United States: SEC Issues Guidance Regarding Research Analysts And Underwriters Under The JOBS Act

On August 22, 2012, the SEC staff issued Frequently Asked Questions to provide guidance on certain provisions of the Jumpstart Our Business Startups Act ("JOBS Act") which affect research analysts and underwriters¹.

The provisions in the JOBS Act addressed by the SEC's FAQs are (1) a prohibition on rules which restrict the ability of a broker or dealer to "arrange" communications between an analyst and an investor in connection with the IPO of an emerging growth company (in general, any company with total gross revenue of less than $1 billion for the most recently ended fiscal year), (2) a prohibition on rules which restrict the ability of an analyst to participate in any communication with company management that is also attended by investment bankers in connection with an emerging growth company IPO, (3) a rule permitting emerging growth companies to engage in oral or written communications with potential investors that are "qualified institutional buyers" (QIBS) under Rule 144A or institutional accredited investors under Regulation D prior to or following the date of filing a registration statement with the SEC, and (4) a prohibition on rules that prohibit brokers or dealers from publishing research within a prescribed period of time prior to the expiration date of a lockup agreement.

The Frequently Asked Questions provided the following guidance:

1. Broker-dealers can help emerging growth companies "test the waters," notwithstanding Exchange Act Rule 15c2-8(e).

The JOBS Act allows emerging growth companies or persons authorized to act on their behalf to engage in oral or written communications with potential investors that are QIBs or institutional accredited investors before or after the date of filing a related registration statement. However, Rule 15c2-8(e) provides that a broker or dealer may not participate in a distribution related to a registration statement unless the broker or dealer takes reasonable steps to make available a copy of the preliminary prospectus to each of its associated persons who are expected to "solicit customers' orders."

This has raised the question whether a broker or dealer must make such preliminary prospectuses available before it can help emerging growth companies test the waters. The SEC has clarified that if an underwriter requests from a customer a non-binding indication of interest that includes the amount of shares the customer might purchase in the potential offering at particular price levels—but does not ask the customer to commit to purchase the securities—the underwriter would likely not be "soliciting a customer order" for purposes of Rule 15c2-8(e), absent other factors, and therefore such broker or dealer could help the emerging growth company test the waters.

The SEC also stated that Rule 15c2-8 only applies where a registration statement has been "filed" with the SEC. However, emerging growth companies submit draft registration statements confidentially for staff review, and the SEC has clarified that such submission does not constitute a "filing" and therefore Rule 15c2-8 does not apply until the registration statement is publicly filed.

2. The JOBS Act does not affect the Global Settlement.

In 2003 and 2004, the SEC, NASD, NYSE and other regulators instituted settled enforcement actions againt 12 broker-dealers to address conflicts of interest between the firms' research and investment banking functions. The firms agreed to comply with various undertakings related to a separation of research and investment banking, compensation of research personnel, firewalls between research and investment banking, restriction on activities by research and investment banking personnel, and disclosures in research reports. The SEC has confirmed that the JOBS Act does not modify the Global Settlement. An amendment of the Global Settlement would require an application to the court by one or more of the settling firms. The Global Settlement also provides that a provision of the Global Settlement can be modified or removed if the SEC adopts a rule or approves an exchange rule with the stated intent to supersede that provision.

3. Associated persons of broker-dealers can "arrange" communications between an analyst and a potential investor during an IPO of common equity of an emerging growth company, notwithstanding NASD Rule 2711(c)(6).

The JOBS Act provides that the SEC and national securities associations cannot adopt or maintain any rule which restricts the ability of a broker dealer to "arrange" communications between an analyst and an investor in an IPO of common equity of an emerging growth company. Such arranging activity may include an investment banker forwarding a list of clients to an analyst that the analyst could contact, an analyst forwarding a list of potential clients it intends to communicate with to investment bankers in order to facilitate scheduling, or investment bankers arranging calls between analysts and clients.

However, NASD Rule 2711(c)(6) provides that investment banking department personnel are prohibited from directing a research analyst to engage in sales or marketing efforts related to an investment banking transaction or engaging in communications with a current or prospective customer about an investment banking transaction. The SEC has clarified that the arranging activity described above permitted by the JOBS Act would not be deemed to violate the prohibition contained in NASD Rule 2711(c)(6). The SEC noted, though, that communications with current or prospective customers related to an investment banking transaction must still be fair, balanced and not misleading, and firms subject to the Global Settlement must continue to create and enforce firewalls between research and investment banking personnel reasonably designed to prohibit all communications between the two except as expressly permitted.

4. The JOBS Act permits analysts to attend meetings with company management in the presence of investment banking personnel in connection with the IPO of an emerging growth company, but the extent of this privilege depends on whether the bank is a party to the Global Research Settlement.

