Study guide
The Series 87 shifts from analysis to obligation: what a research analyst may say, when, with what disclosures, and how reports reach the public. This chapter covers the conflict-of-interest regime of FINRA Rule 2241, the SEC's certification and fair disclosure rules, the approval chain for research reports, and the rules that govern trading around and dissemination of research.
FINRA Rule 2241: Separating Research from Banking
FINRA Rule 2241 requires member firms to adopt written policies and procedures that identify and manage conflicts of interest between research and other business lines, above all investment banking. The rule insulates analysts structurally: investment banking personnel may not supervise research analysts or control their compensation, and coverage decisions cannot be dictated by banking. Prepublication review of a research report by investment banking is prohibited, and review by anyone else not directly responsible for preparing the report is restricted, with exceptions for legal and compliance staff. Sections of a draft may be shared with the subject company only to verify facts, and the rating and price target may not be shared in advance; legal or compliance oversight of the process is required. Compensation rules follow the same logic. An analyst's pay may not be based on specific investment banking transactions or contributions to banking business, and a committee that excludes investment banking representation must review and approve each analyst's compensation at least annually, documenting its basis and considering factors such as the quality and accuracy of the analyst's work. Firms and analysts may not promise favorable research, a particular rating, or a price target as consideration for business, and retaliation against an analyst for an unfavorable but honest report is prohibited. Analysts are also barred from participating in efforts to solicit investment banking business, including pitch meetings and, in most circumstances, deal road shows. Finally, firms must restrict analysts' personal trading in covered securities, including trading inconsistent with the analyst's current recommendation, subject to narrow exceptions such as documented financial hardship.
Quiet Periods and Required Disclosures
Rule 2241 imposes quiet periods after offerings. A firm that participated as underwriter or dealer in an initial public offering may not publish research on the issuer for a minimum of 10 days following the offering; a firm that acted as manager or co-manager of a secondary offering faces a minimum three-day quiet period. Two relief valves exist: the quiet periods generally do not apply to offerings by emerging growth companies as defined under the JOBS Act, and a firm may publish during a quiet period concerning significant news or events with legal or compliance authorization. Research reports must also carry specific disclosures, presented clearly and prominently. The ratings distribution shows the percentage of all securities the firm rates that are assigned buy, hold, and sell categories, and for each category the percentage of subject companies that received investment banking services from the firm within the previous 12 months. If the firm has assigned a rating or price target for at least one year, the report must include a line graph of the security's daily closing prices marking the dates each rating or target was assigned or changed. Additional required disclosures include any financial interest of the analyst or a household member in the subject company's securities; the firm or its affiliates beneficially owning 1 percent or more of a class of the issuer's common equity; investment banking compensation received in the past 12 months or expected or intended to be sought in the next three months; whether the firm makes a market in the security; and any other material conflict known at publication. Similar disclosure duties apply in public appearances.
Regulation AC and Regulation FD
Regulation AC, the SEC's analyst certification rule, requires that every research report include a certification by the analyst that the views expressed accurately reflect his or her personal views about the subject securities and companies. The report must also state whether any part of the analyst's compensation was, is, or will be related, directly or indirectly, to the specific recommendations or views expressed; if compensation is so related, that connection must be disclosed. The rule extends to public appearances: firms must periodically obtain records or certifications from analysts covering their public statements, and if an analyst will not provide the certification, the firm must notify its examining authority and disclose the failure in that analyst's subsequent research reports for a defined period. Regulation FD addresses the other side of the information flow and binds issuers rather than analysts. When an issuer, or someone acting on its behalf, discloses material nonpublic information to securities professionals or to holders likely to trade on it, the issuer must make the information public simultaneously if the disclosure was intentional, and promptly if it was unintentional. For analysts, the practical effect is that private guidance from management, such as an early read on the quarter, is off limits. The mosaic theory remains permissible: an analyst may assemble individually nonmaterial or public pieces of information into a valuable conclusion. An analyst named Priya may conclude from supplier checks and channel data that Orbix Semiconductor's quarter is weak; she simply cannot be told so privately by the chief financial officer.
Approval, Rule 2210, and the Anatomy of a Report
Before a research report reaches clients, it must be approved. FINRA Rule 1220(a)(14) establishes the supervisory analyst registration category, obtained by passing the Series 16 exam, and supervisory analysts are the personnel qualified to approve a member's equity research reports; certain communications may otherwise require approval by an appropriately registered principal. Research also lives inside FINRA Rule 2210, which sorts member communications into retail communications, distributed or made available to more than 25 retail investors within any 30 calendar-day period; correspondence, sent to 25 or fewer; and institutional communications. A typical published research report is a retail communication, which triggers pre-use approval and content standards: statements must be fair and balanced, provide a sound basis for evaluating the security, and avoid false, exaggerated, unwarranted, promissory, or misleading claims. Price targets are permitted when they have a reasonable basis and are accompanied by disclosure of the valuation methods used and the risks that could impede achievement; ratings must be defined in the report and used consistently with their plain meaning. Report types include initiation of coverage, rating or estimate changes, earnings reviews, industry or thematic pieces, and short update notes, and each carries the same core obligations. Distributing third-party research requires review procedures and clear labeling. When a firm terminates coverage, it must promptly notify customers and generally provide a final report comparable in scope and detail to prior reports, including a final recommendation and the rationale for termination, or disclose why providing one is impracticable.
