Looking Ahead: Research Rule Developments Thursday, May 28 10:00 a.m. 11:00 a.m.

Transcription

1 Looking Ahead: Research Rule Developments Thursday, May 28 10:00 a.m. 11:00 a.m. Topics: Understand and apply the research conflict of interest rules. Summarize for, and advise your firms and clients on, risks associated with analyst communications. Discuss the implications of recent research related enforcement actions. Speakers: Philip Shaikun (moderator) Associate Vice President and Associate General Counsel FINRA Office of General Counsel James Brigagliano Partner Sidley Austin, LLP James Day Vice President and Chief Counsel FINRA Enforcement Pamela Torres General Counsel Goldman, Sachs & Co Financial Industry Regulatory Authority, Inc. All rights reserved.

2 Looking Ahead: Research Developments FINRA Annual Conference May 28, 2015 Washington, DC

3 Panelists Moderator: Philip Shaikun, Associate Vice President and Associate General Counsel, FINRA Office of General Counsel Panelists: James Brigagliano, Partner, Sidley Austin, LLP James Day, Vice President and Chief Counsel, FINRA Enforcement Pamela Torres, General Counsel, Goldman, Sachs & Co. 1

4 Agenda FINRA equity and debt research proposals Enforcement trends and recent actions Citibank and Toys R Us cases and implications Case studies 2

5 Consolidated Equity Proposal Key Provisions Policies based with overarching principles Proactive identification and management of conflicts Obligations of individuals to comply with procedures Quiet period reductions for initial public offering (IPOs) and secondary offerings Selective dissemination interpretation Principles-based personal trading restrictions Exemption from compensation provision if limited IB activity Exemption from registration requirements for non-research analysts 3

6 Debt Research Proposal Key Provisions Tiered approach: full protections for retail debt research/broad exemptions for institutional debt research Negative consent: QIB + Rule 2111 suitability standard; or Affirmative consent: any institutional account under Rule 4512(c) Permissible communications between research and trading Distinction between sales and trading and principal traders Sales and trading, but not principal trading, may provide customer feedback as part of evaluations Research department budget determination excludes principal traders Exemption for limited principal trading activity 4

7 Recent Enforcement Actions Settlements involved a wide range of research related issues: Investment banking conflicts (TRU) Polices & procedures governing selective disclosure Indirect participation in roadshows Enforcement priorities continue to include disclosure issues under Rule 2711 (Research Analysts and Research Reports) 5

8 Recent Enforcement Actions Selective Disclosure Idea Dinners Citigroup Global Markets Inc. FINRA found that CGMI violated FINRA Rule 5280 and NASD Rule 3010: Did not implement adequate procedures for analysts participation in idea dinners (in particular, for analyst ideas that were inconsistent with published research) Did not prevent selective dissemination by a non-us registered salesperson Did not adequately discipline analysts who violated its policies FINRA also found that CGMI violated NASD Rule 2711(c)(5) because one of its analysts indirectly participated in road show presentations in connection with two IPOs $15 million penalty, censure, certification regarding compliance with FINRA rules SEC action relating to idea dinners: In the Matter of Monness, Crespi, Hardt & Co., Inc. (Aug SEC Settlement) 6

9 Toys R Us 10 Firms fined a total of $43.5 million Toys R Us IPO In April 2010, Toys R Us and its private equity owners (sponsors) invited 10 firms to compete for a role in Toys R Us planned IPO. Toys R Us asked equity research analysts from each of the 10 firms to make separate presentations to Toys R Us management and sponsors to evaluate the analysts and ensure the analysts views on key issues, including valuation factors, were aligned with the views expressed by the firms investment bankers. Each firm understood that the performance of its analyst would be a key factor in determining whether the firm received an underwriting role in the IPO. Each of the firms offered favorable research coverage in return for a role in the IPO, either during the analysts presentation or afterwards in response to a request from TRU for a valuation. 7

10 Toys R Us Violations All firms violated 2711(c)(4) by allowing their analysts to make a presentation to TRU and its sponsors during the solicitation period All firms violated 2711(e) by offering favorable research coverage to induce investment banking business Six firms violated 2711(i) by failing to have adequate policies and procedures relating to analysts participating in solicitation of IB business and offering favorable research coverage 8

