[Federal Register Volume 68, Number 64 (Thursday, April 3, 2003)]
[Notices]
[Pages 16325-16328]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-8035]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47590; File No. SR-NASD-2003-13]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 by the National Association of Securities 
Dealers, Inc. Relating to Proposed Interpretive Material Regarding the 
Use of Investment Analysis Tools

March 28, 2003.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and rule 19b-4 thereunder,\2\ notice is hereby given that 
on February 3, 2003, the National Association of Securities Dealers, 
Inc. (``NASD'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in items I, II, 
and III below, which Items have been prepared by the NASD. On February 
27, 2003, the NASD amended the proposed rule change.\3\ The Commission 
is publishing this notice to solicit comments on the proposed rule 
change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See February 27, 2003 letter from Barbara Z. Sweeney, Senior 
Vice President and Corporate Secretary, to Katherine A. England, 
Assistant Director, Division of Market Regulation, Commission, and 
attachments (``Amendment No. 1''). The original proposed rule change 
was inadvertently submitted without page 5, and contained some 
technical deficiencies. In Amendment No. 1, the NASD removed pages 
1-25 of the original filing and replaced them with new pages 1-25. 
The Commission did not require the NASD to re-file pages 26-230.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The NASD proposes to adopt a new Interpretive Material (``IM'') to 
NASD rule 2210(d)(2)(N), to allow NASD member firms to use certain 
investment analysis tools that show the probability that investing in 
specific securities or mutual funds may produce a desired result. The 
text of the proposed rule change is below. Proposed new language is in 
italics.\4\

    \4\ The Commission notes for purposes of clarification that all 
of the proposed rule language is new language. While some of the 
language appears in brackets, this does not signify language that is 
being removed, as is normally the case in proposed rule language 
that is published in the Federal Register.
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IM-2210-6. Requirements for the Use of Investment Analysis Tools

    (a) General Considerations
    This Interpretive Material provides a limited exception to NASD 
Rule 2210(d)(2)(N).\1\
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    \1\NASD rule 2210(d)(2)(N) prohibits NASD member firms from 
making predictions or projections of specific investment results to 
the public. In the past, the rule also had been interpreted as 
prohibiting members from providing customers access to investment 
analysis tools that show the probability that investing in specific 
securities or mutual funds will produce a desired result. This 
Interpretive Material allows member firms to offer such tools 
(whether customers use the member's tool independently or with 
assistance from the member), written reports indicating the results 
generated by such tools and related sales material in certain 
circumstances.
    Rule 2210(d)(2)(N) does not prohibit, and this Interpretive 
Material does not apply to, automated educational tools that are 
hypothetical or general in nature. For instance, rule 2210(d)(2)(N) 
generally does not prohibit, and this Interpretive Material does not 
cover, portfolio-based planning tools that merely generate a 
suggested mix of asset classes, broad categories of securities or 
funds, or probabilities as to how classes of financial assets or 
styles of investing might perform.
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    No member may imply that NASD endorses or approves the use of any 
investment analysis tool or any recommendation based on such a tool. A 
member that intends to offer an investment analysis tool under this 
Interpretive Material (whether customers use the member's tool 
independently or with assistance from the member) must, at least 30 
days prior to first use, (1) provide NASD's Advertising Regulation 
Department (Department) access to the investment analysis tool and (2) 
file with the Department any template for written reports produced by, 
or sales material concerning, the tool.\2\ The member also must provide 
any supplemental information requested by the Department. If the 
Department requests changes to the investment analysis tool, written-
report template or sales material, the member may not offer or use the 
tool, written-report template or sales material until all changes 
specified by the Department have been made by the member and approved 
by the Department. In addition, as in all cases, a member's compliance 
with this Interpretive Material does not mean that the member is acting 
in conformity with other applicable laws and rules. A member that 
offers an investment analysis tool under this Interpretive Material 
(whether customers use the member's tool independently or with 
assistance from the member) is responsible for ensuring that use of the 
investment analysis tool and all recommendations based on the 
investment analysis tool (whether made via the automated tool or a 
written report) comply with NASD's suitability rule (rule 2310), the 
other provisions of rule 2210, and the other applicable federal 
securities laws and Securities and Exchange Commission and NASD rules.
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    \2\ Sales material that members disseminate to the public must 
be in the same form in which it was submitted to NASD for review and 
approval. Members cannot redact or alter such sales material after 
receiving NASD approval and must file with the Department any 
modified version of the sales material, at least 30 days prior to 
first use of the modified version of the sales material.
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    (b) Definition
    For purposes of this Interpretive Material and any interpretation 
thereof, an ``investment analysis tool'' is an interactive 
technological tool that produces simulations and statistical analyses 
that present a range of probabilities that various investment outcomes 
might occur, thereby serving as an additional resource to investors in 
the evaluation of the potential risks of and returns on particular 
investments.
    (c) Use of Investment Analysis Tools and Related Written Reports 
and Sales Material
    A member may provide an investment analysis tool (whether customers 
use the member's tool independently or with assistance from the 
member), written reports indicating the results generated by such tool 
and related sales material \3\ only if:
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    \3\ Sales material that contains only an incidental reference to 
an investment analysis tool (e.g., a brochure that merely mentions a 
member's tool as one of the services offered by the member) does not 
need to include the disclosures required by this Interpretive 
Material and does not need to be filed with the Department, unless 
otherwise required by another rule 2210 provision.
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    (1) the tool presents a range of probabilities that various 
investment outcomes might occur and does not state that a particular 
investment outcome will, in fact, occur;
    (2) the tool prominently presents a fair and balanced 
representation of the range of possible investment outcomes

