[Federal Register Volume 88, Number 225 (Friday, November 24, 2023)]
[Notices]
[Pages 82482-82495]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-25881]
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SECURITIES AND EXCHANGE COMMISSION
Release No. 34-98977; File No. SR-FINRA-2023-016]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of a Proposed Rule Change To Amend
FINRA Rule 2210 (Communications With the Public) To Permit Projections
of Performance of Investment Strategies or Single Securities in
Institutional Communications
November 17, 2023.
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 November 13, 2023, the Financial Industry Regulatory Authority, Inc.
(``FINRA'') 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 FINRA. The
Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
FINRA is proposing to amend FINRA Rule 2210 (Communications with
the Public). Currently Rule 2210 prohibits projections of performance
or targeted returns \3\ in member communications, subject to specified
exceptions. The proposed rule change would allow a member to project
the performance or provide a targeted return with respect to a security
or asset allocation or other investment strategy in an institutional
communication or a communication distributed solely to qualified
purchasers as defined in the Investment Company Act of 1940
(``Investment Company Act'') that promotes or recommends specified non-
public offerings, subject to stringent conditions to ensure these
projections are carefully derived from a sound basis.
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\3\ Targeted returns reflect the aspirational performance goals
for an investment or investment strategy. Projections of performance
reflect an estimate of the future performance of an investment or
investment strategy, which is often based on historical data and
assumptions. Projections of performance are commonly established
through mathematical modeling. See Investment Advisers Act Release
No. 5653 (December 22, 2020), 86 FR 13024, 13081 n.699 (March 5,
2021) and accompanying text.
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The text of the proposed rule change is available on FINRA's
website at http://www.finra.org, at the principal office of FINRA and
at the Commission's Public Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, FINRA 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. FINRA 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
Rule 2210's General Prohibition of Projections and Its Exceptions
Rule 2210 provides that communications may not predict or project
performance, imply that past performance will recur or make any
exaggerated or unwarranted claim, opinion or forecast.\4\ The general
prohibition against performance projections is intended to protect
investors who may lack the capacity to understand the risks and
limitations of using projected performance in making investment
decisions.
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\4\ See FINRA Rule 2210(d)(1)(F).
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This general standard does not prohibit certain types of
communications, however. First, Rule 2210 allows a hypothetical
illustration of mathematical principles, provided it does not predict
or project the performance of an investment or investment strategy.\5\
The ``hypothetical illustration of mathematical principles'' exception
to the prohibition of projections applies to tools that serve the
function of a calculator that computes the mathematical outcome of
certain assumed variables without predicting the likelihood of either
the assumed variables or the outcome. For example, this exception
applies to a calculator that computes a net amount of savings that an
investor would earn over an assumed period of time with assumed
variables of rates of returns, frequency of compounding, and tax
rates.\6\
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\5\ See FINRA Rule 2210(d)(1)(F)(i).
\6\ On the other hand, this exception would not apply to a
calculator that predicted the likelihood of achieving these assumed
variables and outcomes. See Notice to Members 04-86 (November 2004),
n.3.
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Second, the general prohibition on projections does not preclude a
member from employing an investment analysis tool, or a written report
produced by an investment analysis tool, that includes projections of
performance provided it meets the requirements of FINRA Rule 2214
(Requirements for the Use of Investment Analysis Tools).\7\ FINRA
adopted the predecessor to Rule 2214 in 2004 to allow members to offer
or employ technological tools that use a mathematical formula to
calculate the probability that investment outcomes (such as reaching a
financial goal) would occur.\8\
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\7\ See FINRA Rule 2210(d)(1)(F)(ii).
\8\ See Notice to Members 04-86, supra note 6.
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An ``investment analysis tool'' is an interactive technological
tool that
[[Page 82483]]
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.\9\ Investors may use
an investment analysis tool either independently or with the assistance
from a member and may receive written reports generated by the tool
that include projected performance that is consistent with Rule 2214's
requirements.\10\
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\9\ See FINRA Rule 2214(b).
\10\ For a more detailed discussion of the differences between
FINRA Rule 2214 and the proposal, see Comparison to Projections
Permitted by FINRA Rule 2214, infra.
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Third, members may include a price target in a research report on
debt or equity securities, provided that the price target has a
reasonable basis, the report discloses the valuation methods used to
determine the price target, and the price target is accompanied by
disclosure concerning risks that may impede achievement of the price
target.\11\
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\11\ See FINRA Rule 2210(d)(1)(F)(iii).
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In addition, a communication with the public regarding security
futures or options may contain projected performance figures (including
projected annualized rates of return), provided that the communication
meets specified requirements.\12\ Among other things, the communication
must be accompanied or preceded by a standardized risk disclosure
statement, the communication may not suggest certainty of the projected
performance, parameters relating to such performance figures must be
clearly established, and the projections must disclose and reflect all
relevant costs, commissions, fees, and interest charges (as
applicable).\13\
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\12\ See FINRA Rules 2215 (Communications with the Public
Regarding Security Futures) and 2220 (Options Communications).
\13\ See FINRA Rules 2215(b)(3) and 2220(d)(3).
