In this case, the issuer cancelled a proposed secondary stock offering for which the broker-dealer was planning to act as the lead underwriter.  At that point, the issuer planned another offering, and the broker-dealer was invited to participate as a co-manager.   However, according to the SEC, the broker-dealer’s participation was made contingent by the issuer upon the broker-dealer commencing research coverage – a “quid pro quo” – which the investment bank agreed to do.  In commencing research coverage, the investment bank rated the stock a “buy,” with a price target that was considerably higher than its then current market price.¹

In issuing the fine, the SEC relied on its traditional guidance as to when a broker-dealer is subject to Section 5(b)(1)’s potential limitations on issuing research.  In particular, the SEC has stated that a broker-dealer that publishes research is subject to Section 5(b)(1):

• while seeking to participate in the underwriting of the issuer’s securities offering;
• after having been invited to participate by the issuer in the underwriting of its securities offering; or
• after reaching an understanding with the issuer that it will participate as a managing underwriter in the issuer’s securities offering.

Under these circumstances, the SEC will typically view a research report about the subject company as an improper prospectus.  While SEC Rule 139 includes a safe harbor from the definition of “prospectus” for research reports that satisfy the rule, this safe harbor excludes cases such as this one, where the broker-dealer initiated coverage.  Here, the SEC deemed the research report to be a prospectus, due to its potential to condition the market.  The SEC’s fine in this matter is further indication of regulatory interest in research related supervisory and oversight lapses.

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