By Electronic and Messenger Delivery

April 30, 2002

Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street NW
Washington, D.C. 20549-0609

Re: File Nos. SR-NASD-2002-21 and SR-NYSE-2002-09

Ladies and Gentlemen:

We submit this letter in response to a request for comment by the Securities and Exchange Commission (the "Commission") on proposed rule amendments by the National Association of Securities Dealers, Inc. ("NASD") and the New York Stock Exchange ("NYSE") relating to research analyst conflicts of interest.1 We appreciate the opportunity to comment on the matters raised in the proposed amendments (the "Release").

These comments have been prepared by members of the Subcommittee on Market Regulation, the Subcommittee on Securities Registration and the Subcommittee on International Securities Matters (the "Subcommittees") of the Committee on Federal Regulation of Securities (the "Committee"), Section of Business Law of the American Bar Association. A draft of this letter was circulated for comment among members of the Subcommittees and the Chairs and Vice-Chairs of the other subcommittees and task forces of the Committee, the officers of the Committee, the members of the Committee's Advisory Committee and the officers of the Section. This letter generally represents the views of those who have reviewed it but does not represent the official position of the American Bar Association, the Section, its officers or the Committee. Various members of our Subcommittees represent broker-dealers, issuers and others who might have interests in the matters raised in the Release. However, in preparing this comment letter we have endeavored to avoid reflecting the interest of any individual client or any particular group.


We agree that changes should be made, building on changes already implemented by the industry as reflected in the Securities Industry Association ("SIA") Best Practices for Research, to end or curtail certain practices that potentially undermine analyst independence and objectivity in order to restore the confidence of investors shaken by recent events. Without question, investors and our capital markets benefit from information provided by analysts.2 Further, no one doubts the importance of providing investors with research free from improper influence; such influence potentially undermines investor protection by placing the unwary investor at risk and the perception of such influence can corrode investor confidence.

Improper influence can arise from many sources and it is appropriate for self-regulatory organizations ("SROs") to address those potential sources that fall under their purview. Thus, we believe it is appropriate and commendable that the NASD and NYSE have proposed rules designed to address conflicts potentially arising from investment banking activities and investments in subject companies that could bias research.

At the same time, it is important to recognize that such rules must be carefully drawn to preserve the strengths of our capital markets. While investor protection and investor confidence are fundamental to the efficiency and success of the American capital markets, dealing with potential analyst conflicts is only one aspect among many that must be addressed, albeit one that has gained considerable media and political attention. Focus on this one aspect should not obscure the need to consider the effects of the proposed rules on other critical elements that make our capital markets the envy of the world. Indeed, the SEC is statutorily obligated to consider whether proposed rules promote efficiency, competition and capital formation.

As described below, we are concerned that the proposed rules rely too heavily on measures that disrupt the flow of information to the market place, without considering the harmful effects that will follow. In our view, such measures should be more refined. The new rules should better balance the need to deal with potential analyst conflicts with the effect on markets and capital formation of more restrictive regulation.

In particular, we believe the proposed rules should be revised to eliminate quiet periods (restrictions on the publication of post-offering research by members acting as managers and co-managers) and blackout periods (restrictions on the publication of research following an analyst's personal trading in a subject company). We are concerned that these and other provisions of the proposed rules will disrupt the flow of information to the market place, introduce unacceptable inefficiencies to the market, and place broker-dealers and their public company clients seeking to raise capital at a competitive disadvantage. With respect to this last point, we are particularly concerned that the proposals, if adopted without significant change, will provide a distinct competitive disadvantage for capital raising efforts within the U.S. and will have an especially adverse impact on small and mid-sized companies seeking to access capital and gain market recognition. We believe that the goals of the proposed rules can be accomplished without these onerous provisions, and we provide recommendations in this regard.

We also have a number of concerns regarding the roles assigned to legal and compliance departments. In particular, we believe the requirement that would interpose the legal/compliance department between research analysts and subject companies is undesirable and unworkable and should be eliminated from the proposed rules. We also believe that the role assigned to the legal/compliance department to review and approve research reports is an inappropriate role, one more suited to supervisory analysts and research management. At the least, we believe that firms should be given the latitude to determine who is best situated for this role and whether such reviews and approvals are necessary prior to publication of the research. If a firm determines that there are effective procedures that do not involve pre-approval by the legal/compliance department, those procedures should be permitted.

We strongly support the effort by the SROs' to require more meaningful disclosure. While disclosure can provide investors with useful information to identify an analyst's possible bias or personal interest, the proposed disclosure requirements in several important ways do not provide information so meaningful to investors that the information must accompany each research report, as that term is defined in the proposals. Thus, we recommend that certain of the disclosure requirements be modified and that firms be provided with more flexibility to determine the most appropriate means to provide disclosures to their clients.

There are a number of other aspects to the proposed rules that raise issues, which we address below. In some instances (for example, with regard to the international implications of the proposals), our concerns relate to, not what the proposals address, but what they fail to address. We are also concerned that there has been no notice or discussion of an implementation schedule for the rules, which, on their face, present difficult technical and staffing issues.