11 Case Study Managing Solicitation Risk Joe Analyst is preparing his slide deck for his Firm s upcoming annual New Technology Conference. He receives the following from an executive at Zap It!, a private company that is participating on a panel at the conference with three other companies who have all been heralded by the media as the hottest startups of 2015 : Dear Joe, I am looking forward to seeing you at the conference next week! As you know, I joined Zap It! a few months ago as their CFO after being at Dazzle.com for several years. I always appreciated your thoughtful coverage of Dazzle.com, and I wanted to see if we could schedule some time before my panel so I could hear about your current views on our industry, Zap It! specifically, and how you would position our business to investors. It would be great to know what you think are the key comps for Zap It! and your valuation views on Zap It! I have attached our latest company presentation for your information. By the way, I met with several of your technology bankers last week they are an impressive bunch! Best regards, Sally Joe knows that Zap It! has been discussed repeatedly in the media as one of the top 2015 IPO prospects. However, he hasn t been brought over-the-wall or authorized by his Firm to vet Zap It! nor has he been notified by his Control Group that the Firm is in a solicitation period with respect to a proposed IPO of Zap It! 9

12 Case Study Managing Solicitation Risk Several weeks after the Conference, Joe is notified by the Control Room advising that Research Management has approved wall-crossing him for vetting purposes in connection with a proposed banking transaction. Joe gets on a chaperoned call with Anna and Charlie, an MD and VP, respectively, in the Technology Banking Group, and is told the following: Joe, we ve been approached by Zap It! to pitch for their IPO next week. We want to talk to you about any thoughts you have on Zap It!, including who you think are its closest comps, its product mix, potential investor concerns, and how you would approach valuation. As you probably know, PE, LLC is a significant shareholder of the company, and has asked for your contact details. They know that the CFO is a big fan of yours and told us that they are interested in speaking directly to you with Zap It! management when they are in town next week. When Joe gets off the call he sees that he has an from PE, LLC asking whether he is available to meet with them and Zap It! management next Tuesday at 10:00am. 10

13 Case Study Top Ideas Joe returns from a two week vacation with his family. He is clearing through his in-box in the morning and comes across an from Big Apple hedge fund, one of the firm s largest clients: We are launching our 2015 top ideas contest. This contest will take place over six months, and will require each participant to join us for a monthly dinner to discuss their three top stock ideas for that month. We will pay for dinner you bring the stock picks! We will track performance and tally the results, and announce the winner at the end. If you want to participate, you must send us your top three picks for June no later than Friday, May 29 th we will meet for dinner on Wednesday, June 3 rd where you can defend your picks! It is May 29 th. Joe wants to submit Dazzle.com as one of his stock picks for the contest the stock has dipped in the last week on rumors that orders have cooled and is now 30% below his published target price. Joe doesn t believe the noise, and thinks it is a great opportunity to buy the stock ahead of their Q2 earnings announcement, which he expects to beat expectations. He currently has the stock at a Hold rating, but had thought it might be time to upgrade the stock to a Buy. He knows, though, that he will never get the Note through the Research Review Committee before Monday. He decides to go ahead and highlight Dazzle.com to Big Apple using his current target price, hoping he will have it upgraded by the time of the Wednesday dinner. 11

14 Case Study Fixed Income Analyst Communication with Trading Sarah is a fixed income analyst focused on high yield bonds in the metals, mining and steel industry. One of her companies, Glitter Mining Inc., the largest owner of gold mines in North America, has been struggling lately as the forecasts for gold prices have plummeted since the beginning of the year. Sarah has a published Sell view on the company as she thinks the pressure on gold prices will have a significant impact on Glitter s ability to cover its maintenance costs on its mines and could negatively impact their credit rating. While at her desk, Sarah sees a story come across Bloomberg: PE, LLC rumored to be taking big stake in Glitter. Her phone rings; she picks up Jack in HY trading: Sarah just saw the news on Glitter. Talk to me. What is the impact on their bonds? Sarah hesitates; certainly the news is likely to cause the spread on Glitter s 2016 bonds to tighten and the price to rise, particularly if the market thinks the company will use the cash to refinance them at a lower interest rate. As a short-term buying opportunity, it is probably a good time to jump in. But the long-term prospects for the company are shaky, and even with a cash infusion, the downward gold price trends are likely to be a drag on earnings for the foreseeable future. Her thought process is interrupted by Jack: Sarah, need to know now where do I price the bonds? Sarah responds: It is a buying opportunity on the 16s, Jack spreads are going to tighten; good idea to jump in now. Jack hangs up and places an order for $100m of Glitter s bonds due

