[Federal Register Volume 59, Number 31 (Tuesday, February 15, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-3425]


[[Page Unknown]]

[Federal Register: February 15, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33606; File No. SR-NASD-93-69]

 

Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by National Association of Securities Dealers, Inc. Relating to 
Guidelines Regarding the Use of Rankings in Mutual Fund Advertisements 
and Sales Literature

February 9, 1994.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on November 
22, 1993, the National Association of Securities Dealers, Inc. 
(``NASD'' or ``Association'') filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission'') the proposed rule change as 
described in Items I, II, and III below, which Items have been prepared 
by the NASD. The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The NASD is proposing to adopt Guidelines Regarding the Use of 
Rankings in Mutual Fund Advertisements and Sales Literature. Below is 
the text of the proposed rule change. Proposed new language is 
italicized.

Guidelines for the Use of Rankings in Mutual Fund Advertisements and 
Sales Literature

I. Definition of ``Ranking Entity''

    For purposes of these guidelines, the term ``Ranking Entity'' 
refers to any entity that provides general information about mutual 
funds to the public, that is independent of the mutual fund and its 
affiliates, and whose services are not procured by the mutual fund or 
any of its affiliates to assign the fund a ranking. Examples of 
``Ranking Entities'' include services such as Morningstar and Lipper 
and financial publications such as Money and Barron's.

II. Required Disclosures

    A. Headlines/Prominent Statements.
    1. A headline or other prominent statement must not state or imply 
that a mutual fund is the best performer in a category unless it is 
actually ranked first in the category.
    2. Prominent disclosure of the mutual fund's ranking, the total 
number of mutual funds in the category, the name of the category, and 
the period on which the ranking is based (i.e., the length of the 
period and the ending date; or, the first day of the period and the 
ending date), must appear in close proximity to any headline or other 
prominent statement that refers to a ranking.
    B. All advertisements and sales literature containing a mutual fund 
ranking must disclose, with respect to the ranking:
    1. the name of the category (e.g., growth funds);
    2. the number of funds in the category;
    3. the name of the Ranking Entity;
    4. the length of the period and the ending date, or, the first day 
of the period and the ending date;
    5. criteria on which the ranking is based;
    6. for load funds, whether the ranking takes into account sales 
charges;
    7. if fees have been waived or expenses advanced during the period 
on which the ranking is based, and the waiver or advancement had a 
material effect on the ranking, a statement to that effect; and
    8. the publisher of the ranking data (e.g., ``ABC Magazine, June 
1993'').
    The disclosure required by B1, B2 and B3 must be set forth 
prominently in the body of the advertisement or sales literature.
    C. If the mutual fund ranking consists of a symbol (e.g., a star 
system) rather than a number, the advertisement or sales literature 
also must disclose the meaning of the symbol (e.g., a four-star ranking 
indicates that the fund is in the top 30% of all mutual funds).
    D. All advertisements and sales literature containing a mutual fund 
ranking must disclose that past performance is no guarantee of future 
results.

III. Time Periods

    A. Any mutual fund ranking set forth in an advertisement or sales 
literature must be, at a minimum, current to the most recent calendar 
quarter ended prior to the submission for publication.
    B. Except for money market mutual funds;
    1. advertisements and sales literature must not use any ranking 
based on a period of less than one year.
    2. a mutual fund ranking based on total return must be accompanied 
by rankings based on total return for the one, five and ten year 
periods (or life of the fund) supplied by the same Ranking Entity in 
the category and based on the same time period; and,
    3. a mutual fund ranking based on the current SEC standardized 
yield must be accompanied by rankings based on total return for the 
one, five and ten year periods (or life of the fund) supplied by the 
same Ranking Entity in the category and based on the same time period.
    IV. Categories
    A. The choice of category (including a subcategory of a broader 
category) on which the mutual fund ranking is based must be one that 
provides a sound basis for evaluating the performance of the fund.
    B. Subject to the standards below, a mutual fund ranking must be 
based only on (1) a published category or subcategory created by a 
Ranking Entity or (2) a category or subcategory created by a fund or a 
fund affiliate, but based on the performance measurements of a Ranking 
Entity.
    C. When the mutual fund ranking is based on a subcategory, the 
advertisement or sales literature must disclose the name of the full 
category and the fund's ranking and the number of funds in the full 
category. This requirement does not apply if the subcategory is (1) 
based solely on the investment objectives of the funds included and (2) 
created by a Ranking Entity. This disclosure could be included in a 
footnote.
    D. The advertisement or sales literature must not use any category 
or subcategory that is based upon the mutual funds' asset size (whether 
or not it has been created by a Ranking Entity).
    E. If an advertisement uses a category created by the mutual fund 
or a fund affiliate, including a ``subcategory'' of a category 
established by a Ranking Entity, the advertisement must prominently 
disclose:
    1. the fact that the fund or its affiliate has created the ranking 
category;
    2. the number of funds in the category;
    3. the basis for selecting the category; and
    4. the Ranking Entity that developed the research on which the 
ranking is based.
    E. An advertisement or sales literature containing a headline or 
other prominent statement that proclaims a mutual fund ranking created 
by a fund or its affiliate must indicate, in close proximity to the 
headline or statement, that the mutual fund ranking is based upon a 
category created by the fund or its affiliate.

