[Federal Register Volume 69, Number 194 (Thursday, October 7, 2004)]
[Notices]
[Pages 60200-60206]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-2529]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50463; File No. SR-NASD-2003-13]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Granting Approval of Proposed Rule Change and 
Amendment No. 1 Thereto, and Notice of Filing and Order Granting 
Accelerated Approval of Amendment Nos. 2 and 3 to Adopt New 
Interpretive Material to NASD Rule 2210(d)(2)(N) to Allow NASD Member 
Firms to Use Certain Investment Analysis Tools

September 28, 2004.

I. Introduction

    On February 3, 2003, the National Association of Securities 
Dealers, Inc. (``NASD'') filed with the Securities and Exchange 
Commission (``Commission'' or ``SEC''), pursuant to section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to adopt a new Interpretive 
Material (``IM'') to NASD Rule 2210(d)(2)(N) that would allow NASD 
member firms to use investment analysis tools that show the probability 
that investing in specific securities or mutual funds may produce a 
desired result. On February 27, 2003, the NASD amended the proposed 
rule change.\3\ The proposed rule change, as amended, was published for 
notice and comment in the Federal Register on April 3, 2003.\4\ The 
Commission received seven comment letters on the proposal.\5\ On 
December 2, 2003, the NASD responded to the comment letters and amended 
the proposed rule change.\6\ The NASD filed another amendment to make 
minor changes to the proposed rule change on February 27, 2004.\7\ This 
order approves the proposed rule change as modified by Amendment No. 1. 
Simultaneously, the Commission provides notice of filing of Amendment 
Nos. 2 and 3 and grants accelerated approval of Amendment Nos. 2 and 3. 
The complete text of the proposed rule change, as approved, is attached 
as Exhibit A.
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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, SEC, and 
attachments (``Amendment No. 1''). The original proposed rule change 
was inadvertently filed without page 5. In Amendment No. 1, 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.
    \4\ See Securities Exchange Act Release No. 47590 (March 28, 
2003), 68 FR 16325.
    \5\ See infra note 8 (citing comment letters).
    \6\ See December 2, 2003, letter from James S. Wrona, Associate 
General Counsel, NASD, to Katherine A. England, and attachments 
(``NASD Response Letter'' or ``Amendment No. 2''). See also infra 
Section III (discussing the NASD's response to comments and 
amendments to the proposed IM).
    \7\ See February 26, 2004, letter from James S. Wrona to 
Katherine A. England, and attachments (``Amendment No. 3''). In 
Amendment No. 3, the NASD made changes to the format of the proposed 
rule language, and added specific references to NASD and Commission 
rules and requirements.
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II. Summary of Comments

    The Commission received seven comment letters on the NASD's 
proposed rule change as modified by Amendment No. 1.\8\ One comment 
letter supported the NASD's rule change as originally proposed, five 
supported the proposed rule change but suggested certain modifications, 
and one opposed the proposed rule change.\9\ The following summary of 
comments provides an overview of the commenters' concerns:
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    \8\ See the following letters to Jonathan G. Katz, Secretary, 
SEC: April 24, 2003, letter from Alexander C. Gavis, Associate 
General Counsel, Fidelity Investments (``Fidelity Letter''); April 
24, 2003, letter from Tamara K. Salmon, Senior Associate Counsel, 
Investment Company Institute (``ICI Letter''); April 24, 2003, 
letter from Michael J. Hogan, Harris Investor Services LLC (``Harris 
Letter''); April 29, 2003, letter from Christopher P. Gilkerson, 
Vice President and Associate General Counsel, Office of Corporate 
Counsel, Charles Schwab & Co. (``Schwab Letter''); May 1, 2003, 
letter from Scott W. Campbell, Executive Vice President and General 
Counsel, Financial Engines, Inc. (``FE Letter''); May 7, 2003, 
letter from Eliot Wagner, Chair, Technology & Regulation Committee, 
and Hardy Callcott, Chair, Online Brokerage Legal Committee, 
Securities Industry Association (``SIA Letter''); and May 9, 2003, 
letter from John M. Ramsay, Senior Vice President and Regulatory 
Counsel, The Bond Market Association (``BMA Letter'').
    \9\ The FE Letter expressed approval of the proposed rule change 
(asserting the proposed rule change ``will benefit investors and 
enhance competition in the securities industry''). FE Letter at 1. 
The Fidelity, ICI, Schwab, SIA, and BMA Letters expressed approval 
of the proposed rule change with modifications. The Harris Letter 
opposed the proposed rule change.
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     NASD Should Revise the Definition of Investment Analysis 
Tools
    Several commenters suggested that the NASD revise its definition of 
investment analysis tools.\10\ One commenter expressed concern that the 
proposed definition of investment analysis tools does not clearly 
reflect the ``distinction between tools that show a probability that 
investing in specific securities or mutual funds will produce

