FINRA Proposes Amendments to New FINRA Rule 2242 (Debt Research Analysts and Debt Research Reports) | Practical Law

FINRA Proposes Amendments to New FINRA Rule 2242 (Debt Research Analysts and Debt Research Reports) | Practical Law

The Financial Industry Regulatory Authority (FINRA) has proposed to amend FINRA Rule 2242 (Debt Research Analysts and Debt Research Reports) to make certain clarifications to the new rule prior to its effective date of July 16, 2016.

FINRA Proposes Amendments to New FINRA Rule 2242 (Debt Research Analysts and Debt Research Reports)

by Practical Law Corporate & Securities
Published on 26 May 2016 • USA (National/Federal)
The Financial Industry Regulatory Authority (FINRA) has proposed to amend FINRA Rule 2242 (Debt Research Analysts and Debt Research Reports) to make certain clarifications to the new rule prior to its effective date of July 16, 2016.
On May 24, 2016, the Financial Industry Regulatory Authority (FINRA) issued a proposed rule change to amend new FINRA Rule 2242 (Debt Research Analysts and Debt Research Reports). Rule 2242 takes effect on July 16, 2016.
Like FINRA's equity research rules, Rule 2242 is intended to foster objectivity and transparency in debt research and to provide investors with more reliable and useful information with which to make investment decisions. The rule sets out a tiered approach in that, in the retail context, it imposes similar protections to those provided to recipients of equity research under current FINRA rules, while providing broad exemptions for debt research distributed only to institutional investors and for firms with limited investment banking and principal trading activities.
The purpose of the proposed rule change is to clarify four aspects of Rule 2242:
  • The consent requirement for institutional debt research reports distributed to non-US investors by non-US affiliates of FINRA member firms.
  • The consent requirement for institutional debt research reports distributed to specified persons for informational purposes unrelated to investing in debt securities.
  • The scope of the institutional debt research report exemption when distributing third-party debt research reports to eligible institutional investors.
  • The disclosure requirements for debt research analysts in public appearances.

Distribution to Non-US Investors by Non-US Affiliates of Members

Rule 2242(j) exempts debt research reports distributed solely to eligible institutional investors from most of the provisions regarding supervision, coverage determinations, budget and compensation determinations, and all of the disclosure requirements applicable to debt research reports distributed to retail investors. The proposed rule change would amend Rule 2242 to include Supplementary Material providing that the requirements of paragraphs (j)(1)(A) and (B) of the rule would not apply to the distribution of an institutional debt research report by a non-US affiliate of a FINRA member firm to a non-US investor, so long as:
  • The non-US investor is not a customer of the member.
  • The non-US investor is a customer of the non-US affiliate of the member.
  • The non-US affiliate of the member has a reasonable basis to believe that the customer meets the definition of "institutional account" in Rule 4512(c).
A member's research reports, including globally branded research reports, could be distributed by a non-US affiliate of the member to its non-US customers under proposed Supplementary Material in Rule 2242.12 without including the consents required for the member to rely on the general institutional exemption available under the rule.

Distribution to Persons for Informational Purposes

The proposed rule change would amend Rule 2242 to include Supplementary Material in Rule 2242.13 that would permit a member firm to distribute institutional debt research reports to specified persons for informational purposes unrelated to investing in debt securities, provided that the member:
  • Does not distribute the reports prior to their publication.
  • Has disclosed that:
    • the member may provide to institutional investors debt research reports that are not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors; and
    • the debt research reports would be provided only for informational purposes and not for the purpose of making an investment decision related to debt securities.
The proposed Supplementary Material would also allow the member to reasonably conclude that the person has consented to receiving debt institutional research reports according to the terms of Rule 2242.13, if the person receiving institutional debt research does not contact the member to request that the institutional debt research reports not be provided.
Institutional debt research could be distributed for informational purposes to:
  • Regulators for regulatory purposes.
  • Academics for academic purposes.
  • Issuers for the purpose of enhancing knowledge of their industry, their competitors, and market and economic factors.
  • Media organizations for news gathering purposes.

Distribution of Third-Party Debt Research Reports to Institutional Investors

The proposed rule change would amend Rule 2242 to clarify that a member that distributes third-party debt research reports to institutional investors under the institutional exemption must establish, maintain, and enforce written policies and procedures reasonably designed to comply with paragraphs (g)(1), (g)(2), (g)(4), and (g)(6) of Rule 2242. These paragraphs provide that:
  • A member may not distribute third-party debt research if it knows or has reason to know the research is not objective or reliable (Rule 2242(g)(1)).
  • A member must establish, maintain, and enforce written policies and procedures reasonably designed to ensure that any third-party debt research report it distributes contains no untrue statement of material fact and is otherwise not false or misleading (Rule 2242(g)(2)).
  • A member is not required to review a third-party debt research report to determine compliance with paragraph (g)(2) of the rule if the debt research report is an independent third-party debt research report (Rule 2242(g)(4)).
  • A member must ensure that a third-party debt research report is clearly labeled as such and that there is no confusion on the part of the recipient as to the person or entity that prepared the debt research report (Rule 2242(g)(6)).
The review requirements in Rules 2242(g)(2) and (g)(4) for third-party debt research reports and independent third-party debt research reports, respectively, would apply to reports distributed to retail investors or to institutional investors. Accordingly, third-party debt research reports distributed under the exemption would be subject to the same review requirements as third-party debt research reports distributed to retail investors. With respect to disclosures, the proposed rule change would clarify that third-party debt research reports distributed under the institutional exemption would not be required to carry the specific disclosures applicable to retail debt research set out in Rule 2242(g)(3).
The proposed rule change would require that third-party debt research reports distributed to institutional investors disclose prominently:
  • "This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors."
  • If applicable, "This report may not be independent of [Firm's] proprietary interests. [Firm] trades the securities covered in this report for its own account and on a discretionary basis on behalf of certain clients. Such trading interests may be contrary to the recommendation(s) offered in this report."

Public Appearances by Debt Research Analysts

Rule 2242(d) requires disclosures from debt research analysts in public appearances, including debt research analysts that only prepare debt research reports under the institutional debt research exemption. The proposed rule change would amend Rule 2242 to add new Supplementary Material .14 to clarify that the public appearance disclosure requirements do not apply in circumstances where attendance is limited to institutional investors eligible to receive institutional debt research reports.
The proposed rule change would require that:
  • The member maintain records sufficient to demonstrate that attendance at the public appearance was limited to institutional investors eligible to receive institutional debt research.
  • The records be maintained for at least three years from the date of the public appearance.
The disclosure requirements of Rule 2242(d) would apply where attendance at the public appearance was not limited to institutional investors eligible to receive institutional debt research reports.

Effectiveness

The proposed rule change takes effect on filing with the SEC. The implementation date of the proposed rule change will be July 16, 2016 (the effective date of Rule 2242).
Update: The proposed rule change was filed with the SEC, and took effect on, June 1, 2016. The implementation date of the proposed rule change will be July 16, 2016.
For a detailed discussion of FINRA Rule 2242, see Practice Note, Debt Research and Debt Research Analysts.