[[Page 16326]]

that the tool's algorithm determines have a reasonable probability of 
occurrence; \4\
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    \4\ The entire range of investment outcomes would encompass a 
range of numbers that, as a practical matter, cannot be calculated 
accurately. The IM therefore requires that the tool, written report 
of the tool's results or related sales material show the range of 
possible investment outcomes that the tool's algorithm determines 
have a reasonable probability of occurrence.''
    The tool, written report of the tool's results or related sales 
material must depict a ``fair and balanced representation'' of this 
range. A ``fair and balanced representation'' would include, at a 
minimum, the ``upside,'' ``downside'' and ``median'' projections of 
estimated outcomes, but would not require a depiction of every 
outcome in between. Any representation that, in light of all the 
facts and circumstances, is misleading will not be considered a 
``fair and balanced representation'' of the range. For example, the 
presentation of a range of possible outcomes skewed to depict only 
or to weigh in favor of positive market performance would not be a 
``fair and balanced representation'' of the range. In this regard, 
whenever the tool, written report of the tool's results or related 
sales material shows an outcome that the investor has a certain 
chance of achieving on the ``upside,'' the tool, written report, or 
related sales material must also show the corresponding outcome on 
the ``downside.'' Moreover, the tool, written report or related 
sales material should make clear that the dollar amount representing 
the ``downside'' is not the worst-case scenario, and it must include 
a prominent statement of the estimated probability (for example, a 
``5% chance'' or ``1 in 20 chance'') that the investor will end up 
with less than the ``downside'' amount that the tool generates.
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    (3) the tool uses a mathematical process that can be audited and 
reviewed;
    (4) the member describes the criteria and methodology used, 
including the investment analysis tool's limitations and key 
assumptions;
    (5) the member explains that results may vary with each use and 
over time;
    (6) the member describes the universe of investments considered in 
the analysis, explains how the tool determines which securities to 
select, discloses if the tool favors certain securities \5\ and, if so, 
explains the reasons for the selectivity, and states that other 
investments not considered may have characteristics similar or superior 
to those being analyzed; and
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    \5\ This disclosure must indicate, among other things, whether 
the investment analysis tool searches, analyzes or in any way favors 
certain securities within the universe of securities considered 
based on revenue received by the member in connection with the sale 
of those securities or based on relationships or understandings 
between the member and the entity that created the investment 
analysis tool. The disclosure also must indicate whether the 
investment analysis tool is limited to searching, analyzing or in 
any way favoring securities in which the member makes a market or 
has any other direct or indirect interest. Members are not required 
to provide a ``negative'' disclosure (i.e., a disclosure indicating 
that the tool does not favor certain securities).
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    (7) the member displays the following additional disclosure: 
``IMPORTANT: The projections or other information generated by [name of 
investment analysis tool] regarding the probabilities that various 
investment outcomes might occur are hypothetical in nature, do not 
reflect actual investment results and are not guarantees of future 
results. [Name of investment analysis tool] only presents a range of 
possible outcomes.''
    (d) Disclosures
    The disclosures and other required information discussed in 
paragraph (c) must be written, clear and prominent.
* * * * *

