April 18, 2002
BY INTERNET AND FIRST CLASS MAIL
Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 5th Street, N.W.
Washington, DC 20549-0609
Re: Proposed Rule Changes by the National Association of Securities Dealers, Inc. ("NASD") and the New York Stock Exchange, Inc. ("NYSE") Relating to Research Analyst Conflicts of Interest; File Nos. SR-NASD-2002-21 and SR-NYSE-2002-09
Dear Mr. Katz:
We appreciate this opportunity to comment on the proposed changes to NASD and NYSE rules relating to research analysts conflicts of interest, which the Securities and Exchange Commission ("SEC" or the "Commission") published for comment in Release No. 34-45526 on March 14, 2002. The NASD, through its wholly owned subsidiary NASD Regulation, Inc., proposes to adopt new NASD Rule 2711, entitled "Research Analysts and Research Reports," and the NYSE proposes to amend existing Rules 472 and 351, entitled "Communications with the Public" and "Reporting Requirements," respectively (collectively, the "Proposed Rules"). The Proposed Rules contain similar restrictions on the investment banking departments, research departments, and subject company relationships and communications of member firms, and impose additional disclosure requirements on members and their associated persons preparing research reports and making public appearances.
We believe that the Proposed Rules are written too broadly, and may be construed incorrectly to apply to research reports prepared by non-registered, foreign broker-dealers distributed to U.S. persons by NASD or NYSE member firms in accordance with Rule 15a-6 under the Securities Exchange Act of 1934, as amended (the "Exchange Act") and related SEC interpretations. This may have the effect of significantly curtailing access by U.S. investors to research prepared by foreign broker-dealers.
In addition, many jurisdictions and foreign self-regulatory organizations ("SROs") are presently addressing similar issues to those dealt with by the Proposed Rules.1 We believe that it is preferable for local SROs to address these issues for their member firms rather than having overlapping domestic and foreign rules apply to the same firm. Overlapping rules by U.S. and foreign SROs would create an unreasonable compliance burden and an inappropriate extra-territorial application of domestic SRO rules.
We do not believe that the NASD and the NYSE fully considered the international implications of the Proposed Rules. Therefore, we believe that the NASD and the NYSE should make clear that the Proposed Rules do not apply to foreign research distributed in accordance with Rule 15a-6 before such rules are approved by the Commission.
The Distribution of Foreign Research in the United States under Rule 15a-6
Rule 15a-6 under the Exchange Act provides conditional exemptions from U.S. registration for foreign broker-dealers that engage in certain direct and indirect activities involving U.S. investors and securities markets, including the provision of research to U.S. persons. One of the SEC's stated objectives in adopting Rule 15a-6 was "to facilitate access to foreign markets by U.S. institutional investors through foreign broker-dealers and the research that they provide."2
Under the interpretive position affirmed by the SEC in the release adopting Rule 15a-6, the Commission does not require the registration of a foreign broker-dealer that distributes research reports to U.S. person through a registered broker-dealer, provided that, among other things, the registered broker-dealer prominently states on the research report that it accepts responsibility for its content, and all other contacts between the foreign broker-dealer and the customer are conducted in accordance with Rule 15a-6.3 Rule 15a-6(a)(2) also provides an exemption from registration for a foreign broker-dealer that furnishes research reports directly, or indirectly pursuant to a relationship with a registered broker-dealer in compliance with paragraph (a)(3) of the Rule, to "major U.S. institutional investors."4
The SEC has recognized that certain SRO rules applicable to research reports distributed by member organizations are also applicable to foreign research distributed by registered broker-dealers pursuant to Rule 15a-6.5 For example, NASD and NYSE advertising rules would require disclosure of the identity of the preparer of foreign research distributed by a member organization.6
The Effect of the Proposed Rules on Rule 15a-6
Most provisions of the Proposed Rules, such as the restrictions on the relationship between the investment banking and research departments, and the limitations on the compensation and personal trading of research analysts, if strictly construed, would not affect foreign broker-dealers distributing research to U.S. persons under Rule 15a-6.7 Other provisions, such as the prohibitions on certain interactions with subject companies are simply inapplicable. However, the provisions with respect to the disclosures required to be made in research reports may be construed to apply to foreign research reports distributed by NASD and NYSE member firms in accordance with Rule 15a-6. Proposed NASD Rule 2711(a)(8) defines the term "research report" to mean "a written or electronic communication that the member has distributed or will distribute with reasonable regularity to its customers or the general public, which presents an opinion or recommendation concerning an equity security." The definition by its terms applies to any research report distributed by a NASD member firm, including research prepared by a foreign broker-dealer that is distributed by the member in accordance with Rule 15a-6. Consequently, a literal reading of proposed NASD Rule 2711(h), concerning the disclosures to be made by member firms in research reports, would apply to foreign research distributed under Rule 15a-6.8 The same is true for the disclosure requirements contained in the proposed amendments to NYSE Rule 472(k).