Given the extent and magnitude of the issues raised by the proposed rules and the need for further interpretation, we recommend that they be revised and re-published for comment. The Release has been highly effective in focusing attention on these important issues, and the public and interested parties should be given an opportunity to comment further on the responses to issues that are raised. Re-publication will also provide the SEC, NASD and NYSE the opportunity to address the effect of the proposals on efficiency, competition and capital formation.

Notwithstanding our concerns, we support the proposed prohibition of promises of favorable research, specific ratings or price targets or the use of threats to change research, ratings or price targets for the purpose of gaining business. Similarly, limits on the ability of investment banking department or subject companies to bring improper influence to bear on reports are commendable, although we do not agree with the mandatory role assigned to legal/compliance with respect to these limits. We also believe that the prohibition on owning pre-initial public offering ("IPO") securities in the analyst's coverage sectors and the prohibition on personal trading contrary to the analyst's published recommendations can be useful prophylactics intended to bolster the investing public's confidence in research analysts. Additionally, we support the proposed limitation on tying analyst compensation to specific investment banking services and the limitation on investment banking department supervision and control of research analysts, although we suggest that a clarification be made that supervision incidental to a "wall crossing" pursuant to a firm's information barrier procedures will not violate the rule.

We comment below on those aspects of the proposals the raise the most significant issues.

Restrictions on Information Flow

The flow of information, whether from issuers, the government, rating agencies or others, is critical to the markets and to an efficient market place. One of the hallmarks of the U.S. capital markets is the degree to which issuers and other market participants are required to (or voluntarily choose to) provide information to the markets. Over the last decade, both the amount of available information and the speed at which it is disseminated have increased significantly, trends that will continue, if not accelerate. Indeed, the Commission itself is embarked on a mission to enhance and accelerate corporate disclosures and to make more current and continuous the flow of information to the investing public.3 At the same time innovations in technology continue to provide new, faster and more effective ways to communicate information.4

It has long been the role of research analysts to help interpret the information available to the market place to assist investors in making investment decisions. Indeed, if the role of analysts were less critical to an efficient market place, it is likely that there would be less concern over potential conflicts of interest.

At a time when more information is available more quickly to investors, the NASD and NYSE propose to slow down, and, most disturbingly, in some instances, stop the flow of research to investors. The proposed NASD and NYSE rules will accomplish this by:5

Quiet Periods

The effect of the proposed rules will be to limit the information provided to investors. Even assuming that some meaningful research will reach investors following "significant news," it is clear that most research that would otherwise be published will not be.11

No persuasive reason has been given for denying investors information for periods that continue well past the end of selling efforts, simply because the analyst's firm is a manager or co-manager.12 Rather, it appears the NASD and NYSE are unwilling to permit investors to evaluate conflict disclosures during particular periods but instead would require that, during those periods, investors be protected by denying them access to research rather than providing research accompanied by disclosure of the relevant conflicts. In effect, the proposed rules place the NASD and NYSE in the unusual and inappropriate position of determining for investors what research they can receive and when they can receive it.

The determination by the NASD and NYSE that there is a need for the proposed quiet periods is particularly of concern because this activity is also effectively regulated by existing rules promulgated by the SEC.13 Those SEC rules were developed over many years, reflect a careful balance of competing interests, and embody the general principal that more, not less, research should be encouraged. Indeed, in recent years, the SEC has indicated concern that the current rules may be too restrictive given today's rapid and global dissemination of information.14

Further, it is important to note that SEC Securities Act Rule 174, unlike the proposed rules, does not actually ban research under any set of circumstances. Written research is permitted if a copy of the IPO final prospectus is delivered with or prior to the research. In the past, the difficulty in delivering a prospectus caused firms to dispense with research for the 40 or 90-day period specified in Section 4(3) of the Securities Act of 1933. Even after the Commission reduced the quiet period to 25 days in 1988, as a practical matter, research was rarely, if ever, published during that period. With the advent of the internet, some firms now make research available virtually immediately through the use of hyperlinks to the prospectus.

The more restrictive requirements proposed by the NASD and NYSE will undermine this existing regulatory scheme. For example, immediately following an IPO, a company may be covered by analysts that are only from the firms that served as managers and co-managers. Pursuant to the proposed quiet periods, the issuer will be able to issue earnings reports and press releases or make other announcements for 15 additional days without any research reaching the market. If firms other than the managers and co-managers cover the company, their coverage would be the only coverage for 40 days. The analysts most likely to know the strengths and weaknesses of an issuer will be silenced by the proposed quiet periods.

The proposed quiet period for secondary offerings can have an even greater impact on the market place because of the dependence of an existing market on continued research. The ban would be imposed even though there is reduced likelihood of the research overly affecting the trading market for a seasoned issuer.