[[Page 60201]]

a desired result and tools that show probabilities as to how classes of 
financial assets or style of investing might perform'' (emphasis in 
original).\11\ Other commenters suggested that the NASD revise the 
definition to allow for tools that present a single probability of 
achieving a desired result, rather than limiting the definition to 
tools that provide a range of probabilities.\12\ These commenters 
believed that the presentation of a single probability of achieving a 
desired result can be achieved in a fair and balanced manner through 
the use of disclosure and/or tool functionality.\13\
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    \10\ Fidelity Letter at 3; Schwab Letter at 2-4; SIA Letter at 
4; BMA Letter at 2-4, 6; Harris Letter at 13. Amendment No. 1 
defined an investment analysis tool as ``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.'' Amendment No. 1 at 3.
    \11\ Fidelity Letter at 3. Though the commenter noted that the 
distinction is indicated in the IM's first footnote, the commenter 
recommended that the distinction be recognized in the text of the 
definition. Id.
    \12\ Id. at 4; Schwab Letter at 4 (``* * * there are tools whose 
purpose and use do not include presenting a range of 
probabilities.''); SIA Letter at 3.
    \13\ See e.g., Fidelity Letter at 4.
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    One commenter further suggested that the NASD's proposed definition 
of investment analysis tools should be revised so that it fully 
reflects the purpose of the IM and explains ``which tools are not 
covered by the IM's prescriptive text and therefore are already 
permissible under existing [NASD] Rule 2210(d). * * *'' \14\ The 
commenter argued that, since several of the proposed investment 
analysis tool disclosure requirements ``only make sense if the tool 
results in or analyzes investment recommendations,'' investment 
analysis tools that analyze a self-directed client's portfolio in light 
of a goal provided by the client, such as retirement, and do not make 
any investment recommendations should be excluded from the proposed 
definition of investment analysis tools.\15\ Additionally, the 
commenter recommended that investment analysis tools that registered 
representatives currently use internally to make recommendations to 
clients (where the tool is not client-facing) also should be excluded 
from the NASD's proposed definition of investment analysis tools.\16\ 
The commenter offered a revised definition of investment analysis 
tools, stating that the failure to amend the NASD's proposed definition 
``will lead to confusion and inconsistency between past and current 
interpretations and practices under different parts of [NASD] Rule 
2210(d).'' \17\
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    \14\ Schwab Letter at 2.
    \15\ Id. at 2-3. See also SIA Letter at 4 (investment analysis 
tools that include yield or performance information as part of an 
analysis of a client's portfolio in light of client-supplied goals 
should be excluded).
    \16\ Schwab Letter at 3. See also SIA Letter at 4 (arguing that 
investment analysis tools used internally by registered 
representatives or investment advisers in the course of preparing 
advice for clients should be excluded from the scope of the IM's 
prohibition).
    \17\ Schwab Letter at 3.
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    One commenter suggested that investment analysis tools provided 
exclusively to institutional investors should be excluded from the 
scope of the proposed IM's prohibition,\18\ while another commenter 
encouraged the NASD to revise the definition of investment analysis 
tools to clarify that the IM does not apply to bond calculators or risk 
management tools used by money managers and institutional investors to 
help manage portfolios.\19\ One commenter opined that the definition is 
``unnecessarily broad and confusing'' and argued that the NASD tried to 
clarify that ``certain `automated educational' [t]ools that present 
certain `portfolio analysis' financial planning may not be subject to 
the rule, but it appears that portfolio-based planning [t]ools that are 
more than `educational' would be subject to the rule.'' \20\
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    \18\ SIA Letter at 4.
    \19\ BMA Letter at 6.
    \20\ Harris Letter at 13.
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     NASD Should Clarify the Requirement That Investment 
Analysis Tools Use a Mathematical Process That Can Be Audited and 
Reviewed
    Several commenters suggested that the NASD further explain its 
intent with regard to the requirement that investment analysis tools 
use a mathematical process that can be audited and reviewed.\21\ The 
commenters expressed concern that this requirement could be interpreted 
to require member firms to obtain third-party audits of investment 
analysis tools.\22\ Two commenters urged the NASD to clarify that it 
does not intend for members to collect and maintain an archive of 
calculations of each session during which an investment analysis tool 
is used.\23\ One commenter noted that some broker-dealers may purchase 
their investment analysis tools from third party vendors who may not be 
willing to waive confidentiality provisions in licensing agreements 
with respect to granting the broker-dealer access to the mathematical 
processes of the investment analysis tools.\24\
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    \21\ ICI Letter at 3; Fidelity Letter at 5; Harris Letter at 14.
    \22\ Fidelity Letter at 5; ICI Letter at 3.
    \23\ Schwab Letter at 4 (``The final IM should make clear that 
it is only the general mathematical process itself that must be 
documented and not the specific calculations generated for any 
specific application of the tool.''); Harris Letter at 14 (``No 
guidance is provided as to how a member firm must audit the [t]ool, 
what features are subject to an audit requirement or whether it 
applies on a per client basis.'')
    \24\ Harris Letter at 14.
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     NASD Should Modify the Requirement to Disclose the 
Universe of Investments Considered
    Some commenters suggested that the NASD modify its disclosure 
requirements to eliminate unnecessary and duplicative disclosure. For 
example, several commenters opposed the requirement of a disclosure 
statement explaining that there are other investments that were not 
considered by the investment analysis tool that may have 
characteristics similar or superior to those analyzed by the tool.\25\ 
One of those commenters suggested that the requirement be revised to 
require disclosure only of a description of the universe of investments 
considered in the analysis, reasoning that investors ``would likely be 
confused by boilerplate disclosure stating that other similar 
investments were not considered.'' \26\ One commenter argued that by 
requiring disclosure of the universe of investments considered in the 
analysis, investors would know that not all investments offered 
anywhere were considered.\27\
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    \25\ ICI Letter at 3; Harris Letter at 15; Fidelity Letter at 5-
6.
    \26\ Fidelity Letter at 6 (``. . .[t]his would give [investors] 
the impression that the `grass may be greener' with other 
investments, but would fail to provide the investor with any 
meaningful analysis.'').
    \27\ ICI Letter at 3.
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     NASD Should Modify the Proposed Disclosure Requirements
    The NASD's proposed disclosure requirements apply not only to 
investment analysis tools, but also to written reports indicating the 
results generated by the use of investment analysis tools, and any 
related sales material. Commenters had varying concerns about this 
aspect of the proposal. For example, one commenter advocated an 
alternative approach in which the NASD would grant member firms the 
discretion to determine the best approach regarding disclosure between 
investment analysis tools and the reports generated by use of the 
tools, rather than requiring that all written reports contain the same 
disclosure, which would be redundant and unhelpful.\28\ The commenter 
also suggested that the disclosure requirements not be applied broadly 
to all tool-related sales material, but rather be limited to sales 
material containing a