V. Multiple Class/Two-Tier Funds

    Mutual Fund rankings for more than one class or fund with the same 
portfolio must be accompanied by prominent disclosure of the fact that 
the funds or classes have a common portfolio.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the NASD included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The NASD has prepared summaries, set forth in sections 
(A), (B), and (C) below, of the most significant aspects of such 
statements.

(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    Ranking entities, mutual funds and fund affiliates categorize and 
rank mutual funds in various ways such as, for example, according to 
fund type, performance over a given period of years, total return, SEC 
standardized yield, with and without sales charges and risk/reward. 
Article III, Section 35(d)(2)(M) of the NASD Rules of Fair Practice\1\ 
sets forth the specific standard in communications with the public that 
a member who makes investment comparisons, directly or indirectly, must 
ensure that the purpose of the communication is clear and that the 
comparison is fair and balanced, including any material differences 
between the subjects of the comparisons. The use of mutual fund 
rankings prepared by ranking entities, mutual funds and fund affiliates 
to demonstrate mutual fund performance qualifies as such a comparison.
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    \1\NASD Manual, Rules of Fair Practice, Art. III, Sec. 
35(d)(2)(M), (CCH)  2195.
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    As the number of mutual funds has increased substantially in recent 
years, so have the number of mutual fund ranking entities. As the 
number of ranking entities has increased, the NASD has observed an 
increased reference to mutual fund rankings in fund advertisements and 
sales literature. In response to the increasing reference by mutual 
fund groups to such mutual fund rankings in mutual fund advertisements 
and sales literature, the NASD determined to provide guidance on the 
use of fund rankings and is proposing a comprehensive set of guidelines 
to be used when mutual fund advertisements and sales literature include 
references to mutual fund rankings.

Guidelines for Use of Rankings in Advertising and Sales Literature

Definition of Ranking Entity

    The term ``Ranking Entity,'' for purposes of the Guidelines, refers 
to an entity that provides general mutual fund information to the 
public, is independent of the fund and its affiliates\2\ and whose 
services are not used by the fund or its affiliates to assign the fund 
a ranking. The definition encompasses entities formed specifically to 
provide such information as well as financial publications and 
periodicals which include such a service in their publications.
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    \2\With respect to any fund, a Ranking Entity will be deemed to 
be independent of that fund and its affiliates for the purposes of 
these Guidelines only if it is not an ``affiliated person'' of that 
fund and its affiliates as such term is defined in Section 2(a)(3) 
of the Investment Company Act of 1940, 15 U.S.C. 80a-2(a)(3) (1988).
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Required Disclosures

    The Guidelines contain certain required disclosures. All 
advertisements and sales literature containing a ranking must disclose 
the name of the mutual fund category, the number of funds in the 
category, the name of the Ranking Entity, the period on which the 
ranking is based, the criteria on which the fund is ranked, whether, 
for load funds, the ranking takes into account sales charges, a 
statement as to the material effect, if any, of fees waived or expenses 
advanced during the period on which the ranking is based, and the 
publisher of the ranking data. Disclosure of the publisher allows the 
reader to obtain further information, if desired.
    Additionally, because prominent statements often command the same 
attention as headlines, the name of the mutual fund category, the total 
number of funds in the category, and the period on which the ranking is 
based must be disclosed in close proximity to any headline or prominent 
statement. Such statement or headline may not state or imply that a 
fund is ranked first in a category when it is not.
    All advertising or sales literature using a ranking system 
consisting of a symbol must disclose the meaning of the symbol. 
Finally, all advertising and sales literature containing a ranking must 
disclose that past performance is no guarantee of future results.

