Series 7 Unit 19
SEC Advertising Rules
2 Rules: Rule 135a dealing with generic advertising Rule 156, titled Investment Company Sales Literature
Required Disclosures of Investment Company Rankings
A headline or other prominent statement must not state or imply that an investment company or investment company family is the best performer in a category unless it is ranked first in the category. Other disclosures include: -the name of the category (i.e growth) -the name of the ranking entity and, if applicable, the fact that the investment company or an affiliate created the category or subcategory -criteria on which the ranking is based (eg, total return, risk-adjusted performance) -the fact that past performance is no guarantee of future results -a ranking based on total return must be accompanied by rankings based on total return for 1,5, 10, or since inception, if shorter
Quiet Period
A member firm, acting as manager or co-manager of a securities offering, may not publish research nor may an analyst make a public appearance regarding the subject company for 40 days following an IPO, or for 10 days following an additional issue offering. FINRA interprets the date of the offering to be the alter of the effective date of the registration statement or the first date on which the securities were bona fide offered to the public. Take Note** The following items fall outside the definition of research reports: -discussions of broad-based indices -commentaries on economic, political, or market conditions -technical analyses concerning the demand and supply for a sector, index, or industry based on trading volume and price. -statistical summaries of multiple companies' financial data, including listings of current ratings. -notices of ratings or price target changes
Required Approvals of Public Communications
A principal of your firm may be required to approve or review communications to the public. Here are the requirements: -Institutional: no preapproval of a principal is required. When such procedures do not require review of all institutional communications before first use or distribution, they must include provision for the education and training of associated persons as to the firm's procedures governing institutional communications. -Retail: preapproval of a principal is required. -Correspondence: Pre- or Post-review of a principal is required -Public Appearance: preapproval of a principal may be required but is not mandated. -Independently prepared reprints: These must be preapproved by a principal if the communication meets the definition of a retail communication. -Research reports: Approval requirements are based on how they are defined (institutional, retail). Research reports must be preapproved by a principal if the communication meets the definition of a retail communication. -Electronic Communications -Website preapproval of a principal is required -Electronic bulletin boards-- use of an online interactive forum by a registered representative must be approved by a principal, although each post does not require principal approval -Emails and instant messaging: approval requirements are based on how they are defined (institutional, retail, or correspondence). -Generic Advertising: Preapproval of a principal is required
Research Reports
A research report is a document prepared by an analyst or strategist, typically as a part of a research team for an investment advisor or BD. The report may focus on an individual stock or sector of the economy and generally, but not always, will recommend buying, selling, or holding an investment. FINRA has established rules designed to improve the objectivity of research reports and provide investors with more useful and reliable information when making investment decisions. Members must take steps to ensure that all research reports reflect an analyst's honest view and that any recommendation is not influenced by conflicts of interest, such as investment banking business with the issuer. If a member issues a report or a research analyst renders and opinion that is inconsistent with the analyst's actual views regarding a subject company, FINRA considers such action fraudulent. To ensure the investing public receives objective information from the media and publications, the FINRA rules require the following: -firms must clearly explain their ratings systems, use rating terms according to their plain meaning, note the percentage of all ratings they have assigned to each category (buy/sell/hold) and document the percentage of investment banking clients in each category -analysts' compensation may not be tied to the firm's investment banking revenues. -analysts must disclose in their research reports and public appearances whether they or any member of their households have a financial interest in the subject security and whether their employer firms owned 1% or more of any class of a subject company's equity securities at the close of the previous month. -research reports must disclose whether, within the last 12 months, the firm has received fees for investment banking services from--or managed or co-managed--a public offering for a company that is the subject of a research report. They must also disclose whether the firm expects to receive or intends to seek in the three months following publication of a research report any investment banking fees from any company that is the subject of a report. -an investment adviser or a BD may not present to a client research reports, analyses, or recommendations prepared by other persons or firms without disclosing the fact that the adviser or BD did not prepare them. An investment adviser or a BD may base a recommendation on reports or analyses prepared by others, as long as these reports are not represented as the investment adviser's or BDs own.
Product Communications
All communications must clearly describe the product as either variable life or a variable annuity, as applicable. Proprietary names may be used in addition to these descriptions. There may be no implication that the product being offered or its underlying account is a mutual fund.