[[Page 60202]]

detailed description of the tools as well as investor-specific 
probability presentations.\29\ Similarly, another commenter suggested 
that, rather than requiring the member firm to make the same disclosure 
in all reports and sales material, ``the member could determine where 
disclosure of this information would be most appropriate, so long as 
the totality of the disclosure provided to the investor includes all 
elements of disclosure required by the IM.'' \30\
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    \28\ Fidelity Letter at 6. Rather, the commenter recommended 
that firms be required to rationalize disclosure between the tool 
and the reports, and opined of a greater likelihood that investors 
would read the disclosure information if firms are given discretion 
in this area. Id.
    \29\ Id. at 7-8.
    \30\ ICI Letter at 4. See also SIA Letter at 4 (recommending 
flexibility in provisions for disclosure and presentation of 
information).
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    One commenter argued against the NASD's proposal to apply the 
disclosure requirements broadly to all investment analysis tool-related 
sales material, and recommended that the disclosure requirements apply 
only to ``sales material that contains either a detailed description of 
the tool or investor-specific probability presentations.'' \31\ Without 
this constraint on the scope of the disclosure requirement, the 
commenter believed that all pieces of sales material might fall within 
the scope of the proposed rule, and therefore be required to comply 
with the substantive and disclosure requirements outlined in IM-2210-
(c) and (d). For both written reports and sales material, the commenter 
recommended that the NASD allow member firms the flexibility to self-
determine the appropriate disclosure for reports and sales 
material.\32\
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    \31\ Fidelity Letter at 6-7.
    \32\ Id.
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    One commenter suggested that the NASD allow members to have 
discretion over where to place the required clear and prominent 
disclosures ``as part of the tool's interactive process and/or on any 
report that provides the tool's result.'' \33\ The commenter encouraged 
the NASD to modify the proposed rule to expressly permit both written 
and electronic disclosures, ``given that this is a rule about 
electronic investment analysis tools.'' \34\ In a general criticism of 
the disclosure provision, one commenter suggested that, for most 
investment analysis tools, the NASD's mandated conditions and 
disclosures ``are unnecessary either because the presentation, purpose 
or level of detail of the [t]ool is self evident, or the [t]ool itself 
contains sufficient context and disclosure without the additional NASD 
requirements.'' \35\
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    \33\ Schwab Letter at 4.
    \34\ Id.
    \35\ Harris Letter at 14.
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     NASD Should Modify or Eliminate the 30-Day Pre-Filing and 
Approval Requirement
    Most of the commenters opposed the NASD's proposed requirement that 
member firms provide the NASD with access to a proposed investment 
analysis tool at least 30 days prior to its first use, and the required 
filing of any templates for written reports produced by, or sales 
material concerning, the tool.\36\ One commenter believed that the pre-
use access and filing requirement ``places broker-dealers at a 
competitive disadvantage given that investment advisers, mutual funds, 
and unregulated financial portals on the Web have no such pre-use 
approval process for their investment analysis tools.''\37\ Another 
commenter opposed the pre-filing requirement by arguing that it ``would 
result in significant delays in the launch of investment tools to 
investors.'' \38\ Noting that investment analysis tools can take from 
as little as a few months to over a year or more to develop, the 
commenter remarked that the pre-use access and filing requirement would 
essentially insert the NASD into the development cycle of investment 
analysis tools, likely at the final stages of the process. The 
commenter argued that this ``will result in member firms devoting a 
