 2005).
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    On April 28, 2003, the Commission, along with other regulators, 
announced a global settlement of enforcement actions against certain 
investment firms that followed joint investigations by regulators of 
allegations of undue influence of investment banking interests on 
securities research at brokerage firms.\12\ The Global Settlement was 
approved by the court on October 31, 2003. On September 24, 2004, the 
court approved amendments to the Global Settlement, which, among other 
things, amended the Addendum to provide additional, more specific 
guidelines relating to analyst communications with members of a 
settling firm's sales force and prospective investors in the context of 
certain investment banking transactions, and were intended to avoid 
research analysts becoming, or being perceived as, part of the 
investment banking team or otherwise promoting a particular 
transaction.\13\
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    \12\ The terms of the settlement are available at http://www.sec.gov/litigation/litreleases/finaljudgadda.pdf (``Global 
Settlement'').
    \13\ The SROs note that the proposed rule changes are similar in 
certain aspects to provisions found in the Global Settlement. The 
SROs have stated that the proposed rule changes have not been 
proposed for the purpose of conforming to the Global Settlement, or 
addressing differences between the Global Settlement and SRO rules. 
Rather, the SROs believe that the proposed rules are appropriate in 
that they would facilitate the goal of more objective and reliable 
research.
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A. Current NYSE and NASD Rules Governing Disclosure of Conflicts of 
Interest

    The SROs' research analyst conflicts of interest rules were 
designed to foster greater public confidence in securities research and 
to protect the objectivity and independence of securities analysts.

[[Page 22169]]

The rules contain a number of elements, including:
     Structural reforms to increase analyst independence, 
including a prohibition on investment banking personnel supervising 
analysts or approving research reports and limiting the compensatory 
evaluation of analysts to officials employed by the broker or dealer 
who are not engaged in investment banking activities;
     A prohibition on tying analyst compensation to a specific 
investment banking services transaction;
     Restrictions on personal trading by analysts;
     A prohibition on retaliation by members and employees of 
members involved with investment banking activities against analysts as 
a result of an adverse, negative, or otherwise unfavorable research 
report or public appearance; and
     A prohibition on offering favorable research to induce 
investment banking business.

B. Proposed Changes to NYSE and NASD Rules

    The proposed SRO rule changes further define the types of 
communications that are inappropriate for research analysts and 
investment banking personnel. Thus the rules further insulate analysts 
from investment banking pressure, thereby promoting the integrity of, 
not only research reports and public appearances, but all 
communications by research analysts to customers as well as internal 
personnel. The Commission provides here a general overview of the 
proposed rule changes.
    First, the proposals would prohibit a research analyst from 
directly or indirectly participating in a road show related to an 
investment banking services transaction, or otherwise communicating 
with customers in the presence of investment banking personnel or 
company management about an investment banking services transaction. 
Therefore, such ``three-way'' communications between research, 
customers and banking, as well as those involving research, customers 
and issuers, are prohibited.
    Second, the proposals would prohibit investment banking personnel 
from directly or indirectly directing a research analyst to engage in 
sales and marketing efforts or other communications with a current or 
prospective customer related to an investment banking services 
transaction.
    Finally, the proposals would require that research analyst written 
and oral communications relating to an investment banking services 
transaction with a current or prospective customer or with internal 
personnel, must be fair, balanced and not misleading, taking into 
consideration the overall context in which the communication is made. 
Thus, the proposals preserve the ability of research analysts to 
educate investors and internal personnel about investment banking 
services transactions, provided such communications are fair, balanced 
and not misleading, considering the overall context in which the 
communication is made.

III. Discussion

    The Commission received one comment letter on the proposed rule 
changes, which supported the approval of the proposals. After careful 
review, the Commission finds, as discussed more fully below, that the 
proposed rule changes, as amended, are consistent with the requirements 
of the Exchange Act and the rules and regulations thereunder applicable 
to the NYSE and NASD.\14\ In particular, the Commission believes that 
the proposals are consistent with Sections 6(b)(5) and 6(b)(8) of the 
Exchange Act,\15\ and Sections 15A(b)(6) and 15A(b)(9) of the Exchange 
Act.\16\
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    \14\ See 15 U.S.C. 78c(f).
    \15\ 15 U.S.C. 78f(b)(5) and (b)(8).
    \16\ 15 U.S.C. 78o-3(b)(6) and (b)(9).
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    Section 6(b)(5) requires, among other things, that the rules of an 
exchange be designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of free trade, to 
remove impediments to and perfect the mechanism of a free and open 
market, and to protect investors and the public interest. Section 
6(b)(5) also requires that the rules of an exchange not be designed to 
permit unfair discrimination between customers, issuers, brokers, or 
dealers. Section 6(b)(8) of the Exchange Act prohibits the rules of an 
exchange from imposing any burden on competition not necessary or 
appropriate in furtherance of the purposes of the statute.
    Section 15A(b)(6) requires that the rules of a registered national 
securities association be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, to foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, and, in general, to 
protect investors and the public interest. Section 15A(b)(9) requires 
that the rules of an association not impose any burden on competition 
that is not necessary or appropriate in furtherance of the purposes of 
the Exchange Act.
    Section 3(f) of the Exchange Act directs the Commission to 
consider, in addition to the protection of investors, whether approval 
of a rule change will promote efficiency, competition, and capital 
formation.\17\ In approving the proposed rule changes, the Commission 
has considered their impact on efficiency, competition, and capital 
formation.
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    \17\ 15 U.S.C. 78c(f).
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    The Commission believes the rule changes, as amended, promote the 
independence of research analysts and the objectivity of the views 
analysts communicate to customers and internal personnel.