We also believe that the proposed quiet periods will distort the capital raising process by inserting a new element into the process for selecting investment banks. Particularly in the case of IPOs, companies seeking capital will be reluctant to chose as managers the investment banks whose analysts are most familiar with the company in order to ensure that authoritative research can be timely issued following an offering. This negative effect is likely to have a disproportionate impact on small and mid-cap companies that are covered by few, if any, analysts and do not generally have a wide choice of managers. These companies legitimately seek to broaden market interest by encouraging investment banking firms to provide research coverage.

The proposed quiet periods also will aggravate the imbalance between research practices within the U.S and those outside the U.S. Many foreign jurisdictions encourage, rather than discourage research during and after securities offerings. This imbalance will serve as another incentive for foreign and multinational companies to limit capital-raising to markets outside the U.S. where investors will have more access to research. This not only would be against our national interest, but also would place U.S. broker-dealers at a competitive disadvantage and exclude U.S. investors from direct investment opportunities in foreign securities offerings. It would also have the perverse effect of encouraging institutional investors, who have easier access to research produced outside the U.S., to seek research not subject to the protections found in research published under U.S. standards.

In an apparent attempt to limit the impact of the quiet periods, the proposed rules limit the bans to offerings managed or co-managed by the analyst's firm. This will unfairly burden and discriminate against one particular segment of the investing public -- the clients of each manager and co-manager. In practice, those deprived of meaningful research are likely to be retail investors, since institutional investors typically have many more sources from which to obtain research. For an offering managed or co-managed by several "bulge bracket" firms, millions of investors could be deprived of research from analysts likely to be the most knowledgeable about an issuer at the point when investors most need information. Given the trend toward multiple co-managers (involving all the firms that regularly cover the issuer) the ban can result in a blackout of all coverage even for those companies which could have research published under Rule 139(a).

Also, the proposed quiet periods will create an information void that will unfairly advantage those who stand to gain from a lack of information in the market place to the detriment of the investing public. For example, short sellers or a potential acquirer could "leak" information to the market during quiet periods knowing that knowledgeable research analysts are not available to assess that information. Without research analysts "to set the record straight," the value of a company's stock could plummet in volatile times on unsubstantiated rumors -- with the losses absorbed by the investing public.15 Similarly, without research analysts to provide reasoned analysis to debunk a rumor potentially causing an unwarranted increase in a company's value, investors could be harmed when the wrongly inflated value is corrected.16

Finally, if the regime otherwise imposed by these rules works as intended, there should be no need for the proposed quiet periods. Therefore, we strongly recommend the elimination of the proposed quiet periods. To the extent that there are residual concerns that particular risks to investors exist during the proposed quiet periods, we recommend those risks be addressed by requiring specific disclosure describing those risks.

Should the final rules, despite our views, include some form of this proposal, we are concerned that the rules will soon become an anachronism placing an ever-increasing drag on the flow of research, as information from issuers increases and technology provides for ever faster dissemination of information to investors. To preclude such a result, we recommend that, if the proposed quiet periods are adopted, the rules include a "sunset" provision that would eliminate the quiet and blackout provisions after a set period (no more than 2 years), unless the NASD and NYSE study their experience under the rules and conclude that their continuation is necessary for investor protection.17

Blackout Periods

Blackout periods are triggered, not by the capital raising efforts of a subject company, but by the personal trading activity in the securities of a subject company by a research analyst that covers the company. Blackout periods add disruptions to the flow of research where none had been imposed before. Accordingly, our concerns regarding this new disruption mirror our concerns about the disruptions that would be imposed by quiet periods.

As with quiet periods, we believe there are less onerous solutions than a ban on research. We recommend, therefore, the adoption of more specific requirements that focus on the analyst's trades in place of the imposition of the blackout period. In this connection, we support the proposed prohibition on trading by analysts in a manner inconsistent with the most recent research report (except under exceptional situations) because that would eliminate the conflict situations of most concern. We would also add to that prohibition a requirement for analysts to pre-clear each trade in any security of a subject company the analyst covers. Such a pre-clearance rule should require that the clearance be in writing, impose responsibility on the analyst's supervisors to determine whether the trade or subsequent research reports raise any conflict, and, if so, require that the supervisor take appropriate action.

The rule should give firms flexibility to determine the appropriate action that will adequately protect investors, with advice from legal/compliance or other appropriate sources as necessary. Appropriate action by research management might include a ban on research, the release of research only after following the proposed exception process, unwinding the trade, assigning coverage responsibility to another analyst, or, prominently disclosing the trade that created the potential conflict. Given these (and perhaps other alternatives), the proposed ban is far more restrictive than necessary.

Ineffective "Exception" Process

We recognize that the proposed rules provide a mechanism that would permit research during a quiet or blackout period following "significant news or significant events" that could affect a subject company. However, we do not believe that the proposed mechanism will moderate the effect of the bans on research to any significant degree.

First, many reports will be foreclosed because of the difficulty in determining when news or an event is "significant" enough to warrant treatment as an exception. The NASD explains that "in general" a materiality standard should be applied, but application of a "materiality" standard is notoriously difficult and subject to 20-20 hindsight. The difficulties (and risks) in applying this standard will, at the least, chill attempts to publish research during quiet and blackout periods.