The disclosures mandated by proposed Rules 2711(h) and 472(k) go far beyond the due diligence required by accepting responsibility for foreign research under Rule 15a-6 and existing NASD and NYSE advertising rules, to include disclosures about potential conflicts of interest available only from the foreign broker-dealer.9 Such an application would effectively curtail the use of Rule 15a-6 by foreign broker-dealers unwilling to provide such information. The Proposed Rules would thereby frustrate one of the primary objectives of Rule 15a-6 - i.e., to facilitate access to foreign markets through foreign broker-dealers and the research that they provide. We do not believe that the NASD and the NYSE considered this effect of the Proposed Rules on the application of Rule 15a-6. And, if they did, we do not believe that the SEC should permit such a limitation on the federal exemption by the rules of the SROs.
The Proposed Rules Should Not Apply to Research Distributed under Rule 15a-6
We believe that the NASD and the NYSE should make clear that the Proposed Rules do not apply to foreign broker-dealers and foreign research distributed by member firms in accordance with Rule 15a-6. It is important that any accommodation reached by the NASD and the NYSE should not limit the scope of the exemptions available under the federal rule. Therefore, any application of the Proposed Rules to foreign research should be restricted to functions that can be performed by the member firm.
To address any possible confusion to the recipients of foreign research distributed under Rule 15a-6, we believe that it would be appropriate for NASD and NYSE member firms to provide a general disclosure similar to the following: The firm that prepared this report may not be subject to U.S. rules with regard to the preparation of research reports and the independence of analysts. Of course, additional disclosure information would be provided in the report in accordance with foreign law and the rules of the foreign SROs.
We note that some commentators have suggested additional disclosure to the effect that the foreign broker-dealer or analyst that prepared the research may have a conflict of interest due to the receipt of compensation from the issuer, the ownership of securities or otherwise. Since a member firm with no relation to the foreign broker-dealer may not be privileged to make such a statement, we disagree with this approach.
Again, we thank you for the opportunity to express our views on this important matter. We hope the Commission will find these comments useful. We would be pleased to discuss any of these issues with the Commission staff at their convenience.
Benjamin J. Catalano
|1||See e.g., The Final Report of the Canadian Securities Industry Committee on Analyst Standards (September 1999).|
|2||Exchange Act Release No. 27017 [1989 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 84,428, at 80,232, (July 11, 1989) (hereinafter, the "Rule 15a-6 Adopting Release").|
|3||In addition, the research report must prominently state that any U.S. person wishing to effect a transaction in a security discussed in the report should do so with the registered broker-dealer - not the foreign broker-dealer - and any resulting transactions must be effected by the registered broker-dealer. See id. at 80,244.|
|4||The research report may not recommend the use of the foreign broker-dealer to effect trades in any security, and the foreign broker-dealer may not initiate follow-up contact with the major U.S. institutional investor, or otherwise induce or attempt to induce the purchase or sale of any security by such investor. If these conditions are met, the foreign broker-dealer may effect transactions in securities discussed in the research report at the request of the major institutional investor without registering as a broker-dealer in the United States. However, if the foreign broker-dealer has a relationship with a registered broker-dealer in compliance with paragraph (a)(3) of Rule 15a-6, all trades are required to be executed by the registered broker-dealer. See id. at 80,245-46.|
|5||See id. at n.99 and n.111.|
|6||See Rule 2210(d)(2)(K), NASD Manual (CCH) at 4177; NYSE Rule 472 Supp. Mtrl. .40(7), NYSE Manual (CCH) ¶ 2472.40 at 4027.|
|7|| Proposed NASD Rule 2711 restricts the term "research analyst," and the terms "research department" and "investment banking department," to a person associated with the NASD member, and to departments of the NASD member, respectively. Similar terms under the amendments to proposed Rule 472 by the NYSE contain similar restrictions. Therefore, any provisions under the Proposed Rules that expressly relate to a member's research analysts, research department or investment banking department, would not apply to the same persons or department at the foreign broker-dealer providing research through the member pursuant to Rule 15a-6.