significant amount of time to negotiating comments with the NASD at the 
last stages of development, detracting from focus on launching the tool 
with the public.'' \39\ Noting that the NASD does not consider the 
approval requirement to be a merit based review, and will instead only 
review an investment analysis tool to confirm that the requisite 
disclosures have been made, the commenter argued against the need for a 
30-day pre-filing and approval requirement.\40\ The commenter suggested 
that the NASD conduct its review either ``in due course or after a 
member has first used the tool,'' reasoning that ``the proposed review 
would be an inefficient extension of the NASD staff's responsibilities, 
particularly when the staff is not charged with responsibility of pre-
screening other types of investment tools.'' \41\ Another commenter 
remarked that ``the disclosure requirements, as modified, would be 
clear enough on their face for members to implement, rendering any 
prior review unnecessary.'' \42\
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    \36\ Schwab Letter at 5; Fidelity Letter at 7; Harris Letter at 
16-18; ICI Letter at 4; SIA Letter at 4.
    \37\ Schwab Letter at 5.
    \38\ Fidelity Letter at 7.
    \39\ Id.
    \40\ Id.
    \41\ Id.
    \42\ Schwab Letter at 6.
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    One commenter recommended reducing the 30-day period to a 10-day 
period.\43\ Noting that no other provisions of NASD Rule 2210, nor any 
other interpretive material issued under the rule, require the filing 
of information with the NASD more than 10 days before use, the 
commenter remarked that a 10-day pre-filing and approval requirement 
``will facilitate the ability of members to utilize their current 
internal procedures relating to the review and filing of advertising 
and sales literature in connection with the use of these tools.'' \44\
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    \43\ ICI Letter at 4.
    \44\ Id. Additionally, the commenter recommended that the 
filing, approval, and recordkeeping requirements under NASD Rule 
2210 not apply to amendments to a tool, related sales material, or 
written reports indicating the tool's results that are either non-
substantive or merely updates to preexisting templates that the NASD 
previously approved. Id. at 4-5.
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     NASD Should Clarify Which Regulatory Regime Applies to the 
Use of Investment Analysis Tools
    A few commenters expressed concern that the NASD's proposed IM does 
not resolve ambiguity regarding which regulatory scheme applies to the 
use of investment analysis tools.\45\ Specifically, one commenter 
questioned the uncertainty of whether ``the rule prohibiting 
predictions and projections, the existing exception to this rule for 
hypothetical illustrations of mathematical principles, the exception to 
this rule for tools as proposed in the IM, or the rule permitting 
forecasts that are not unwarranted and have a reasonable basis'' 
applies to the use of investment analysis tools.\46\ The same commenter 
alleged that the proposed IM took a ``broader historical 
interpretation'' of the scope of the NASD Rule 2210(d)(2)(N) 
prohibition as applied to investment analysis tools, and suggested that 
the language ``be revised to avoid upsetting settled expectations.'' 
\47\ The commenter noted that many broker-dealers consider their 
investment analysis tools to fall under the exception to the general 
prohibition of Rule 2110(d)(2)(N) that permits hypothetical 
illustrations of mathematical principles.\48\
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    \45\ SIA Letter at 2; Harris Letter at 4-19.
    \46\ SIA Letter at 2.
    \47\ Id. at 4. The SIA Letter recommended that the IM should be 
revised to describe the NASD's prior application of the prohibition 
as applying to ``communications (generated by a tool or otherwise) 
that unfairly implied a specific result, included exaggerated or 
unwarranted claims or contained misrepresentations.'' Id. at 5.
    \48\ Id. at 3.
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    Similarly, one commenter recommended that the NASD explain in more 
detail the difference between a permissible ``forecast'' and a 
prohibited ``projection or prediction'' and suggested that the IM is 
inconsistent

