FINRA Issues Long-Awaited Concept Proposal for Regulation of Debt Research

March 17, 2011

FINRA has issued Regulatory Notice 11-11, in which it proposes its concept for regulation of debt research issued by member firms. FINRA describes the concept as one that would apply “objective safeguards and disclosure requirements” to debt research with a “tiered approach” providing most of the same protections to retail recipients of debt research as presently provided to all recipients of equity research, while exempting  debt research provided solely to institutional investors from some of the provisions in NASD Rule 2711 that apply to equity research.

Comments are solicited and are due by April 25, 2011.

FINRA officials had previously discussed their intent to propose a rule regulating debt research that differentiates research for retail and institutional investors. The publication of Notice 11-11 merits close attention by FINRA members that prepare both equity and debt research, as well as by FINRA members that distribute research, even if they do not prepare the research themselves. 

Regulatory Notice 11-11 may preview a new road map for regulation of research generally, if FINRA moves to differentiate all research based on whether it is provided to retail or institutional investors, rather than whether it is equity or debt research. FINRA should be encouraged to consider collateral consequences of this proposal and any resulting proposed rule(s).  

Standards Proposed for All Debt Research


FINRA alludes to a proposed definition of “debt research report” that would track the current definition in NASD Rule 2711 for equity research ("a communication that includes an analysis of securities and that provides information reasonably sufficient upon which to base an investment decision") subject to the same exceptions currently in place for equity research reports in NASD Rule 2711.1 However, FINRA does not articulate a proposed definition of “analysis.” A great deal of material currently produced is not considered debt research because it deals with short-term trading ideas, and a definition that is overly broad could significantly impact market practices. Therefore, in commenting on this proposal member firms should request further clarification with regard to what FINRA will consider research, and what will not be encompassed in the definition of a research report.

FINRA suggests defining “debt security” as a “security” other than an “equity security,” a “treasury security” or a “municipal security” (as defined in the federal securities laws). This definition could sweep in a variety of securities not usually considered “debt,” such as mutual funds and other pooled investment vehicles.

In addition, FINRA suggests that for purposes of the debt research rule it would define “institutional investor” using the definition of “institutional account” in its suitability rule, which would provide for some degree of consistency in assessing whether an account/customer is institutional or retail.2 FINRA requests comment on whether this is the optimal definition for “institutional investor.”

Communications Firewalls

FINRA recognizes in Regulatory Notice 11-11 that communications between debt research analysts and debt sales and trading personnel are critical to the operation of both businesses. Therefore, FINRA expressly suggests permitting certain communications between debt research analysts and sales and trading personnel, and prohibiting others. In considering issues for comment, FINRA member firms should evaluate closely these proposed permitted and prohibited communications to determine whether FINRA has sufficient understanding of the relationship between debt research analysts and sales and trading personnel. As stated in Regulatory Notice 11-11, the permitted communications would be as follows:

  • Provision by debt research analysts to sales and trading personnel of information about the creditworthiness of issuers and other information reasonably related to the price/performance of a debt issuer’s debt securities provided that the information is consistent with the analyst’s published research. These communications would have to be consistent with similar communications that an analyst might have with the member’s customers. They would not be “inconsistent” with published research, however, when discussing investment objectives or time horizons that differ from the analyst’s published views.
  • Provision by sales and trading personnel to debt research analysts of specific information about a bond instrument, current prices, spreads, liquidity and similar market information relevant to the analyst’s valuation of a particular debt security.
  • Input from sales and trading personnel to Research Management regarding debt research coverage decisions, provided that final coverage decisions are made by Research Management.

Prohibited communications would expand on current FINRA Rule 5280, which requires information barriers to prevent trading ahead of research reports, and would include:

  • Attempts by sales and trading personnel to influence a debt analyst’s opinion or views to benefit the trading position of the firm, of a customer or of a class of customers;
  • Debt research analysts identifying or recommending to sales and trading personnel specific potential trading transactions that are not identified in the analysts’ currently published reports;
  • Debt research analysts disclosing the timing of, or material investment conclusions in, a pending debt research report; and
  • Debt research analysts having any other communication for the purpose of determining the profile of a customer to whom research should be directed.

FINRA Proposes Standards for Debt Research Modeled on, but for Retail Stricter in Some Ways Than, Current Standards for Equity Research

Standards Applicable to All Debt Research

The contemplated debt research rule would, in many ways, track the current requirements of NASD Rule 2711 with regard to equity research reports. FINRA contemplates a rule with regard to ALL debt research that:

  • Prohibits promises of favorable debt research coverage in connection with investment banking transactions;
  • Prohibits debt research analysts’ involvement in pitching for investment banking business, participation in road shows and other affirmative marketing of investment banking transactions to investors;
  • Prohibits, or significantly restricts, certain three-way meetings about investment banking services transactions where research analysts and customers meet with either investment banking personnel or issuer management representatives;
  • Prohibits input into research coverage by investment banking personnel;3 
  • Prohibits retaliation by firm personnel against debt research analysts for unfavorable debt research regarding an issuer;
  • Prohibits pre-publication review of pending debt research by a subject company (beyond fact checking) and investment banking personnel, and if research is directed to retail investors, also prohibits such pre-publication review by any other non-research personnel; and
  • Prohibits investment banking personnel from directing research analysts to engage in any sales or marketing efforts or from directing any communications with customers about any investment banking services transaction.

