As summarized below, FINRA is currently seeking comment on proposed amendments to FINRA Rule 2241 and FINRA Rule 2242 to create a limited safe harbor for specified brief, written analysis distributed to eligible institutional investors that comes from sales and trading or principal trading personnel but that may rise to the level of a research report (desk commentary). The proposed safe harbor would be subject to conditions, including compliance with a number of the Rule 2241 or Rule 2242 provisions to mitigate research-related conflicts.
In addition, the proposed safe harbor would require firms to include a âhealth warningâ on desk commentary and to obtain negative consent from eligible institutional investors to receive such commentary.
Many firms produce desk commentary, a type of sales material directed to institutional investors that is based on the observations of sales and trading or principal trading personnel. These communications are usually brief, focused on the near term, and prepared and disseminated quickly in response to trading events or news flashes. FINRA understands that many institutional investors value the timely flow of information and trade ideas from desk personnel but do not base their investment decisions on the commentary. Instead, these investors, which are capable of exercising independent judgment in evaluating recommendations and reaching investment decisions, selectively incorporate the information as a data point into their own analysis and trading process.
Depending on the content, desk commentary can sometimes constitute a âresearch reportâ or âdebt research reportâ under Rules 2241 and 2242. In general, those terms are defined in the respective rules to cover any written (including electronic) communication that includes an analysis of âequity securities of individual companies or industriesâ (Rule 2241) or âdebt security or an issuer of a debt securityâ (Rule 2242) and that provides information reasonably sufficient upon which to base an investment decision.
In some instances, FINRA has seen what effectively amounts to fundamental research coming off the trading desk. In those circumstances, there is no question that the communications meet the definition of a research report and should be subject to rigorous supervisory review to ensure compliance with all of the applicable provisions of either Rule 2241 or 2242. As discussed below, this type of research would not qualify as desk commentary eligible for the safe harbor.
More commonly, FINRA has observed that desk commentary does not meet the definition of a research report due to either insufficient analysis or because the communication falls into a specified exception to the definition. However, in some cases, desk commentary may technically fall within the research report definition, even where it falls well short of the type of fundamental research that originally gave rise to the research conflict of interest rules. FINRA understands that discerning between those desk communications that fall just on either side of the line of being a research report can sometimes be difficult and that the supervisory scrutiny required to make those judgments can impede the timely receipt of the information by those institutional investors that value it.
As such, the proposed safe harbor for desk commentary is intended to create a feasible and effective supervisory framework that will provide firms more compliance certainty in their review of these research communications, subject to a number of conditions, including compliance with key conflict management provisions of the rules. The proposal seeks to maintain the information flow from the desk that is valued by institutional investors, while continuing to provide safeguards commensurate with the context and scope of the communications and the experience and sophistication of its recipients. The proposal would maintain the full protections of the research rules for any research distributed to retail investors. And firms must still establish, maintain and enforce written procedures reasonably designed to prevent the dissemination of material non-public research information.
Safe Harbor Conditions
The proposal would provide a non-exclusive safe harbor from someâbut not allâof the research rule provisions for eligible desk commentary, subject to several conditions. The safe harbor would be available to desk commentary that meets certain author, content and recipient conditions set out below. If the conditions are satisfied, the communication and its author would be exempt from all of the provisions of either Rule 2241 or 2242, as applicable, except for those provisions with which compliance is specified as a condition for the safe harbor.
The recipient condition of the safe harbor would limit distribution of desk commentary to investors that satisfy the Rule 2111 institutional suitability standard and from which the firm has received negative consent to receive the communications. The necessary consent may be obtained by written disclosure to the institutional investor that the firm may provide the investor desk commentary from sales and trading or principal trading personnel that may sometimes constitute research reports under FINRA rules that is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to research reports prepared for retail investors. If the institutional investor does not contact the firm and request to receive only research reports subject to the full protections of Rules 2241 or 2242, as applicable, the firm may reasonably conclude that the institutional investor has consented to receiving communications for the purpose of the safe harbor.
Conflict Management
The proposed safe harbor under both Rules 2241 and 2242 would require compliance with several common provisions of those rules to mitigate the most serious research-related conflicts that can be present with desk commentary.
As set forth in more detail below, the proposed safe harbor for equity desk commentary would require compliance with additional provisions of Rule 2241 to mitigate the influences of investment banking.
The proposed safe harbor under both Rules 2241 and 2242 would require a firm to establish, maintain and enforce written policies and procedures reasonably designed to, among other things, ensure that desk commentary subject to the safe harbor is made available only to eligible institutional investors. A firm could not rely on the proposed safe harbor with respect to such desk commentary that the firm has reason to believe will be redistributed to a retail investor. In addition, the proposed safe harbor would not relieve a firm of its obligations to comply with the anti-fraud provisions of the federal securities laws and FINRA rules.
Disclosure
The proposed safe harbor would require desk commentary to carry a âhealth warningâ similar to what is required for debt research distributed pursuant to the institutional debt research exemption in Rule 2242(j). The health warning would state:
- âThis document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to research reports prepared for retail investorsâ; and
- If applicable, âClients should assume that this document is not independent of [Firmâs] proprietary interests. [Firm] trades, and will continue to trade, the securities covered in this document for its own account and on a discretionary basis on behalf of certain clients. Such trading interests may be contrary to or entered into in advance of this document.â
Safe Harbor Relief
Compliance with the safe harbor conditions would relieve a firm that produces and distributes desk commentary from compliance with several of the rulesâ conflicts management provisionsâincluding, notably the separation requirements between research and sales and trading and principal trading personnelâand the specific disclosure requirements.
The safe harbor also would exclude compliance with the registration and qualification requirements for equity research analysts. NASD Rule 1050, including its qualification requirements, applies to a research analyst who is primarily responsible for the preparation of the substance of an equity research report or whose name appears on an equity research report.
For further information, please refer to FINRA Regulatory Notice 2017-16.