[[Page 60203]]

with prior NASD staff interpretations, which the commenter interpreted 
as having previously authorized the use of investment analysis tools, 
and takes an unprecedented and overly expansive interpretation of Rule 
2110(d)(2)(N).\49\ The same commenter recommended that the NASD 
withdraw the proposed IM and instead work to harmonize what the 
commenter characterized as inconsistencies within NASD rules and 
between NASD and NYSE rules with respect to the terms ``forecast,'' 
``projection'' and ``prediction,'' where all three terms are, in the 
commenter's opinion, sometimes used interchangeably.\50\ The commenter 
opined that investment analysis tools should be treated as 
``permissible forecasts'' under existing interpretations of Rule 
2110(d)(2)(N) and suggested that current NASD rules against exaggerated 
or unwarranted claims or misrepresentations already provide adequate 
safeguards for the public.\51\
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    \49\ Harris Letter at 7-8.
    \50\ Id. at 6.
    \51\ Id. at 5.
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     NASD Should Clarify the Applicability of the IM to 
Entities Dually Registered as Investment Advisers
    Two commenters requested the NASD to clarify whether a broker-
dealer that also is registered as an investment adviser would be 
subject to the provisions of the IM when offering public customers an 
investment analysis tool in its capacity as an investment adviser.\52\ 
One commenter suggested that since investment analysis tools offered by 
registered investment advisers are already subject to regulation and 
oversight under the regulatory regime applicable to registered 
investment advisers, such tools should not be subject to an additional 
layer of regulation under the NASD IM when offered through a broker-
dealer to its customers or through a united Web site of a broker-dealer 
dually-registered as an adviser.\53\ Similarly, the same commenter 
requested the NASD to clarify the applicability of the IM to investment 
analysis tools offered by affiliates of a broker-dealer, as well as 
non-affiliates and other third parties, including instances where a 
broker-dealer's Web site links to such other party's investment 
analysis tool.\54\
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    \52\ FE Letter at 4 (n. 14); Harris Letter at 11-12).
    \53\ Harris Letter at 11-12.
    \54\ Id. at 3, 12.
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     Undue Burden on Competition
    Some commenters objected to what they believe is a potential burden 
on competition that could result from the proposed IM, in particular 
the pre-filing and approval process.\55\ The commenters were concerned 
that the IM could affect the ability of NASD-member firms to compete 
with investment advisers, banks, financial planners, financial Web 
sites, non-NASD broker-dealers and other non-regulated entities that 
would not be subject to the pre-use filing and approval process with 
respect to investment analysis tools.
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    \55\ See, e.g., Schwab Letter at 5; Harris Letter at 4. But see 
FE Letter at 3-5 (asserting that the proposed IM will level the 
playing field among investment advisers, broker-dealers and other 
financial institutions, increase competition, foster innovation, and 
benefit investors).
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    One commenter stated that member firms linking customers to an 
investment adviser, bank, or other affiliated or non-affiliated third 
party offering an investment analysis tool may or may not be subject to 
the rule, the uncertainty of which the commenter believes creates 
competitive disadvantages for certain classes of member firms depending 
on their organizational structure and relationships with third 
parties.\56\ Another commenter suggested that the pre-review process 
could inhibit the incentive of NASD-member firms to develop proprietary 
products tailored to the needs of their customers and favor third-party 
vendors who would not be subject to the rule.\57\
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    \56\ Harris Letter at 4-5.
    \57\ BMA Letter at 5.
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III. The NASD's Response to Comments

