Practitioners and market participants often complain that rules and regulations ought to be principles-based rather than prescriptive. In advocating for principles-based regulation, the argument is often made that the objectives underlying the rules and regulations should be clear to those subject to compliance requirements. In November 2014, the Financial Industry Regulatory Authority, Inc., or FINRA, filed a proposed rule change with the Securities and Exchange Commission, or the SEC, which was subsequently amended in early 2015, to adopt NASD Rule 2711 (the equity research rule) as new FINRA Rule 2241 with significant modifications. Although the proposed changes generally retain many of the principal provisions of Rule 2711, proposed Rule 2241 represents a shift in approach. The proposed rule relies on a principles-based approach that puts more emphasis on the effective design and monitoring of a member firm’s compliance policies and procedures to mitigate and avoid conflicts of interest. As such, in preparing for the new rule, member firms may be required to take a more holistic approach to reviewing and revising their policies and procedures and undertake a more rigorous look at the types of activities that may pose conflicts of interest or be perceived as improperly influencing research. In addition to implementing this new approach, proposed Rule 2241 attempts to establish a level playing field as between investment banks subject to the Global Settlement and those that are not, as well as establish a level playing field in the treatment of research relating to issuers that are emerging growth companies, or EGCs, and those that are not. At the same time that it filed the proposed rule change relating to equity research, FINRA also filed a rule proposal relating to debt research, which is substantially similar although it takes into account the fact that debt research generally is more oriented at institutional investors.

Identifying and Managing Conflicts of Interest – Rule 2241(b) -

Rule 2241(b), titled “Identifying and Managing Conflicts of Interest,” sets forth the principles underlying the revised rule. It requires member firms to establish, maintain and enforce written policies and procedures reasonably designed to identify and effectively manage conflicts of interest related to (a) the preparation, content and distribution of research reports, (b) public appearances by research analysts, and (c) the interaction between research analysts and persons outside of the research department, including investment banking and sales and trading personnel, the subject companies and customers. The Supplemental Material that forms part of the rule itself includes some prescriptive requirements addressing areas in which FINRA believes there is heightened risk of undue influence being applied to research. For example, in Supplemental Material .02, “Joint Due Diligence,” FINRA states that it interprets clause (c) above to prohibit joint due diligence sessions involving a research analyst in the presence of investment banking department personnel prior to the selection by the issuer of the underwriters for the investment banking transaction. Once

Originally published in NSCP Currents on May 1, 2015.