The JOBS Act provides that, in connection with an IPO of the common equity of an emerging growth company, the SEC and national securities associations may not adopt or maintain any rule which restricts a securities analyst from participating in any communications with the management of an emerging growth company that is also attended by any other associated person of a broker or dealer, including investment bankers.

The SEC believes that this portion of the JOBS Act primarily reflects an intent to allow analysts to participate in emerging growth company management presentations with sales force personnel, so that the issuer's management does not need to make separate and duplicative presentations to analysts.

For brokers and dealers subject to the Global Settlement, the SEC notes that the Global Settlement was not affected by the JOBS Act, and the Global Settlement still requires firms to create and enforce firewalls between research and investment banking personnel reasonably designed to prohibit all communications between the two, except as expressly allowed in the court order. Therefore, analysts of banks subject to the Global Settlement are not allowed to participate in a communication in the presence of investment banking personnel.

On the other hand, banks that are not subject to the Global Settlement are now allowed to have their analysts attend meetings with issuer management that are also attended by investment banking personnel in connection with an emerging growth company IPO, including pitch meetings (though the analysts cannot engage in otherwise prohibited conduct in such meetings, such as engaging in efforts to solicit investment banking business). Therefore, according to the SEC, before the firm is retained to underwrite an offering, analysts of such non-Global Settlement firms in attendance at such meetings could introduce themselves, outline their research program and the types of factors that the analyst would consider in his or her analysis, and ask follow-up questions to better understand factual statements made by company management. After the firm is formally retained to be an underwriter, according to the SEC, analysts at such non-Global Settlement firms could participate in presentations by the management to educate a firm's sales force about the company and discuss industry trends, provide information obtained from investing customers, and communicate their views.

The SEC also notes that all other antifraud provisions and other rules still govern research analyst conflicts. Analysts cannot change their research as a result of a communication in an effort to obtain investment banking business. An analyst continues to be prohibited from giving tacit acquiescence to overtures from management that attempt to create an expectation of favorable research coverage if the analyst's firm is chosen to underwrite the emerging growth company's IPO. An analyst remains prohibited from providing views that are inconsistent with the analyst's personal views, or from making a statement that is misleading taking into consideration the overall context in which the statement was made. Investment banking personnel remain prohbited from directly or indirectly directing a research analyst to engage in sales or marketing efforts related to an investment banking transaction. And firms still need to institute and enforce appropriate controls to make sure that analysts are not engaging in prohibited conduct, such as solicitation, at any meetings with company management that are also attended by investment banking personnel.

5. Research analysts still may not participate in road shows or engage in communication with customers in the presence of investment bankers or management about an investment banking transaction, notwithstanding the JOBS Act.

Even though the JOBS Act provides that the SEC and national securities exchanges cannot restrict an analyst from participating in communications with the management of an emerging growth company that is also attended by investment bankers, the SEC believes that this does not address roadshows or communications with customers in the presence of investment bankers or management. Therefore, the SEC believes that the restrictions of NASD Rule 2711(c)(5)(A) and (B) continue to apply. According to the SEC, research analysts are prohibited from directly or indirectly (A) paricipating in a road show related to an investment banking transaction and (B) engaging in any communication with a current or prospective customer in the presence of investment banking personnel or company management about an investment banking transaction.

6. The JOBS Act does not affect rules regarding the supervision, compensation or evaluation of research analysts.

The JOBS Act does not affect NASD Rule 2711(b)(1) ("No research analyst may be subject to the supervision or control of any employee of the member's investment banking department, and no personnel engaged in investment banking activities may have any influence or control over the compensatory evaluation of a research analyst") or NASD Rule 2711(d) (Restrictions on Research Analyst Compensation) ("No member may pay any bonus, salary or other form of compensation to a research analyst that is based upon a specific investment banking services transaction") and corresponding NYSE rules.

7. The JOBS Act does not affect rules regarding the pre-publication review of research reports by non-research personnel or an emerging growth company.

The JOBS Act does not affect NASD Rule 2711(b)(2) ("except as provided in paragraph (b)(3), no employee of the investment banking department or any other employee of the member who is not directly responsible for investment research ("non-research personnel"), other than legal or compliance personnel, may review or approve a research report of the member before its publication"), NASD Rule 2711(b)(3) ("non-research personnel may review a research report before its publication as necessary only to verify the factual accuracy of information in the research report or identify any potential conflict of interest," subject to limited condiitons), NASD Rule 2711(c)(1) ("except as provided in paragraphs (c)(2) and (c)(3), a member may not submit a research report to the subject company before its publication") and NASD Rule 2711(c)(2) ("a member may submit sections of such a research report to the subject company before its publication for review as necessary only to verify the factual accuracy of information in those sections" subject to certain conditions) and corresponding NYSE rules.

8. The JOBS Act does not permit firms to promise favorable research in exchange for the business of or compensation from an emerging growth company.