Second, and more significantly, legal/compliance will be hard pressed to overcome the premise underlying the quiet and blackout periods that disclosure of potential conflicts is not adequate warning to investors about the possible effects of potential conflicts. Given that premise, legal/compliance is likely to authorize only factual repetition of the "significant news," without meaningful commentary or analysis. If legal/compliance staff permitted meaningful analysis to be published, the firm would face criticism (and possible regulatory sanction) for providing biased research to investors.18 Thus, while "research" might be published during these bans, it is likely to be stripped of what is meaningful to investors -- the insights of the analyst.

Third, legal/compliance is unlikely to approve reports with meaningful analysis because the proposed rules provide no standards for such reviews and provide no explicit safe harbor for good faith decisions by legal/compliance. Without an understanding of the underlying purpose for the review and the standards by which the review should be conducted, legal/compliance will be constrained to take the most conservative approach -- either to authorize no reports whatsoever or authorize only reports devoid of analysis.19

In this regard, we recommend that, if quiet and blackout periods are adopted as proposed, guidance be provided to clarify the purpose of, and standards to be applied during reviews mandated by the proposed rules. We further recommend that the rules explicitly provide a safe harbor to firms for good faith judgments made when authorizing exceptions to the bans.

Inappropriate Roles Assigned to Legal/Compliance

The proposed rules assign four "gate keeping" roles to legal/compliance departments:

Although the proposed rules do not require direct contact between legal/compliance departments and subject companies, they thrust legal/compliance departments into the relationship between subject companies and research analysts in order to determine the basis for changes to draft ratings and price targets. While such intermediation may deter improper communications, it is also likely to chill all communications by companies about draft reports including communications that would be helpful to investors.

Authorizing reports published during quiet and blackout periods will require legal/compliance departments to act in what, in essence, are supervisory roles. Legal/compliance departments will make judgments whether ratings or price target changes are appropriate or not. Legal departments will review research to determine whether it has a reasonable basis or is the product of conflicted interests. In short, the proposed rules will require legal departments to have a direct role in the preparation of research reports.

We believe these "gate-keeping" roles are inappropriate for legal/compliance departments and that they inappropriately diminish management's responsibility for research.24

It is questionable whether legal/compliance departments have the expertise for this role. More importantly, even if legal/compliance departments had (or could obtain) such expertise, this role more appropriately has been, and should continue to be the responsibility of research management. To the extent the proposals would interpose legal/compliance departments as supervisors of research analysts, they undercut one of the key principles of self-regulation -- the responsibility of management for supervision. The appropriate role for legal/compliance departments in this regard is to provide advice and counsel to the supervisory personnel of the research department -- not to make decisions that are tantamount to operating the business.

Accordingly, we recommend that the proposed rules be revised to eliminate legal/compliance department intermediation with subject companies and legal/compliance department review of reports in connection with quiet and blackout periods.

We note in this regard that current NASD and NYSE rules require review of research by supervisory analysts and we understand that the assignment of the gate-keeping function to supervisory analysts could be appropriate. However, we are mindful that mandating these roles to supervisory analysts (or, for that matter, to legal/compliance departments) hamstrings firms in allocating resources and assigning functions to those best qualified to perform these functions. We are also mindful that smaller firms generally have less flexible staffing than larger firms and the impact of designating roles by rulemaking could disproportionately fall on smaller firms.

Thus, we recommend that, if the proposed gate-keeping functions are retained, the rules be revised to provide members with the flexibility to determine who should perform these functions and what steps should be taken to see that the objectives of the rules are accomplished. Such flexibility will not diminish responsibility but rather will place it squarely where it belongs, on management of the firm. Such flexibility also will permit those most qualified to review the research and will avoid the inevitable chill on permitted communications likely to result from mandating these roles to legal/compliance.

We are also concerned about the delays that the proposed gatekeeper functions will impose on the issuance of research. While easy to minimize in theory, in practice, requirements to document the basis for changes and then justify those changes (including responding to questions and appropriately revising the justifications) could easily take hours. Even when there is no explicit requirement to document the process, the process can be expected to slow the release of research. While some may view a delay of hours as insignificant, that generally is not the view of investors, particularly if the delay pushes release of the report until after the market opens or until after market close in an environment of fast-breaking news about public companies.25

If these gatekeeping functions are retained, we believe that members should be provided with flexibility to determine when reports should be reviewed. Specifically, we believe that post-publication (as contrasted to pre-publication) review should be permitted in appropriate circumstances.

In establishing the pre-publication review requirement, we understand that the intent was to stop the issuance of a report that is the product of improper influence on the analyst. We believe the SROs, however, did not sufficiently take into account the deterrence value of the review itself. We believe that firms and analysts will be deterred from improper conduct by knowing that the rationale for changes and the interactions with the subject company leading to changes will be closely scrutinized.26 To those not deterred, post-publication review will uncover indications of improper influence as readily as pre-publication review. Once there are "red flags" suggesting inappropriate interactions with particular companies and/or analysts, the existing requirements of the SEC and SROs that firm management respond to red flags have proven reliable in enforcing standards and protecting investors in the past. While firms could respond to red flags by imposing a requirement to review reports prior to release, we do not think that pre-review should be mandated in all cases when doing so will likely delay publication of completely proper reports, to the detriment of investors.

