U.S. Securities Law Briefing.

Transcription

1 April 2010 U.S. Securities Law Briefing. Court Modifies Global Research Analyst Settlement. Judge William Pauley of the Southern District of New York recently agreed to modifications to the settlement entered into against the 12 firms (the Settling Firms ) covered by the settlement of SEC v. Bear, Stearns & Co. Inc., et al. (the Global Research Analyst Settlement or Settlement ). The modifications would allow, among other things, investment banking and research staff to participate in joint due diligence sessions under certain circumstances. The court, however, rejected a change that would have allowed the Settling Firms research and banking personnel to communicate about market or industry trends, conditions, or developments outside the presence of internal legal or compliance staff. Most of the modifications to Addendum A to the Settlement, which sets out the reforms imposed on the Settling Firms, were requested on the basis that rules issued by the National Association of Securities Dealers Inc. (the NASD ) and the New York Stock Exchange ( NYSE ) already address the concerns raised by the provisions to be amended or removed. Consequently, a Settling Firm s conduct with respect to many of the removed or amended provisions should not substantially change following the modifications since they are already subject to similar restrictions under the NYSE or NASD rules. Contents Background... 1 Amendments to the Settlement... 2 Joint Due Diligence Sessions... 2 Continuing Restriction on Communications on Market Trends... 3 Other Approved Amendments... 3 Conclusion... 5 Appendix I to this briefing provides a summary table comparing the 2004 version of Addendum A with the version recently approved by Judge Pauley. Background The Global Research Analyst Settlement was the culmination of enforcement actions by the U.S. Securities and Exchange Commission (the SEC ), state securities regulators, the NYSE, the NASD and the New York State Attorney General, alleging research analyst conflicts of interest against 10 investment banks and two research analysts. Among other reforms, the Settlement mandated that the Settling Firms: maintain separate reporting and supervisory structures for their research and investment banking operations; prohibit investment banking personnel from evaluating the performance of research analysts; prevent communications between firms' research and banking operations except as necessary for an 1 U.S. Securities Law Briefing

2 analyst to advise the firm concerning the viability of a transaction; provide further information to investors about the limitations of research; and disclose on a quarterly basis price targets, ratings and earnings per share forecasted for each covered company. The Settlement also provided that with respect to any provision that had not been expressly superseded by subsequent rulemaking within five years, the parties expected that the SEC would agree to an amendment or modification of such provision, subject to court approval, unless the SEC believes such amendment or modification would not be in the public interest. Amendments to the Settlement In their 3 August 2009 letter to Judge Pauley, the Settling Firms requested modification of a number of provisions of Addendum A. Although the Settling Firms preferred that all of Addendum A s existing operative provisions be eliminated, the SEC only agreed not to oppose removing or amending some of the provisions. Consequently, the Settling Firms did not request amendments to provisions such as the requirement for physical separation of research analysts and investment banking staff or the prohibition on investment banking input into the research budget or company-specific coverage decisions. Joint Due Diligence Sessions The court approved almost all of the Settling Firms proposed changes, including an amendment to allow investment banking and research staff to participate in joint due diligence sessions if certain conditions are met. Section I.10(c) of Addendum A now allows research analysts to assist the firm in confirming the adequacy of disclosure in offering or other disclosure documents for a transaction based upon the analysts communications with the company and other third parties (such as suppliers, customers, accountants, vendors and other third parties). However, if investment banking personnel are present or otherwise participate in communications by research analysts with the company or other third parties, the following conditions must be met: 1. the joint communications must be for the due diligence purpose of gathering or confirming information about the company related to the proposed transaction; 2. the joint communications must either (a) take place after the receipt by the firm of an investment banking mandate; or (b) in case of transactions other than initial public offerings, be in connection with either a block bid or a competitive secondary or follow-on offering or similar transaction where the issuer or selling shareholder has requested that the firm submit a transaction proposal; 3. in the case where an investment banking mandate has been received, the communications are held in the presence of internal legal or compliance staff, or underwriters or other 2 U.S. Securities Law Briefing