Guarantees
Although insurance products contain a number of specific guarantees, the relative safety of the product from these guarantees may not be over emphasized b/c it depends on the claims-paying ability of the insurance company. There may be no representation or implication that a guarantee applies to the investment return or principal value of the separate account. Also, it may not be represented or implied that an insurance company's financial ratings apply to the separate account. Although the rating firms S&P and Moody's Investor Service offer ratings on the financial health of insurance companies, the primary source used by almost everyone in the industry is A.M. Best. An A or A+ rating from them signifies substantial ability to meet their claim obligations.
Electronic Communications With the Public
Although not classified as a specific type of communication, with the growth of the internet and the rise of e-communications in general, it has been necessary for FINRA to bring electronic communications in the securities industry into the regulatory framework. Websites, whether sponsored by the company itself or set up by an individual registered representative, are considered retail communications and are subject to applicable filing and recordkeeping rules. They must be reviewed and approved by a principal before first use and must contain no exaggerated claims or misleading information, and if materially altered since the last filing, must be reapproved and refiled. There must also be nothing in the website that suggests business affiliation with or approval by FINRA. Members may indicate FINRA membership on a member's website, provided member provides a hyperlink to FINRA's homepage--www.finra.org-- in close proximity to the member's indication of FINRA membership. This provision also applies to a website relating to the member's investment banking or securities business maintained by or on behalf of any person associated with a member. Electronic Bulletin Boards are also considered retail communications, but a registered representative using one, or a chat room, need not identify himself as a registered person. Use of an online interactive forum by a registered representative must be approved by a principal, although each post does not require principal approval. The communications must be held in normal standards of accuracy and completeness. Individual emails to customers fall under the definition of correspondence and are subject to the appropriate standards of conduct and supervision. Instant messaging could qualify as retail communication or correspondence, depending on the size of the audience. FINRA has released several notices dealing with the use of social media, such as FB and Twitter. Take note** Regulations are clear--firms must have established procedures to maintain, review, and supervise communications transmitted via blogs, email, instant messaging, texts, twitter ,FB, and whatever new communication forum is coming our way. Recently a firma nd some reps were fined when it was discovered that reps had used outside electronic sources for securities related business.
Options communications may contain projected performance figures (including projected annualized rates of return), provided that A) all such communications are accompanied or preceded by the Options Disclosure Document. B) the client has returned the options account agreement within the specified time. C) all such communications are accompanied or preceded by a warning of the possible defalcation by an officer of the exchange. D) in communications relating to annualized rates of return, the returns are not based on any less than a 30-day experience.
Answer is A E: Once the communications get specific enough to include performance figures, prior or concurrent delivery of the ODD is necessary. Although the risks must be disclosed, possible defalcation by an exchange officer (a form of embezzlement), is not an investment-related risk. The requirement to return the options account agreement within 15 days has nothing to do with permitted options communications. When annualized rates of return are shown, the minimum is a 60-day period, not 30 days.
Which of the following would be defined as a research report? A) A notice that the rating for a bond has been downgraded by Moody's B) A document that states the banking industry is ready for recovery but ABC Bank will not participate in the recovery and if owned, investors should sell the security C) A written opinion that the economy is poised for recovery D) A technical analysis that indicates the demand for steel is increasing based on the trading volume and price of the steel industry
Answer is B E: One of the keys to defining a research report is that it suggests taking action (buy, sell, or hold) on the subject security. The term does not include commentaries on economic, political, or market conditions.
Liquidity
B/c variable life insurance and variable annuities frequently involve substantial charges and/or tax penalties for early withdrawal, there may be no representation or implication that these are short-term, liquid investments. Any statement about the ease of liquidation of these products must be accompanied by the negative impact of factors such as contingent deferred sales loads, tax penalties, and impact on cash value and death benefits.