Flexibility in Providing Disclosures

While we strongly support disclosure as the preferred means to accomplish the goals of the proposed rules, we believe that more flexibility should be provided to firms to determine how best to provide the required disclosures to clients. As proposed, the requirement to add numerous disclosures to each report will further delay and, in some instances prevent, the publication of reports unless more flexibility is provided.

While some delay can be minimized by the development of automated processes, not every firm will be able to develop such processes. This will disadvantage firms that cannot automate the processes and the investors who look to those firms for research advice. Even for firms that automate the disclosures, automated systems do not always work as designed and are disrupted from time to time. Even with automated systems, time must be taken to review disclosures report-by-report to verify the systems have provided the required information.

If implemented as proposed, the rules will require as many as 15 separate disclosures for each subject company. The disclosures will be so lengthy that they threaten to overwhelm the reader with information and could become as lengthy as or even lengthier than the research they accompany.27

As a technical matter, such lengthy disclosures simply will not work with all means of communicating research. E-mail alerts, information sent to personal digital assistants ("PDAs"), electronic distribution of reports, and possibly other communications currently used to disseminate research information may not be practical, if each communication must include the full set of disclosures. Thus, we urge that the rules be revised to permit greater flexibility in providing disclosures to investors.

As a general matter, we believe cross-reference in each report to a website where all disclosures are maintained should be permitted to satisfy all disclosure requirements. This would reduce some of the delays imposed by the new disclosure requirements, and, more importantly, would allow the dissemination of research that would otherwise be precluded because the means of communication cannot accommodate such lengthy disclosures. We note in this regard that the Commission's latest initiatives presuppose that information on websites is readily accessible to investors and can provide timely disclosure of information relevant to investment decisions.28

If reliance on a web-based disclosure system is not acceptable, we recommend that the rules be revised to:

We believe rules such as these would provide the flexibility to use web-based disclosures and to make adjustments without further rulemaking as technology advances; flexible rules are preferable to the proposed rules which, at the outset, are likely to shut down some research and introduce further delays in disseminating research.

Price Chart

We are concerned about the impact of the information contained in a price chart with respect to those investors that direct their own trading activities and are not willing to pay for personal investment advice. We believe that the price chart information, standing alone, has the potential to be misleading to non-institutional investors and, particularly, to investors who are short-term in their investment strategies.

Not every rating or target price change is expected to result in immediate action by investors or to have an immediate impact on the issuer's stock price. Many such changes have a long-term horizon. Also, a firm can be the first to change its view about a stock, but the impact on the stock price may only be observable when other firms have also changed their views.

In addition, the required price line may also be misleading because of general market movements over the covered period. We request clarification as to whether firms will be permitted to include separate price lines for the S&P 500 or similar broad market index or for an index related an issuer's industry.

Disclosure of Future Compensation and Client Relationships

We believe that the requirement to disclose that a firm reasonably expects to receive compensation from a subject company within three months following publication of the report should be eliminated.30 We believe this requirement raises significant information barrier and signaling issues. Such disclosures will inevitably signal up-coming events. The violative potential of this disclosure is particularly significant in the case of boutique and less-diverse firms. If such disclosures do not present a "signaling" risk, it is likely to be because the issuer is a continuing client of the member or its affiliates and the disclosures have become meaningless boilerplate. Further, to the extent such disclosures do not become boilerplate because of a continuing relationship, they could reveal business activities to competitors that normally are kept confidential.

We recommend that this provision be replaced by an "educational disclosure" that, at any time, "the customer should assume that the broker-dealer and/or its affiliates will have further business relationships with the issuer." We believe this is preferable to a requirement that presents a signaling risk, discloses closely held business information to competitors or becomes boilerplate.

Disclosure of Beneficial Ownership

We also believe that the proposal to require disclosure as to whether the member or its affiliates own 1% or more of any class of security of the subject company does not use the right calculation method nor percentage-of-ownership level that correctly identifies those situations where a conflict of interest may be presumed to exist that would justify the requisite disclosure. We believe the correct methodology is one that looks at a financial, rather than voting, interest. Therefore, we recommend that the proposed rules be revised to specify that the methodology for calculation should net out all short positions against all long positions (i.e., be the net long position) in order to arrive at an accurate measure of the firm's financial interest.

Further, we believe that the rule should distinguish between the amount of securities that a broker-dealer could acquire in the course of its day-to-day ordinary market making activities and an amount that would give rise to a potential conflict of interest. Therefore, we recommend that the percentage of financial interest be increased from 1% to 5% as a more appropriate measure of significance. Firms currently have systems to report 5% ownership or policies that prevent the firm from reaching that level. A reduction from the 5% threshold would require changes to those systems and create additional compliance burdens.