    The NASD filed Amendment No. 2 on December 3, 2003, which responded 
to the comments and elaborated on the NASD's rationale for the proposed 
IM. Amendment No. 2 modified the NASD's proposal to accommodate many of 
the commenters' concerns.\58\ The NASD's responses to several of the 
more significant issues are addressed below.
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    \58\ See NASD Response Letter, supra note 6.
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    One of the NASD's modifications to the proposed rule was a further 
delineation of the types of communications generally prohibited by the 
proposed IM. In Amendment No. 2, the NASD modified the proposed IM to 
make it consistent with the recently amended language of NASD Rule 
2210(d)(1)(D), formerly NASD Rule 2210(d)(2)(N), by clarifying that the 
proposed rule change ``prohibits predictions and projections involving 
the likely performance of both specific securities and investment 
strategies and styles'' (emphasis in original).\59\ Noting that the 
dividing line between predictions of specific investments and 
investment strategies ``is problematic and no meaningful distinction 
can be made from the perspective of investor protection,'' the NASD 
broadened the scope of the proposed IM by expanding the definition of 
investment analysis tools to allow members to use or offer tools that 
present ``the likelihood of various investment outcomes if certain 
investments are made or certain investment strategies or styles are 
undertaken,'' as long as the member complies with the proposed IM's 
requirements.\60\
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    \59\ Id. at 2. The initial version of the proposed IM ``focused 
on projections of specific securities and did not indicate that 
[NASD] Rule 2210(d)(1)(D) also applied to predictions and 
projections involving investment strategies and styles.'' Id. An 
exception to NASD Rule 2210(d)(1)(D) permits a hypothetical 
illustration of mathematical principals, provided that it does not 
predict or project the performance of an investment or investment 
strategy. See Securities Exchange Act Release No. 47820 (May 9, 
2003) (SR-NASD-2000-12), 68 FR 27116, 27123 (May 19, 2003) (adopting 
amended NASD Rule 2210).
    \60\ NASD Resposne Letter, supra note 6, at 2-3 (emphasis in 
original). The revised definition states that an investment analysis 
tool is ``an interactive technological tool that produces 
simulations and statistical analyses that present the likelihood of 
various investment outcomes if certain investments are made or 
certain investment strategies or styles are undertaken, thereby 
serving as an additional resource to investors in the evaluation of 
the potential risks and returns of investment choices.'' Amendment 
No. 3, supra note 7, at 2-3.
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    In response to commenters' concerns with the pre-filing 
requirement, the NASD modified the proposed IM to eliminate the 30-day 
pre-filing requirement and instead require members to file their 
investment analysis tools with the NASD Advertising Regulation 
Department within 10 days after first use. The NASD recognized 
commenters' concerns with respect to the NASD interfering in the 
development of investment analysis tools and acknowledged that the pre-
filing requirement is unnecessary in light of the fact that the NASD 
staff will not be conducting a merit review of the tools.\61\ Further, 
the NASD modified the proposed IM to exempt from the 10-day post-use 
access and filing requirement members that provide investment analysis 
tools exclusively to institutional customers. Such members would, 
however, remain subject to the disclosure requirements and would retain 
their suitability obligations.\62\ The NASD further modified the 
proposed IM to require members to provide the NASD with access to 
investment analysis tools or re-file with the NASD the written-report 
templates or sales materials only if firms make a material change to 
the investment analysis tools,

[[Page 60204]]

written-report templates, or sales materials.\63\
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    \61\ NASD Response Letter, supra note 6, at 3.
    \62\ Id.
    \63\ Id. at 4.
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    The NASD also responded to commenters' concerns regarding the 
permissibility of calculating a single probability score by amending 
the proposed IM to eliminate the requirement that investment analysis 
tools present a range of probabilities, including upside, downside, and 
median projections.\64\ The NASD recognized that the removal of this 
requirement would simplify the proposed IM by eliminating a provision 
that did not particularly contribute to the goals of investor 
protection.\65\
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    \64\ Id.
    \65\ Id.
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    Similarly, the NASD eliminated the requirement that investment 
analysis tools use a mathematical process that can be audited and 
reviewed. The NASD recognized the difficulty inherent in requiring NASD 
examiners to review the mathematical processes of investment analysis 
tools for compliance with the proposed IM. Further, the NASD eliminated 
the requirement in order to avoid any perception that may have led the 
investing public to believe that the NASD would be performing a merit-
based review of these investment analysis tools.\66\
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    \66\ Id.
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    The NASD also responded to a suggestion that the NASD standard be 
harmonized with New York Stock Exchange Rule 472 that permits forecasts 
that are clearly labeled as such and are not exaggerated or 
unwarranted.\67\ The NASD explained that ``forecasts'' relate to 
estimates of economic performance and results, which is different from 
predicting or projecting how a particular investment or investing style 
might perform.\68\ Accordingly, the NASD affirmed its belief in 
requiring member firms to provide the information specified in the 
streamlined disclosure requirements of the amended IM when offering 
investment analysis tools, in addition to requiring that the tools not 
produce misleading, exaggerated, or unwarranted claims.\69\
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    \67\ Id. at 5.
    \68\ Id.
    \69\ Id.
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    With regard to commenters who stated their belief that investment 
analysis tools are already permitted by the exception to NASD Rule 
2210(d)(2)(N) permitting hypothetical illustrations of mathematical 
principles, the NASD explained that amended NASD Rule 2210(d)(1)(D), 
formerly NASD Rule 2210(d)(2)(N), operates generally to prohibit 
investment analysis tools, as they make predictions and projections 
which are prohibited by the rule.\70\ Rather, the hypothetical 
illustration exception applies to ``tools that serve the functions of a 
calculator that computes the mathematical outcome of certain assumed 
variables without predicting the likelihood of either the assumed 
variables or the outcome.'' \71\
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    \70\ See Securities Exchange Act Release No. 47820 (May 9, 2003) 
(SR-NASD-2000-12), 68 FR 27116, 27125 (May 19, 2003) (noting that 
the rule permits a member to present a hypothetical illustration of 
mathematical principles (e.g., a mutual fund cost calculator), but 
would not permit the illustration to predict or project the 
performance of an investment or investment strategy, since making a 
prediction based on those calculations could be misleading to 
investors).
    \71\ NASD Response Letter at 5.
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IV. Discussion and Commission Findings