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

1. Purpose
    The NASD proposes to allow NASD member firms to use certain 
investment analysis tools that show the probability that investing in 
specific securities or mutual funds may produce a desired result. Under 
the proposed IM, members could offer investment analysis tools and 
written reports showing the results of such tools (and use related 
sales material) only if the tools, reports or sales material present a 
range of probabilities that various investment outcomes might occur and 
do not state that a particular investment outcome will, in fact, occur; 
present a fair and balanced representation of the range of possible 
investment outcomes that the tool's algorithm determines have a 
reasonable probability of occurrence; use a mathematical process that 
can be audited and reviewed; describe the criteria and methodology 
used, including the tool's limitations and key assumptions; explain 
that results may vary with each use and over time; and describe the 
universe of investments considered in the analysis, explain how the 
tool determines which securities to select, disclose if the tool favors 
certain securities and, if so, explain the reason for the selectivity, 
and state that other investments not considered may have 
characteristics similar or superior to those being analyzed.
    In addition, the following disclosure must be displayed: 
``Important: The projections or other information generated by [name of 
investment analysis tool] regarding the probabilities that various 
investment outcomes might occur are hypothetical in nature, do not 
reflect actual investment results and are not guarantees of future 
results. [Name of investment analysis tool] only presents a range of 
possible outcomes.''
    The proposed IM also would require members to provide NASD's 
Advertising Regulation Department with access to the tool (as well as 
any template for written reports showing the results of the tool or 
sales material concerning such tool) at least 30 days prior to first 
use. The review and approval are not merit-based, but rather focus on 
whether the member has complied with the disclosure requirements and 
the other requirements of NASD rule 2210, such as the prohibitions on 
exaggerated, unwarranted and misleading statements and claims. Finally, 
the IM makes clear that, to the extent that these tools produce 
recommendations, the NASD's suitability rule would apply.
2. Statutory Basis
    The NASD believes that the proposed rule change is consistent with 
the provisions of section 15A(b)(6) \5\ of the Act, which requires, 
among other things, that the NASD's rules be designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, and, in general, to protect investors 
and the public interest. As discussed above, the proposed IM requires 
members to disclose various material aspects of the investment analysis 
tools and reports that they generate. The proposed IM also would 
require members to provide access to the tool (as well as any template 
for written reports showing the results of the tool or sales material 
concerning such tool) to the Advertising Regulation Department at least 
30 days prior to first use. In addition, the proposal reminds firms of 
their suitability obligations. The NASD believes that these 
restrictions will enable firms to provide investment analysis tools to 
investors while making clear to investors the limitations of such 
tools. As such, the investment analysis tools should allow investors to 
make educated judgments about how particular strategies or investments 
might perform.
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    \5\ 15 U.S.C. 78o-3(b)(6).

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[[Page 16327]]