3 counsel who are knowledgeable about the terms of the Settlement; and 4. in the case of the block bid or competitive secondary/followon offering, the firm s legal or compliance staff reasonably believes that the firm will not have a meaningful opportunity to conduct separate due diligence prior to the award of a mandate, and the communications are held in the presence of internal legal or compliance staff. To the extent that the due diligence communications with research analysts are later communicated to investment banking staff, the communications must be made in the presence of internal legal or compliance staff, or underwriters or other counsel who are knowledgeable about the terms of the Settlement. Continuing Restriction on Communications on Market Trends Although the SEC did not oppose the amendment, the court refused to allow modifications of section I.10(a) of Addendum A, which sets the rules by which research analysts may respond to a request by investment banking staff for their views on the merits of a proposed transaction or a potential candidate for a transaction, or market or industry trends, conditions or developments. Addendum A allows a research analyst to respond through research management or in the presence of internal legal/compliance staff. The Settling Firms advocated changing the provision to allow research and investment banking staff to communicate regarding market or industry trends outside of the presence of legal/compliance staff if the communications are consistent to those that an analyst would have with investors, and to allow communications to learn more about a particular company if in the presence of legal/compliance staff. The court rejected the proposed amendment, stating that allowing the change would undermine the separation between research and investment banking.... The parties' proposed modification would deconstruct the firewall between research analysts and investment bankers erected by the parties when they settled these actions. Other Approved Amendments Other than the proposed amendment to section I.10(a) of Addendum A, Judge Pauley approved all the other amendments proposed by the Settling Firms without comment. Most of the modifications to the Settlement, such as the removal of the prohibition on investment banking staff input on research analysts compensation or evaluations, were requested on the basis that the provisions were already covered by similar NYSE or NASD rules. Consequently, a Settling Firm s conduct with respect to such provisions should not substantially change following the court order since they are already subject to similar restrictions under the NYSE or NASD rules. However, in a few areas, the court approved amendments to Settlement provisions that are not already covered by NYSE or NASD rules, so the 3 U.S. Securities Law Briefing

4 Settling Firms will likely be revising their procedures and policies soon to take advantage of the deletion from Addendum A of the following requirements: Separate dedicated legal/compliance staff for the research department; Review by the audit committee of the firm s parent/holding company of the research department s budget and expenses; Joint research/investment banking due diligence restrictions (joint due diligence is now allowed under the conditions described above); Communications between research analysts and a group of 10 or more of firm s sales force or 10 or more investors must be chaperoned by a legal/compliance staff member; Written logs must be maintained for three years of communications between research analysts and group of 10 or more of firm s sales force or 10 or more investors; Internal research memos distributed to a group of 10 or more of the firm s sales force must be reviewed in advance by internal legal/compliance staff and retained for three years; and Research analysts may only attend or participate in a widelyattended conference where investment banking staff are attending or participating (the new Addendum A allows attendance at any widelyattended event ). The court also agreed to add a paragraph to the provision in the Settlement on superseding rules and amendments, which now says that the SEC will agree to further amendment of Addendum A (subject to court approval), unless the amendment would not be in the public interest, upon the earlier of: (i) 15 March 2011 or (ii) the effective date of new research rules proposed by the Financial Industry Regulatory Authority ( FINRA ) 1 in Regulatory Notice (October 2008), if such rules address the remaining provisions of the modified Addendum A. 1 FINRA comprises the former NASD and the member regulation, enforcement and arbitration functions of the NYSE. 4 U.S. Securities Law Briefing

