New Conflict Rules for Debt Research


We are pleased to include below Fried Frank’s analysis of the new conflict rules for debt research recently proposed by FINRA, kindly provided by Linda Riefberg.  The biographies of the authors are at the end of this article.  Note that the deadline for comments on the proposed rules is April 2, 2012. Click here for our previous commentary on the proposed rules.

Research Analyst Conflict of  Interest:  Extending the Rules to Debt Research

By Gregory P. Gnall and Linda S. Riefberg of Fried, Frank, Harris, Shriver & Jacobson LLP

Introduction – The Latest in Research Conflict Rules

The most recent development in the ongoing regulatory battle against research analyst conflicts of interest is the FINRA revised rule proposal in Regulatory Notice 12-09 entitled “Debt Research Reports” that extends most of the firewalls created for equity research to debt research providers.[1] This Regulatory Notice is a follow-up to the Regulatory Notice jointly issued by the NASD and NYSE (now consolidated as FINRA) in July 2006[2] and the concept proposal of Regulatory Notice 11-11 that introduced the idea of a rule proposal addressing conflicts of interest involving debt research analysts.  The concept proposal has engendered some industry commentary and led to certain modifications.  The FINRA Rule proposal also supplants the Bond Market Association best practices that were published in 2004 for voluntary compliance.[3] In its recent Report on Securities Research, the Government Accountability Office (“GAO”) agreed that rulemaking covering debt research analysts was needed to even the playing field and protect retail investors.[4]

The FINRA Rule proposal would expand the existing regulatory framework for equity research under which the research function must be kept separate from other firm interests in debt research. However, the proposed rule would create a two-tiered approach, where institutional investors have the ability to opt out of most of its provisions.  There are other differences between the equity research rules (the “Equity Rules”), as contained in NASD Rule 2711, and the proposal relating to fixed income research, which are highlighted below (the “Debt Rule”); most notably, in requiring disclosures of firm positions in debt securities and in being more permissive in allowing some communication between research analysts and trading desk personnel.  FINRA requests that any comments be submitted by April 2, 2012.


In the decade since research analyst and investment banking conflicts of interest took center stage in the regulation of the financial industry, much has occurred. First was the Global Research Analyst Settlement, which was the culmination of a year-long coordinated investigation by the SEC, NYSE, NASD, the New York Attorney General and other state securities regulators of twelve of the leading equity research providers, leading to a $1.5 billion settlement involving disgorgement, penalties and investor education.  In addition to various structural reforms, the settling firms were required to deliver independent research valued at over $400 million[5] to their customers for five years after the settlement. All the settling firms also had to undergo independent consultant reviews of their policies and procedures, and the NASD and NYSE adopted rule reforms that codified a strict separation between the research and investment banking departments surrounding the creation and distribution of equity research.[6] For the settling firms, some of the restrictions that date from the original settlement did not fade away with the passage of time, as many expected, but have persevered,[7] and the concern about research analysts being influenced by business interests remains.  As recently as September 2011, FINRA issued a Regulatory Notice[8] reminding all firms of the need to maintain vigilance in keeping the interests of issuers and investment banking separate from the research analysts covering stocks.


Under Regulatory Notice 12-09, “debt security” is defined as any security other than “equity securities,” “municipal securities,” “treasury securities” and “security-based swaps.”  A “debt research report” is defined as any written (including electronic) communication that includes an analysis of debt securities and that provides information reasonably sufficient upon which to base an investment decision.  The proposed Debt Rule cross-references the definition of “research report” in FINRA Rule 2711 (the Equity Rule) and, therefore, the Debt Rule would not apply to communications distributed to fewer than 15 persons, periodic reports prepared for clients that discuss prior investment decisions, and internal communications that are not sent to customers. Further, the definition of “research report” does not include communications that only discuss broad-based indices; commentaries on economic, political or market conditions; technical analyses concerning demand and supply of a sector or industry; statistical summaries of companies’ financial data; recommendations to increase or decrease holdings in a sector or industry; and notices of ratings or price target changes, if the firm directs readers to the most recent research on that product.   FINRA declined to categorically exclude “trader commentary” or other communications emanating from sources other than the research department, such as sales and trading, based on its view that the degree of protections afforded should be based on the type of recipient, and not the nature of the communication.

How to Manage Conflicts

Since the premise of both the Debt and Equity Rules is to maintain the integrity of research through the creation of firewalls between analysts and other firm personnel, the proposed Debt Rule has a number of similarities to the Equity Rule.  As with the Equity Rule, the proposed Debt Rule would prohibit investment banking department personnel from directing a debt research analyst to engage in sales or marketing efforts, or to communicate with a current or prospective investment banking client about an investment banking transaction.  Also, as in the equity realm, the proposed rule prohibits a debt research analyst from participating in pitches and road shows.  There are also similar rules about prepublication review of research, wherein the subject company may only view the research to verify the facts.  Both sets of rules have provisions preventing retaliation against the analyst by others at the firm who may have been personally disadvantaged by a research report or analyst appearance.