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Need for an Additional Exception
FINRA understands that some broker-dealer customers, in particular
institutional investors, request other types of projected performance
that the current rules do not allow. These customers may request
information that includes projections of performance or targeted
returns concerning investment opportunities to help them make informed
investment decisions but are unable to receive this information from
members due to the prohibition on projections. For example, a member's
views regarding the projected performance of an investment strategy or
single security may be useful to institutional investors and qualified
purchasers (``QPs''), as defined under the Investment Company Act,\14\
who are eligible to invest in certain non-public offerings that are
relying on exceptions from registration under the Securities Act of
1933 (``Securities Act'') and the Investment Company Act.
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\14\ Section 2(a)(51)(A) of the Investment Company Act defines
the term ``qualified purchaser'' as (i) any natural person who owns
not less than $5 million in investments (as defined by the SEC);
(ii) a family-owned company that owns not less than $5 million in
investments; (iii) a trust not formed for the purpose of acquiring
the securities offered, as to which each trustee or other person
authorized to make decisions with respect to the trust, and each
settlor or other person who has contributed assets to the trust, is
a person described in clauses (i), (ii), or (iv); and (iv) any other
person, acting for its own account or the account of other qualified
purchasers, who in the aggregate owns and invests on a discretionary
basis not less than $25 million in investments. See 15 U.S.C. 80a-
2(a)(51)(A).
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In addition, projected performance may be useful for institutional
investors and QPs that either have the financial expertise to evaluate
investments and to understand the assumptions and limitations
associated with such projections, or that have resources that provide
them with access to financial professionals who possess this expertise.
Such investors often test their own opinions against performance
projections they receive from other sources, including issuers and
investment advisers. Because Rule 2210 generally precludes a member
from providing projected performance or targeted returns in marketing
communications distributed to institutional investors and QPs, these
investors cannot obtain a member's potentially different and valuable
perspective.
FINRA recognizes, however, that any proposed rule amendment that
would allow projections of performance or targeted returns in specified
communications must not increase the risk of potential harm to retail
investors. As discussed below, the proposed rule change is narrowly
tailored to address the need for projections or targeted returns by
restricting their use only in specified scenarios involving
institutional investors or QPs, well-established categories of persons
that have been previously determined to be financially sophisticated or
able to engage expertise for purposes of the securities laws.\15\ As a
general matter, the proposed rule change would not alter the current
prohibitions on including projections of performance or targeted
returns in most types of retail communications. In addition, even in
situations where a natural person qualifies as an institutional
investor or QP, Exchange Act Regulation Best Interest \16\ would
require members to act in the investor's best interest when making a
recommendation of a securities transaction or investment strategy
involving securities, regardless of whether a projection is used as a
basis for the recommendation.
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\15\ See, e.g., Privately Offered Investment Companies,
Investment Company Act Release No. 22597 (April 3, 1997), 62 FR
17512 (April 9, 1997) (adopting rules to implement a legislative
exclusion from regulation under section 3(c)(7) of the Investment
Company Act for privately offered investment companies ``whose
investors are all highly sophisticated investors, termed `qualified
purchasers''').
\16\ See 17 CFR 240.15l-1 (``Reg BI'').
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Proposed Amendments
The proposed rule change would create a new, narrowly tailored,
exception to the general prohibition of projections. First, the
proposed rule change would permit institutional communications to
include projections of performance or targeted returns. An
institutional communication is any written (including electronic)
communication that is distributed or made available only to
institutional investors,\17\ but does not include a member's internal
communications.\18\
[[Page 82484]]
Second, the proposed rule change would permit projected performance and
targeted returns in communications that are distributed or made
available only to QPs and that promote or recommend a private placement
that is sold solely to QPs (``QP private placement
communications'').\19\ Recipients of QP private placement
communications are referred to herein as ``QP private placement
investors.'' \20\ Institutional investors and QP private placement
investors are referred to herein collectively as ``Projection-Eligible
Investors.''
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\17\ Rule 2210(a)(4) provides that ``institutional investor''
means any:
(A) person described in Rule 4512(c), regardless of whether the
person has an account with a member;
(B) governmental entity or subdivision thereof;
(C) employee benefit plan, or multiple employee benefit plans
offered to employees of the same employer, that meet the
requirements of Section 403(b) or Section 457 of the Internal
Revenue Code and in the aggregate have at least 100 participants,
but does not include any participant of such plans;
(D) qualified plan, as defined in Section 3(a)(12)(C) of the
Exchange Act, or multiple qualified plans offered to employees of
the same employer, that in the aggregate have at least 100
participants, but does not include any participant of such plans;
(E) member or registered person of such a member; and
(F) person acting solely on behalf of any such institutional
investor.
Rule 4512(c) defines ``institutional account'' to mean the
account of: (1) a bank, savings and loan association, insurance
company or registered investment company; (2) an investment adviser
registered either with the SEC under Section 203 of the Advisers Act
or with a state securities commission; or (3) any other person
(whether a natural person, corporation, partnership, trust or
otherwise) with total assets of at least $50 million.
\18\ See Rule 2210(a)(3). The definition of ``institutional
investor'' provides in part that no member may treat a communication
as having been distributed to an institutional investor if the
member has reason to believe that the communication or any excerpt
thereof will be forwarded or made available to a retail investor.
See FINRA Rule 2210(a)(4). Accordingly, if a member distributed or
made available a communication containing projected performance or a
targeted return to an institutional investor, and the member had
reason to believe the institutional investor would forward or make
available that communication to a retail investor, FINRA would not
consider the communication to be an institutional communication for
purposes of the proposed rule change's requirements.
