Via Electronic Delivery
September 23, 2002
Jonathan G. Katz
Re: Proposed Regulation Analyst Certification,
Dear Mr. Katz:
The Charles Schwab Corporation ("Schwab") appreciates the opportunity to submit these comments on proposed Regulation Analyst Certification ("Regulation AC"). Schwab serves its broker-dealer clients through its subsidiaries, Charles Schwab & Co., Inc., Schwab Capital Markets L.P., CyberTrader, Inc. and U.S. Trust Securities. Charles Schwab & Co., Inc. is a New York Stock Exchange ("NYSE") and National Association of Securities Dealers, Inc. ("NASD") member firm, and Schwab Capital Markets L.P., CyberTrader, Inc. and U.S. Trust Securities are NASD members.
Schwab strongly supports the efforts of the Securities and Exchange Commission (the "Commission" or "SEC"), as described in the Regulation AC proposing release1, to "promote the integrity of research reports and investor confidence in the recommendations contained in those reports." We share the Commission's concerns that "investment banking relationships and certain compensation arrangements may adversely affect analyst objectivity and, as a result, the integrity of the views expressed in research reports and public appearances." Schwab is also concerned about the apparent deep erosion of investor confidence in the securities markets, which we believe is due in part to investor concerns about analyst objectivity. Schwab applauds the Commission's ongoing initiatives to restore confidence in the securities markets. We view Regulation AC, along with the rules recently adopted by the NYSE and the NASD to address research analyst conflict of interests (the "SRO Analyst Rules") as significant initial steps towards addressing, or at least requiring disclosure of, conflicts of interest. Schwab encourages the Commission to continue its efforts to seek out and address conflicts of interest in our industry, particularly those relating to the distribution and sale of the securities of investment banking clients to retail investors.
We do, however, have some questions about the application of Regulation AC to certain research and some suggestions about ways in which we believe Regulation AC might be improved by making it more consistent with the SRO Analyst Rules. With the hope of enhancing the Commission's ongoing efforts to address research analyst conflicts of interest, we offer the following comments.
I. Background: Research at Schwab.
Schwab offers its clients proprietary research, most notably our Schwab Equity Ratings (described in some detail below) and other market information and educational tools. Schwab also offers its clients third-party research from sources such as S&P, Morningstar, Argus, First Call and Goldman Sachs. By providing its clients with this information, Schwab strives to empower clients so that they can make better and more informed investment decisions.
Schwab currently offers three types of proprietary research: quantitative research, technical analysis, and "public policy" research. These three types of research (collectively referred to in this letter as "Schwab Research") cover a broad cross-section of publicly traded equities. Schwab does not engage in traditional investment banking. For example, Schwab participates in equity underwriting only as a selling group member. We currently provide the following types of Schwab Research:
II. Application of Regulation AC to Quantitative Research.
While Schwab strongly supports the efforts of the Commission to address research analyst conflicts of interest, we do seek clarification regarding the application of proposed Regulation AC to quantitative research. As proposed, Regulation AC would require that a research analyst certify that the "views expressed in the research report accurately reflect the research analyst's personal views about any and all of the subject securities or issuers." This analyst certification requirement appears to assume traditional brokerage firm fundamental research analysis in which a research analyst follows or covers a group of securities within a particular industry or sector of the market. With such fundamental research, the research analyst provides his or her subjective views and judgments about a particular security in a research report which is then attributed to the particular analyst. With quantitative research, however, a research analyst typically does not follow or cover a security or group of securities and the research is generally not attributed to a particular analyst. Although certain research department personnel are involved in quantitative research relating to the model and its investment criteria, quantitative research reports do not reflect any research analyst's subjective personal views and judgments about individual securities or group of securities. Instead, the views and any ratings expressed in such research reports are based on objective criteria and are derived from the quantitative model. Therefore, we believe that the appropriate type of certification for quantitative research (such as the Schwab Equity Ratings) should be a certification by the firm that the views expressed in the research report about the subject securities are derived from the firm's systematic quantitative research model.
III. Research Analyst Certification Regarding Compensation.
Proposed Regulation AC also would require in relevant part that the analyst certify whether any part of the analyst's compensation was, is, or will be, directly or indirectly related to the specific recommendations or views expressed by the research analyst in the report. In the Proposing Release, the Commission noted that certain compensation arrangements "may adversely affect analyst objectivity." While we agree, we believe that the analyst compensation certification could be interpreted to cover not only compensation arrangements that may adversely impact analyst objectivity, but also certain other legitimate analyst compensation arrangements. For example, we believe that compensation arrangements that permit firms to reward analysts for the performance of the views expressed in applicable research reports and ratings contained in those reports should be encouraged as they help to better align the interests of the firm, the analyst and investors. Therefore, we request that the Commission clarify that Regulation AC is not intended to address compensation arrangements relating to the performance of the views expressed in research reports and ratings.
IV. Distribution of Third-Party Research.
As described in Section I above, we believe that our clients benefit from the depth of market-related information we offer to them, including third-party research. Schwab concurs with the Securities Industry Association ("SIA") that in situations in which a broker-dealer distributes third-party research, the party producing the research should have responsibility for complying with Regulation AC. As similarly noted in our comment letter to the Commission regarding the SRO Analyst Rules, to hold otherwise would provide a strong disincentive against providing third-party research at all - a result that would diminish the utility and objectivity of the information made available to retail investors.
V. "Clear and Prominent" Certification.
Under proposed Regulation AC, research reports2 must include a clear and prominent certification. In the Proposing Release, the Commission indicated that it would expect that the required certifications would be included in the front page of the report or that the front page would specify the page or pages on which each certification is found. We request that the Commission indicate that (as similarly indicated by the NYSE and the NASD in their Joint Memorandum regarding the SRO Analyst Rules) electronic research reports may utilize hyperlinks to the required Regulation AC certification, provided that the first screen that the investor sees clearly and prominently labels the hyperlink to the required certification. Additionally (and also indicated by the NYSE and the NASD in their Joint Memorandum), when hyperlinks are not possible in electronic communications (such as in the PDF format) firms should be permitted to follow the requirements for paper reports. Therefore, the first printed page of a PDF document would either have the certification or refer the reader to the pages where the certification is located.
In the Proposing Release, the Commission requests comment as to whether Regulation AC should make allowances for compendium research reports covering six or more securities. Specifically, the Proposing Release asks, for example, if firms should be permitted to publish the required disclosures for a compendium in a place other than the research report. As permitted under the SRO Analyst Rules, we believe that in a compendium, firms should be permitted to direct the reader in a clear and prominent manner as to where they may obtain the applicable Regulation AC certifications in written or electronic format. We request that the Commission provide guidance (as was similarly provided by the NYSE and the NASD in their Joint Memorandum) that a compendium report can provide a toll-free number to call or a postal address to write to for the required certifications and that electronic compendium reports may include a hyperlink to the required certifications.
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Schwab supports the goal of the Commission to promote the integrity of research reports and investor confidence in the recommendations contained in those reports. We believe Regulation AC and the SRO Analyst Rules are significant initial steps to addressing conflicts of interest that have long affected the securities markets. Our comments are intended to assist the Commission in making Regulation AC as effective as possible in meeting that goal. Schwab continues to urge the Commission, the NYSE and the NASD to examine other conflicts of interest that can harm retail investors, particularly those relating to the distribution and sales process. If you have any questions regarding this letter, please contact me. Thank you for providing us with this opportunity to comment on proposed Regulation AC.
W. Hardy Callcott