M E M O R A N D U M
The Associated Press, Dow Jones & Company, Inc., Forbes Inc., Gannett Company, Inc., The McGraw-Hill Companies, Inc., The Newspaper Association of America, The New York Times Company, Reuters, Time Inc., Tribune Company and The Washington Post Company hereby submit the attached comment letter on proposed New York Stock Exchange rule changes relating to research analyst conflicts of interest.
March 10, 2003
Jonathan G. Katz
Re: Proposed NYSE Rule Changes Relating to Research Analyst Conflicts of Interest, File No. SR-NYSE-2002-49
Dear Mr. Katz:
On behalf of our clients, The Associated Press, Dow Jones & Company, Inc., Forbes Inc., Gannett Company, Inc., The McGraw-Hill Companies, Inc., The New York Times Company, Reuters, Time Inc., Tribune Company and The Washington Post Company, we appreciate the opportunity to comment on proposed New York Stock Exchange ("NYSE" or "Exchange") rule changes relating to disclosure of research analyst conflicts of interest in "public appearances," including print media interviews and newspaper articles. As the publishers of Associated Press Newswires, The Wall Street Journal, Barron's, Dow Jones Newswires, Forbes, USA Today, BusinessWeek, The New York Times, Reuters Newswires, Time, Fortune, Money, The Los Angeles Times, Chicago Tribune, Newsday, The Washington Post and other print and electronic news products, our clients have a vital interest in the accuracy and availability of business news and information. The Newspaper Association of America, which represents over 2,000 newspapers comprising 90 percent of the daily circulation in the United States, also joins in these comments.
We have reviewed the NYSE's proposed rule changes, which were filed with the Securities and Exchange Commission (the "Commission") and published for comment on December 31, 2002. See NASD and NYSE Rulemaking: Proposed Rule Changes Relating to Exchange Rules 344, 345A, 351 and 472 and the National Association of Securities Dealers, Inc., Securities Exchange Act of 1934 ("Exchange Act") Release No. 34-37110 (Dec. 31, 2002). As representatives of the press, we recognize the laudable goal of the proposed rule changes, that is, to bring greater transparency to the financial marketplace by providing more accurate and complete information to investors and readers. We are concerned, however, that some aspects of the proposal, when read in conjunction with a joint interpretive memorandum (the "Joint Memo") issued by the NYSE and the National Association of Securities Dealers ("NASD") on June 26, 2002, could have an effect contrary to that which was intended.
Specifically, the rules could be read to regulate the access and editorial discretion of the media by directing analysts to decline appearances with media outlets that previously have not included in their articles or broadcasts the disclosures of interests the rules require of analysts. We believe this raises serious constitutional concerns and conflicts with Congress's goal, set forth in Section 501 of the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act"), of providing investors with more useful and reliable information concerning analyst recommendations. Rather than broadening the amount of information available to be published, the proposed rule changes would restrict dissemination of information to the public, and in so doing stifle a critical outlet through which information about companies is distributed. Research analysts would be inhibited, not encouraged, in their communications with the financial press. Thus, the proposed rule changes would chill important speech and increase uncorroborated reporting and reports that rely on unnamed sources.
Our concerns can be addressed, however, by revisions to the proposed rules and the Joint Memo clarifying that an analyst need not decline appearances with media outlets that previously have not included the required disclosures. If the NYSE believes additional steps are necessary to assure that information about analyst conflicts is publicly available, we submit that there are other ways to accomplish this objective without raising the constitutional and public policy concerns discussed below.
Impact of the Proposed NYSE Rule Changes on the Media and Investors
As noted above, the proposed rule changes and the Joint Memo (which is referenced in the release containing the proposed rules) would require analysts to decline subsequent appearances with media outlets that have not included the disclosures mandated by the rules. We believe that these rules would restrict the access and editorial discretion of the media and reduce the information available to investors. Whatever the rules that apply to analysts, it is up to reporters and editors to exercise their independent news judgment as to what information should be included in articles. One can foresee instances in which an analyst discloses a potential or former "conflict" at the time of an interview, and the news organization later concludes that this information is no longer relevant to its readers. Especially in print publications, space is not unlimited; but in all news publications, the readers' time and therefore their attention is limited. Under the proposed rule changes, however, should reporters and editors choose to edit or eliminate the required disclosures, they would be denied access to their analyst sources - a punishment clearly designed to compel publication of the disclosures. As a result, media outlets would be forced either to publish the often-lengthy disclosures in their entirety or risk losing a valuable source of information. Some reporters and editors faced with this dilemma might choose not to report an analyst's views at all; others might publish analyst opinions anonymously, without attribution. Under either scenario, the result would be less complete and less transparent information in the marketplace - a lose-lose situation for investors.