\19\ The proposed rule change would create a new exception from
the prohibition on performance projections for communications that
are distributed or made available only to QPs and that promote or
recommend either a Member Private Offering that is exempt from the
requirements of FINRA Rule 5122 pursuant to Rule 5122(c)(1)(B), or a
private placement exempt from the requirements of FINRA Rule 5123
pursuant to Rule 5123(b)(1)(B). Both Rule 5122(c)(1)(B) and Rule
5123(b)(1)(B) exempt from those rules' requirements private
offerings sold solely to qualified purchasers, as defined in Section
2(a)(51)(A) of the Investment Company Act.
\20\ In most cases, an individual investor who has $5 million or
more in investments, but who does not have at least $50 million in
assets, will be both a qualified purchaser under the Investment
Company Act and a retail investor for purposes of Rule 2210.
Accordingly, some QP private placement communications will be either
correspondence or retail communications under the rule. See FINRA
Rule 2210(a)(2), (a)(5), and (a)(6).
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Even within these narrow circumstances, the proposed rule change
would impose additional investor protection obligations. The exception
would be conditioned on: (1) the member adopting and implementing
written policies and procedures reasonably designed to ensure that the
communication is relevant to the likely financial situation and
investment objectives of the investor receiving the communication and
to ensure compliance with all applicable requirements and obligations;
(2) the member having a reasonable basis for the criteria used and
assumptions made in calculating the projected performance or targeted
return, and retaining written records supporting the basis for these
criteria and assumptions; \21\ (3) the communication prominently
disclosing that the projected performance or targeted return is
hypothetical in nature and that there is no guarantee that the
projected or targeted performance will be achieved; and (4) the member
providing sufficient information to enable the investor to understand
(i) the criteria used and assumptions made in calculating the projected
performance or targeted return, including whether the projected
performance or targeted return is net of anticipated fees and expenses;
and (ii) the risks and limitations of using the projected performance
or targeted return in making investment decisions, including reasons
why the projected performance or targeted return might differ from
actual performance.
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\21\ FINRA recognizes that there are some differences between
targeted returns and projections of performance. As discussed above,
targeted returns are aspirational and may be used as a benchmark or
to describe an investment strategy or objective to measure the
success of a strategy. Projections of performance, on the other
hand, use historical data and assumptions to predict a likely
return. Thus, targeted returns may not involve all (or any) of the
assumptions and criteria applied to generate a projection. However,
FINRA does not believe that the difference between targeted returns
and projections of performance is always readily apparent to the
recipient of a communication. Accordingly, the presentation of both
projections of performance and targeted returns would be subject to
the same conditions, including that both must have a reasonable
basis.
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Written Policies and Procedures
The proposed rule change would require a member to adopt and
implement written policies and procedures reasonably designed to ensure
that the communication is relevant to the likely financial situation
and investment objectives of the investor receiving the communication
and to ensure compliance with all applicable requirements and
obligations. In adopting written policies and procedures concerning the
investor's likely financial situation and investment objectives,
members should consider including content that requires the member to
consider the audience that receives a communication that presents
projected performance or a targeted return. In particular, such a
communication should only be distributed where the member reasonably
believes the investors have access to resources to independently
analyze this information or have the financial expertise to understand
the risks and limitations of such presentations. If an investor does
not have this financial expertise and receives a communication
containing a projection or targeted return, FINRA would expect that the
written policies and procedures be reasonably designed to ensure that
the investor has the resources necessary to access financial
professionals that possess this expertise.\22\
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\22\ FINRA would not view the mere fact that an investor would
be interested in high returns as satisfying the requirement that the
projected performance or targeted return is relevant to the likely
financial situation and investment objectives of the intended
audience.
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For example, members could meet the requirement to adopt and
implement policies and procedures reasonably designed to ensure that
the projected performance or targeted returns are relevant to the
likely financial situation and intended audience of the institutional
communication or QP private placement communication by relying on its
past experiences with particular types of institutional investors and
QP private placement investors who seek this information. A firm may
wish to further tailor its intended audience for such a communication
to persons or entities that have expressed interest in particular types
of securities, or who have invested in similar securities in the past.
In addition, even in situations where an investor has the financial
expertise or resources necessary to understand the risks and
limitations of a projection or targeted return, if the member
recommends a securities transaction or investment strategy involving
securities to an investor who is a ``retail customer'' as defined in
Reg BI,\23\ the member must establish, maintain, and enforce written
policies and procedures reasonably designed to achieve compliance with
Reg BI.\24\
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\23\ Reg BI defines ``retail customer'' to mean a natural
person, or the legal representative of such natural person, who (i)
receives a recommendation of any securities transaction or
investment strategy involving securities from a broker, dealer, or
natural person who is an associated person of a broker or dealer,
and (ii) uses the recommendation primarily for personal, family, or
household purposes. See 17 CFR 240.15l-1(b)(1).
\24\ See 17 CFR 240.15l-1(a)(2)(iv).