15 Looking Ahead: Research Rule Developments Thursday, May 28 10:00 a.m. 11:00 a.m. Resources FINRA Rule Filings SR-FINRA , Proposed Rule Change to Adopt FINRA Rule 2241 (Research Analysts and Research Reports) in the Consolidated FINRA Rulebook SR-FINRA , Proposed Rule Change to Adopt FINRA Rule 2242 (Debt Research Analysts and Debt Research Reports) FINRA Newsroom FINRA Fines 10 Firms a Total of $43.5 Million for Allowing Equity Research Analysts to Solicit Investment Banking Business and for Offering Favorable Research Coverage in Connection With Toys"R"Us IPO (December 2014) FINRA Fines Citigroup Global Markets Inc. $15 Million for Supervisory Failures Related to Equity Research and Involvement in IPO Roadshows (November 2014) FINRA AWC Financial Industry Regulatory Authority Letter of Acceptance, Waiver, and Consent (No ) Financial Industry Regulatory Authority, Inc. All rights reserved.

16 Research Rules Frequently Asked Questions (FAQ) FINRA.org Page 1 of 5 5/27/2015 Research Rules Frequently Asked Questions (FAQ) Following are FAQs about FINRA s research conflict of interest rules. 1. Do NASD Rules 2711(c)(4) and 2711(e) prohibit a research analyst from meeting with an issuer while the issuer is engaged in the underwriter selection process for an offering? NASD Rule 2711(c)(4) provides that no research analyst may participate in efforts to solicit investment banking business. Accordingly, no research analyst may, among other things, participate in any "pitches" for investment banking business to prospective investment banking clients, or have other communications with companies for the purpose of soliciting investment banking business. The rule contains an exception, which provides that the provision shall not prevent a research analyst from attending a pitch meeting in connection with an initial public offering (IPO) of an Emerging Growth Company (EGC), as defined in NASD Rule 2711(a)(11), that is also attended by investment banking personnel; provided, however, that a research analyst may not engage in otherwise prohibited conduct in such meetings, including efforts to solicit investment banking business. NASD Rule 2711(e) states that no member may directly or indirectly offer favorable research, a specific rating or a specific price target, or threaten to change research, a rating or a price target, to a company as consideration or inducement for the receipt of business or compensation. Whether a particular communication between a research analyst and an issuer violates one or both of these provisions will depend on the context and content of the communication. Of particular importance are the type and stage of an offering and the context created by the issuer. With respect to an IPO, FINRA sees three stages, with a sliding scale of attendant risks where an analyst communicates with an issuer: (1) a pre-ipo period; (2) a solicitation period; and (3) a post-mandate period. FINRA emphasizes that these periods serve only as guideposts for risk assessment purposes and do not create periods during which particular communications between an analyst and an issuer are absolutely prohibited or permitted. FINRA considers communications by a research analyst with an issuer during a solicitation period, other than bona fide vetting or due diligence communications by the member, to carry significantly elevated risk. In general, FINRA believes that positive statements to an issuer by a research analyst during a solicitation period carry a high risk of constituting an impermissible promise of favorable research. FINRA recognizes that vetting and due diligence communications enable the research analyst to assess the issuer for underwriting commitment purposes, to gather or confirm information about the issuer to comply with the disclosure obligations of the federal securities laws, and to gather information on behalf of investors. Since those communications are for the purposes of obtaining information from the issuer in furtherance of the analyst s research function, depending on the facts and circumstances, they carry lower risk than where a research analyst shares his or her views or valuations with an issuer. Of course, vetting or due diligence communications also must be managed carefully to avoid the risks discussed previously. In FINRA s view, these risk management considerations exist during a solicitation period, irrespective of who initiates a meeting or communication, or the setting. Thus, the same considerations would apply whether an issuer initiates a meeting at which it requests the analyst s views as part of the issuer s underwriter selection process or a research analyst initiates a meeting for bona fide due diligence purposes where the issuer then asks for the