Moreover, news articles frequently are revised, condensed, summarized and republished by various wire and other services to other media outlets. It would be impossible, even if it were constitutionally appropriate, for the reporters and editors of the original published article to assure that the required disclosures are included in excerpts, digests and summaries republished and re-edited by other outlets.
Most media outlets, including our clients, typically try to discover and evaluate the significance of the conflicts of interest that any sources have, including analysts. Our clients' reporters and editors weigh the relevance and impact of such conflicts, and they regularly include descriptions of sources' conflicts in their articles and even decide, when appropriate, that a source's conflicts of interest are so acute as to make it impossible to use information provided by that source. Our clients' reputations depend on the integrity and independence of their reporting, and they take source conflicts very seriously.
Requiring analysts to disclose material conflicts in public appearances certainly is something we support. Compelling reporters and editors to publish prescribed information or face losing access to a source, however, is not only unnecessary, but we also believe unconstitutional.
First Amendment Concerns
As a matter of both constitutional law and the bedrock tradition of the free press in this country, decisions as to what information to include in articles lie with reporters and editors. This assures the independence of the press from government influences. We believe the proposed NYSE rule changes, together with the Joint Memo, violate this core principle.
In Miami Herald Publishing Co. v. Tornillo, 418 U.S. 241, 256 (1974), the Supreme Court struck down a Florida statute that punished a newspaper if it failed to afford a political candidate the right to publish a reply to criticism of the candidate published in that newspaper. The newspaper's failure to print a reply was punishable as a misdemeanor. The Supreme Court held unanimously that the statute violated the First Amendment:
The Florida statute in Tornillo was struck down because it exacted a penalty on the Miami Herald for failing to publish officially-prescribed content. Similarly, the proposed NYSE rule changes exact a penalty on the media - albeit not a criminal penalty - for failure to publish specified information concerning research analyst conflicts of interest. Under the proposal, an analyst, and all of his or her colleagues at any member firm, would be required to decline subsequent appearances with media outlets that previously have not included the required disclosures. The deprivation of a source of newsworthy information is a serious and material penalty for any news organization. It is a deprivation that is intended to compel the media to accept the Commission's and the NYSE's judgment about what is newsworthy and must be published in articles that include information derived from interviews with research analysts.
It does not matter constitutionally that the source-deprivation penalty inflicted by the proposed NYSE rules operates only indirectly to dictate what the press chooses to publish. Indirect compulsion of publication is equally offensive to the First Amendment principles of Tornillo. In Pacific Gas & Electric Co. v. Public Utilities Commission of California, 475 U.S. 1 (1986), the Supreme Court struck down a California Public Utilities Commission order that required Pacific Gas & Electric Company to include messages from a consumer group in its billing envelopes. As the Court noted in that case, "Just as the State is not free to 'tell a newspaper in advance what it can print and what it cannot,' the State is not free either to restrict appellant's speech to certain topics or views or to force appellant to respond to views that others may hold. Under Tornillo a forced access rule that would accomplish these purposes indirectly is similarly forbidden." Id. at 12 (internal citations omitted, emphasis added).1 See also Memphis Publishing Co. v. Leech, 539 F. Supp. 405 (W.D. Tenn. 1982), in which a Tennessee statute requiring certain newspapers to include text within particular advertisements for alcoholic beverages was found to violate the First Amendment under Tornillo.2
Moreover, it is not sufficient constitutionally that the proposed rule changes apply only when an analyst is making a recommendation or offering an opinion in a "public appearance." The proposal defines "public appearance" for disclosure purposes to include, among other things, participation in seminars, forums and print media interviews, as well as the writing of articles in which an analyst makes a recommendation or offers an opinion. Given the breadth of this definition, the proposal is not sufficiently tailored to meet First Amendment scrutiny.