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Reasonable Basis Requirement
The ``reasonable basis'' requirement follows well-established
precedents. FINRA Rules 2210 and 2241 (Research Analysts and Research
Reports) require a price target in a research report to have a
reasonable basis.\25\ SEC rules also require performance projections
contained in specified documents to be based on good faith and have a
reasonable basis.\26\
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\25\ See FINRA Rule 2210(d)(1)(F)(iii) and FINRA Rule
2241(c)(1)(B).
\26\ See Securities Act Regulation S-K, 17 CFR 229.10(b)
(providing in part that the use in documents specified in Securities
Act Rule 175 and Exchange Act Rule 3b-6 of management's projections
of future economic performance have a reasonable basis and reflect
its good faith assessment of a registrant's future performance).
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FINRA believes that it is important for members to consider
appropriate factors in forming a reasonable basis for the criteria used
and assumptions made in calculating projected performance or a targeted
return pursuant to proposed Rule 2210(d)(1)(F)(iv). Accordingly, FINRA
is proposing to include a new Supplementary Material to Rule 2210 that
would list some, but not all, factors
[[Page 82485]]
that members should consider in developing a reasonable basis. FINRA
incorporated some of the relevant factors that members of the financial
research and analysis industry use when considering the basis for a
recommendation to a customer.\27\
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\27\ Some, but not all, of the proposed factors in the proposed
Supplementary Material come from the CFA Institute's discussion of
Standard V in the Institute's Standards of Practice Handbook.
Standard V requires, among other things that CFA Institute Members
and Candidates ``[h]ave a reasonable and adequate basis, supported
by appropriate research and investigation, for any investment
analysis, recommendation, or action.'' See CFA Institute, Standards
of Practice Handbook 155-156 (11th ed. 2014).
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Proposed Supplementary Material 2210.01 would provide that, in
forming a reasonable basis for the criteria used and assumptions made
in calculating projected performance or a targeted return pursuant to
proposed Rule 2210(d)(1)(F)(iv), with no one factor being
determinative, members should consider multiple factors. Such factors
may include, but are not limited to, the following:
(1) Global, regional, and country macroeconomic conditions (for
example, considering potential civil or political instability or
weather conditions that may impact projected performance);
(2) Documented fact-based assumptions concerning the future
performance of capital markets;
(3) In the case of a single security issued by an operating
company, the issuing company's operating and financial history;
(4) The industry's and sector's current market conditions and the
state of the business cycle (for example, including a consideration of
any characteristics unique to the industry and sector, such as the
effect of rising mortgage rates on the housing sector);
(5) If available, reliable multi-factor financial models based on
macroeconomic, fundamental, quantitative, or statistical inputs, taking
into account the assumptions and potential limitations of such models,
including the source and time horizon of data inputs;
(6) The quality of the assets included in a securitization (taking
into consideration, for example, the ability to assess the credit
quality of underlying assets through available data and the performance
of similar pools);
(7) The appropriateness of selected peer-group comparisons (for
example, the relative similarities or differences among the components
of a selected peer group versus the subject issuer, the number of
constituents in the peer group, and the reasonableness of the
comparison);
(8) The reliability of research sources (including, for example,
whether there is a relationship between the issuer and the research
source that could pose a conflict of interest; whether the research has
been subject to peer review before publication; whether the research is
based on reliable or verifiable factual information);
(9) The historical performance and performance volatility of the
same or similar asset classes;
(10) For managed accounts or funds, the past performance of other
accounts or funds managed by the same investment adviser or sub-
adviser, provided such accounts or funds had substantially similar
investment objectives, policies, and strategies as the account or fund
for which the projected performance or targeted returns are shown;
(11) For fixed income investments and holdings, the average
weighted duration and maturity;
(12) The impact of fees, costs, and taxes; and
(13) Expected contribution and withdrawal rates by investors.
Proposed Supplementary Material 2210.01(b) also would provide that
members may not base projected performance or a targeted return upon
(i) hypothetical, back-tested performance or (ii) the prior performance
of a portfolio or model that was created solely for the purpose of
establishing a track record.\28\
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\28\ See MassMutual Institutional Funds, 1995 SEC No-Act. LEXIS
747 (September 28, 1995) (permitting the use of open-end management
investment company performance that included the performance of
unregistered predecessor separate investment accounts (``SIAs'')
whose assets were transferred to the investment company, based in
part upon the representation that the predecessor SIAs were created
for purposes entirely unrelated to the establishment of a
performance record). FINRA would not consider an investment
manager's proprietary seed capital accounts that were created for
purposes unrelated to the establishment of a performance record to
be prohibited by proposed Supplementary Material 2210.01(b)(ii).
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Disclosure Requirements
The requirement to provide sufficient information in the
communication to enable the intended audience to understand the
criteria used and assumptions made in calculating the projected
performance or targeted return is not intended to prescribe any
particular methodology or calculation of such performance. Nor does
FINRA expect a firm to disclose proprietary or confidential information
regarding the firm's methodology and criteria. Firms would be expected,
however, to provide a general description of the methodology used
sufficient to enable the investors to understand the basis of the
methodology, as well as the assumptions underlying the projection or
targeted return. Without this basic information, particularly regarding
assumptions about future events, it is more likely that a projection or
targeted return would mislead a potential investor.
The proposed rule change also would require a member to provide
sufficient information in the communication to enable a Projection-
Eligible Investor to understand the risks and limitations of using the
projected performance or targeted return in making investment
decisions, including reasons why the projected performance or targeted
return might differ from actual performance. This requirement is
intended to help ensure that such investors do not unreasonably rely on
a projection or targeted return given its uncertainty and risks.