17 Research Rules Frequently Asked Questions (FAQ) FINRA.org Page 2 of 5 5/27/2015 analyst s views. Context is relevant to the degree of attendant risk. Thus, for example, FINRA would not expect a research analyst to refrain from sharing his or her industry views at a previously scheduled conference during a solicitation period where the issuer may be in attendance. In contrast, in circumstances where an issuer overtly or tacitly expresses that the selection of underwriters will be based in whole or in part on the views of a research analyst (including valuation), FINRA believes any subsequent sharing of those views by the member or the research analyst during the solicitation process would carry unmanageable risk. In general, FINRA considers a solicitation period to begin when the issuer makes known that it intends to proceed with an IPO and ends when there is a bona fide awarding of the underwriting mandates. While typically a solicitation period will commence with a request for proposal from an issuer or other communication that will expressly indicate an intent to proceed with an IPO, firms must carefully assess the context and content of a request for information from an analyst by an issuer during an ostensible pre-ipo period to assess the risk of complying with the request. For example, where an analyst has indicia either from the type of information being requested by the issuer or from other reliable sources that the issuer has already determined to proceed with an IPO, the analyst should consult with legal and compliance personnel to make a reasonable determination whether a solicitation period has begun before complying with the information request. With respect to the end of a solicitation period, to the extent an issuer determines the deal participants on a rolling basis, a solicitation period would end for a particular firm when it is informed that it has been awarded a role in the offering or has been rejected for a role. While the same risk management principles apply to follow on offerings, FINRA believes that, depending on the facts and circumstances, the risks associated with communications between an analyst and an issuer may be lower during a solicitation period than during an IPO. For example, where an analyst already covers an issuer and has no reason to know that the issuer intends to conduct a follow on offering, FINRA believes a firm could effectively manage the risk of violating the rules by maintaining effective information barriers to prevent the analyst from learning of the intended offering and by limiting the analyst s post-ipo communications with the issuer to ordinary course communications for the benefit of the firm s research customers. Where a firm has existing coverage and there is a post-ipo market valuation of the issuer, FINRA would not expect an analyst, in the ordinary course of discharging his or her research function, to share with the issuer a valuation or conclusions not contained in a published research report. Posted: 5/27/15 2. Are there restrictions on research analyst communications with an issuer in a pre-ipo period? While the prohibitions against participating in efforts to solicit investment banking business and promises of favorable research apply outside of a solicitation period and will depend on the particular facts and circumstances, FINRA believes the risk of violating these provisions in connection with communications between a research analyst and an issuer are lower during a pre-ipo period. As such, FINRA believes the risk of violating these provisions in connection with communications for purposes other than vetting or due diligence during a pre-ipo period can be effectively managed by a firm s policies and procedures and could include, for example, discussions regarding the issuer s competitors, the IPO market and an issuer s readiness for an offering. However, FINRA cautions that a pre- IPO period is not a safe harbor for all analyst communications with an issuer. For example, answering questions from an issuer as to how an analyst would value or position the issuer would not only carry increased risk of violating these provisions even in a pre-ipo period, but the questions may also be indicia that the issuer has already determined to proceed with an IPO. Firm s policies and procedures should address circumstances where issuer statements or questions suggest that an IPO determination has been made, including consultation with legal and compliance personnel.

18 Research Rules Frequently Asked Questions (FAQ) FINRA.org Page 3 of 5 5/27/2015 Posted: 5/27/15 3. Are there restrictions on research analyst communications with an issuer in a post-mandate period? Does a solicitation period continue where an issuer has not fully resolved the specific roles or economics awarded to firms in the offering? FINRA believes that, depending on the facts and circumstances, the risks associated with communications between a research analyst and an issuer are lower during a post-mandate period, similar to a pre-ipo period. As such, FINRA believes policies and procedures can effectively manage the risk of violating NASD Rule 2711(c)(4) and (e) in a post-mandate period and that it would generally be appropriate for an analyst to communicate with the issuer his or her views about valuation, pricing and structuring of the transaction, even if the valuation or pricing assessment is positive. FINRA understands that in awarding the mandates for a transaction, an issuer will not always finalize the roles or economics assigned to each firm that the issuer has determined will participate in the offering. Assuming the issuer has made a bona fide award of the underwriting mandates, FINRA believes the risks associated with subsequent communications between an analyst and issuer can be effectively managed, even where the issuer has not fully resolved the specific roles and economics for each firm. However, FINRA notes that there is no safe harbor in a post-mandate period, and therefore firms must consider the context and issuer expectations in evaluating the permissibility of communications with the issuer. A firm s policies and procedures should address circumstances that could give rise to impermissible promises of favorable research, such as where the issuer suggests the final roles or economics will be based on the highest valuation given by a firm s research analyst. Posted: 5/27/15 4. May investment banking consult with a research analyst about valuation or other views during a solicitation period? Subject to applicable requirements (e.g., chaperones for a Global Settlement firm) and a firm s policies and procedures to insulate research analysts from investment banking pressure, FINRA believes it would not be inconsistent with NASD Rule 2711(c)(4) and (e) for investment bankers to consult with analysts about valuation and other views during a solicitation period. However, bankers may not convey to the issuer that a valuation is either the research analyst s valuation or a joint valuation of the bankers and research analyst. Moreover, absent a repudiation, bankers may not convey a valuation to an issuer where there has been a request from the issuer or tacit understanding that the valuation of the bankers and research analyst will be aligned or that any valuation presented will reflect the analyst s views. Thus, consistent with Regulatory Notice 11-41, where an issuer creates an improper expectation that a firm s valuation will reflect a research analyst s view or analyst alignment with the investment bankers view, a firm that wishes to continue to compete for a role in the offering must repudiate the overture and explain that any valuation provided represents the bankers views only and that the firm cannot make any representations about the views of the research analyst. In such circumstances, a firm must document the repudiation. FINRA notes that any communications between investment bankers and research analysts during a solicitation period regarding valuation or the research analyst s views present heightened risks that investment bankers will influence the research s analyst s views, and must be managed carefully. Posted: 5/27/15