The fact that a registered broker-dealer must accept responsibility for foreign research distributed under Rule 15a-6 does not mean that the foreign broker-dealer's research analysts and research and investment banking departments are thereby associated with the registered broker-dealer. In the release adopting Rule 15a-6, the SEC expressly stated that it "uses and entity approach with respect to registered broker-dealers," e.g., "[i]f [a] foreign broker-dealer establishes an affiliate in the United States, . . . only the affiliate must be registered as a broker-dealer; the foreign broker-dealer would not be required to register." Rule 15a-6 Adopting Release at 80,237. Therefore, a self-regulatory organization should not be permitted to use compliance with Rule 15a-6 to extend the application of its rules to operate over personnel of a foreign broker-dealer relying on the federal exemption.
|8||However, it also seems clear from these and other provisions of proposed Rule 2711 that the NASD did not contemplate that the Rule would apply in the context of research furnished under Rule 15a-6. For example, paragraph (h)(3) of proposed Rule 2711 requires that "[a] member must disclose in research reports and a research analyst must disclose in public appearances if the research analyst or a member of the research analyst's household serves as an officer, director or advisory board member of the subject company." While the NASD may have jurisdiction to require such disclosure by the member firm in a research report distributed under Rule 15a-6, it clearly does not have jurisdiction to require such disclosure by the foreign analyst who prepared the research, even if the analyst is presenting the report during chaperoned visits with the member's customers in the United States. The analyst is not associated with (i.e., controlling or controlled by) the member, and therefore does not fall within the definition of "research analyst" under the Rule.|
|9|| The interpretive position affirmed by the SEC coincident with the adoption of Rule 15a-6 merely requires that a registered broker-dealer "accept responsibility" for the "content" of foreign research distributed to U.S. persons on behalf of a foreign broker-dealer. In this regard, the SEC stated in the Rule 15a-6 Adopting Release:
Rule 15a-6 Adopting Release at 80,246 n.116 (emphasis supplied). Significantly, this due diligence under Rule 15a-6 can be performed unilaterally by the registered broker-dealer, based on publicly available information, and pertains only to the merit of the recommendation - not to any information regarding conflicts of interest or other information peculiar to the analyst or his or her firm. NASD and NYSE advertising rules also require reviews and disclosures that can be performed by the member firm without relying on the foreign broker-dealer. See generally, NASD Rule 2210 and NYSE Rule 472, supra at n.6.
Other provisions of Rule 15a-6 require foreign broker-dealers to provide potentially non-public information to registered broker-dealers - such as the types of information regarding foreign associated persons specified in Rule 17a-3(a)(12) under the Exchange Act - in order to obtain an exemption from registration under the Rule. However, this requirement relates only to foreign broker-dealers that have established relationships with their U.S. counterparts in accordance with paragraph (a)(3) of the Rule. Other foreign broker-dealers that have not established such relationships may, nevertheless, distribute research through registered broker-dealers in the United States without providing such information in accordance with the interpretive position affirmed with the adoption of Rule 15a-6. The Proposed Rules, however, would foreclose this option to them unless they are also willing to provide the additional information required by the Proposed Rules.