Time Periods

    The NASD believes that the use of rankings which are current 
reduces the possibility that such rankings will be deceptive or 
misleading. The NASD recognizes that different Ranking Entities provide 
rankings with varying frequencies, but believes that the industry 
should be provided with a minimum standard of what is current. 
Therefore, rankings should be at least current to the most recent 
calendar quarter, though use of more current ranking data would be 
permissible. The NASD believes that the current standard of the most 
recent calendar quarter is reasonable and not misleading.
    The NASD is concerned about a member's ability to select a ranking 
based on a time period that would show the fund in the best light 
without providing balancing information. Thus, the NASD believes that, 
for all mutual funds except money market mutual funds, rankings based 
on a period of less than one year are not meaningful, could be 
misleading and, therefore, should not be used. Additionally, rankings 
based on either total return or the SEC standardized yield must be 
accompanied by rankings based on the total return for the one, five and 
ten year (or mutual fund life) periods supplied by the same Ranking 
Entity and must be based on the same time period. This requirement 
parallels the SEC requirement that performance information must be 
accompanied by one, five and ten year (or mutual fund life) total 
return performance figures.

Categories

    Recognizing the many ways in which data on mutual fund performance 
can be presented, the NASD believes it is important to set standards 
for methods of fund categorization which provide a sound basis for 
evaluating the performance of a fund. Generally, advertisements and 
sales literature must use only categories or subcategories created by 
the Ranking Entities. Advertisements or sales literature using rankings 
based only on a subcategory must disclose the name of the full 
category, the fund's ranking and the number of funds in the full 
category, unless the subcategory is based solely on the investment 
objectives of the funds and is created by a Ranking Entity.
    However, categories or subcategories created by a fund or fund 
affiliate may be used as long as performance is measured by the 
performance measurements of a Ranking Entity. Additionally, categories 
or subcategories created by a fund or its affiliate must also 
prominently disclose the fact that the fund or its affiliate has 
created the ranking category, the number of funds in the category, the 
basis for selecting the category, and the identity of the Ranking 
Entity that developed the research on which the ranking is based. 
Headlines and prominent statements using a ranking created by a fund or 
its affiliate must also disclose in close proximity to the headline or 
prominent statement that the ranking is based on a category created by 
the fund or its affiliate.
    Finally, advertisements or sales literature may not use any ranking 
category based on the fund's asset size since such information would 
not provide a meaningful basis upon which the fund's performance could 
be evaluated.

Multiple Class/Two-Tier Funds

    Advertisements or sales literature containing rankings for more 
than one class or fund with the same portfolio must disclose the fact 
that the funds or classes have a common portfolio.
    The NASD believes that the proposed rule change is consistent with 
the provisions of Section 15A(b)(6) of the Act\3\ in that the 
guidelines will work to protect investors and the public interest by 
establishing a baseline of standards to guide the use of mutual fund 
rankings in advertising and sales literature in promoting the sale of 
mutual funds and by preventing the misleading use of such rankings.
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    \3\15 U.S.C. Sec. 78o-3.
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(B) Self-Regulatory Organization's Statement on Burden on Competition

    The NASD does not believe that the proposed rule change will result 
in any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants, or Others

    The Guidelines, which are not subject to NASD member vote, were 
circulated to members in NASD Notice to Members 93-76 (November 1993). 
Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register, or within such longer period (i) as the Commission 
may designate up to 90 days of such date if it finds such longer period 
to be appropriate and publishes its reasons for so finding or (ii) as 
to which the self-regulatory organization consents, the Commission 
will:

A. By order approve such proposed rule change, or
B. Institute proceedings to determine whether the proposed rule change 
should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are field with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to File Number SR-NASD-93-69 and 
should be submitted by March 8, 1994.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority, 17 CFR 200.30-3(a)(12).
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-3425 Filed 2-14-94; 8:45 am]
BILLING CODE 8010-01-M