The Securities and Exchange Commission has approved amendments to the FINRA rules which govern equity research analysts.


The Securities and Exchange Commission has approved amendments to the FINRA rules which govern equity research analysts. The amendments largely retain and reorganize the core provisions of the existing FINRA rules and interpretations governing equity research conflicts of interest in the areas of prepublication review of research, research coverage decisions, supervision of research analysts, research budget determinations, analyst compensation, information barriers, retaliation against analysts, solicitation and marketing of investment banking transactions, promises of favorable research, prepublication review of research by the subject company, disclosures in research reports and public appearances, termination of research, and distribution of research reports. However, principal changes from existing regulations include:

  • reducing the quiet periods during which a broker-dealer that participated in an offering may not disseminate research from 40 or 25 days to a minimum of 10 days (following an IPO) and from 10 days to a minimum of three days (following a secondary offering), with no quiet periods applicable to emerging growth companies;
  • eliminating the 15-day quiet period before and after the expiration, waiver or termination of a lockup agreement with a company or its shareholders;
  • requiring broker-dealers to establish and maintain written procedures reasonably designed to address potential conflicts of interest arising from equity research;
  • prohibiting prepublication review of facts in research reports by investment banking personnel;
  • prohibiting research analysts and investment banking personnel from conducting joint due diligence for an issuer before underwriters for an offering are mandated;
  • expanding the duty to disclose material conflicts of interest in research reports to associated persons (such as supervisors) with the ability to influence the content of a research report;
  • expanding the exemption for firms with limited investment banking activity;
  • expanding the prohibition on retaliation from investment banking personnel to all employees;
  • modifying the rules governing trading activity by research personnel by replacing various prescriptive requirements with more flexible policies and procedures;
  • creating a new exemption from the analyst registration requirements for research reports produced by persons whose primary job function is something other than producing research;
  • clarifying circumstances when broker-dealers may issue differentiated research products to different customers; and
  • eliminating the annual attestation requirement for compliance with the research rules.

The equity research analyst rule amendments were proposed by FINRA in November 2014 and approved by the SEC in July 2015 following receipt and review of public comments. FINRA intends to announce the effective date of the rules in a Regulatory Notice no later than mid-September 2015 and has stated that the effective date should be no later than 180 days after publication of the Regulatory Notice announcing SEC approval.

Summary of principal changes to equity research rules

FINRA’s amendments to the equity research rules to a large extent codify and reorganize the existing rules and interpretations which govern equity research. However, the primary changes are summarized below.

Policies and procedures governing conflicts of interest

The amendments modify the structure of the equity analyst rules by first providing a new overarching provision requiring preparation of policies and procedures governing conflicts of interest and then including the familiar list of specific prohibitions and guidelines.

The new overarching provision requires broker-dealers to establish, maintain and enforce written policies and procedures reasonably designed to identify and effectively manage conflicts of interest related to (i) the preparation, content and distribution of equity research reports, (ii) public appearances by equity research analysts, and (iii) the interaction between research analysts and those outside the research department, including investment banking and sales and trading personnel of the broker-dealer, companies whose equity securities are the subject of a research report, and customers. The written policies and procedures must be reasonably designed to promote objective and reliable research that reflects the truly held opinions of research analysts and to prevent the use of research reports or research analysts to manipulate or condition the market or favor the interests of the firm or a current or prospective customer or class of customers.

FINRA’s proposing release noted that although the rules do not mandate physical separation between research and the investment banking department, “FINRA would expect such physical separation except in extraordinary circumstances where the costs are unreasonable due to a firm’s size and resource limitations. In those instances, a firm must implement written policies and procedures, including information barriers, to effectively achieve and monitor separation between research and investment banking personnel.”

Prepublication review of research reports

The amendments require that broker-dealers prohibit all forms of prepublication review, clearance or approval of research reports by investment banking services personnel, and do not allow prepublication factual review by investment banking services personnel. Under the prior equity research rules, investment banking services personnel had been permitted, subject to compliance with specified procedures, to review research reports prior to publication for factual accuracy and to identify any potential conflicts of interest.