International Application of the Proposed Rules

Application to Foreign Private Issuers

We recommend that any rules adopted pursuant to the Release specifically exclude research reports relating to foreign private issuers. The desired standardization of disclosures in research reports relating to domestic registrants will not be achieved in connection with reports relating to foreign private issuers, because such issuers are generally also the subjects of reports prepared and distributed by non-NASD member entities outside the United States that would not be subject to the proposed rules. This inconsistency would result in the distribution of two forms of reports: those prepared by NASD member firms that are subject to the proposed rules and those prepared by non-NASD member firms that are not subject to such rules.

Although we view the enhanced disclosure contemplated by the proposed rules to be desirable, we believe it would be unfair to subject NASD member firms to mandated disclosures regarding an issuer which are not also required to be provided by other major research entities covering the same issuer. As described above, any limitations imposed on the ability of an NASD member firm to communicate with an issuer, or to publish research reports relating to an issuer, would place the firm at a significant disadvantage to non-NASD member entities that are not so restricted. Finally, any imposition of a quiet period in connection with the publication of a research report following a public offering would place an NASD member at a significant competitive disadvantage if other firms, including non-NASD member firms that act as managers or co-managers in the non-U.S. portions of global offerings, were free to public research without similar restrictions.

Notwithstanding our general support for the SRO proposals, we believe that the complexity of the issues presented in connection with research reports relating to foreign private issuers, and the competitive effects that the imposition of such rules would have on NASD member firms, strongly suggest that research reports relating to foreign private issuers be excluded from the scope of any SRO rules. Sensitivity to foreign practices and procedures has led the Commission to exclude foreign private issuers from the application of other rules, such as Regulation FD, and has led to accommodations in many other situations. We believe that any consideration of rules which would imposing procedural or disclosure obligation on research reports relating to foreign private issuers would involve a review and analysis of foreign practices and regulatory regimes, which would require significantly more time than has been afforded during the comment period applicable to the Release.

Application of Proposed Rules to Non-U.S. Affiliates of Member Firms

We believe that any rules that may be adopted pursuant to the Release should clearly state that they are not intended to apply to non-U.S. affiliates of member firms. Because foreign affiliates of NASD member firms regularly issue research reports in accordance with the customs and practices of the non-U.S. markets where they operate, we believe that any interpretation of the scope of the proposed rules which would impose upon NASD member firms responsibility for research published by their foreign affiliates would result in significant competitive disadvantages to the foreign affiliates. We do not believe that the purpose of the proposed rules should be to impose any structural, procedural or disclosure burdens on research created by such foreign affiliates that is not distributed by the member firms in the U.S. If such research is distributed by an NASD member firm in the U.S., it should be treated no differently than research obtained by such firm from non-affiliated entities.

Overbroad/Unclear Definitions

Many of the definitions are overbroad and unclear in their application. We are particularly concerned about two which, if not revised, are likely to worsen the disruption to the flow of research described above.

If not narrowed, the definition of "research report" could be viewed as applying to research that is unrelated to (or, at the least, remote from) potential conflicts facing equity research analysts. For example, the proposed rules could be viewed as applying to technical, quantitative and strategic research and to market commentary. They also could include industry reports and partial reports that simply update investors without changing ratings or targets.31 Indeed, given the NYSE's formulation that research reports "are generally defined as, but are not limited to...", the rules arguably could apply to debt research, an application we understand is clearly not intended.

The definition of "public appearance" is also problematic because, according to the NYSE, it "includes, without limitation, participation in a seminar...or other public appearance or public speaking activity." The difficulty with this definition (in addition to the unlimited expansiveness of the NYSE's "includes, without limitation" language) is that "other public appearance or public speaking activity" (or, the NASD's formulation, "other public speaking activity") is so broad as to arguably capture comments by analyst at a social activity. Indeed, the specific list of "public appearances" appears to cover virtually every situation that could concern the NASD and NYSE leaving only such social situations to be covered by "other" public appearances.

In each case, we believe that the definition can be crafted more narrowly to precisely identify what is intended, and we recommend that such changes be made to the proposed definitions.


The Subcommittees appreciate the opportunity to comment on the proposals and respectfully requests that the Commission consider the recommendations set forth above. We are prepared to meet and discuss these matters with the Commission and the Staff and to respond to any questions.

Respectfully submitted,


Stanley Keller

Chair, Committee on Federal Regulation of Securities


Brandon Becker

Chair, Subcommittee on Market Regulation


Stephen H. Cooper

Chair, Subcommittee on International Securities Matters


Alan J. Berkeley

Chair, Subcommittee on Securities Registration

Drafting Committee:

Brandon Becker
John T. Bostleman
David L. Fenimore
K. Susan Grafton
John Huber
Guy Lander
Joseph McLaughlin
Suzanne E. Rothwell
Jeffrey Rubin

cc: Harvey L. Pitt, Chairman
Isaac C. Hunt, Jr., Commissioner
Cynthia A. Glassman, Commissioner
Annette L. Nazareth, Director, Division of Market Regulation
Alan L. Beller, Director, Division of Corporation Finance