FINRA notes that it does not anticipate carrying over from Rule 2711 the concept of a prohibition on debt analysts receiving pre-IPO securities of issuers the analysts cover and the imposition of quiet periods around the issuance of debt research reports.4

Standards for Retail Debt Research

In addition to the general requirements described above, FINRA contemplates stricter standards for retail debt research than for debt research provided exclusively to institutional investors. This distinction is based on FINRA’s view that there is now “increased retail investment risk in complex debt securities [and]…that the allegations of misconduct in the sale of auction rate securities (ARS) illuminated this fact and provided a very concrete example that potential conflicts of interest in the publication and distribution of debt research can exist just as they do for equity research.”5

Many of the suggested requirements for retail debt research would be easily adapted from existing equity research practices, and may in fact reflect firms’ current practices in light of the BMA Guiding Principles.6 But several elements of the retail debt research rule envisioned by the FINRA staff could render retail debt research economically infeasible, specifically proposals that would:

  • Prohibit both investment banking AND sales and trading personnel from providing input into the determination of the research department budget;
  • Prohibit research compensation from being based on (1) specific investment banking transactions, (2) specific sales and trading transactions, and (3) research contributions to the member firm’s investment banking or sales and trading activities; and
  • Prohibit supervisory and compensatory evaluation of debt analysts by both investment banking AND sales and trading personnel.

In addition, the proposed approach to differentiate retail from institutional debt research will have limited utility to FINRA member firms that generally produce a single product for all customers. 

Exemption for Research Provided Solely to Institutional Investors

FINRA acknowledges in the Regulatory Notice that institutional investors trading debt securities do so as counterparties more than as customers. FINRA recognizes that institutional investors value timely flow of analysis and trade ideas related to debt securities, are aware of potential conflicts of interest between a member’s recommendations and trading interests and are capable of exercising independent judgment in evaluating such recommendations and reaching their own pricing decisions. FINRA therefore suggests in the Regulatory Notice that it would exempt debt research disseminated exclusively to institutional investors “from most of the structural safeguards and disclosures described…for retail debt research…”. Such exempted research would have to comply with the general standards discussed above, be clearly distinguished from retail research and include a “health warning” prominently on the first page of each report that would inform recipients that:

  • The research is intended for institutional investors only and is not subject to the independence and disclosure standards applicable to research provided to retail investors;
  • If applicable, that the firm trades the securities discussed in the research as principal for its own account and on behalf of certain clients and that trading interests may be contrary to the recommendations in the research and that the research may not be independent of the firm’s proprietary interests; and
  • If applicable, that the research may be inconsistent with recommendations offered in the firm’s research disseminated to retail investors.

FINRA contemplates that institutional investors would be allowed, under a debt research rule, to opt out of the institutional-only exemption, and once opted out, receive only research fully compliant with the requirements for retail investors.

Comment Sought

FINRA seeks comment on the proposal as a whole and also on several specific points including:

  • Definitions;
  • Opt-in versus opt-out in connection with the institutional investor exception;
  • Whether the proposed approach could adversely impact the availability of debt research to retail investors;
  • Whether certain categories of debt research might be exempted from all contemplated rules; and
  • Whether additional disclosures should be considered for institutional-only debt research.

FINRA members should consider commenting on the concept release. Entities that produce debt research but that are not FINRA members also should consider commenting on the concept release, because FINRA expresses its view in the Regulatory Notice that third-party debt research distributed by member firms should be subject to supervision and disclosure obligations similar to those presently applicable to third-party equity research reports. Finally, institutional investors who use debt research should consider whether the concept release would discourage FINRA members from providing debt research or trading ideas that those investors value.

Please direct questions to any of the listed lawyers or to any other Bingham lawyer with whom you ordinarily work on related matters.

Amy Natterson Kroll, Partner, Broker-Dealer, 202.373.6118

David Boch, Partner, Broker-Dealer Group, 617.951.8485

Roger P. Joseph, Practice Group Leader, Investment Management; Co-chair, Financial Services Area, 617.951.8247

Edwin E. Smith, Partner, Financial Restructuring; Co-chair, Financial Services Area, 617.951.8615

Tim Burke, Practice Group Leader, Broker-Dealer Group; Co-chair, Financial Services Area, 617.951.8620

1 FINRA Regulatory Notice 11-11, “Debt Research Reports,” March 2011, p. 3, available at (last accessed March 14, 2011). For a complete listing of exceptions currently in place for equity research reports, see FINRA Rule 2711(a)(9).
2 FINRA Notice 11-11, p. 3. The term “institutional account” is defined as “the account of (a) the account of a bank, savings and loan association, insurance company, or registered investment company, (b) an investment adviser registered either with the Securities and Exchange Commission under Section 203 of the Investment Advisers Act of 1940 or with a state securities commission (or any agency or office performing like functions) or (c) any other entity (whether a natural person, corporation, partnership, trust or otherwise) with total assets of at least $50 million. See FINRA Rule 2111(b) and NASD Rule 3110(c)(4).
3 Some of these proposed provisions, such as the prohibition of input into research coverage by investment banking personnel, are not reflective of current practice at many firms and may have significant implications depending on FINRA’s intention in proposing the provisions.
4 FINRA Notice 11-11, note 7.
5 FINRA Notice 11-11, p. 2.  
6 See Regulatory Notice 11-11 for a full outline of the elements that the staff envisions including in the retail debt research rule.

This article was originally published by Bingham McCutchen LLP.