Joint due diligence

FINRA’s newly articulated position for both debt and equity research is that research analysts may not perform due diligence in the presence of investment banking department personnel prior to the selection of underwriters by an issuer in connection with an investment banking services transaction. According to FINRA’s proposing release, “[o]nce the mandate has been awarded, FINRA believes joint due diligence may take place in accordance with appropriate written policies and procedures to guard against interactions to further the interests of the investment banking department. At that time, FINRA believes that the efficiencies of joint due diligence outweigh the risk of pressure on research analysts by investment banking.”

Quiet periods

The amendments significantly reduce the quiet periods during which broker-dealers may not publish or otherwise distribute research reports, and during which research analysts may not make public appearances related to a subject company, if the broker-dealer has acted as an underwriter or dealer for an initial public offering or a manager or co-manager for a secondary offering. Under the amended rules the applicable quiet periods are a minimum of 10 days following the date of an initial public offering, reduced from 40 days for a manager or co-manager and 25 days for other underwriters and dealers, and a minimum of three days following the date of a secondary offering, reduced from 10 days. The amendments also confirm that the quiet period restrictions for initial public offerings and secondary offerings do not apply to offerings by an emerging growth company. Existing exemptions remain for the effects of significant news or a significant event on the subject company, as well as for “actively traded securities” (as defined in Regulation M).

In addition, the amendments eliminate the provision that had prohibited broker-dealers from publishing or disseminating a research report, or making a public appearance regarding a subject company, 15 days prior to and 15 days after the expiration, termination or waiver of a lockup agreement entered into by the broker-dealer with the subject company or its shareholders that restricted the sale of securities by a subject company or its shareholders.

Retaliation against research analysts

The amendments provide that a broker-dealer must prohibit its employees from directly or indirectly retaliating or threatening to retaliate against equity research analysts due to adverse, negative or otherwise unfavorable research reporting or public appearances that may adversely affect the broker-dealer’s present or prospective business interests. FINRA’s prior equity analyst rules contained a similar prohibition but extended only to retaliation by investment banking personnel, rather than to all employees of the broker-dealer. FINRA’s proposing release notes that this provision “is not intended to limit a member’s authority to discipline or terminate a research analyst, in accordance with the member’s written policies and procedures, for any cause other than writing an adverse, negative, or otherwise unfavorable research report or for making similar comments during a public appearance.”

Personal trading by research analysts

The amendments significantly revise the rules which govern personal trading by research analysts. Both the old and new rules prohibit research analysts from purchasing or selling securities in a manner contrary to their most recent recommendations and from purchasing or receiving pre-IPO shares of an issuer if the issuer is principally engaged in the same types of business as companies followed by the research analyst. Under the old rules, specific blackout periods were established during which research analysts were not permitted to trade in securities (or derivatives of securities) of companies they covered.

Under the amended rules, rather than imposing specific blackout periods on analysts, broker-dealers must establish written policies and procedures that restrict or limit trading by a research analyst account2 in securities, any derivatives of such securities and funds whose performance is materially dependent on the performance of securities covered by the research analyst. Such policies and procedures must ensure that research analyst accounts, supervisors of research analysts and associated persons with the ability to influence the content of a research report do not benefit in their trading from knowledge of the content or timing of a research report before the intended recipients of such report have had a reasonable opportunity to act on the information in the research report.

Notwithstanding the foregoing, the amendments permit broker-dealers to adopt procedures which would allow research analysts in the case of “financial hardship circumstances” to trade securities of a subject company in a manner inconsistent with the most recent recommendation provided by the research analyst. The old rules required prior approval by the legal and compliance personnel before a research analyst could effect such trades.

The amendments also confirm that if a broker-dealer institutes a policy that prohibits a research analyst from holding securities (or options on or derivatives of such securities) of the companies in the analyst’s coverage universe and the analyst is required in accordance with this policy to sell securities, such analyst may sell such securities even if inconsistent with the analyst’s public recommendations so long as the broker-dealer establishes a reasonable plan to liquidate such holdings and such plan is approved by the legal or compliance department.