For example, an institutional communication or QP private placement
communication may need to disclose, as a reason why the projected
performance or targeted return might differ from actual performance,
that the projection does not reflect actual cash flows into and out of
an investment portfolio. This is particularly true when a projection is
expressed as an internal rate of return (``IRR''), since forward-
looking IRR shows a return earned by investors over a particular
period, calculated on the basis of future cash flows to and from
investors.\29\ If the actual future cash flows differ from the
assumptions, the actual IRR may differ from the projected IRR.
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\29\ IRR is also known as money-weighted returns and reflects
the percentage rate earned on each dollar invested for each period
the dollar was invested. IRR is calculated as the discount rate that
makes the net present value of all cash flows from an investment
equal to zero. This can be contrasted to a time-weighted return,
which is the compounded growth rate of $1 over the time period.
Average annual total returns used by mutual funds pursuant to
Securities Act Rule 482 are an example of time-weighted returns.
Time-weighted returns ignore the size and timing of investment cash
flows and, therefore, provide a measure of manager or strategy
performance, while IRR measures how a specific portfolio performed
in absolute terms. See Regulatory Notice 20-21 (July 2020).
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General Standards and Supervision Under Rule 2210
As with all communications with the public, institutional
communications and QP private placement communications that contain
projected performance or targeted returns must meet Rule 2210's general
standards, including the requirements that communications be fair and
balanced,
[[Page 82486]]
provide a sound basis for evaluating the facts in regard to any
particular security or type of security, and not contain false,
exaggerated, unwarranted, promissory or misleading content.\30\
Accordingly, in addition to the reasonable basis standard, any
communication containing a projection or targeted return would be
prohibited from presenting exaggerated or unwarranted projections or
targeted returns. FINRA believes this constraint would prohibit a
member from presenting a projection that purports to show, for example,
longer term returns for an equity security offered shortly before or
after the date of the communication, as it would be viewed as
unwarranted and lacking a sound basis due to the difficulty in
predicting future securities markets and economic conditions.
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\30\ See FINRA Rule 2210(d)(1)(A) and (B).
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Members currently must adopt appropriate procedures for the
supervision and review of both institutional and retail
communications.\31\ If the proposed rule change is adopted, these
supervisory procedures would need to include the review of projections
of performance or targeted returns used in both institutional
communications and QP private placement communications, including
compliance with the proposed rule change's specific conditions. In
addition, members generally would be required to approve prior to use
any QP private placement communication that falls within Rule 2210's
definition of ``retail communication.'' \32\
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\31\ See FINRA Rule 2210(b)(1) and (b)(3).
\32\ As discussed above, if a QP is an individual that has less
than $50 million in assets, the QP generally will be a retail
investor under Rule 2210 since the QP does not fall within the
definition of institutional investor. In such cases, if the QP
private placement communication were distributed or made available
to more than 25 QPs that fall within the definition of retail
investor within a 30-day period, it would be a retail communication
that a registered principal generally must approve prior to use. See
FINRA Rule 2210(b)(1).
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Members that use third-party vendors to perform core business or
regulatory oversight functions must establish and maintain a
supervisory system, including written supervisory procedures, for any
activities or functions performed by third-party vendors that are
reasonably designed to ensure compliance with applicable securities
laws and regulations and with applicable FINRA rules.\33\ Accordingly,
if a member relies on third-party models or software to create a
projection or targeted return, the member would be expected to
establish and maintain a supervisory system reasonably designed to
ensure that any projections or targeted returns created by a third-
party vendor are used consistently with the proposed rule change's
requirements.
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\33\ See Regulatory Notice 21-29 (August 2021).
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For example, the member would need to ensure that there is a
reasonable basis for the criteria used and assumptions made in
calculating the projected performance or targeted return and would need
to retain written records supporting the basis for such criteria and
assumptions. Members should make reasonable efforts to determine
whether the model or software is sound and should make reasonable
inquiries into the source and accuracy of the data used to create the
projection or targeted return. If the member has reason to suspect that
the third-party model or software lacks a sound basis, the member
should investigate the matter and, if it cannot be reasonably assured
that the model or software is sound, must not use it. Among factors
that a member may wish to employ to evaluate the third-party model or
software are the assumptions used to create the projection or target,
the rigor of its analysis, the date and timeliness of any research used
to create the model or software, and the objectivity and independence
of the entity that created the model or software.
As discussed above, members also must keep in mind that if they use
a projection of performance or targeted return in connection with a
recommendation of a securities transaction or investment strategy
involving securities to a retail customer, the recommendation must meet
the requirements of Reg BI.\34\
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\34\ See 17 CFR 240.15l-1. The definition of ``retail customer''
under Reg BI differs from the definition of ``retail investor''
under FINRA Rule 2210, which includes any person other than an
institutional investor, regardless of whether the person has an
account with a member. See FINRA Rule 2210(a)(6). Accordingly, a
natural person could be a ``retail customer'' for purposes of Reg BI
but an ``institutional investor'' under Rule 2210 (e.g., a natural
person with at least $50 million in total assets). See supra note 17
(definition of ``institutional investor'' under FINRA Rule
2210(a)(4)).