CMO Suitability
CMOs are multi-class debt instruments backed by a pool of mortgages, such as Ginnie Maes. They are far more complex than stocks and bonds. Even the registered reps may have a difficult time understanding how these work. FINRA Rule 2216 states that before a member can sell a CMO to a retail customer, the firm must be sure the representative is trained and must offer the customer educational material that includes the following information and a discussion on: -the characteristics and risks of CMOs, including prepayment rates and average lives -the interest rates, including their effect on value and prepayment rates -tax considerations -transaction costs and liquidity -the structure of CMOs, including the different tranches that are offered and the risks pertaining to each -the relationship between mortgage loans and mortgage securities -questions an investor should ask before investing -a glossary of terms Any retail communication concerning CMOs: -may not compare CMOs to any other investment vehicle, including bank CDs -must disclose, if applicable, that a government agency backing applies only to the face value of the CMO and not to any premium paid -must disclose that a CMOs yield and average life will fluctuate depending on the prepayment rate and changes in interest rates.
Single Premium Variable Life
Communications regarding single premium variable life may only emphasize investment features of this product if an adequate explanation of the life insurance features is also provided. When life insurance policy is funded with too much money within a seven year period, it is defined as a modified endowment contract (MEC). MECs have restricted access to cash values and also lose some tax advantages that other cash value policies have. Therefore, few single premium life insurance policies are issued.
Correspondence
Correspondence is written or electronic communication that is distributed or made available to 25 or fewer retail investors within any 30 calendar-day period. FINRA means this to include current and prospective customers. Each member must establish written procedures that are appropriate to is business, size, structure, and customers for the review of incoming and outgoing correspondence with the public. This includes procedures to review incoming correspondence directed to registered reps. Firms need to be able to properly identify and handle customer complaints and to ensure that customer funds and securities are handled in accordance with firm procedures. Procedures may allow for either pre- or post-review of correspondence by a principal. When pre-review is not required, the firm must include a provision for the education and training of associated persons as to the firm's procedures governing correspondence. These procedures must include documentation of such education and training, and surveillance and follow-up to ensure that such procedures are implemented and adhered to. Evidence that these supervisory procedures have been implemented and carried out must be maintained and made available to FINRA upon request.
Prefiling
Filing with FINRA at least 10 business days before the use of any retail communication is required for: -a new member for a one-year starting on the day its FINRA membership becomes active. -retail communications concerning registered investment companies that include a custom ranking -retail communications concerning options if the ODD has not been previously delivered (filing it with FINRA must first be done at least 10 CALENDAR days in advance)
Use of Investment Company Rankings in Retail Communications
For the purposes of this rule, the term ranking entity refers to any entity that provides general information about investment companies to the public, that is independent of the investment company and its affiliates, and whose services are not procured by the investment company or any of its affiliates to assign the investment company a ranking. Members may not use investment company rankings in any retail communication other than -rankings created and published by ranking entities -rankings created by an investment company or an investment company affiliate but based on standard performance measurements
Generic Advertising SEC Rule 135A
Generic Advertising promotes securities as an investment medium, but does not refer to any specific security. Generic advertising often includes information about: -the securities investments that companies offer -the nature of investment companies -services offered in connection with the described securities -explanations of various types of investment companies -descriptions of exchange and reinvestment privileges -where the public can write or call for further info All generic advertisements must contain the name and address of the sponsor of the advertisement but never include the name of any specific security. A generic advertisement may be placed only by a firm that offers the type of security or service described Take Note: Firms must have available for sale the type of security or service they advertise. For example, a brokerage firm is not permitted to advertise no-load MFs if it does not sell them.
Exclusions From the Filing Requirement
Here are some of the most likely exclusions to be tested: -Retail communications that previously have been filed with FINRA and that are to be used without material change -Retail communications that do not make any financial or investment recommendation or otherwise promote a product or service of the member -Retail communications that do no more than identify a national securities exchange symbol of the member or identify a security for which the member is a registered market maker -Retail communications that do no more than identify the member -Correspondence -Institutional communications -Communications that refer to types of investments solely as part of a listing of products or services offered by the member -Retail communications that are posted on an online interactive electronic forum.
Hypothetical Illustrations of Rates of Return in Variable Life Insurance
Hypothetical Illustrations showing assumed rates of return may be used to demonstrate the performance of variable life policies. Rules that apply to the use of these illustrations include the following: -Hypothetical illustrations may not be used to project or predict investment results -Illustrations may use any combination of assumed investment returns up to and including a gross rate of 12%, provided that one of the returns is a 0% gross rate. The maximum rate illustrated should be reasonable, considering market conditions and the available investment options. -Illustrations must reflect the maximum mortality and expense charges associated with the policy for each assumed rate of return illustrated. Current charges may also be illustrated. In general, variable life product performance may not be compared with other investment products. However, comparison of variable life with a term insurance product is permitted to demonstrate the concept of tax-deferred growth resulting from investment in the variable product.