    The Commission has reviewed carefully the proposed rule change, the 
comment letters, and the NASD's response to the comments, and finds 
that the proposed rule change is consistent with the requirements of 
the Act and the rules and regulations thereunder applicable to a 
national securities association \72\ and, in particular, the 
requirements of section 15A(b)(6) of the Act,\73\ 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.
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    \72\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \73\ 15 U.S.C. 78o-3(b)(6).
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    In particular, the Commission notes that, in response to 
commenters' concerns, the NASD modified the proposed IM to eliminate 
the 30-day pre-filing requirement in favor of a 10-day post-use access 
and filing requirement. Additionally, the filing requirement is waived 
for investment analysis tools provided exclusively to institutional 
investors, though the Commission notes that such tools would still be 
subject to the disclosure requirements of the proposed IM. The 
Commission believes this modification of the proposed IM addresses the 
commenters' concerns and that the amended provision is reasonable. 
Since the NASD will not be performing substantive merit reviews of 
these tools, however, the Commission reminds NASD member firms of the 
need to take great care in providing complete and understandable 
disclosure to minimize the potential for any investment analysis tool 
literature or output to be presented in a misleading manner.\74\
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    \74\ The Commission notes that NASD member firms should be 
particularly mindful when an investment analysis tool or any report 
or sales material derived from such a tool is used in any way that 
could be construed as promoting the future performance of one or 
more specific investment companies. Tools, reports, or sales 
materials that are used in this manner may raise issues under the 
antifraud provisions of the federal securities laws and implicate 
the investment company advertising rules. See, e.g., 17 CFR 
230.156(b)(2) (Rule 156(b)(2) under the Securities Act of 1933 
provides that representations about future investment performance 
could be misleading under certain circumstances including situations 
where representations are made as to possible future gains or 
income.).
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    With respect to the disclosure regarding the universe of 
investments considered by investment analysis tools, the Commission 
agrees that the NASD's approach is reasonably tailored to provide 
meaningful disclosure regarding the securities considered by the tools 
and the limitations inherent in the scope of any analysis provided. 
Regarding commenters' concerns about the requirement that investment 
analysis tools use a mathematical process that can be audited, the 
Commission notes that the NASD has dropped this provision from the 
proposed IM. The Commission believes that this modification to the 
proposed IM is reasonable. While the Commission acknowledges that the 
NASD's modification was intended, in part, to alleviate the commenters' 
concerns that the NASD intended for members to collect and maintain an 
archive of calculations performed by the tools, or to perhaps require 
third-party audits of the tools, the Commission reminds NASD members 
that any investment analysis tools purporting to employ mathematical 
principles while accounting for certain variables and assumptions 
should, by their nature, be capable of being audited with respect to 
the processes employed and functions performed by the tools.
    Similarly, the Commission notes that the NASD has amended the 
proposed IM to remove the requirement that investment analysis tools 
present a range of probabilities, thereby allowing tools to present a 
single probability of achieving a desired result. While the Commission 
believes this modification is reasonable, the Commission reminds 
broker-dealers of the importance of meaningful and readily-
understandable disclosure for any investment analysis tools that 
present the likelihood of achieving a single result in such a way that 
guards against the potential for misleading the investing public.

[[Page 60205]]

    In response to one commenter's concerns regarding broker-dealers 
dually registered as investment advisers, the Commission notes that the 
proposed IM applies only to NASD members. Further, with respect to the 
obligations of a broker-dealer for hyperlinked information, the 
Commission reminds NASD members of the Commission's guidance regarding 
the applicable theories of liability for hyperlinked information.\75\
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    \75\ See Securities Exchange Act Release No. 42728 (April 28, 
2000), 65 FR 25843 (May 4, 2000) (regarding the entanglement and 
adopting theories of liability for hyperlinked information).
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    The Commission does not believe that the proposed IM will place any 
undue burden on competition. The Commission notes the elimination of 
the pre-use filing requirement from the proposed IM and, though 
financial advisers and other entities may not be subject to the IM 
since the NASD's jurisdiction only extends to its member broker-
dealers, the Commission feels that the amended IM is narrowly tailored 
to prevent fraudulent practices and protect the investing public 
without unduly restricting or burdening the competitive market for 
these types of products with respect to NASD members.
    With regard to all other issues raised by the commenters, the 
Commission is satisfied that the NASD has adequately addressed the 
commenters' concerns.
    The Commission expects that the NASD will carefully monitor 
compliance with the provisions of the IM among its member broker-
dealers offering investment analysis tools and, in particular, will 
review the required disclosures, including the nature of the tools' 
output, with an eye towards preventing misleading and fraudulent 
statements and protecting the investing public.
    The Commission finds good cause for approving Amendment Nos. 2 and 
3 before the thirtieth day after the date of publication of notice of 
filing thereof in the Federal Register. The NASD filed Amendment No. 2 
in response to comments it received after the publication of the notice 
of filing of the proposed rule change, to address certain commenters' 
concerns and to amend the proposed IM. In addition, the NASD filed 
Amendment No. 3 to make minor modifications to the proposed rule 
change, including formatting changes and adding references to NASD and 
Commission rules and requirements. Because Amendment No. 2 is 
responsive to the commenters' concerns and Amendment No. 3 is 
responsive to the Commission's suggested modifications, and because 
neither Amendment presents any novel issues, the Commission finds good 
cause for accelerating approval of Amendment Nos. 2 and 3.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether Amendment Nos. 2 
and 3 are consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-NASD-2003-13 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File No. SR-NASD-2003-13. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 the filing 
also will be available for inspection and copying at the principal 
office of the Exchange. All comments received will be posted without 
change; the Commission does not edit personal identifying information 
from submissions. You should submit only information that you wish to 
make available publicly. All submissions should refer to file number 
SR-NASD-2003-13 and should be submitted on or before October 28, 2004.

