Research Reports of Certain Covered Investment Funds Now Receive Safe Harbor Protection from Being Deemed Offers or Sales
January 28, 2019
Pursuant to new Rule 139b (Rule) under the Securities Act of 1933, the publication of a “research report” on “covered investment funds” by an unaffiliated broker-dealer will not be deemed an “offer for sale or offer to sell” requiring registration under the 1933 Act, provided certain conditions are met.1 The Rule defines the term “covered investment fund” to include registered investment companies and business development companies, as well as publicly traded commodity pools that invest primarily in commodities, currencies, or derivative instruments that reference commodities or currencies. This new, non-exclusive, safe harbor is similar to the long-standing safe harbor available for research on public operating companies. The Rule became effective on January 14, 2019.
The SEC adopted the Rule pursuant to Congressional mandate in the Fair Access to Investment Research Act of 2017 (FAIR Act).2 The FAIR Act was designed to encourage broker-dealers to publish proprietary research on “covered investment funds” and directed the SEC to amend Rule 139 (which provides a safe harbor from the 1933 Act’s market conditioning and gun jumping limitations on communications occurring around the time of a registered public offering) to include certain investment fund research reports published or distributed by broker-dealers. In the Adopting Release, the SEC expressed its belief that the Rule would “increase competition in the market for” and “encourage some broker-dealers to publish” research reports on covered investment funds. As the Rule’s safe harbor is non-exclusive, broker-dealers that publish or distribute reports for some covered investment funds (e.g., commodity- or currency-based trusts or funds that have a class of securities registered under the Securities Exchange Act of 1934) also may be able to rely on Rule 139.
In addition, the SEC adopted new Rule 24b-4 under the Investment Company Act of 1940, which excludes covered investment fund research reports from the filing requirements for investment company sales literature under the 1940 Act, provided the report complies with the communications content standards of the Financial Industry Regulatory Authority (FINRA) or another self-regulatory organization. The SEC also amended Rule 101 of Regulation M to exempt Rule 139b research, consistent with the existing exception for Rule 139 research on operating companies.
Background on Rule 139b
Prior to its amendment by the FAIR Act, Rule 139 provided a safe harbor with respect to research reports on companies that registered their securities on Forms S-3 or F-3, but that rule did not cover research reports about covered investment funds. The SEC considers the distribution of “research reports containing information, opinions or recommendations” with respect to a proposed offering, under certain circumstances to be “offers to sell under Section 5(c) [of the 1933 Act], particularly when a broker-dealer is a participant in the distribution.”3 The SEC also takes the position that “research reports disseminated by participating broker-dealers in the waiting or post-effective periods which do not meet Section 10 prospectus requirements or are not accompanied by a Section 10 prospectus may violate Section 5(b)(1).”4
Rule 139b adopts the definition of a “covered investment fund research report” to comport with the FAIR Act, which defines that term to mean a research report published or distributed by a broker-dealer about a covered investment fund or any securities issued by the covered investment fund.
Definitions
A research report refers to a “written communication, as defined in Rule 405 under the [1933] Act, 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.” This definition is identical to the definition in Rule 139.
The SEC adopted the definition of a “covered investment fund research report” as originally proposed in May 2018. The definition excludes research reports published or distributed by: the covered investment fund itself; any affiliate of the covered investment fund; or any broker-dealer that is an investment adviser (or an affiliated person of the investment adviser) to the covered investment fund.5 In the Adopting Release, the SEC reiterated its stance that it would be “inappropriate” for a broker-dealer covered by the affiliate exclusion to indirectly publish or distribute a research report that it could not publish or distribute directly.
To rely on the safe harbor, the report must be issued in the regular course of business. This requirement is generally comparable to the restrictions set forth in Rule 139, which provide that the publication or distribution of a research report may not represent either the initial publication of research reports about an issuer or its securities, or the re-initiation of such publication following a discontinuation (Initiation or Re-Initiation Requirement). The Initiation or Re-Initiation Requirement applies only to covered investment funds that do not have a class of securities in a “substantially continuous distribution.” The Adopting Release indicates that the determination of whether a class of securities is in “substantially continuous distribution” would be based on a “facts and circumstances” test, but that mutual funds and exchange-traded funds would generally be considered to be engaged in substantially continuous distributions.
Covered investment research reports include both “issuer-specific” research reports and “industry research” reports (which may cover more than one issuer), and such reports must satisfy different requirements in order to qualify for the safe harbor. In a departure from its proposal, the SEC additionally required that any presentation of fund performance in a research report must comply with “certain standardized presentation requirements,” which differ according to the type of covered investment fund.6
Issuer-Specific Research Reports
An “issuer-specific” research report will be covered by the safe harbor if the particular covered investment fund was subject to requirements of the 1940 Act and/or Exchange Act to file certain periodic reports7 for at least 12 calendar months prior to the issuance of the issuer-specific research report, and those periodic reports were filed in a timely manner. Notably, covered investment funds must have a market value (or net asset value for mutual funds) of at least $75 million to be covered by the Rule’s safe harbor for issuer-specific research reports.8 This market value requirement does not apply to industry research reports.
Industry Research Reports
For an “industry research” report to be eligible for the safe harbor, each covered investment fund must be subject to the reporting requirements of Section 30 of the 1940 Act or the reporting requirements of Sections 13 or 15(d) of the Exchange Act. Unlike issuer-specific research reports, industry research reports may include covered investment funds that have less than 12 months of reporting history.
Applicability of FINRA Filing Requirements
In the Adopting Release, the SEC interprets the FAIR Act as not requiring covered investment fund research reports to be filed with the SEC under Section 24(b) of the 1940 Act if such reports comply with the content standards of FINRA (i.e., FINRA Rule 2210(d)(1)) or another self-regulatory organization. In addition, Rule 24b-4 excludes covered investment fund research reports from the filing requirements for investment company sales literature under Section 24(b) of the 1940 Act, provided that such reports comply with the content standards of FINRA or another self-regulatory organization. This could narrow the types of communications that would be required to be filed with FINRA under FINRA Rule 2210, which regulates broker dealers’ communications with the public.9 Covered investment fund research reports would continue to be subject to FINRA’s recordkeeping requirements, “even if the broker-dealer would not be required to file the research report with FINRA or the Commission.”
Footnotes
1) Covered Investment Fund Research Reports, Release Nos. 33-10580; 34-84710; IC-33311; File No. S7-11-18, 63, Nov. 30, 2018 (Adopting Release).
2) Fair Access to Investment Research Act of 2017, Pub. L. 115-66, 131 Stat. 1196 (2017).
3) SEC Research Reports, Release No. 33-6492, Oct. 5, 1983 [48 FR 46801].
4) Id.
5) The SEC determines the affiliated status of a person publishing or distributing a research report (and therefore, whether the person is covered by the affiliate exclusion) by evaluating the extent of such person’s involvement in the preparation of the research report.
6) Reports for open-end funds must meet the standardized performance requirements set forth in Rule 482 under the 1933 Act, while reports for closed-end funds must comply with the instructions to item 4.1(g) of Form N-2.
7) For example, such reports may include those on Forms N-CSR, N-Q, N-PORT, N-MFP and N-CEN.
8) Issuer-specific research reports on unlisted closed-end funds, including unlisted business development companies, are not covered by the Rule’s safe harbor.
9) If a broker-dealer’s research report on a covered investment fund goes beyond pure research and analysis, and would be viewed as promoting or recommending the fund, the report is required to be filed with FINRA pursuant to Rule 2210, notwithstanding the FAIR Act or new Rule 24b-4.
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