United States: FINRA Proposes To Permit Use Of Predictions/Projections Of Investment Strategy Performance

Exception Proposed to FINRA Communication Rule's Prohibition on Predictions or Projections of Performance



In February, the US Financial Industry Regulatory Authority ("FINRA") proposed amendments1 to its rule regarding communications with the public, Rule 2210, that would allow broker-dealers to distribute a customized hypothetical investment planning illustration that includes projected performance of an asset allocation or other investment strategy (but not with respect to an individual security).2 The amendments would be a carve-out from Rule 2210's prohibition on predictions or projections of performance.

FINRA is currently soliciting comments to the proposal. All comments must be received by March 27, 2017.

Background: FINRA's Communications Rule

Overview of Rule 2210 and Its Content Standards

Rule 2210 governs broker-dealer communications with the public. Rule 2210's requirements include principal review, filing, and record-keeping requirements, certain disclosure requirements, as well as content standards discussed in greater detail below.

Under Rule 2210(d)(1), all communications with the public, including "institutional communications"—communications which are distributed to only institutional investors—must adhere to the following five content standards3:

  • All broker-dealer communications with the public must be based on principles of fair dealing and good faith, must be fair and balanced, and must provide a sound basis for evaluating the facts in regard to any particular security or type of security, industry, or service;
  • No broker-dealer may make any false, exaggerated, unwarranted or misleading statement or claim in any communication with the public. Information may be placed in a legend or foot-note only in the event that such placement would not inhibit an investor's understanding of the communication;
  • If any testimonial in a communication with the public concerns a technical aspect of investing, then the person making the testimonial must have the knowledge and experience to form a valid opinion with respect to the applicable subject; and,
  • Communications with the public may not predict or project performance, imply that past performance will recur or make any exaggerated or unwarranted claim, opinion or forecast, subject to limited exceptions. [emphasis added]

Rule 2210 Prohibition on Predictions and Projections of Performance

Rule 2210(d)(1)(F)'s broad prohibition on predictions or projections of performance is subject to four narrow exceptions: (i) investment analysis tools that comply with FINRA Rule 2214; (ii) price targets in research reports; (iii) certain projections concerning security futures and options; and (iv) hypothetical illustrations of mathematical principles. Notwithstanding the availability of these exceptions, the prohibition on prediction or projection of investment performance is a relatively rigid prohibition, and, as noted above, is not subject to an exemption for institutional investors.

This broad prohibition against predictions or projections of performance has historically presented an obstacle in the marketing and advertising efforts of broker-dealers, particularly for those broker-dealers engaged in institutional private placement activities, where institutional investors regularly insist on receiving both projections of performance and target return figures4, as well as the underlying data for such projections, in order to evaluate underlying assumptions and to make investment decisions. FINRA has been reluctant to provide exemptions beyond those enumerated in the rule.5

The Proposed Amendments

The proposed amendments would provide an exception to the prohibition of projections or predictions for distribution of a customized hypothetical investment planning illustration. In particular, the exception would cover illustrations that project the performance of an asset allocation or other investment strategy, but not those that project the performance of an individual security. The exception would be available for all firms, including firms that operate only an online platform, and could be relied upon with respect to communications with both current and prospective customers.

The proposed exception would require that there be a "reasonable basis" for all assumptions, conclusions and recommendations, and that there be clear and prominent disclosure of the fact that the illustration is hypothetical and that there is no assurance that any described investment performance or event will occur. All material assumptions and limitations applicable to the illustration would have to be disclosed.

FINRA stated that a "reasonable basis" might be established by reference to historical financial data, including data regarding historical performance and performance volatility of asset classes, the effects of macroeconomic factors, and the impact of fees, costs and taxes, etc. The proposal notes that an unreasonable emphasis on any one factor underlying a projection may cause such projection to be considered noncompliant. In addition, FINRA noted that basing a projection upon hypothetical back-tested performance or the past performance of particular investments by an asset manager would be per se unreasonable.

Finally, the proposal would establish specific supervisory requirements for the permitted illustrations. In general, permitted illustrations would require registered principal approval prior to use or distribution, although firms that utilize a template illustration would be allowed to obtain principal approval of the template in lieu of obtaining approval for each individual illustration.

Concluding Thoughts

The proposed amendments to Rule 2210 represents a significant, positive step in the harmonization between broker-dealer and investment advisory standards, and would simplify the compliance and oversight requirements for firms that are dual-registered as both broker-dealers and investment advisers. In addition, the relaxing of the prohibition on projections would allow broker-dealers to provide to their clients information that may be important to customers' investment decision-making processes.

However, the relaxing of the prohibition on projections remains limited under the proposal, as the exception is limited to strategy planning asset allocation tools, and does not permit, for example, projections relating to prospective investment outcomes for pooled investment vehicles or any other individual security. Further, the data that broker-dealers are permitted to reference in order to form the "reasonable basis" for any projection is also subject to limitations that may constrain use of the exemption. 

With that said, steps in the direction of permitting prudent, professional use of predictions or projections of performance are most welcome.

Footnotes

1  FINRA's proposal is made in Regulatory Notice 17-06, available at: http://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-17-06.pdf

2  For more information regarding FINRA regulation of broker-dealer communications with the public, please see: "New Rules Regarding Communications With the Public by Brokers and Dealers Take Effect" (November 1, 2003), currently available at: http://www.shearman.com/en/newsinsights/publications/2003/11/new-rules-regarding-communications-with-the-publ__.

3  For purposes of Rule 2210, an "institutional investor" means any: (A) (i) bank, savings and loan association, insurance company or registered investment company; (ii) an investment adviser registered either with the SEC under Section 203 of the Investment Advisers Act or with a state securities commission (or any agency or office performing like functions); (iii) any other person (whether a natural person, corporation, partnership, trust or otherwise) with total assets of at least $50 million; (B) governmental entity or subdivision thereof; (C) employee benefit plan, or multiple employee benefit plans offered to employees of the same employer, that meet the requirements of Section 403(b) or Section 457 of the Internal Revenue Code and in the aggregate have at least 100 participants, but does not include any participant of such plans; (D) qualified plan, as defined in Section 3(a)(12)(C) of the Securities Exchange Act of 1934, or multiple qualified plans offered to employees of the same employer, that in the aggregate have at least 100 participants, but does not include any participant of such plans; (E) FINRA member or registered person of such a member; and (F) person acting solely on behalf of any such institutional investor.

4  We note that target returns are, by definition, neither predictions nor projections of performance. However, our experience has been that FINRA will carefully review the use of target returns not only for consistency with the content standards described above, but also to see if, as used, they are de facto predictions or projections of performance. In the past, FINRA has brought enforcement action for use of target returns that FINRA believed to be inconsistent with the content standards described above.

5 See Interpretive Letter to W. Thomas Conner, National Association for Variable Annuities, granting the use of hypothetical illustrations in variable life insurance or annuity contracts only as they may be required pursuant to Part 51 of Title 11 of the Official Compilation of Codes, Rules and Regulations of the State of New York ("Regulation 60"). The letter is available at: http://www.finra.org/industry/interpretive-letters/february-5-1999-1200am. In contrast, see Interpretive Letter to Dawn Bond, FSC Securities Corporation, denying the use of investment projections with respect to financial plans used by a dual-registered broker-dealer/investment adviser to recommend a proposed portfolio to clients. The letter is available at: http://www.finra.org/industry/interpretive-letters/july-30-1998-1200am.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.