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 proposed IM was published for comment in NASD Notice to Members 
02-51 (August 2002). Fifty-six comments were received in response to 
the Notice. A copy of the Notice to Members is attached as Exhibit 2. 
Copies of the comment letters received in response to the Notice are 
attached as Exhibit 3. Of the 56 comment letters received, 50 were 
generally in favor of allowing members to provide customers access to 
investment analysis tools and five were opposed. (One of the comments 
received was non-responsive.) Numerous commenters noted that other 
financial service providers have used these types of tools for years 
without any customer confusion.
    The NASD both clarified and modified certain aspects of the IM as a 
result of some of the comments that it received. For instance, a number 
of commenters requested that the NASD clarify the types of tools that 
rule 2210(d)(2)(N) currently prohibits and that would be eligible for 
the IM's limited exception. The IM now explains that NASD staff has 
interpreted rule 2210(d)(2)(N) as prohibiting members from providing 
customers with access to investment analysis tools that show the 
probability that investing in specific securities or mutual funds may 
produce a desired result. Such tools would be permitted under the 
proposed IM if they adhere to the IM's requirements. The revised 
proposed IM also states that rule 2210(d)(2)(N) does not prohibit and 
the proposed IM thus does not apply to automated educational tools that 
are hypothetical or general in nature. Rule 2210(d)(2)(N), for example, 
generally does not prohibit and the proposed IM does not cover 
portfolio-based planning tools that merely generate a suggested mix of 
asset classes, broad categories of securities or funds, or 
probabilities regarding how classes of financial assets or styles of 
investing might perform.
    Some commenters also requested that the NASD broaden the IM to 
include an exception for written reports indicating the results of the 
tools' analyses, which the NASD did not expressly discuss in the 
proposed IM that was distributed for comment. In general, these 
commenters opined that members should be able to provide reports to 
customers so that the customers have the opportunity to review the 
results and to ask follow-up questions or otherwise consult with a 
registered representative about the results. The IM now provides such 
an exception. Members may provide customers with such written reports 
if they fulfill the requirements set forth in the IM for members' use 
of the tools, including the first-use filing requirement, which could 
be accomplished by filing a template with the NASD (rather than by 
filing each individual report).
    In addition, a number of commenters who reviewed the IM that 
previously was published for comment asked for clarification of the 
provision that required members to ``prominently disclose the range of 
all possible investment outcomes generated by the investment analysis 
tool.'' In general, the commenters stated that providing a range of 
``all possible outcomes'' would be cumbersome, confusing and 
impractical given the number of variables. Indeed, one commenter opined 
that it would be virtually impossible to depict all possible outcomes. 
Several commenters suggested that members should not be required to 
provide the range of all possible outcomes, but rather the range of 
outcomes that can be determined with a high degree of certainty.
    In response to these comments, the NASD modified the provision. The 
IM explains that the entire range of investment outcomes would 
encompass a range of numbers that, as a practical matter, cannot be 
calculated accurately. The IM therefore requires a ``fair and balanced 
representation'' of the range of possible investment outcomes that the 
tool's algorithm determines have a ``reasonable probability of 
occurrence.'' For example, a range of outcomes for which there is at 
least a one in 20 chance of occurrence on both the ``upside'' of the 
range and on the ``downside'' of the range would be deemed a range of 
outcomes that have a ``reasonable probability of occurrence.'' This 
requirement will allow tools to eliminate the statistically 
insignificant outcomes (for example, those for which there is less than 
a one in 20 chance of occurrence), while still guaranteeing that the 
tool will show a range of likely investment outcomes that illustrates 
the relationship between risk and return. The tool should measure the 
outcomes that have a ``reasonable probability of occurrence'' with 
adequate precision to ensure a high degree of confidence in their 
accuracy.
    However, the tool, written report of the tool's results or related 
sales material must depict a ``fair and balanced representation'' of 
this range. A ``fair and balanced representation'' would include, at a 
minimum, the ``upside,'' ``downside'' and ``median'' projections of 
estimated outcomes, but would not require a depiction of every outcome 
in between. Any representation that, in light of all the facts and 
circumstances, is misleading will not be considered a ``fair and 
balanced representation'' of the range. For example, the presentation 
of a range of possible outcomes skewed to depict only or to weigh in 
favor of positive market performance would not be a ``fair and balanced 
representation'' of the range. In this regard, whenever the tool, 
written report of the tool's results or related sales material shows an 
outcome that the investor has a certain chance of achieving on the 
``upside,'' the tool, written report or related sales material must 
also show the corresponding outcome on the ``downside.'' Moreover, the 
tool, written report or related sales material should also make clear 
that the dollar amount representing the ``downside'' is not the worst-
case scenario, and it must include a prominent statement of the 
estimated probability (for example, a ``5% chance'' or ``one in 20 
chance'') that the investor will end up with less than the ``downside'' 
amount that the tool generates.

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 NASD 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, including whether the proposed rule 
change is consistent with the Act. The Commission specifically seeks 
comment on whether the fund advertising rules or any other Commission 
rules are implicated by the use of the investment analysis tools 
described in this proposed rule change. Persons making

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written submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0609. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed 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-2003-13 and should be submitted by April 24, 2003.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\6\
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    \6\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-8035 Filed 4-2-03; 8:45 am]
BILLING CODE 8010-01-P