Fund Performance Predating Inclusion in a Variable Product
Illustrations are sometimes used to show how an existing fund would have performed as an investment option within a variable life or variable annuity policy. Performance that predates a fund's inclusion may be used only if no significant changes occurred to the fund at the time or after it became a part of the variable product.
Independently Prepared Reprint
Independently prepared reprints are retail communications and have some special characteristics that generate exam questions. An independently prepared reprint (IPR) consists of any article that meets certain standards. A key requirement is that the reprint was prepared by an independent publisher and was not materially altered by the member. A member may alter the contents of an IPR only to make it consistent with applicable regulatory standards or to correct factual errors. An article reprint qualifies as an IPR under the rules only if, among other things, its publisher is not an affiliate of the member using the reprint or any underwriter or issuer of the security mentioned in the reprint. Also, neither the member using the reprint nor any underwriter or issuer of a security mentioned in the reprint may have commissioned the reprinted article. IPRs must be preapproved by a principal and are exempted from the FINRA filing requirements
Institutional Communication
Institutional Communication is any written communication that is distributed or made available only to institutional investors but does not include a member firm's internal communications. The following is a list of those included in FINRA's definition of institutional investor: -FINRA member firm or registered person of the member firm -Bank -Savings and loan -Insurance company -Registered investment company -Registered investment adviser -Any entity with $50 million or more of total assets, including natural persons -Governmental entity -Employee benefit plan (401k, 403b, 457) that has at least 100 participants -Person acting solely on the behalf of an institutional investor This definition is important b/c any entity that isn't define as an institution is retail. The rule specifically includes the individual participants of employee benefit plans from the definition of institutional investors. If a member has reason to believe that a communication or excerpt of the communication intended for institutional investors will be forwarded to or made available to a person who is not an institutional investor, the communication must be treated as a retail communication until the member reasonably concludes the improper practice has ceased. Each member must establish written procedures that are appropriate to its business, size, structure, and customers for the review of institutional communications used by the member and its associated persons by an appropriately qualified, registered principal. Such procedures must be reasonably designed to ensure that institutional communications comply with applicable standards. When such procedures do not require review of all institutional communications before firs use or distribution, they must include provision for the education and training of associated persons as to the firm's procedures governing institutional communications, documentation of such education and training, and surveillance and follow-up to ensure that such procedures are implemented and adhered to. Evidence that these supervisory procedures have been implemented and carried out must be maintained and made available to FINRA upon request.
Product-Specific Advertisements and Disclosures
No material fact or qualification may be omitted if it could cause the communication to be misleading. Although most of these standards apply to all forms of communications with the public, the principal should be aware of the nuances. Exaggerated or misleading statements are prohibited. In determining whether a communication is misleading, FINRA calls for consideration of the following: -Overall context of the statement--a statement that is misleading in one context may be appropriate in another. AN essential test in this regard is the balanced treatment of risks and potential returns. -different levels of explanation or detail may be needed, depending on the audience and the ability of the member to control who might come in contact with the communication. -overall clarity of the communication--FINRA warns that unclear statements can create serious misunderstandings to the point of constituting a rules violation. Example; overly technical explanations or material disclosures buried in footnotes are likely to confuse the reader and could be construed as misleading
Postfiling
Postfiling with FINRA within 10 business days of first use is required for: -retail communications that promote or recommend a specific registered investment company or family of registered investment companies -retail communications concerning public DPPs -retail communications concerning collateralized mortgage obligations (CMOs) registered under the Securities Act -if a member has filed a draft version or storyboard of a television or video retail communication pursuant to a filing requirement, then the member must also file the final filmed version within 10 business days of first use or broadcast.