A. Prohibition on Research Analyst Participation in Road Shows and 
Certain Three-Way Communications [NASD Rule 2711(c)(5) and NYSE Rule 
472(b)(6)(i)]

    The proposals prohibit research analysts from participating in road 
shows related to investment banking services transactions, or otherwise 
communicating with customers in the presence of investment banking 
personnel or company management about an investment banking services 
transaction.
    NASD believes that by prohibiting research analyst participation in 
road shows, the proposed rule change will further reduce the pressure 
on research analysts to give an overly optimistic assessment of a 
particular transaction. Further, NYSE believes that the proposed 
provisions to prohibit analysts from engaging in any communication 
regarding investment banking services with current or prospective 
customers in the presence of investment banking personnel or company 
management also will reduce the pressure on research analysts to give 
overly optimistic assessments of investment banking services 
transactions.
    We believe that it is appropriate that the SROs prohibit research 
analysts from participating in road shows, as well as from engaging in 
communications with investors in the presence of investment banking 
personnel or issuer management. In addition, we believe that the 
prohibition on research analyst communications with customers in the 
presence of investment banking or company management will guard against 
research analysts being, or being perceived as, part of the sales and 
marketing team for

[[Page 22170]]

a transaction, rather than as independent sources of information.
    We also note that the Round II rules included a prohibition on 
research analyst involvement in efforts to solicit investment banking, 
which were designed to further the goals of research objectivity and 
investor confidence by eliminating all participation by research 
analysts in solicitation efforts, which could suggest a promise of 
favorable research in exchange for underwriting business.
    Likewise, the proposed prohibition on research analyst 
participation in road shows would seek to provide for greater analyst 
objectivity and guard against analysts becoming part of the investment 
banking team for a transaction. The Commission finds that the rule 
changes to prohibit research analyst involvement in road shows related 
to investment banking transactions and three way communications between 
research, customers, and issuers or investment banking personnel, are 
consistent with the Exchange Act, particularly Sections 6(b)(5), 
6(b)(8), 15A(b)(6), and 15A(b)(9).

B. Investment Banking Directed Communications With Customers [NASD Rule 
2711(c)(6) and NYSE Rule 472(b)(6)(ii)]

    The proposals would prohibit investment banking department 
personnel from directing a research analyst to engage in sales or 
marketing efforts and any other communication with a current or 
prospective customer about an investment banking services transaction.
    NASD believes this proposal is important to eliminate attempts by 
investment banking personnel to pressure a research analyst to engage 
in communications related to an investment banking services 
transaction, thereby further insulating research analysts from 
influences that could affect their objectivity. Further, the NYSE 
believes the proposal preserves the traditional function of research 
analysts (providing analysis of securities and transactions), while 
placing further limitations on the ability of investment banking 
personnel to influence and/or compromise the objectivity of research 
analyst analyses. The NYSE believes that it is important for investor 
protection that research analyst views be objective, unbiased, and not 
the result of pressure on an analyst.
    The Commission believes it is appropriate for the SROs to prohibit 
investment banking personnel from directing research analysts to engage 
in sales and marketing efforts or to engage in customer communications 
relating to an investment banking services transaction. We believe that 
these provisions will further insulate research analysts from 
investment baking pressure by cutting off the ability of investment 
banking personnel to directly, or indirectly (e.g. through other 
parties), direct research analysts to engage in sales or marketing 
efforts, or otherwise communicate with customers about a transaction. 
Thus, we believe the proposals would promote analyst objectivity and 
independence and find that the proposed rules are consistent with the 
Exchange Act, particularly Sections 6(b)(5), 6(b)(8), 15A(b)(6), and 
15A(b)(9).

C. Fair and Balanced Requirement [NASD Rule 2711(c)(7) and NYSE Rule 
472(b)(6)(iii)]

    The proposed rule changes require that all research analyst 
communications (written and oral) with current or prospective customers 
or with internal personnel relating to an investment banking services 
transaction, must be fair, balanced and not misleading, taking into 
consideration the overall context in which the communications are made.
    NASD believes that the primary role of a research analyst is to 
provide unbiased analysis of companies and transactions and to value 
securities accurately. Therefore, NASD and NYSE note that the proposed 
rule changes permit research analysts to educate investors and member 
personnel about investment banking services transactions, so long as 
such permissible communications to investors and internal personnel are 
fair, balanced and not misleading, taking into account the overall 
context in which such communications are made. Thus, NYSE notes that, 
while the proposed rule should insulate research analysts from 
potential undue influence of investment bankers and company management, 
it would not interfere with legitimate activities.
    The Commission believes that the SRO proposals are designed to 
promote the objectivity and independence of research analysts by 
explicitly requiring that all research analyst written and oral 
communications with customers, as well as with internal firm personnel, 
must be fair, balanced and not misleading, considering the context of 
the communications. These requirements build on existing SRO standards 
for research analyst communications with the public and provide 
additional safeguards for research communications with personnel within 
the broker-dealer.\18\ The Commission further believes that the SROs' 
determination to require that such communications be fair, balanced and 
not misleading is consistent with Sections 6(b)(5), 6(b)(8), 15A(b)(6) 
and 15A(b)(9).
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    \18\ See NASD Rule 2210 (``Communications with the Public'') and 
NYSE Rule 472 (``Communications with the Public'').
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D. Implementation

    The SROs suggest that the proposed rule changes become effective 45 
days after approval by the Commission and the Commission believes that 
this is reasonable.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Exchange Act,\19\ that the proposed rule changes (SR-NYSE-2004-24; SR-
NASD 2004-141), as amended, are approved.
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    \19\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\20\
Margaret H. McFarland,
Deputy Secretary.
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    \20\ 17 CFR 200.30-3(a)(12).
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[FR Doc. E5-2002 Filed 4-27-05; 8:45 am]
BILLING CODE 8010-01-P