Late Friday, FINRA released proposed new rules for addressing debt research conflicts of interest.  The current proposal is based on the concept proposal presented by FINRA in s Regulatory Notice 11-11, as revised for comments submitted on that published notice.  FINRA's Comment Period Expires 4/2/12. Today's revised proposal maintains a tiered approach based on whether debt research is distributed to retail or institutional investors.  Debt research distributed to retail investors would carry most of the same protections provided to recipients of equity research;  institutional investors could opt in to a framework that exempts such research from many of those provisions. Beginning with RegNote 11-11 ("2011 Proposal"). In the 2011 proposal, FINRA suggested requiring firms to identify and manage conflicts of interest ("COI's") related to the preparation and distribution of debt research reports.  It used a tiered approach that generally would provide retail debt research recipients with the same extensive protections provided to recipients of equity research, with certain modifications.  It also exempted debt research provided solely to institutional investors from many of those provisions, including nearly all disclosure requirements. The 2011 Proposal further provided that institutional investors could opt in to the more protective regime afforded debt research distributed to retail investors.  And it set forth unique guidelines for communications between debt research analysts and sales and trading personnel that acknowledged:  (i) the need to ration a debt analyst’s resources among the multitude of debt securities;  (ii) the limitations on price discovery in the debt markets; and (iii) the need for trading personnel to perform credit risk analyses with respect to current and prospective inventory.  FINRA received 6 comment letters and, based in part on those comments and further discussion with the industry, FINRA has put out this revised debt research proposal. FINRA directs casual readers to the key provisions of the revised proposal, but strongly recommends that interested parties carefully read the attached rule text for a complete and detailed understanding of the proposal. For those who don't wish to read C-I's overview of the proposal, at this time, can link onto FINRA's release, by clicking:   [FINRA RegNote 12-09, February 2012, "Debt Research Reports"]. Definitions. The concept proposal defined “debt security” as any “security” other than an “equity security,” a “treasury security” or a “municipal security” (as those terms are defined in the federal securities laws).  The definition of “debt research report” closely followed the current definition of equity research report—i.e., a communication that includes an analysis of a debt security and provides information reasonably sufficient upon which to base an investment decision - and contained the same exceptions currently in place for equity (e.g., discussions of broad-based indices and commentaries on economic, political or market conditions). The definition of “institutional investor” in the concept proposal was the same as “institutional account” in FINRA’s suitability rule.  Thus, the proposed definition generally covered:

• a bank, savings and loan association, insurance company or registered investment company;
• an investment adviser registered either with the SEC 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
• any other entity (whether a natural person, corporation, partnership, trust or otherwise) with total assets of at least $50 million.

[N.B. This was a brief coverage of the definitions section.] Identifying and Managing Conflicts of Interest. The revised proposal incorporates most of the structural safeguards contemplated by the concept proposal. In that regard, the revised proposal requires firms to establish, maintain and enforce policies and procedures reasonably designed to identify and manage conflicts of interest related to:  (i) the preparation, content and distribution of debt research reports;  (ii) public appearances by debt research analysts; and,  (iii) the interaction between debt research analysts and those outside the research department, including investment banking, sales and trading and principal trading personnel,4 subject companies and investors. This section further addresses these subsections:  (i) Prepublication Review;  (ii) Coverage;  (iii) Solicitation and Marketing of Investment Banking Transactions;  (iv) Supervision;  (v) Budget and Compensation;  (vi) Personal Trading;  (vii) Retaliation and Promises of Favorable Research. Content and Disclosure in Debt Research Reports. With respect to debt research distributed to retail investors, the revised proposal imposes most of the same disclosure requirements that apply in the equity research context, with a few modifications to reflect certain differences between the debt and equity markets. Subsections in this topic include:  (i) Recommendations and Ratings;  (ii) Conflicts Disclosure;  (iii) Termination of Coverage. Public Appearances. The revised proposal closely parallels the equity research rules with respect to disclosure in public appearances, with the exception referenced above regarding disclosure of firm holdings of the equity of the subject company. Thus, the revised proposal requires disclosure by debt research analysts in public appearances:

• of the analyst and his or her household member’s financial interest in the subject company;
• if the analyst knows or has reason to know that the firm or any affiliate received compensation from the subject company in the previous 12 months;
• if the debt analyst received compensation from the subject company in the previous 12 months;
• if the analyst knows or has reason to know that the subject company has been a client in the previous 12 months and the nature of services provided; and \
• of any other material conflict of interest of the debt research analyst or firm that the analyst knows or has reason to know at the time of the public appearance .

We pass on details for these 4 topics:

Standards Applicable to Research Distributed to Institutional Investors. Communications Between Debt Research Analysts and Trading Desk Personnel. Distribution of Member and Third-Party Research Reports. Exemption for Members With Limited Investment Banking Activity.

Supplementary Material. The revised proposal contains supplementary material to provide guidance on various provisions.  In addition to the communications between research and trading and the disclosure of non-investment banking services compensation discussed above, the supplementary material addresses:

• prohibitions on information in pitch materials;
• prohibitions on joint due diligence conducted with an issuer in the presence of investment banking personnel;
• restrictions on communications with customers and internal personnel;
• submission of sections of a draft debt research report for factual review;
• persons with the ability to influence the content of a research report; and
• obligations of persons associated with a member firm with respect to provisions that require the firm to have policies and procedures restricting or prohibiting certain conduct.

FINRA OGC Contacts. Direct questions to these members of the Office of General Counsel:  Philip Shaikun, (202) 728-8451; Racquel Russell, Assistant General Counsel, (202) 728-8363. For further details, go to: [FINRA RegNote 12-09, February 2012, "Debt Research Reports"].