Performance Reporting
Probably the most common offense deals with performance. Representations about past or future investment performance could be misleading b/c of statements or omissions made involving a material fact. Per SEC Rule 156, examples of these would include -representations implying that future gain or income may be inferred from or predicted based on past investment performance. -portrayals of past performance, made in a manner in which would imply that gains or income realized in the past would be repeated in the future. -failure to disclose, if a sales load or any other nonrecurring fee is charged, the maximum amount of the load or fee. If the sales load or fee is not reflected, a statement that the performance data does not reflect the deduction of the sales load or fee, and that, if reflected, the load or fee would reduce the performance quoted. In any sales literature for an investment company, other than a money market fund, that contains performance data, average annual total return (after taxes on distributions, as well as after taxes on distributions and redemption) for one-, five-, and 10-year periods must be shown. If the fund has been in operation for a shorter period of time, the life of the fund must be used. Longer periods may be shown in 5year increments up to the life of the fund. If the sales literature refers to yield, it must include the total return figures and show the CY in no greater size or prominence than total return. The quotation must also identify the length of the period quoted and the last day in the base period used in the computation. Some muni bonds funds like to advertise a tax-equivalent yield. To do so, they must show both the CY and total return as earlier in addition, and the tax-equivalent yield may be set out in no greater prominence. If the fund carries a sales load, performance data must indicate the effect of the load.
Other Communications
Public Appearance Independently Prepared Reprint Research Reports
Public Appearance
Public appearance is participation in a seminar, Webinar, forum (including an interactive electronic forum such as a chat room), radio or television interview, or other public appearance or public speaking activity. Each member shall establish written procedures that are appropriate to its business, size, structure, and customers to supervise its associated persons' public appearances. Therefore, pre-approval of a principal may be required but is not mandated. Such procedures must provide for the education and training of associated persons who make public appearances as to the rm's procedures, documentation of such education and training, and surveillance and follow-up to ensure that such procedures are implemented and adhered to. Evidence that these supervisory procedures have been implemented and carried out must be maintained and made available to FINRA upon request. Any scripts, slides, handouts, or other written (including electronic) materials used in connection with public appearances are considered communications for purposes of this rule, and members must comply with all applicable provisions of this rule based on those communications' audience, content, and use. If an associated person recommends a security in a public appearance, the associated person must have a reasonable basis for the recommendation. The associated person also must disclose any conflicts of interest that may exist, such as a financial interest in any security being recommended. This disclosure is not required when the security recommended is a MF or variable contract of an insurance company. If past performance of a mutual fund or variable contract is shown, it must be for no less than the previous 12 months.
Retail Communication
Retail communication is defined in FINRA Rule 2210 as "any written (including electronic) communication that is distributed or made available to more than 25 retail investors within a 30 day calendar-day period." What would commonly be thought of as ADVERTISEMENTS and SALES LITERATURE generally fall under this definition. Some specific examples of retail communication would include: -telemarketing or other sales scripts (if expected to be used with more than 25 noninstitutional investors within a 30 day period) -posts to an interactive electronic forum -a storyboard of a television or video ad -independently prepared reprints What is a retail investor? Any person--other than an institutional investor--regardless of whether the person has an account with any firm is considered a retail investor. With a few exceptions, an appropriately qualified registered principal of the member must approve each retail communication before the earlier of its use or filing with FINRA's Advertising Regulation Department. The requirement to have a principal approve retail communication does not apply if, at the time that a member intends to distribute it: -another member has filed it with FINRA's advertising department and has received a letter from the department stating that it appears to be consistent with applicable standards -the member using it in reliance upon the letter has not materially altered it and will use it in a manner that is consistent with the conditions of the department's letter -if it is a post to an interactive electronic forum The requirement of prior principal approval generally will not apply with regard to any retail communication that does not make any financial or investment recommendation or otherwise promote a product or service of the member. FINRA may also grant an exception from the approval rule for good cause. Notwishstanding any other exception, an appropriately qualified registered principal of the member must approve each retail communication before the earlier of its use or filing with FINRA. ***TTA***Please note that the term RETAIL CUSTOMER refers to any customer--existing or prospective--that does not fit into the definition of of institutional client.