19 Research Rules Frequently Asked Questions (FAQ) FINRA.org Page 4 of 5 5/27/ How, if at all, does application of the rules differ in the context of an IPO for an Emerging Growth Company? Section 105(b) of the Jumpstart Our Business Startups Act (JOBS Act) permits research analysts to participate in any communication with the management of an EGC concerning an IPO that is also attended by any other associated person of a broker-dealer. SEC staff provided guidance on this provision in Question 4 (the SEC FAQ 4) of its JOBS Act Frequently Asked Questions About Research Analysts and Underwriters. SEC FAQ 4 states that the SEC staff interprets this provision as primarily reflecting a Congressional intent to allow analysts to participate in emerging growth company management presentations with sales force personnel so that the issuer s management would not need to make separate and duplicative presentations to analysts at a time when senior management resources are limited. FINRA understands SEC FAQ 4 to identify specific and narrow examples of permissible communications by a research analyst while in attendance at an EGC IPO pitch meeting or in other meetings during a solicitation period concerning an EGC IPO with issuer management that are also attended by other associated persons of a brokerdealer. Further, the SEC staff specifically stated in SEC FAQ 4 that while Section 105(b) permits analysts to attend pitch meetings, Section 105(b) does not... permit analysts to engage in otherwise prohibited conduct in such meetings... for example, [it does not] affect SRO rules that otherwise prohibit an analyst from engaging in efforts to solicit investment banking business [like NASD Rule 2711(c)(4)]. FINRA further views SEC FAQ 4 to be consistent with the risk management guidance set forth in Question 1 above, and does not view SEC FAQ 4 to create a safe harbor for sharing a research analyst s views and valuations with an issuer during the underwriter selection process for either an EGC or non-egc IPO or to change the risk management guidance set forth in Question 1 above, other than to allow attendance by a research analyst at a pitch meeting for an EGC IPO. Firms should contact SEC staff to the extent they have questions about the examples cited in SEC FAQ 4 or other particular communications by a research analyst during an EGC pitch meeting. Posted: 5/27/15 6. May a member provide to an issuer during a solicitation period its previously published research reports? FINRA believes that it would not be inconsistent with NASD Rule 2711(c)(4) and (e) for a member s investment bankers to provide (or arrange for others to provide) to an issuer during a solicitation period its previously published research reports (or electronic access to those reports), upon request by the issuer, provided that the request is made to the investment bankers and not the research analyst, is unsolicited, and the research reports have been previously published and generally made available to investing clients of the firm. If an investment banker were to provide only its selection of reports or to comment on the reports, these actions would carry an elevated risk of being viewed as impermissible conduct. Posted: 5/27/15 7. Do FINRA rules govern inappropriate communications or conduct by issuers? FINRA rules apply only to FINRA members. While the conduct of most issuers is not governed by FINRA s rules, some FINRA members may from time to time issue securities or function as advisor to an issuer in connection with an offering. While NASD Rule 2711 does not specifically address conduct by a member when acting as issuer or an

20 Research Rules Frequently Asked Questions (FAQ) FINRA.org Page 5 of 5 5/27/2015 advisor to an issuer, FINRA expects members acting in those capacities to be respectful of the regulatory obligations of other members participating, or competing to participate, in an offering. Depending on the particular facts and circumstances, FINRA believes it could be inconsistent with just and equitable principles of trade for a member acting in those capacities to request, induce or pressure another member to engage in conduct that, if acquiesced to, would result in a violation of Rule Posted: 5/27/15 Sitemap Privacy Legal 2015 FINRA.