1 Exchange Act Release No. 34-45526, 67 Fed. Reg. 11526 (March 14, 2002).
2 As noted by the Supreme Court, "The SEC expressly recognize[s] that `[the] value to the market of [analysts'] efforts cannot be gainsaid; market efficiency in pricing is significantly enhanced by [their] initiatives to ferret out and analyze information and thus the analyst's work redounds to the benefit of all investors.'" Dirks v. Securities and Exchange Commission, 463 U.S. 646 n. 17 (1983) (citations omitted).
3 See e.g., SEC to Propose New Corporate Disclosure Rules, SEC Press Release 2002-22 (Feb. 13, 2002); Specifics of the President's Ten Point Plan to Improve Corporate Responsibility and Protect America's Shareholders (March 3, 2002), at; Harvey Pitt, How to Prevent Future Enrons, Wall Street Journal, Dec. 11, 2001, at Op-Ed, available at
4 E-mail alerts, instant messaging and "blast" voice mails are just three examples, virtually unknown only a few years ago. As the Commission recently stated in a different but related context, "[a]dvances in technology and the increased dependence on the ready availability of current corporate information have reshaped the way our markets operate. Technological developments that significantly reduce timeframes for the capture and analysis of information necessitate a new consideration of the timing of mandated disclosure to the markets." Form 8-K Disclosure of Certain Management Transactions (Proposed Rule), Exchange Act Release No. 33-8090, 67 Fed. Reg. 19913, 19915 (Apr. 12, 2002) (to be codified at 17 C.F.R. pts. 230, 239 and 249). We address below some of the difficulties that will be brought about by the proposed rules if applied to these (and perhaps other) new technologies.
5 We recognize that the proposed rules provide for an "exception" process and describe below why this process does not alleviate our concerns.
6 NASD Proposed Rule 2711(f)(1). For ease of reference, we refer only to the NASD proposal. We note, however, that in a number of instances, there are textual discrepancies between the NASD proposal and the NYSE proposal. Given the nature of our comments, we have not attempted to identify or reconcile those differences. However, we note that there appear to be numerous differences, and our experience shows that significant difficulties can be caused by even seemingly small differences in wording. We therefore recommend that the NYSE and NASD adopt identically worded rules, else application of the rules by member firms will be plagued by interpretive difficulties caused solely by inconsistencies in wording. This is inefficient and unnecessary and will penalize those firms that are most diligent in their attempts to adhere to the rules. Moreover, the SRO with the more restrictive standard would become the arbiter of practice in the industry, at least for firms that are subject to the rules of both SROs. Where firms are not subject to both rules, client protection standards would vary depending on the happenstance of which SRO their brokerage firm is a member.
7 NASD Proposed Rule 2711(f)(2).
8 NASD Proposed Rule 2711(g)(2). While the proposed rule is written in terms of placing restrictions on personal trading by analysts, the presumption of the rule is that, absent an exception, research will not be disseminated for 30 calendar days following trading in the securities of a subject company by an analyst covering that company. As a practical matter, this means a 30-day "blackout" following an analyst's transaction.
9 NASD Proposed Rules 2711(b)(3)(A)&(B) (analyst communications with investment banking); 2711 (c)(2)(B)&(C) (analyst communications with a subject company); 2711(f)(2) (publication of research during quiet periods); 2711(g)(2)(B) (publication of research after personal trading by an analyst);
10 Proposed NASD Rule 2711(h). Except as addressed below, we believe the proposed additional disclosures are generally appropriate. Our principal concern with the proposed disclosures is the lack of flexibility provided to firms to determine what means are effective to provide the information to their clients.
11 We note that the proposals do not make clear whether or not the quiet periods are triggered by debt offerings. If debt offerings trigger the quiet periods, the adverse effect of the rules will be magnified. With sufficiently frequent debt offerings, some firms will be able to publish equity research on subject companies only sporadically, if at all. We doubt that the intention of the proposed rules is to create quiet periods for equity research following debt offerings since there has been no evidence advanced that debt offerings create conflicts for equity analysts and since, heretofore, equity research has not generally been prohibited during or after the distribution of debt securities. See SEC Securities Act Rule 138, 17 C.F.R. 230.138. We therefore recommend that, if the quiet periods are retained, clarification be provided that debt offerings do not trigger the quiet period restrictions.
12 We note that the terms "manager" and "co-manager" are not defined in federal securities laws or regulations and that Rule 139 does not make such a distinction, nor has it ever. Rather, firms are designated as such for a myriad of reasons, not all of which relate to compensation levels, which we presume is the source of the underlying conflict the quiet periods are designed to address. Thus, the terms are likely to be over-inclusive by including firms not compensated significantly more than others in an offering. Accordingly, we recommend that, if the quiet periods are retained, guidance be provided that more precisely identifies the managers and co-managers subject to the bans based on comparative compensation levels.