The First Amendment applies to the NYSE's proposed rule changes if they constitute state action. See Desiderio v. NASD, 191 F.3d 198, 206 (2d Cir. 1999). We are fully aware of the case law suggesting that, particularly in the context of arbitration procedures or awards, the self-regulatory organizations ("SROs") are private entities and that the "mere" fact of their pervasive regulation or statutory genesis does not make them state actors. Id.3 But these generalities do not apply to the particular context of the proposed rules.
The governing principle of state action, as set forth in various Supreme Court and Second Circuit decisions, remains that private entities may be held to constitutional standards if their actions are "fairly attributable to the State." See Lugar v. Edmondson Oil Co., 457 U.S. 922, 937 (1982). In this regard, there is state action when a complaining party can show that there is a "sufficiently close nexus" between the challenged action and the State so as to treat seemingly private behavior as that of the State. Perpetual Securities v. Tang, 290 F.3d 132, 137 (2d Cir. 2002). There is also state action when government "has exercised coercive power or has provided such significant encouragement, either overt or covert, that the choice must in law be deemed to be that of the State." Blum v. Yaretsky, 457 U.S. 991, 1004-1005 (1982). In other words, although the "mere" fact of the pervasive regulation of the SROs does not automatically hold them to the constitutional scrutiny applied to state actors, it does not necessarily preclude them from the state actor designation either. Here, the proposed rules do not stem solely from the regulatory prerogative of the SROs, but rather from the evident history of government involvement and direction that gave rise to the proposed rules.
In the case of these proposed rules, the government - through legislation enacted by Congress and the President and actions by the Commission pursuant to that legislation and its own initiatives - has provided not only encouragement, but specific direction to the NYSE and the NASD that clearly constitutes state action. This is not a situation in which the SROs have initiated the action as private actors. Instead, as the Commission recently stated, the NYSE and NASD proposals "are part of an ongoing process on [the Commission's] part and that of the NYSE and NASD to address conflicts of interest affecting the integrity and objectivity of research by securities firms." Final Rule: Regulation Analyst Certification, Securities Act Release No. 33-8193, at 2 (Feb. 20, 2003). This "ongoing process" began with a joint investigation launched in April 2002 by the Commission, the NYSE, the NASD, the New York Attorney General and state regulators into analyst conflicts of interest and led to the first round of NYSE and NASD rulemaking in May 2002. See NASD and NYSE Rulemaking, Exchange Act Release No. 34-45908 (May 10, 2002).
Shortly thereafter, Congress enacted the Sarbanes-Oxley Act. Section 501 of the Sarbanes-Oxley Act directs the Commission, "or upon the authorization and direction of the Commission, a registered securities association or national securities exchange," to adopt rules designed to address analyst conflicts of interest, including a rule requiring securities analysts to disclose conflicts of interest in "public appearances." See Exchange Act §15D(a)-(b). Section 501 further states that "the Commission may promulgate and amend its regulations, or direct a registered securities association or national securities exchange to promulgate and amend its rules" to carry out the statutory mandate. See Exchange Act §15D(c).
It is clear from the release containing the proposed NYSE and NASD rule changes that the changes were intended to comply with the Sarbanes-Oxley Act and were developed in coordination with the Commission. In its statement of purpose, the NYSE indicates that "certain of the disclosure requirements and prohibitions that the [Sarbanes-Oxley Act] mandates have already been adopted in the new NYSE Rules. . . . The NYSE is currently analyzing the differences between the [Sarbanes-Oxley Act] and NYSE Rules, to determine the extent of additional amendments to be made." NASD and NYSE Rulemaking: Proposed Rule Changes Relating to Exchange Rules 344, 345A, 351 and 472 and the National Association of Securities Dealers, Inc., Exchange Act Release No. 34-37110, at 19 (Dec. 31, 2002). The release also states that amendments to NYSE Rule 472 are intended to "bring it into conformity with certain of the new requirements of the [Sarbanes-Oxley] Act." Id. at 22. According to the NASD, the NYSE and the NASD agreed that the rule changes were necessary as a result, in part, of "further discussions with the SEC staff." Id. at 23. Footnotes to the release also demonstrate that the NYSE's proposal was developed in coordination with Commission staff. See id. at 28, footnotes 7, 8 and 10.
In light of the statutory mandate and the direction and encouragement provided by the Commission, it is evident that the proposed rule changes constitute "state action" for First Amendment purposes. Because the rules would compel publication of disclosures prescribed by the NYSE (a state actor), they constitute a violation of the First Amendment and should be revised accordingly.