5 Conclusion The modifications approved by the court are a welcome development given that most of the restrictions required by Addendum A are already addressed by the NYSE and NASD rules. In the areas not already covered by such rules, the changes are not significant, or with respect to the now allowed joint due diligence sessions, conditions have been put in place designed to ensure that investors are protected. We will continue to monitor developments in this area and welcome any queries you may have. Contacts For further information please contact: Jeff Cohen (+1) jeff.cohen@linklaters.com Scott Sonnenblick (+1) scott.sonnenblick@linklaters.com Jason Manketo (+44) jason.manketo@linklaters.com Jon Gray (+852) jon.gray@linklaters.com Ed Fleischman Senior Counsel (+1) This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. Linklaters LLP. All Rights reserved 2010 Linklaters LLP is a limited liability partnership registered in England and Wales with registered number OC The term partner in relation to Linklaters LLP is used to refer to a member of Linklaters LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP together with a list of those non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ or on and such persons are either solicitors, registered foreign lawyers or European lawyers. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by ing us at marketing.database@linklaters.com. edward.fleischman@linklaters.com One Silk Street London EC2Y 8HQ Telephone (+44) Facsimile (+44) Linklaters.com 5 U.S. Securities Law Briefing A

6 Appendix I Amendments to Addendum A 2004 Version of Addendum A 2010 Modifications to Addendum A [and Settling Firms Rationale] I. Separation of Research and Investment Banking 1. Reporting Lines Research and Banking will be separate units with entirely separate reporting lines. 2. Legal/Compliance Research will have its own dedicated legal and compliance staff. 3. Budget Research budget and expenses will be determined by firm s senior management without input from Banking. Parent company audit committee must review such budget and expenses to ensure compliance. 4. Physical Separation Research and Banking will be physically separated in order to prevent information flow. 5. Compensation Research compensation will be determined by Research management and firm s senior management (not including Banking personnel). 6. Evaluations Evaluation of Research personnel will not be done by nor may there be input from Banking. 7. Coverage Banking will have no input on company-specific coverage decisions and Banking revenues will not be taken into account in making coverage decisions. 8. Termination of coverage When decision is made to terminate coverage on company, a final research report on the company will be made available using the ordinary means of dissemination. 9. Prohibition on soliciting Banking business Research may not participate in efforts for Banking business, such as participating in pitches for Banking business. 10. Firewalls between Research and Banking 10(a). Banking may seek, through Research management or in the presence of internal legal/compliance staff, the views of Research about merits of proposed transaction or candidate for proposed transaction, or market or industry trends, conditions or developments. Communications cannot be for purpose of having Research identify potential investment banking transactions. 10(b). Research may communicate view about potential transaction or candidate in connection with review by a requesting committee, but Research must have chance to express views outside of presence of Banking. 10(c). Research may assist in confirming adequacy of disclosure but any communication to Banking must be made in presence of underwriters or other counsel on transaction or internal legal/compliance staff. 10(d). After the firm has received an investment banking mandate or in connection with a block bid, Research may: (i) communicate views on pricing and structuring to equity capital markets group ( ECM ); (ii) provide ECM with information from investors regarding pricing and structuring; (iii) participate with ECM or independently in education of sales force regarding transactions but may not appear jointly with issuer management or Banking personnel (other than ECM) if (1) Research s oral communications of recommendations have a reasonable basis; (2) oral communications to group of 10 or more of firm s sales force are reasonable and balanced and in presence of legal/compliance personnel; (3) all internal use memos are identified as being views of Research; (4) internal research memos given to group of 10 or more of sales force must be reviewed beforehand by legal/compliance; (5) written log of all communications under (2) is maintained; and (6) all written logs and internal research memos described in (4) must be kept for three years. Removed. [NYSE and NASD rules require that Research may not be subject to Banking s supervision and Banking may not review research reports.] Removed. [Firms already have legal and compliance staff experienced in monitoring settlement compliance, so no need for separate legal/compliance staff for Research.] Removed audit committee review requirement. [Consistent with public interest.] Removed. [NYSE and NASD rules prohibit Banking from having influence or control over Research compensation.] Removed. [NYSE and NASD rules prohibit Banking from having influence or control over compensatory evaluation of research.] Removed. [NYSE and NASD rules contain similar requirements.] Removed. [NYSE and NASD rules contain similar requirements.] Banks requested change to allow communications between Banking and Research outside presence of legal/compliance staff on market or industry trends, conditions or developments, as long as communications consistent with that an analyst might have with investors. Judge Pauley rejected this change. Amended to allow Research and Banking to participate in due diligence together if certain conditions are met. [Allowing joint due diligence is more effective and conditions protect investors.] Amended to allow communications by Research also in case of competitive secondary or follow-on offering where issuer or selling shareholder has requested that firm submit a transaction proposal. [Firms need to get analysts view when they only have a short time to respond to a proposal.] Amended to remove 10(d)(iii)(2) requirement that communications to more than 10 salespeople be in presence of legal/compliance, and to remove 10(d)(iii) (4), (5) and (6) requirements regarding internal research memos being reviewed by legal/compliance and maintaining written logs and memos. [NYSE and NASD have similar rules covering such communications but such rules do not contain the deleted requirements.] 6

