FINRA has issued a request for comments (FRN 11-11) on a concept proposal for a rule to identify and manage conflicts of interest involving the preparation and distribution of debt research reports. The proposal is the result of a determination by FINRA staff to engage in definitive rulemaking relating to debt research, in part as a result of observations of increased risk to retail investors from complex debt securities, citing as an example allegations of misconduct in the auction rate securities (“ARS”) market.
NASD Rule 2711 regulates the preparation and distribution of research by member firms concerning equity securities, as defined in section 3(a)(11) of the Securities Exchange Act of 1934, but not of research concerning debt securities. FINRA notes that SEC Regulation AC, which requires certification of research by research analysts, applies to both equity and debt research. In a 2005 report on their respective research analyst rules, the NASD and NYSE Regulation, the predecessors to FINRA, indicated that they intended to monitor the extent to which member firms adopted the Guiding Principles of the Bond Market Association (now part of SIFMA) as applied to debt research. The NASD and NYSE Regulation subsequently found cases where member firms lacked any policies and procedures to manage debt research conflicts to comply with applicable SRO ethical and anti-fraud rules. Those findings were reported in Notice to Members 06-36.
Bifurcated Approach to Debt Securities
FINRA proposes to take a bifurcated approach to the regulation of debt research, depending on whether the research is provided to retail customers or only to institutional customers. In recognition of the fact that institutional customers often engage in transactions with member firms on a counterparty basis, rather than a customer basis, FINRA’s proposed approach would require disclosures only of a general nature to institutional customers (defined to mean the same as an “institutional account” for purposes of the FINRA suitability rule). Certain restrictions intended to prevent debt research personnel from being influenced by the investment banking and sales and trading departments would also apply to research provided to institutional customers. Institutional customers could elect to be treated like retail customers under the rule.
Under the proposed debt research rule, debt research provided to retail customers would be subject to all of the requirements applicable to equity research. In addition, the debt research rule would also address conflicts between the research department and sales and trading personnel, an area not currently covered by the equity research rule. FINRA notes that it does not envision proposing, with respect to debt research, the ban on research analysts receiving pre-IPO shares or the imposition of quiet periods around the issuance of research reports.
Request For Comments
FINRA has specifically requested comments on the application of bifurcated treatment, including whether the institution-only carve-out is likely to affect the availability of debt research to retail customers. However, comments on all aspects of the conceptual rule are invited. Comments are due by April 25, 2011.