In debt research, investment banking, trading and sales personnel, including the principal trading personnel, are prohibited from any prepublication review.  Interestingly, in contrast, under the Equity Rules, trading and sales personnel are allowed prepublication review in order to verify the facts contained in an equity research report.

Unlike the Equity Rule, the Debt Rule does not require the member to notify its customers when it is terminating coverage, since the coverage of debt securities is more “episodic.”[9]

Both the Equity Rule and the proposed Debt Rule prohibit any explicit or implicit promise of favorable debt research, specific content, ratings or recommendation as an inducement for the receipt of business.  The Equity Rules prohibit a research analyst from being subject to the supervision or control of an employee of the Investment Banking department.  The Debt Rules go one step further and disallow a debt research analyst from being subject to the supervision or control of anyone in the sales and trading and principal trading departments.

Along the same lines, both sets of rules create a separation in budget and compensation decisions between the research department and other departments of the broker-dealer.  Both situations require that a committee be in place to make analyst’s compensation determinations, and similar factors are in place for considerations including the productivity and quality of the research, and the ratings given by customers, peers and sales and trading personnel. Both sets of rules require policies and procedures to prohibit compensation based on investment banking or trading activities.  In addition, the Equity Rule does not allow any person engaged in investment banking activities to influence or control the compensation of the analyst. The Debt Rule treats compensation somewhat differently.  Under the proposal, sales and trading personnel, but not persons engaged in investment banking or principal trading, may give input to research management relating to compensation determinations.

Opt Out Requirement

The most significant difference between the Equity Rule and the proposed Debt Rule is that the latter would create a two-tiered approach, where most of the requirements of the rule are not applicable to debt research reports distributed to institutional investors,[10] if the institutional investors notify the member firm in writing that they do not wish to be treated as a retail investor for purposes of the debt research.  The definition of institutional investor relies on the FINRA definition of institutional investor used in other contexts, and purposely does not extend to accredited investors under the Rule 501, Regulation D usage of high net worth individuals.  According to FINRA, the monetary thresholds for Regulation D are too low to mean the investor is necessarily sophisticated.   The member must have policies and procedures in place to ensure that institutional debt research does not get distributed to retail investors, and if it has reason to believe that the research is being redistributed to retail investors, then the exemption cannot be used. If the exemption for institutional investors is relied upon, then the research distributed to such investors must contain the following legend:

“This research 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.”

A firm would also have to disclose that: (i) it trades securities covered in the report for its own account and on behalf of clients, and that such trading interests may be contrary to the views stated in the report, and (ii) the views in the report to institutional investors may differ from the views given to retail customers.

Even if an institutional investor opts out of being treated as a retail customer under the Debt Rule, there are several provisions that nevertheless still apply, such as:

•     Prohibiting debt analysts from participating in pitches and other solicitations;

•     Prohibiting debt analysts from participating in road shows and marketing on behalf of issuers;

•     Prohibiting investment banking personnel from directing a debt analyst to engage in marketing, or to communicate with a current or prospective customer about an investment banking transaction;

•     Prohibiting prepublication review by the subject company;

•     Prohibiting retaliation by a firm employee against a debt analyst based on their unfavorable research view; and

•     Prohibiting the promise of favorable debt research as an inducement for business or compensation.

Impermissible Personal Trading

The proposed Debt Rule also is similar to the Equity Rule in prohibiting an analyst from making any purchase or sale in the security inconsistent with the analyst’s recommendation, although firms may have procedures in place to establish financial hardship as a basis for permitting such a trade. The Debt Rules also require firms to restrict or limit trading by the debt analyst in securities, derivatives and funds whose performance is materially dependent upon the performance of securities covered by the analyst. The Debt Rule also mandates that supervisors and associated persons who have the ability to influence research not be allowed to benefit by their own trading based on their knowledge of the content or timing of the publication of research.

Disclosures That Must Be Made

The disclosure requirements for debt research reports are also similar to those applied in the equity context.  For debt research, the facts in the research and the recommendation or rating must each have a reasonable basis. If ratings are used, then the time horizons and benchmarks for the ratings have to be explained. The proposal would require firms to explain the percentages of their ratings that are buy, hold or sell regardless of what rating system, if any, they use.  This is similar to the distribution of ratings that equity analysts are required to disclose, including the percentage of subject companies in those categories in which the member provided investment banking services in the preceding 12 months. Where the research coverage has extended for at least a year, the firm has to disclose all the previous ratings and dates, but does not have to plot a price chart, as is required with equities.

There are also various requirements that the debt analyst disclose conflicts that could impact the integrity or credibility of the research.  This includes disclosure of:

•     whether the debt research analyst or a member of their household has any holdings in the debt security or other financial interest;

•     whether the debt research analyst received compensation based upon the firm’s investment banking or sales and trading revenue;

•     and as to the firm, any compensation received for investment banking services in the preceding 12 months;

•     and any financial interest the firm has in the company, where the positions amounted to a material conflict of interest which the debt analyst (or someone with the ability to influence the content of the report) knew or had reason to know when the research was published.