Names Rule
Rule 156 also addresses certain broad categories of investment company names that are likely to mislead investors about an investment company's investments and risks. The name rule requires a registered investment company with a name suggesting that the company focuses on a particular type of investment, to invest at least 80% of its assets in the type of investment suggested by its name. In addition, under SEC Rule 482, any advertisement, pamphlet, circular, form letter, or other sales literature addressed to or intended for distribution to prospective investors is considered materially misleading unless the sales literature includes the following information: "An investment in the Fund is not insured or guaranteed by the FDIC or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund."
Communications Regarding Variable Contracts
The following standards apply to all communications related to variable life and variable annuities, in addition to the general FINRA standards governing communications. These standards are applicable to advertisements and sales literature, as well as individualized communications such as personalized letters and computer-generated illustrations, whether printed or made available on-screen.
Required Disclosures of Bond Mutual Fund Volatility Ratings
The name of the entity that issued the rating must be disclosed, along with -the date of the current rating -a link to a website that includes the criteria and methodology used -a statement that there is no standard method to determine the ratings -a description of the types of risk the rating measures (eg, short-term volatility) -a statement that there is no guarantee the fund will continue to have the same rating or perform in the future as rated.
Requirements for the Use of Bond Mutual Fund Volatility Ratings
The term bond MF volatility rating is a description issued by an independent third party. The rating relates to the sensitivity of the NAV of a portfolio of an open-end management investment company that invests in debt securities to changes in market conditions and the general economy. The rating is based on an evaluation of subject factors, including: -the credit quality of the fund's individual portfolio holdings -the market price volatility of the portfolio -the fund's performance, and specific risks, such as -interest rate risk -prepayment risk, and -currency risk These ratings may not describe volatility as a risk rating.
Options Communications
The three categories we've been discussing in this unit also apply to communications about options. A registered options principal (ROP) is responsible for advance approval of retail communications. With regard to retail communication relating to options, the member must file copies with FINRA at least 10 days before first use (prefiling) if the OCC Disclosure Booklet (ODD) has not been delivered. Firms have two methods of filing with FINRA's Advertising Regulation Department: 1) electronically using a web-based filing system 2) in hard copy Options advertising is limited to: -a general description of the security being offered and its issuer, the Options Clearing Corporation (OCC) -a description of the nature and functions of the options markets -the name and address of the person at the member firm placing the advertisement from whom a current OCC Disclosure Booklet may be obtained The advertising may include advertising designs and devices, including borders, scrolls, arrows, pointers, multiple and combined logos and unusual type faces and lettering as well as attention-getting headlines and photographs and other graphics, provided such material is not misleading. Recommendations, past performance, and projected performance are NOT permitted in options advertising.
Summary of FINRA Filing Requirements for Communications with the Public
The unit has covered most of the FINRA filing requirements at the point of discussing the specific product. It will e helpful for you to have al of these in one place. Don't confuse FILING with PRINCIPAL APROVAL.
Filing Requirements
There is a special filing requirement for any new members of FINRA. During its first year of operation, the new member must file ANY retail communication with FINRA at least 10 business days before first use. This is called prefiling. When FINRA says ANY, they mean any retail communication published or used in any: -electronic or other public media, including any generally accessible website -newspaper -magazine or other periodical -radio, television, telephone, or audio recording -video displays, signs or billboards, motion pictures -telephone directories After the first year of registration, a member firm is now established. From this point, the firm may file retail communications within 10 business days of first use (postfiling).
Rule 156
Under federal law, it is unlawful for any person, directly or indirectly, but the use of any means or instrumentality of interstate commerce or of the mails, to use sales literature which is materially misleading in connection with the offer or sale of securities issued by an investment company. Under these provisions, sales literature is materially misleading if it: 1) contains an untrue statement of a material fact, or 2) omits to state a material fact necessary to make a statement made, in the light of the circumstances of its use, not misleading.
TTA
Whether a first-year firm or not, retail communications for investment companies (including mutual funds, variable contracts, and UITs) that include a ranking or a comparison that is generally not published or is the creation of the investment company or the member must be filed with FINRA at least 10 business days before first use (prefiling) In addition, there is a 10-day prefiling requirement for any retail communication involving option contracts (for all members). If the ranking or comparison is generally published or is the creation of an independent entity (Lipper or Morningstar), the usual filing rules for filing will apply (i.e within 10 business days of first use (postfiling)) ***Retail communications must be kept on file for 3 years from last use. This includes electronic as well as paper format.