Attestation requirement

The amendments eliminate the annual attestation requirement for broker-dealers. Under the old rule, broker-dealers were required to adopt and implement written supervisory procedures reasonably designed to ensure compliance with certain of the research analyst rules and to have a senior officer of the broker-dealer attest annually that the firm had adopted and implemented such procedures.

Policies and procedures governing content of research reports

The amendments largely retain the existing content and disclosure requirements regarding equity research reports. However, the amendments add a new requirement that a broker-dealer establish, maintain and enforce written policies and procedures reasonably designed to ensure that facts included in research reports are based on reliable information and that recommendations, ratings or price targets included in a research report have a reasonable basis and are accompanied by a clear explanation of any valuation method used and a fair presentation of any attendant risks.

Catch-all disclosure in research reports

Under the old rules, in addition to a litany of required disclosures, a broker-dealer was required to disclose in research reports any other actual, material conflict of interest of the research analyst or broker-dealer that the research analyst preparing the report knew or had reason to know about. The amendments expand this catch-all obligation to require disclosure of any other material conflict of interest of the research analyst or the broker-dealer that the research analyst or any “associated person of the member with the ability to influence the content of a research report” knows or has a reason to know at the time of the publication or distribution of a research report. This is intended to cover conflicts of interest that, for example, only a supervisor or the head of research may be aware of.

Distribution of member research reports

The amendments provide additional guidance regarding selective, or tiered, dissemination of a firm’s research reports. The new rule requires broker-dealers to establish, maintain and enforce written policies and procedures reasonably designed to ensure that a research report is not distributed selectively to internal trading personnel or a particular customer or class of customers in advance of other customers that the firm has previously determined are entitled to receive the research report.

However, the amendments clarify that firms may provide different research products and services to different classes of customers, provided the products are not differentiated based on the timing of receipt of potentially market moving information and the firm discloses its research dissemination practices to all customers that receive a research product. For example:

A member may offer one research product for those with a long-term investment horizon (“investor research”) and a different research product for those customers with a short-term investment horizon (“trading research”). These products may lead to different recommendations or ratings, provided that each is consistent with the meaning of the member’s ratings system for each respective product. However, a member may not differentiate a research product based on the timing of receipt of a recommendation, rating or other potentially market moving information, nor may a member label a research product with substantially the same content as a different product as a means to allow certain customers to trade in advance of other customers. In addition, a member that provides different research products and services for different customers must inform its other customers that its alternative research products and services may reach different conclusions or recommendations that could impact the price of the equity security. Thus, for example, a member that offers trading research must inform its investment research customers that its trading research product may contain different recommendations or ratings that could result in short-term price movements contrary to the recommendation in its investment research.

FINRA’s proposing release cites as an example a firm which provides a “buy” rating for long-term investor research where it believes a stock will outperform the S&P 500 over the next 12 months and a “sell” rating for short-term trading research where it believes the stock will underperform its sector index over the next month. The firm could maintain the buy in investor research at the same time it had a sell in trading research on the same stock if the firm believed, for example, that the company would report an earnings shortfall soon that would lead to a short-term drop in price relative to the sector index, but that the stock would recover to outperform the S&P 500 over the next 12 months.

Exemption for firms with limited investment banking activity

The amendments expand the exemption for firms with limited investment banking activity. Under current rules, firms which over the previous three years, on average per year, have managed or co-managed 10 or fewer investment banking transactions and generated $5 million or less in gross revenues from these transactions, are exempt from the provisions that prohibit a research analyst from being subject to the supervision or control of an investment banking department employee and from the provisions regarding prepublication review of research by non-research personnel.

The amendment would further exempt broker-dealers with limited investment banking activity from (i) the provision that requires the compensation of a research analyst to be reviewed and approved by a committee that reports to the board, which committee may not have investment banking personnel, (ii) the provisions restricting or limiting research coverage decisions and budget determinations, and (iii) the requirement to establish information barriers to insulate research analysts from the review or oversight by investment banking personnel or other persons who may be biased in their judgment or supervision. However, such firms are still required to establish, maintain and enforce written policies and procedures reasonably designed to ensure that research analysts are insulated from pressure by investment banking and other non-research personnel who might be biased in their judgment or supervision.