The disclosures a debt analyst must make in public appearances is also parallel to the disclosures already required to be made by equity analysts, including the analyst’s financial interest in the company and whether the company or the analyst received compensation from the subject company in the past 12 months; but in both instances of equity and debt research rules, such disclosures do not have to be made if by doing so it would reveal material non-public information.

Permissible Communication Between Analysts and Sales and Trading Personnel

The Debt Rule creates an information barrier between research analysts and sales and trading and principal trading personnel, but carves out certain instances where it is acceptable for them to communicate with research personnel.  According to FINRA, this exception is in recognition of the need for interaction between debt research analysts and sales and trading personnel to communicate customer interests and to assist in generating trading ideas.  Thus, sales and trading personnel may communicate customers’ interest, as long as the analyst doesn’t publish research to benefit the customer (or in the case of principal traders, the firm). The debt analysts can provide customized analyses to customers that are consistent with their research.  Sales and trading and principal trading personnel may seek the views of the debt analyst about subject company creditworthiness, and debt research analysts may seek information from sales and trading and principal trading personnel relevant to a valuation analysis.

How the Debt Rules Impact Distribution of Reports

The Debt Rule would prohibit selectively distributing research to any class of customer or firm department.  There can be different types of research given to different categories of customers, and even different ratings (for example, a long-term investor would have a different product than an investor with a short horizon).  However, the proposed rule makes clear that the differentiation in research cannot be simply as to the timing of the information as that would improperly give one set of customers or firm personnel advance notice of potentially market moving information.

The requirements for third-party distribution of the debt research are the same as those for equity research. The research must be reliable and objective, and contain the appropriate disclosures.  Firms must have procedures in place to ensure that the third-party research not contain untrue or misleading statements. There is a lesser standard for independent third-party research, since it is not affiliated with the firm, and is made available to customers at the customer’s request.  As with equity research, a firm does not have to review independent research, and need not include pertinent disclosures if it makes the research available (for example, by posting it on its website or providing it to a customer who requests it), as opposed to distributing it in the manner it distributes its own research.  Nevertheless, the third-party research must be labeled as such, to avoid confusion to the investor as to who prepared the report.


Given the breadth of the proposed Debt Rules and its potential impact on Debt research analysts, it is expected that many research providers and users will provide comment regarding this rule.  That comment may be submitted to FINRA before the proposal is filed with the SEC for approval or commentators may opt to wait to submit any comments to the SEC.  In any event, there is bound to be more discussion ahead before the proposed Debt Rules are finalized.


[2] NASD, Research Analysts and Research Reports: NASD and NYSE Joint Interpretive Guidance on Fixed Income Research Notice to Members 06-36, (July 2006)

[3] The Bond Market Association, Guiding Principles to Promote the Integrity of Fixed Income Research: A Global Approach to Managing Potential Conflicts of Interest (May 2004).

[4] GAO-12-209 Securities Research: Additional Actions Could Improve Regulatory Oversight of Analyst Conflicts of Interest (Jan. 2012).

[5] SEC, Fact Sheet on Global Analyst Research Settlements (modified Apr. 28, 2003), available at

[6] NASD Rule 2711, NYSE Rule 472.  Throughout this Fried Frank FINAlert, the references to equity research rule, in comparison to the debt rules, are to NASD Rule 2711.

[7] SEC Litigation Release No. 21457(Mar. 14, 2010).

[8] FINRA Regulatory Notice 11-41 (Sept. 2011).

[9] Regulatory Notice 12-09 at p. 10.

[10] The definition of “ institutional investor,” cross- referenced to the definition of “institutional account” under FINRA Rule 4512(c), means: ”1) a bank, savings and loan association, insurance company or registered investment company; (2) an investment adviser registered either with the SEC under Section 203 of the Investment Advisers Act or with a state securities commission (or any agency or office performing like functions); or (3) any other person (whether a natural person, corporation, partnership, trust or otherwise) with total assets of at least $50 million.”

Gregory P. Gnall is a special counsel resident in Fried Frank’s New York office.  He joined the Firm in 2008.  Mr. Gnall has represented US broker-dealers and investment advisers, including the US subsidiaries of major international banking organizations, on SEC, FINRA and CFTC issues concerning the domestic and cross-border fixed income, equities and derivatives markets.  He focuses on matters relating to sales and trading, investment banking, clearing, research and investment advisory activities and deals with registration, margin and reporting issues.  Mr. Gnall also provides advice concerning regulatory examinations and represents clients in SEC and FINRA enforcement matters.  In addition, he conducts internal examinations and SEC and SRO mandated compliance reviews.

Linda Riefberg is special counsel resident in Fried Frank’s New York office, where she is a member of the Firm’s securities enforcement and regulation practice.  She joined the Firm in 2011.  Ms. Riefberg represents institutions and individuals in securities enforcement investigations and other regulatory matters before the Securities and Exchange Commission, Financial Industry Regulatory Authority and state securities regulators.  She also handles securities-related litigations and arbitrations.


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