VI. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\76\ that the proposed rule change (SR-NASD-2003-13), as amended by 
Amendment No. 1, be, and it hereby is, approved, and that Amendment 
Nos. 2 and 3 to the proposed rule change be, and hereby are, approved 
on an accelerated basis.
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    \76\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, pursuant 
to delegated authority.\77\
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    \77\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.

Exhibit A

* * * * *

Proposed IM-2210-6--Investment Analysis Tools

* * * * *

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)(1)(D).\1\ 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 offers or 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, within 10 days of 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. The Department 
may require that the member modify the investment analysis tool, 
written-report template or sales material. The Department also may 
require that the

[[Page 60206]]

member not offer or continue to offer or use the tool, written-
report template or sales material until all changes specified by the 
Department have been made by the member.
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    \1\ NASD Rule 2210(d)(1)(D) states that ``[c]ommunications 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.'' This Interpretive Material allows member 
firms to offer investment analysis 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)(1)(D) does not prohibit, and this Interpretive 
Material does not apply to, hypothetical illustrations of 
mathematical principles that do not predict or project the 
performance of an investment or investment strategy.
    \2\ After the Department has reviewed the investment analysis 
tool, written-report template or sales material, a member must 
notify the Department and provide additional access to the tool and 
re-file any template or sales material if it makes a material change 
to the presentation of information or disclosures as required by 
paragraphs (c) and (d).
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    A member that offers an investment analysis tool exclusively to 
``institutional investors,'' as defined in Rule 2211(a)(3), is not 
subject to the post-use access and filing requirement in this 
paragraph if the communications relating to or produced by the tool 
meet the criteria for ``institutional sales material,'' as defined 
in Rule 2211(a)(2). A member that intends to make the tool available 
to, or that intends to use the tool with, any person other than an 
institutional investor (such as an employee benefit plan participant 
or a retail broker-dealer customer) will be subject to the filing 
and access requirements, however.
    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, as applicable, with NASD's suitability rule (Rule 
2310), the other provisions of Rule 2210 (including, but not limited 
to, the principles of fair dealing and good faith, the prohibition 
on exaggerated, unwarranted or misleading statements or claims, and 
any other applicable filing requirements for advertisements and 
sales literature), the federal securities laws (including, but not 
limited to, the antifraud provisions), the Securities and Exchange 
Commission rules (including, but not limited to, SEC Rule 156 under 
the Securities Act of 1933) and other NASD rules.

(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 the likelihood of various 
investment outcomes if certain investments are made or certain 
investment strategies or styles are undertaken, thereby serving as 
an additional resource to investors in the evaluation of the 
potential risks and returns of investment choices.

(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 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) need not 
include the disclosures required by this Interpretive Material and 
would not need to be filed with the Department, unless otherwise 
required by the other provisions of Rule 2210.
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    (1) The member describes the criteria and methodology used, 
including the investment analysis tool's limitations and key 
assumptions;
    (2) the member explains that results may vary with each use and 
over time;
    (3) if applicable, 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 and, if so, explains the reason for the 
selectivity,\4\ and states that other investments not considered may 
have characteristics similar or superior to those being analyzed; 
and
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    \4\ 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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    (4) the member displays the following additional disclosure: 
``IMPORTANT: The projections or other information generated by [name 
of investment analysis tool] regarding the likelihood of various 
investment outcomes are hypothetical in nature, do not reflect 
actual investment results and are not guarantees of future 
results.''

(d) Disclosures

    The disclosures and other required information discussed in 
paragraph (c) must be clear and prominent and must be in written or 
electronic narrative form.
* * * * *
 [FR Doc. E4-2529 Filed 10-6-04; 8:45 am]
BILLING CODE 8010-01-P