The JOBS Act does not affect NASD Rule 2711(e) ("No member may directly or indirectly offer favorable research, a specific rating or a specific price target, or threaten to change research, a rating or a price target, to a company as consideration or inducement for the receipt of business or compensation") and the corresponding NYSE rule.

9. The JOBS Act does not affect Regulation AC.

Regulation AC provides that brokers, dealers and associated persons must include in research reports certifications by the analyst that the views expressed in the report accurately reflect his or her personal views, and disclose whether or not the analyst received compensation or other payments in connection with his or her specific recommendations or reviews. Broker-dealers must also obtain periodic certification by analysts in connection with views expressed in the analysts' public appearances. The SEC has stated that Regulation AC is not affected by the JOBS Act.

In addition, the SEC has clarified that the broad definition of "research report" in the JOBS Act ("a written, electronic or oral communication that includes information, opinions, or recommendations with respect to securities of an issuer or an analysis of a security or an issuer, whether or not it provides information reasonably sufficient upon which to base an investment decision") does not affect what constitutes a research report under Regulation AC ("a written communication (including an electronic communication) that includes an analysis of a security or an issuer and provides information reasonably sufficient upon which to base an investment decision"). The SEC also reiterated that explanatory language in Regulation AC's adopting release which narrows the research reports covered by Regulation AC remained in effect.

10. The JOBS Act does not affect FINRA rules governing communications by broker-dealers with the public.

The SEC has clarified that the JOBS Act does not impact NASD Rule 2210, which imposes requirements related to the content, filing and approval of broker-dealer communications with the public.

11. Managers and co-managers of an offering may issue research related to an emerging growth company PRIOR to the "expiration, waiver or termination" of a lockup agreement, even though the JOBS Act only addresses research prior to the "expiration" of a lockup agreement.

The JOBS Act provides that the SEC and national securities associations may not adopt or maintain rules prohibiting the publication of research or making public appearances, with respect to an emerging growth company, either (1) within any prescribed period of time following the IPO of the emerging growth company or (2) within any prescribed period of time prior to the expiration date of any lockup agreement.

However, NASD Rule 2711(f)(4) provides that a manager or co-manager of a securties offering may not publish or distribute a research report or make a public appearance 15 days prior to and after the "expiration, waiver or termination" of a lockup agreement. Although the JOBS Act only stated that research must be allowed prior to the "expiration" of a lockup, the SEC has clarified that it interprets

Congress's intent to allow research prior to the "expiration, waiver or termination" of a lockup. The same applies to the equivalent NYSE rule.

While the JOBS Act allows research PRIOR to the expiration of lockup agreements, it does not address research in the 15 days AFTER the expiration, waiver or termination of a lockup agreement. Also, while the JOBS Act allows research following the IPO of the emerging growth company, it does not address research by a manager or co-manager in the 10 days following a secondary offering by an emerging growth company. However, "the staff believes that the policies underlying the change in Section 105(d) are equally applicable to quiet periods during these other time periods." The SEC also said that it understood that FINRA was considering a proposal to eliminate the remaining quiet periods imposed by NASD Rules 2711(f)(1) (prohibiting research by a manager or co-manager in the 40 days after an IPO and the 10 days after a secondary offering), 2711(f)(2) (prohibiting an underwriter of an IPO from issuing research in the 25 days after the IPO) and Rule 2711(f)(4) (prohibiting the issuance of research by a manager or co-manager in the 15 days before or after expiration, termination or waiver of a lockup) with regard to an emerging growth company and its securities.

Footnote

1 For a description of various important aspects of the JOBS Act, see The Jumpstart Our Business Startups Act and Its Impact on Equity Research Analysts, Fried Frank Client Memorandum, David B. Hennes & Carmen J. Lawrence, May 18, 2012; Market Practice Evolves Under the Jumpstart Our Business Startups Act, Fried Frank Client Memorandum, Valerie Ford Jacob, Andrew B. Barkan, Bonnie A. Barsamian, Daniel J. Bursky, Stuart H. Gelfond, Michael A. Levitt, Paul D. Tropp & Vasiliki B. Tsaganos, May 15, 2012; Impact of JOBS Act on Private Investment Funds, Fried Frank Client Memorandum, Jonathan S. Adler & Justin Nasatir, Apr 5, 2012; The Enactment of the Jumpstart Our Business Startups Act: Simplifying the IPO Process While Transitioning to Full Public Company Status, Fried Frank Client Memorandum, Valerie Ford Jacob, Andrew B. Barkan, Bonnie A. Barsamian, Daniel J. Bursky, Stuart H. Gelfond, David B. Hardison, Michael A. Levitt, Paul D. Tropp, Vasiliki B. Tsaganos & Anuja A. Majmudar, Apr 3, 2012; US$500 and a Click: Investing the "Crowdfunding" Way, Fried Frank Client Memorandum, Stuart H. Gelfond & Anthony D. Foti, Jun 12, 2012.

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