---------------------------------------------------------------------------
Comparison to Projections Permitted by FINRA Rule 2214
There are several key differences between the types of projections
that Rule 2214 permits as compared to those that the proposed rule
change would allow. First, Rule 2214 differs from the proposed rule
change in terms of how a projection may be communicated. Rule 2214
allows a projection of performance that is created by an investment
analysis tool that any retail customer uses on a one-on-one interactive
basis, either independently or with a member's assistance, and that
provides individualized results to each user. In contrast, unlike Rule
2214, under the proposed rule change, there is no interactive element
associated with the receipt of projections. Instead, firms could
provide projections or targeted returns to Projection-Eligible
Investors using any form of communication that otherwise complies with
the proposed rule change, applicable requirements of FINRA rules, and
the federal securities laws.
Second, Rule 2214 requires the tool to produce simulations and
statistical analyses that present the likelihood of various investment
outcomes if certain investments are made or certain investment
strategies are undertaken. Although the rule does not expressly require
the use of a particular type of statistical analysis, in many cases
firms (or their vendors) use Monte Carlo simulations for this
process.\35\ In contrast, the proposed rule change would not require
communications to Projection-Eligible Investors that include
performance projections or targeted returns to consider potential
returns under various scenarios and the probability of success for each
scenario.
---------------------------------------------------------------------------
\35\ Monte Carlo simulation involves the use of a computer to
represent the operations of a complex financial system. A
characteristic feature of Monte Carlo simulation is the generation
of a large number of random samples from specified probability
distributions to represent the operation of the system. Monte Carlo
simulation is used in planning in financial risk management and in
valuing complex securities. Monte Carlo simulation is a complement
to analytical methods but provides only statistical estimates, not
exact results. See CFA Institute, Common Probability Distributions
(CFA Program Level I, 2023 Curriculum), available at https://www.cfainstitute.org/membership/professional-development/refresher-readings/common-probability-distributions.
---------------------------------------------------------------------------
Third, Rule 2214's disclosure requirements differ somewhat from
those under the proposed rule change. Rule 2214 requires an investment
analysis tool, a written report generated by the tool, or a related
retail communication to:
Describe the criteria and methodology used, including the
investment analysis tool's limitations and key assumptions;
explain that results may vary with each use and over time;
if applicable, 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; and
[[Page 82487]]
display a prescribed disclosure concerning the
hypothetical nature of the projections, that they do not reflect actual
investment results, and that they are not guarantees of future
results.\36\
---------------------------------------------------------------------------
\36\ See FINRA Rule 2214(c).
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In contrast, the proposed rule change would require a communication
to prominently disclose that the projected performance or targeted
return is hypothetical in nature and that there is no guarantee that
the projection of performance or targeted return will be achieved.\37\
In addition, a member would have to provide ``sufficient information to
enable the investor to understand (i) the criteria used and assumptions
made in calculating the projected performance or targeted return,
including whether the projected performance or targeted return is net
of anticipated fees and expenses; and (ii) the risks and limitations of
using the projected performance or targeted return in making investment
decisions, including reasons why the projected performance or targeted
return might differ from actual performance.'' \38\
---------------------------------------------------------------------------
\37\ See proposed FINRA Rule 2210(d)(1)(F)(iv)d.
\38\ See proposed FINRA Rule 2210(d)(1)(F)(iv)e.
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While the proposed rule change's methodology disclosure requirement
resembles the methodology disclosure requirements in Rule 2214, they
are worded differently to reflect different types of communications to
which the proposed rule change and Rule 2214 apply. For example, an
investment analysis tool permitted by Rule 2214 may recommend that an
investor consider an alternative account portfolio to improve the range
of its potential returns but limit the securities that may populate the
portfolio. This limitation is important information to investors when
considering whether to change their investments. In contrast, the
proposed rule change is more likely to apply to a projection or
targeted return that is included in a communication promoting a single
security or investment strategy distributed to Projection-Eligible
Investors, and thus would impose different disclosure requirements
relative to those scenarios.
Fourth, Rule 2214 does not restrict the types of investors who may
use an investment analysis tool or receive a report generated by the
tool, as both institutional investors and retail investors may receive
a projection of performance under Rule 2214. The reports also must
include clear and prominent specified disclosures, such as a
description of the criteria and methodology used, the tool's
limitations and key assumptions, and other risk and investor
protection-related information.\39\ In contrast, the proposed rule
change would limit receipt of projections or targeted returns to
Projection-Eligible Investors as defined in the rule.
---------------------------------------------------------------------------
\39\ See FINRA Rule 2214(c) and (d).
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Comparison to IA Marketing Rule's Hypothetical Performance Standards
The proposed changes are in many respects consistent with the
Commission's Investment Adviser Marketing rule (``IA Marketing
Rule'').\40\ In this regard, the IA Marketing Rule permits investment
advisers to present hypothetical performance, which includes ``targeted
or projected performance returns with respect to any portfolio or to
the investment advisory services with regard to the securities
offered'' \41\ in an advertisement if the investment adviser meets
specified conditions and does not violate the IA Marketing Rule's other
requirements. In particular, an investment adviser must:
---------------------------------------------------------------------------
\40\ See Investment Advisers Act Release No. 5653 (December 22,
2020), 86 FR 13024 (March 5, 2021) (adoption of Advisers Act Rule
206(4)-1 (Investment Adviser Marketing)) (``IA Marketing Rule
Release'').
