The Financial Industry Regulatory Authority has proposed and is requesting comment on a new rule, FINRA Rule 2240, that would govern research analyst conflicts of interest and would replace and, in various ways, amend current NASD and NYSE rules.1 Significantly, the proposed rule would relax current restrictions on the publication and distribution of research following an offering in which a member firm participates. Currently, NASD Rule 2711(f) and NYSE Rule 472(f) impose a “quiet period” during which a member firm participating in an offering cannot publish or distribute research reports about the issuer, and the firm's research analyst cannot make public appearances relating to the issuer. The current NASD and NYSE rules were initially enacted to address concerns about the significant influence of investment banking interests on the research being published by securities firms that became evident during the late 1990s.
The current quiet periods are as follows:
- 40 days following the date of the initial public offering for managers or co-managers and 25 days after the offering for other underwriters or dealers;
- 10 days following a follow-on offering; and
- 15 days before and after expiration, waiver or termination of a lock-up agreement.
Under the proposed rules, the quiet period would be a minimum of 10 days after an IPO for all managers, co-managers, underwriters and dealers. Follow-on offerings and lock-up expirations, waivers and terminations would no longer trigger a quiet period. Firms still would be required to comply with any additional quiet periods that are separately imposed by the federal securities laws. For example, underwriters may continue to maintain a longer quiet period for an IPO during the 25-day prospectus delivery period.2 While prohibitions would be eliminated for follow-on offerings and be shortened to end well within the 30-day period for most over-allotment options granted in the context of IPOs, firms may also consider revisiting their internal policies for maintaining a quiet period for research while an option to purchase additional securities is still unexercised.
As stated in the Regulatory Notice, FINRA has proposed these changes because it “believes that research issued during such periods potentially offers valuable market information, and the other provisions of the research rules and SEC Regulation AC provide sufficient protection that such research will honestly reflect the analyst’s beliefs and be free from other conflicts that would undermine the value or integrity of research issued during these periods.”
The proposed rule will not retain the exception that is currently incorporated in the existing NASD and NYSE rules for research responding to “significant news or events.” This may not be of much significance, though, given the limited scope of the proposed quiet period and the fact that many underwriters have generally been wary of relying on the exception in practice.
The rule if adopted could lead to changes in the standard lock-up agreement used in IPOs and follow-on equity offerings. Currently, lock-up periods granted by companies, selling shareholders, directors and officers in the context of underwritings are frequently extended so as not to result in a research quiet period if the company intends to release earnings results or if material news or a material event relating to the company occurs within 16 or 17 days of the expiration of the lock-up agreement.3 If the rule is enacted as proposed, it may lead to the elimination of such extension periods, which had been added following the enactment of the existing rules so that investment banks could publish research about earnings releases or material events at the time of a lock-up expiration, waiver or termination. These extensions would no longer be necessary given that lock-up expirations, waivers and terminations would no longer trigger a quiet period. Further, the general reluctance of underwriters to provide waivers or releases from lock-ups prior to their termination may also diminish as underwriters will not have to be concerned about such waiver or release leading to a black-out on research coverage by the underwriters participating in an offering.
The proposed elimination of the quiet period for follow-on offerings will have less of an impact on issuers with “actively-traded securities” within the meaning of Rule 101 of Regulation M (securities that have an average daily trading volume of at least $1 million and public float of at least $150 million),4 as the existing quiet period rules provide relief for the publication and distribution of research relating to such issuers.5
In addition to the changes to the quiet periods, the proposed rule would broaden the obligations on member firms to identify and manage research conflicts and require firms to establish, maintain and enforce general policies and procedures related to the preparation, content and distribution of research reports and public appearances by research analysts. The standards that firms are required to adopt in such policies and procedures largely maintain the existing proscriptions regarding research analyst conduct.
Comments on the proposed rule must be received by FINRA no later than November 14, 2008. Before becoming effective, a proposed rule must be authorized for filing with the SEC by the FINRA Board of Governors, and then must be approved by the SEC, following publication for public comment in the Federal Register.