7 Appendix I Amendments to Addendum A 2004 Version of Addendum A 10(e). Research may attend or participate in widely-attended conference attended by Banking, as long as Research doesn t participate in activities prohibited by Addendum. 10(f). Research and Banking may attend or participate in widely attended firm meetings or sit on same committees at which general matters of firm interest discussed. Any communication between Research and Banking regarding legal or compliance issues must be in presence of legal/compliance. 10(g). Communication between Research and Banking not related to research or investment banking not restricted. 11. Additional Restrictions (a) Research may not participate in company or Banking-sponsored road show and (b) Banking may not direct Research to engage in marketing or selling efforts to investors. After the firm receives a public offering mandate, Research may communicate with investors provided that it does not appear jointly with issuer management or Banking and: (1) Research s oral communications of recommendations have a reasonable basis; (2) oral communications to 10 or more investors are reasonable and balanced; (3) Research s oral communications to 10 or more investors are in presence of legal/compliance; (4) written log of all communications under (2) is maintained; and (5) written logs must be kept for three years. 12. Oversight Requires creation of oversight committee (not to include Banking) to review change in ratings or price targets and quality and accuracy of research reports. II. Disclosure/Transparency and Other Issues 1. Disclosures Certain legends regarding conflicts of interest and information access are required on the front of all research reports. 2. Transparency of Analysts Performance Firm must make publicly available on its website certain information (subject company, analyst s name, date of report, rating, price target, etc), if included in its research reports Modifications to Addendum A [and Settling Firms Rationale] Amended to allow attendance/participation by Research in any widely-attended event. [No rationale.] Amended to remove 11(a) regarding joint road show participation and (b) regarding Banking direction of Research to engage in marketing or selling. [NYSE and NASD rules contain similar restrictions.] Amended to remove 11(b)(3), (4) and (5) regarding communications to 10 or more investors in presence of legal/compliance and maintenance of written logs. [NYSE and NASD have similar rules covering such communications but such rules do not contain the deleted requirements.] 3. Applicability of Addendum requirements. 4. General Firm may not knowingly do indirectly what it may not directly do under Addendum and must implement policies and procedures to prevent Banking and others from influencing research reports to obtain/retain investment banking business. Removed. [NYSE and NASD rules require clear explanation of meaning of ratings and other ratings information in research reports.] 5. Timing Sets out effective date. 6. Review of Implementation Establishes independent monitor. 7. Superseding Rules and Amendments If SEC adopts rule or approves SRO rule with stated intent of superseding settlement provisions, the SEC or SRO rule will govern. After five years, SEC will agree to modifications unless it is not in the public interest. 8. Other Obligations or Requirements Addendum does not relieve firm of any other applicable obligations or requirements. III. Independent, Third-Party Research Amended to add that the SEC would agree to further modifications (unless not in public interest) upon earlier of one year after court approval of modifications or effective date of proposed FINRA research rules. No changes to this section (which requires firms to procure and make available independent research for five years), since the requirements have already expired. 7