\41\ See 17 CFR 275.206(4)-1(e)(8).
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Adopt and implement policies and procedures reasonably
designed to ensure that the hypothetical performance is relevant to the
likely financial situation and investment objectives of the intended
audience;
Provide sufficient information to enable the intended
audience to understand the criteria used and assumptions made in
calculating such hypothetical performance; and
Provide (or, if the intended audience is an investor in a
private fund provide or offer to provide promptly) sufficient
information to enable the intended audience to understand the risks and
limitations of using such hypothetical performance in making investment
decisions.\42\
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\42\ See 17 CFR 275.206(4)-1(d)(6). An investment adviser
presenting hypothetical performance is not required to comply with
certain of the conditions in paragraph (d), such as the requirement
to present performance for one-, five-, and ten-year periods.
---------------------------------------------------------------------------
These requirements are similar to the proposed rule change's
requirements concerning investors that may receive a communication
containing a projection or targeted return and its disclosure
requirements. In addition, similar to Rule 2210, the IA Marketing Rule
prohibits any advertisement that includes any untrue statement of a
material fact or omits to state a material fact necessary to make the
statement made under the circumstances not misleading.\43\
---------------------------------------------------------------------------
\43\ 17 CFR 275.206(4)-1(a).
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As discussed above, the proposed rule change includes other
requirements that are not specifically included in the IA Marketing
Rule. Nevertheless, FINRA anticipates that it would interpret
requirements in the proposed rule change that align with similar
requirements in the IA Marketing Rule consistently with how the
Commission has interpreted those IA Marketing Rule requirements. Thus,
member firms should be able to comply with these proposed requirements
in a manner similar to how investment advisers must comply with similar
requirements applicable to the use of hypothetical performance under
the IA Marketing Rule.\44\
---------------------------------------------------------------------------
\44\ See IA Marketing Rule Release, supra note 40, 86 FR 13024,
13083-85.
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Contributions to Investor Protection
FINRA believes that approval of the proposed rule change would
contribute to investor protection by enabling Projection-Eligible
Investors to access projections when considering specific investments
or strategies. For example, under the current rule, Projection-Eligible
Investors are not permitted to receive projections from broker-dealers,
despite the fact that such projections may assist them in evaluating
potential securities purchases or sales, choosing appropriate
investment strategies, or creating strategic plans for their business
operations. Under the proposed rule change, Projection-Eligible
Investors would have access to projected performance or targeted
returns that must comply with Rule 2210's existing prohibition of false
or misleading statements or claims and the proposed rule change's
disclosure requirements and prohibition on using back-tested
performance to create the projected performance or targeted return.\45\
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\45\ See proposed Supplementary Material 2210.01(b).
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FINRA believes the proposed rule change would also contribute to
investor protection by encouraging issuers of publicly offered or
privately placed securities to select members that are subject to
appropriate regulation and oversight for participation in securities
offerings. FINRA recognizes that Projection-Eligible Investors are
already able to receive projected or targeted returns in communications
from parties other than registered broker-dealers,
[[Page 82488]]
such as unregistered intermediaries \46\ or the securities' issuer.\47\
---------------------------------------------------------------------------
\46\ For example, Congress recently amended the Exchange Act to
create a new registration exemption for certain mergers and
acquisition brokers (``M&A Brokers''). M&A Brokers are not subject
to any federal or self-regulatory organization rules governing their
communications (other than general anti-fraud provisions), including
any prohibitions on including projections or targeted returns in
their communications. See Consolidated Appropriations Act of 2023,
Public Law 117-328 (2022) (codified at 15 U.S.C. 78o(b)(13)).
\47\ The majority of private offerings governed by Securities
Act Regulation D (17 CFR 230.501 et seq.) are sold directly by
issuers without any broker-dealer involvement. Approximately 20
percent of Regulation D offerings involve ``intermediaries,'' such
as broker-dealers. See Capital Raising in the U.S.: An Analysis of
the Market for Unregistered Securities Offerings 2009-2017, SEC
Division of Economic and Risk Analysis (August 2018), https://www.sec.gov/files/dera-white-paper_regulation-d_082018.pdf. Thus,
only a small percentage of investors in private placements are
afforded the protections of FINRA rules and other relevant broker-
dealer regulations that apply when a Regulation D offering involves
a FINRA member firm.
---------------------------------------------------------------------------
Accordingly, the current prohibition of registered broker-dealers
including projected performance or targeted returns in institutional
communications or QP private placement communications creates an
incentive for issuers to avoid the registered broker-dealer channel to
offer securities and instead either use an unregistered firm, or market
securities directly to potential investors. The proposed rule change
would allow members to provide the same or similar information
regarding projected performance or targeted returns that investors are
receiving from issuers or other unregistered intermediaries, but
subject to substantial requirements that enhance investor protections.
The proposed rule change also would allow Projection-Eligible
Investors to receive and compare projections provided by members with
projections from other entities, with appropriate safeguards. For
example, it is very common for issuers to offer their securities
directly to investors using performance projections in their marketing
communications or offering documents.\48\ Approval of the proposed rule
change would not level the regulatory playing field between members,
unregistered firms, and issuers with respect to projected performance,
but it would allow members to present projections and targeted returns
to Projection-Eligible Investors subject to existing and proposed
investor protections.