Dissemination: Rule 5280, Securities Act Rules 137 Through 139, and Regulation M
FINRA Rule 5280 prohibits a member from trading for its own account based on advance knowledge of the content or timing of its own research, and requires policies and information barriers so that personnel who trade cannot see unpublished research. Rule 2241 reinforces fair distribution: a firm may offer different research products and services to different classes of clients, but it may not selectively leak a report or a rating change to favored customers or its own trading desk before publication, and no research analyst account may benefit from advance knowledge of a report. During registered securities offerings, three Securities Act safe harbors define when publishing research does not count as an unlawful offer. Rule 137 covers broker-dealers not participating in the distribution, allowing publication in the regular course of business so long as the firm receives no compensation from the issuer or other offering participants. Rule 138 allows a participating firm to publish research about securities of a reporting issuer other than the type being offered, such as covering the common stock while underwriting nonconvertible debt. Rule 139 allows a participating firm to continue existing coverage: issuer-specific reports are protected for larger seasoned issuers when published in the regular course of business and, generally, without initiating or resuming coverage, while industry reports qualify when the issuer receives no greater prominence than other companies discussed. Regulation M protects offering integrity from the trading side: during a restricted period, generally one or five business days before pricing depending on the security's trading volume and public float, distribution participants may not bid for or purchase the offered security, with exceptions that include actively traded securities and research distributed in reliance on Rules 138 and 139.
Key terms
- Research report
- — A written communication that analyzes individual securities or companies and provides information reasonably sufficient to base an investment decision on.
- Quiet period
- — A window after an offering during which participating firms may not publish research on the issuer: a minimum of 10 days after an IPO for underwriters and dealers, and three days after a secondary offering for managers and co-managers.
- Emerging growth company (EGC)
- — An issuer category created by the JOBS Act, defined by a revenue threshold that is adjusted periodically; the research quiet periods generally do not apply to EGC offerings.
- Information barrier
- — Policies and physical or electronic separations that prevent unpublished research information from flowing to trading, banking, or other conflicted personnel.
- Ratings distribution disclosure
- — A required disclosure showing the percentage of the firm's ratings that are buy, hold, and sell, and for each category the percentage of subject companies that were investment banking clients in the prior 12 months.
- Price chart requirement
- — For securities rated or assigned a price target for at least one year, a required line graph of daily closing prices marking the dates each rating or price target was assigned or changed.
- Regulation AC
- — The SEC rule requiring analysts to certify that reports reflect their personal views and to state whether their compensation is related to the specific recommendations expressed.
- Regulation FD
- — The SEC rule requiring issuers that disclose material nonpublic information to market professionals or shareholders to make it public simultaneously if intentional and promptly if unintentional.
- Mosaic theory
- — The permissible practice of combining public information and individually nonmaterial nonpublic information into a material research conclusion.
- Supervisory analyst
- — A person registered under FINRA Rule 1220(a)(14) after passing the Series 16 exam, qualified to approve a member's research reports.
- Rule 5280
- — The FINRA rule prohibiting a firm from trading ahead of its own research reports and requiring information barriers between research and trading personnel.
- Regulation M restricted period
- — The window, generally one or five business days before pricing depending on trading volume and float, during which distribution participants may not bid for or purchase the security being distributed.
Exam tips
- Memorize the quiet period numbers: a minimum of 10 days after an IPO for participating underwriters and dealers, and three days after a secondary offering for managers and co-managers, with exceptions for emerging growth companies and significant news approved by legal or compliance.
- Learn the disclosure triggers as numbers: 1 percent beneficial ownership, an investment banking compensation lookback of 12 months and a forward window of three months, and the price chart requirement after one year of coverage.
- For Regulation AC, the certification covers two things, personal views and compensation linkage; do not confuse it with Rule 2241's separate disclosure list.
- Know who approves research before distribution: a supervisory analyst registered under Rule 1220(a)(14) by passing the Series 16.
- Sort Securities Act Rules 137, 138, and 139 with two questions: is the firm participating in the offering, and is the research about the security being offered? Rule 137 is for non-participants, Rule 138 covers a participant's research on a different type of the issuer's securities, and Rule 139 covers a participant's continuing coverage.