On May 27, 2015, the Financial Industry Regulatory Authority (“FINRA”) issued a new set of FAQs to provide guidance with respect to its research rule, NASD Rule 2711. The FAQs specifically focus on NASD Rule 2711(c)(4) and Rule 2711(e). NASD Rule 2711(c)(4) generally prohibits research analysts from participating in efforts to solicit investment banking business, including by participating in pitches for investment banking business or having any other communications with potential issuers in order to solicit investment banking business. NASD Rule 2711(e) prohibits FINRA members from directly or indirectly offering favorable research, a specific rating or a specific price target, or threatening to change research, a specific rating or specific price target as consideration or inducement for the receipt of business or compensation.
In the FAQs, FINRA stated that whether a particular communication is prohibited under these provisions depends on the context and content of the communication, especially the type and stage of an offering. With respect to IPOs, FINRA identified three stages with varying degrees of risk: (1) a Pre-IPO Period; (2) a Solicitation Period (which begins 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); and (3) a Post-Mandate Period.
The pre-IPO period
FINRA stated that although the prohibition against efforts to solicit investment banking business and promises of favorable research applies during the Pre-IPO period, the risk of violating these provisions in connection with communications between a research analyst and an issuer are lower during the Pre-IPO Period, than in the Solicitation Period. In FINRA’s view, these risks can be effectively managed through a firm’s policies and procedures in the Pre-IPO period. Such policies and procedures could address communications, which if properly managed, can be permissible during this period including discussions concerning an issuer’s competitors, the IPO market and an issuer’s readiness for an offering. However, FINRA also noted that there is no safe harbor for research analyst communications with an issuer during the Pre-IPO period and answering questions from an issuer as to how a research analyst would value the issuer would be prohibited even during this period and may also indicate that the issuer has already determined to proceed with an IPO (and thus Solicitation Period considerations may already be applicable).
The solicitation period
According to FINRA, communications by a research analyst with an issuer during the solicitation period generally carry a significant risk of constituting an impermissible promise of favorable research. Notwithstanding the foregoing, FINRA acknowledged that vetting and due diligence communications during the Solicitation Period do not carry the same risk since these communications are for the purpose of obtaining information from the issuer in furtherance of the analyst’s research function, rather than when a research analyst shares his or her views or valuations of an issuer.
In addition, FINRA stated that during the Solicitation Period, investment bankers can consult with research analysts about valuation and other views without violating FINRA rules. However, FINRA noted that investment bankers may not convey to the issuer that a valuation is either the research analyst’s valuation or a joint valuation of the investment banker and research analyst. In addition, absent a repudiation, bankers may not convey a valuation to an issuer where there has been a request from the issuer or an understanding that the valuation of the investment banker and research analyst will be aligned or that any valuation presented will reflect the research analyst’s views. FINRA cautioned that any communications between investment bankers and research analysts during the Solicitation Period regarding valuation or the research analyst’s views present increased risks that investment bankers will influence the research analyst’s views and must be carefully managed.
However, FINRA noted that it would not expect a research analyst to refrain from sharing industry views at a previously scheduled conference where the issuer may be in attendance during the Solicitation Period. FINRA also stated that during this period, an investment banker could provide an issuer, upon the issuer’s request, with previously published research reports, as long as the request is made to the investment banker and not the research analyst, the request is unsolicited and the research reports have been previously published and generally made available to clients of the firm.
The post-mandate period
According to FINRA, the risks associated with communications between a research analyst and an issuer are lower during the Post-Mandate Period than during the Solicitation Period. Therefore, similar to the Pre-IPO Period, FINRA noted that policies and procedures should be able to effectively manage the risk of violating NASD Rule 2711(c)(4) and Rule 2711(e). FINRA acknowledged that it would generally be acceptable for an analyst to communicate with the issuer his or her views about valuation, pricing and structuring of the transaction, even if such information is positive. However, FINRA noted that like the Pre-IPO period, there is no safe harbor in the Post-Mandate Period, and therefore a firm must consider the context and issuer expectations in determining the permissibility of communications with the issuer. Policies and procedures designed to manage these types of conflicts should address the circumstances that could give rise to impermissible promises of favorable research, including where an issuer suggests that final roles or economics will be based on the valuation given by a research analyst.
Emerging growth companies
In its FAQs, FINRA also addressed Rule 2711’s applicability to Emerging Growth Companies (“EGCs”). An EGC is defined in the Securities Act of 1933 and the Securities Exchange Act of 1934 as an issuer with “total annual gross revenues” of less than $1 billion during its most recently completed fiscal year. Section 105(b) of the Jumpstart Our Business Startups Act (the “JOBS Act”) allows research analysts to communicate with the management of an EGC regarding an IPO that is also attended by any other associated person of a broker-dealer. The SEC staff has interpreted this provision as reflecting a Congressional intent to allow research analysts to participate in EGC management presentations with sales force personnel so that the issuer’s management does not need to make separate presentations to research analysts at a time when senior management resources are limited. The SEC has further stated that Section 105(b) of the JOBS Act does not permit research analysts to engage in otherwise prohibited conduct in such meetings. FINRA does not view the SEC’s position as creating a safe harbor for sharing a research analyst’s views and valuations with an issuer during the underwriting selection process for either an EGC or non-EGC IPO. Rather FINRA views the provision as simply allowing attendance by a research analyst at a pitch meeting for an EGC IPO while the remainder of FINRA’s risk management guidance outlined above is still applicable.
Follow on offerings
The FAQs indicate that follow on offerings involve similar principles but the risks attendant to research analyst’s communications with issuers during the solicitation period may be lower if effectively managed “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.”