The Supreme Court has stated that the "burden [of a regulation] on protected speech cannot be justified if it could be avoided by a more carefully drafted [regulation.]" Reno v. American Civil Liberties Union, 521 U.S. 844, 874 (1997). In this regard, we believe that the First Amendment concerns outlined above may be avoided by revising the NYSE's proposed rules and the Joint Memo. Specifically, the Joint Memo should be revised to eliminate the requirement that an analyst decline subsequent appearances with media outlets that previously have not included the required analyst disclosures. Instead, an analyst should be deemed in compliance with the rules if he or she makes all of the mandated disclosures to the media outlet and requests that they be included in any publication or broadcast that contains a recommendation or opinion of the analyst. Our suggested changes are set forth in the attached document. If additional steps are believed necessary to assure that information about analyst conflicts is publicly available, other alternatives that do not invade, or attempt to direct, the vital reporting and editorial functions of the press could be considered, such as website posting of conflict-of-interest disclosures by member firms. We welcome the opportunity to discuss these alternatives with you.
We appreciate your consideration of our views. Please contact John F. Olson of Gibson, Dunn & Crutcher at (202) 955-8522 or Stuart Karle of Dow Jones & Company at (212) 416-2164 if we may be of further assistance in this matter.
cc: Hon. William H. Donaldson
Hon. Paul S. Atkins
Hon. Roel C. Campos
Hon. Cynthia A. Glassman
Hon. Harvey J. Goldschmid
Giovanni P. Prezioso
Annette L. Nazareth
Richard A. Grasso
Richard P. Bernard
Edward A. Kwalwasser
NASD and NYSE Rulemaking: Proposed Rule Changes Relating to Exchange Rules 344, 345A, 351 and 472 and the National Association of Securities Dealers, Inc.
Release No. 34-47110; File No. SR-NYSE-2002-49; SR-NASD-2002-154
II. Self-Regulatory Organization's Statements of the Purpose of, and Statutory Basis for, the Proposed Rule Changes
1. NYSE's Purpose
The rule amendments have been phased-in incrementally to provide members and member organizations time to develop and implement policies, procedures and systems and hire additional personnel to comply with the new requirements. The staggered implementation of the Rules began July 9, 2002, with September 9, 2002 and November 6, 2002 as the effective dates for certain specified provisions. Implementation dates for certain of the SRO rules have also been delayed for small firms.
As a result of numerous interpretive requests, on June 26, 2002, the Exchange and the NASD issued a Joint Memo providing interpretive guidance to certain rule provisions. One section of the Joint Memo, relating to public appearances by analysts, has generated comments from persons concerned that the interpretive guidance could have unintended but inappropriate consequences. Specifically, the Joint Memo could be read as attempting to regulate the access and editorial discretion of the media by stating that an analyst should decline subsequent appearances with media outlets that previously have not included the required analyst disclosures. In response to these comments, the SROs are modifying the Joint Memo to provide that an analyst will not violate the Rules if he or she makes all of the mandated disclosures to the media outlet and requests that they be included in any publication or broadcast that contains a recommendation or opinion of the analyst. The Rules will be interpreted in accordance with the revised Joint Memo.
Discussion and Interpretation of Rules Governing Research Analysts and Research Reports (NASD Rule 2711 and NYSE Rules 351 and 472)
Third, several members have inquired whether the public appearance disclosures must be made during an extemporaneous radio or television interview when the research analyst does not possess the required disclosure information. If an analyst cannot make all of the required disclosures during a public appearance then the analyst must decline to make a recommendation or offer an opinion. In addition, if an analyst is invited to submit a column or "op ed" piece to be published in the print media with the analyst's byline, the required disclosures must be included in the text furnished to the media outlet.
A related question is whether a research analyst has complied with the Rules if he or she makes all of the required disclosures during an interview, but the media outlet does not include the disclosures when all or part of the appearance is broadcast or published. The SROs recognize that media content may be revised, edited, condensed, summarized, rebroadcast and republished in various forms and for various purposes. The SROs cannot control these editorial decisions of the media. An analyst will not violate the Rules if he or she makes all of the mandated disclosures to the media outlet and requests that they be included in any publication or broadcast that contains a recommendation or opinion of the analyst.