13 See SEC Securities Act Rules 138, 139 and 174, 17 C.F.R. 230.138, 230.139 and 230.174. The proposed 40 calendar day ban following an IPO should be compared to the 25 calendar day prohibition on research not accompanied by a prospectus imposed by Rule 174. The proposed 10 day ban following secondary offerings should be compared to the latitude to publish research pursuant to the far less onerous provisions of Rules 138 and 139, each of which generally permit the free flow of research for seasoned issuers. Regulation M is similarly structured to permit participating broker-dealers to continue to issue research reports that comply with Rules 138 and 139.
14 See e.g., The Regulation of Securities Offerings ("Aircraft Carrier"), Exchange Act Release No. 33-7606A, 63 Fed. Reg. 67174 (Nov. 13, 1998), at text accompanying note 575 ("The proposed new rules and amendments are designed to increase the amount of information provided to investors. For example, the proposals would allow analysts to distribute research reports around the time of offerings as long as they disclosed potential conflicts of interest. Facilitating communication between analysts and investors would enhance investors' ability to evaluate offerings and should increase the speed at which the market discovers prices.") (footnotes omitted) (emphasis added). Recent statements of SEC officials indicate that revisiting the restrictions on communications in the securities offering process is still on the Commission's agenda.
15 See, e.g., Analysts Rush to Put Out Fires for Clients, Wall Street Journal, March 6, 2002, at B4B.
16 Note that for each of these examples, the "exception process" for "significant news" is unlikely to permit research until after the stock has dropped precipitously or risen dramatically, too late to prevent harm to investors.
17 This recommendation is consistent with proposed legislation that would require the Commission to review final SRO rules regarding equity research analysts' conflicts of interest and report to Congress within 180 days and annually whether the rules are effective. See Corporate and Auditing Accountability, Responsibility, and Transparency Act of 2002, H.R. 3763, 107th Cong. §§ 14(a) & (b) (2d Sess. 2002) ("Oxley Bill") (passed the House of Representatives April 24, 2002).
18 Permitting publication of "substantive" research only if the research clearly is contrary to the purported conflicts is equally unworkable. Such research would still be subject to criticism and possible sanction on the basis that it was not as harsh as it would have been but for the conflicts.
19 Indeed, there is recent precedent that firms will, at most, publish only "neutral" information when faced with such uncertainties. Despite the efforts of the Commission to eliminate barriers to preparing and disseminating research reports during distributions by adopting a specific exception from Regulation M for research reports, firms were constrained in publishing reports that reflected a view or commented on transactions subject to the proxy rules. See e.g., Merrill, Lynch, Pierce, Fenner & Smith Inc., SEC No-Action Letter [1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 77,384, at 77,945 (Oct. 24, 1997).
20 NASD Proposed Rule 2711(b)(3)(A)&(B).
21 NASD Proposed Rule 2711(c)(2)(B)&(C).
22 NASD Proposed Rule 2711(f)(2).
23 NASD Proposed Rule 2711(g)(2)(B).
24 Because legal departments police the information barrier between investment banking and research required by Section 15(f) of the Securities Exchange Act of 1934, we are not as concerned about the assigned role with respect to the review of draft research reports by investment banking.
25 Delays will be aggravated to the extent that the rules force this role on the legal/compliance departments where lack of expertise and staffing constraints (especially at smaller firms) are likely to lead to even greater delays.
26 We note in this regard the efficacy of post-publication review of advertising by the NASD under Rule 2210.
27 Since disclosures must be prominent, most firms will use the same font size as used in the body of the report. This means disclosures for each subject company will be at least a full page in length. For multi-company reports (such as monthly wrap-ups, industry views, etc.) reports could expand to become as much as 5 to 7 times as voluminous as they currently are to accommodate the disclosures.
28 See Acceleration of Periodic Report Filing Dates and Disclosure Concerning Website Access to Reports, (Proposed Rule), Exchange Act Release No. 33-8089, 67 Fed. Reg. 19896, 19903 (Apr. 12, 2002) (to be codified at 17 C.F.R. pts. 229, 240 and 249) ("Modernizing the disclosure system under the federal securities laws involves recognizing the importance of the Internet in fostering prompt and more widespread dissemination of information"); Form 8-K Disclosure of Certain Management Transactions (Proposed Rule), Exchange Act Release No. 33-8090, 67 Fed. Reg. 19913 (Apr. 12, 2002) (to be codified at 17 C.F.R. 230, 239 and 249).
29 We envision that each firm, with the advice and counsel of legal/compliance, would assess what means are reasonable based on its business and its clients. When it is not practicable for disclosures to accompany a report, some firms might opt for web-based disclosure (for example, an on-line broker-dealer) while others could provide the information by facsimile or separate e-mail or by providing a toll-free number or making the investor's registered representative available (or a combination of these or other means). As technology, the firm's business or investor base changes, the firm would adjust its practices accordingly.
30 NASD Proposed Rule 2711(f)(2)(A)(ii).
31 Above, we recommended that the rules provide firms more flexibility in providing disclosures to clients in part because of difficulties anticipated in providing disclosures in industry and partial reports. Even if the definition of research report is narrowed to exclude such reports, we maintain our recommendation to provide more flexibility.