On May 27, 2015, FINRA issued a set of FAQs on its research conflict of interest rules. These FAQs further expand upon views expressed by FINRA in settlement agreements entered into by FINRA in December 2014 with ten investment banks in connection with the 2010 proposed IPO by Toys “R” Us (the “Settlement Agreements”).
Under NASD Rule 2711(c)(4), research analysts are prohibited from participating in a bank’s efforts to solicit investment banking business. Under NASD Rule 2711(e), banking firms may not make promises of favorable research coverage during their efforts to obtain investment banking business. In the Settlement Agreements, FINRA took a broad view of the concepts of soliciting investment banking business and promising favorable research.
Toys “R” Us had notified the ten banks that their research analysts should separately present their views on a number of topics, including valuation, and that the analyst presentations would be considered as part of the selection process. The company also asked all but one of the firms to present the unified view of their investment banks and equity research on valuation, which they were expected to stand behind if they were selected as underwriters. Toys “R” Us awarded mandates for roles in the proposed offering but did not proceed with the IPO. In the Settlement Agreements, FINRA viewed the separate presentations given by the banks’ research analysts as well as the valuation confirmations given by those analysts to Toys “R” Us as impermissible solicitation activity in furtherance of investment banking business and impermissible promises of positive post-IPO research coverage.
In the FAQs, FINRA presented its views on three distinct periods prior to an investment banking transaction and the attendant risks for violating the research conflict of interest rules with respect to each of these periods: (1) the solicitation period, (2) the pre-IPO period, and (3) the post-mandate period. In FINRA’s view, the risk of violating the research conflict rules is greatest during the solicitation period. However, even in the pre-IPO period and the post-mandate period, care needs to be exercised so as to not run afoul of Rule 2711. Among other things, FINRA has not created any safe harbors for conduct in these periods and it may not always be clear as to when one period ends and another begins. Accordingly, the determination for whether there has been a Rule 2711 violation will always be facts-and-circumstances specific.
What follows is a discussion of FINRA’s views with respect to each of the three periods.
Solicitation Period
In FINRA’s view, the greatest risk of violating the research conflict rules exists during the solicitation period for an IPO. FINRA defines the solicitation period as beginning when the issuer makes known that it intends to proceed with an IPO and ending when there is a bona fide awarding of the underwriting mandates. According to FINRA, the solicitation period ends for a particular firm when it has been notified that it has been given a role or rejected for a role in the offering, even if the particular roles or economics of the underwriting syndicate have not yet been determined. FINRA stated in the FAQs that any communications between research analysts and a prospective issuer during a solicitation period for an IPO, other than communications limited to vetting and due diligence purposes, should be strictly limited and even such vetting and due diligence communications must be managed carefully by a bank’s compliance team to avoid impermissible communications.
In the FAQs, FINRA expressed the view that, subject to applicable requirements relating to Global Settlement firms and a firm’s policies and procedures to insulate research analysts from investment banking pressure, investment bankers may consult with analysts about valuation and other issues during a solicitation period, but only so long as the bankers do not convey to the issuer that a valuation reflects the views of its analysts or the joint views of the bankers and analysts. FINRA stated that firms should make clear to prospective issuers that any valuation provided reflects the views of the bankers only and that the firm cannot make any representations regarding the views of its analysts. FINRA further stated that firms may provide previously published research reports only if the issuer makes an unsolicited request for them from the investment bankers, not the analysts, and those reports have been previously made available to the investing clients of the firm.
Additionally, FINRA reiterated in the FAQs that while research analysts are able to participate in IPO-related communications with management of an Emerging Growth Company (“EGC”) that also include members of the investment banking team such as pitch meetings as provided by Section 105(b) of the JOBS Act, analysts may do so only so long as the research analyst does not participate in soliciting investment banking business or engage in other prohibited conduct. FINRA emphasized again that the JOBS Act does not create a safe harbor for analysts to engage in otherwise impermissible communications. In light of this, having research analysts attend meetings with the investment banking team pursuant to Section 105(b) of the JOBS Act may be fraught with risk.
In the context of a follow-on offering, as compared to an IPO, FINRA stated that it believes the risks of violating the conflict rules are lower and, therefore, subject to a firm maintaining a proper information barrier to keep the analyst from learning of a prospective offering, FINRA expressed the view that analysts may continue to engage in ordinary course communications with the issuer to benefit the firm’s investing clients.
Pre-IPO Period
In the FAQs, FINRA expressed its view that the risk of violating the research conflict of interest rules is lower during the period prior to an issuer making the determination to move forward with an IPO process. For example, FINRA indicated that analysts may generally respond to questions regarding the issuer’s competitors, the IPO market and the issuer’s readiness for an IPO. However, FINRA cautioned that it has not created a pre-IPO period safe harbor and firms’ policies and procedures should, among other things, address circumstances where issuer statements or questions suggest that the issuer may have made a determination to proceed with an IPO. FINRA indicated that answering questions from an issuer as to how the issuer would be valued or positioned in the market may be an indication that an IPO determination has been made by the issuer and could potentially violate Rule 2711.
Post-Mandate Period
Once an issuer has awarded a banking firm a role in a prospective offering—even if that firm’s role and economics have not yet been determined—FINRA expressed its view that, like in the pre-IPO period, the risk of a Rule 2711 violation should be lower as compared to the solicitation period. Accordingly, FINRA expressed the belief that it would generally be permissible for a firm’s research analysts to communicate their views regarding valuation, pricing and structuring of a transaction. However, FINRA again emphasized that there is no safe harbor in the post-mandate period, and that firms must consider the context and issuer expectations in evaluating the permissibility of communications with the issuer. FINRA stated that a firm’s policies and procedures should address circumstances that could give rise to impermissible promises of favorable research, such as where an issuer suggests that final roles or economics will be based on the highest valuation given by an analyst.
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In light of the Settlement Agreements and FAQs, investment banks should revisit their research conflict policies and procedures as they relate to Rule 2711 to the extent they have not already done so.
A link to FINRA’s research conflict FAQS can be found here: http://www.finra.org/industry/faq-research-rules-frequently-asked-questions-faq
A link to FINRA’s release relating to the Settlement Agreements can be found here: https://www.finra.org/newsroom/2014/finra-fines-10-firms-total-435-million