FINRA Watching for Promises of Favorable Research in Exchange for Investment Banking Business

September 13, 2011

Approximately ten years ago, the US regulators, including FINRA, began to crack down on a variety of research-related practices, including a perception that positive research was being offered to issuers as an inducement for broker-dealers to be hired as underwriters.  While there have not been any recent reported violations of these rules by FINRA members, there have been reported instances where potential issuers have suggested that they would select underwriters in part based on which were expected to provide positive research coverage.  FINRA has therefore issued a Notice to Members to remind member firms that its rules prohibit them from promising to provide or providing favorable research in exchange for compensation or business, such as an underwriting role in an issuer's upcoming offering.  The notice also outlines member firms' responsibilities in circumstances where an issuer has suggested that it expects favorable research from member firms awarded an underwriting role in the issuer's offering.  While the Notice to Members does not prohibit a member firm from acting as an underwriter in these situations, it is a warning to member firms that they should tread carefully in these instances, and does offer some suggested steps that member firms should take in these circumstances.

FINRA Rules and Guidance Prohibiting Favorable Research in Exchange for Investment Banking Business

NASD Rule 2711 aims to eliminate conflicts of interest between research and investment banking activities of member firms.  More specifically, as summarized in the Notice to Members, NASD Rule 2711(e) prohibits firms from directly or indirectly offering favorable research or a specific rating or price target as consideration or inducement for the receipt of business or compensation.  NASD Rule 2711(c)(4) prohibits research analysts from participating in efforts to solicit investment banking business, including participation in “pitches” to prospective investment banking clients and other communications with issuers for the purpose of soliciting investment banking business.  FINRA has interpreted that provision to prohibit in pitch materials any information about a firm’s research capacity in a manner that suggests, directly or indirectly, that the firm might provide favorable research coverage.

FINRA does not have jurisdiction to regulate issuers that are not broker-dealers and therefore not FINRA members, but it can regulate the conduct of broker-dealers participating in the issuer’s offering.  The Notice to Members makes it clear that where an issuer makes known, expressly or implicitly, that the selection of an offering participant will be predicated on an expectation of positive research coverage, FINRA will closely scrutinize offering participants’ research and other deal-related activities for compliance with FINRA and SEC rules.  FINRA will be looking for issuer “suggestions [that may] take the form of hints, insinuations or other subtle references, but are intended to condition the award of investment banking business on the nature of research attendant to the deal.”  In these circumstances, FINRA expects that member firms that choose to compete for or participate in the offering will:

  • expressly repudiate to the issuer any expectation with respect to the content of research coverage and document such repudiation;
  • implement heightened supervision of their solicitation activities, including pitch meetings and other communications with the issuer, to ensure there is no express or implied acknowledgement to the research expectation; and
  • increase oversight of the preparation and content of their research on the subject company—both before and after deal participants are chosen—including any permissible communications between research and investment banking personnel.

What Should Member Firms Do?

The Notice to Members does not contain any new regulation and does not amend NASD Rule 2711.  In light of FINRA's obvious concern and focus on this area, however, member firms should take a fresh look at pitch materials and any other information about a firm’s research capacity to make sure that they are not presented in a manner that suggests, directly or indirectly, that the firm might provide favorable research coverage. Member firms can continue to pitch for offerings where an issuer has suggested its expectation of positive research, but, in those situations, member firms should consider taking additional precautions to ensure that their personnel attending the pitch properly make clear that it cannot promise favorable coverage.  For example, member firms may want to:

  • include additional disclaiming language in the pitch material and any response to a request for proposal documentation stressing that the member firm is not, and is unable to, make any promises about research coverage, and
  • emphasize appropriate conduct for member firm personnel who meet with the potential issuer, which must avoid any implicit or explicit understanding that positive research is being promised.

In light of the scrutiny being placed on this area by FINRA, member firms would also be prudent to generally ensure that all investment banking and research analyst personnel involved in meetings with potential issuers are educated on FINRA's restrictions in this area and the guidance set out in the Notice to Members.


If you have questions regarding this newsflash, please contact any of the lawyers listed below or your regular Davis Polk contact.

Julia K. Cowles 650 752 2007
Joseph A. Hall212 450
Michael Kaplan212 450
Lanny A. Schwartz212 450
Janice Brunner212 450
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