---------------------------------------------------------------------------
\48\ Under FINRA rules, offering materials are considered
communications with the public for purposes of Rule 2210 if a member
was involved in preparing the materials. If a private placement
memorandum (``PPM'') or other marketing document presents
information that is not fair and balanced or that is misleading,
then the member that assisted in its preparation may be found to
have violated Rule 2210. Moreover, sales literature concerning
securities offerings that a member distributes generally constitutes
a communication by that member to the public, regardless of whether
the member assisted in its preparation. See Regulatory Notice 23-08
(May 2023) at page 11; see also Regulatory Notice 10-22 (April 2010)
and Regulatory Notice 20-21 (July 2020).
---------------------------------------------------------------------------
If the Commission approves the proposed rule change, FINRA will
announce the implementation date of the rule change in a Regulatory
Notice.
2. Statutory Basis
FINRA believes that the proposed rule change is consistent with the
provisions of Section 15A(b)(6) of the Act,\49\ which requires, among
other things, that FINRA 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.
---------------------------------------------------------------------------
\49\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------
FINRA believes that the proposed rule change strikes the right
balance between protecting investors and allowing more investment
information to be communicated to an appropriate audience. As discussed
above, the proposed rule change would not expand the very limited
exceptions that allow specified types of projected performance or
targeted returns in communications to retail investors, such as price
targets contained in research reports or reports generated by
interactive investment analysis tools, other than QP private placement
investors that meet the definition of ``retail investor'' under Rule
2210.\50\
---------------------------------------------------------------------------
\50\ See supra note 20.
---------------------------------------------------------------------------
FINRA believes that the proposed rule change will provide
additional sources of information for Projection-Eligible Investors in
their investment decision making. As mentioned previously, Projection-
Eligible Investors often develop their own opinions regarding the
future performance of an investment based on the multiple sources of
information at their disposal. They test these opinions against the
views and data provided by other sources, which often summarize their
conclusions in terms of a projection of performance of the investment.
This is particularly true in the offering of securities by issuers,
including hedge funds and other investment vehicles. Rule 2210(d)(1)(F)
currently does not permit members to share their views on projection-
related data with Projection-Eligible Investors in these situations due
to its restrictions on members' communicating projected performance
information.
Even so, the proposed changes will provide safeguards for
communications that contain projections of performance or targeted
returns. The proposed changes would require members to adopt and
implement policies and procedures reasonably designed to ensure that
the communication is relevant to the likely financial situation and
investment objectives of the Projection-Eligible Investor receiving the
communication. They would mandate that members have a reasonable basis
for the criteria used and assumptions made in calculating the
projections of performance or targeted returns.
The proposed changes also would require a member to provide
sufficient information to enable the Projection-Eligible Investor to
understand the criteria used and assumptions made in calculating the
projected performance or targeted return, and to understand the risks
and limitations of using projected performance or targeted returns in
making investment decisions.
As discussed above, the proposed changes recognize that Projection-
Eligible Investors are already able to receive projected performance or
targeted returns in communications from parties other than broker-
dealers and more closely aligns the ability of broker-dealers to offer
projections to such investors with the abilities of issuers and other
non-member firms to offer projections. The proposed rule change also
would allow Projection-Eligible Investors to receive and compare
projections provided by members with projections from other entities,
with appropriate safeguards designed to protect investors.
FINRA believes that Projection-Eligible Investors would be better
protected if issuers instead offered their securities through broker-
dealers, which are subject to a much more rigorous set of rules
governing communications than issuers, and that are subject to
regulatory oversight from the Commission, FINRA and state securities
regulators. The proposed rule change may enable more issuers to use
broker-dealers for their securities offerings. In addition,
Projections-Eligible Investors who are retail customers under Reg BI
will receive the additional protections of that rule.
B. Self-Regulatory Organization's Statement on Burden on Competition
FINRA 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.
[[Page 82489]]
Economic Impact Assessment
FINRA has undertaken an economic impact assessment, as set forth
below, to analyze the regulatory need for the proposed rulemaking, its
potential economic impacts, including anticipated costs and benefits,
and the alternatives FINRA considered in assessing how to best meet its
regulatory objectives.
1. Regulatory Need
Among other things, commenters during the retrospective review of
rules governing communications with the public expressed concerns that
the current prohibition on projections of performance imposes undue
restrictions on broker-dealer customers, and in particular
institutional investors and QP private placement investors, without
providing them a concomitant benefit.\51\ The amendments in this
proposed rule change are intended to improve the flow of information by
allowing members to communicate to Projection-Eligible Investors,
subject to conditions, information regarding the projected performance
of an individual security and similar communications related to an
asset allocation or other investment strategy.
---------------------------------------------------------------------------
\51\ See letters responding to Regulatory Notice 14-14 (April
2014) from the Financial Services Roundtable (May 22, 2014) and the
Securities Industry and Financial Markets Association (May 23,
2104), both available at www.finra.org. Additionally, commenters on
Regulatory Notice 17-06 (February 2017) urged FINRA to revise the
proposal to permit projections of performance of single securities
in communications to QPs. See infra notes 65-71 and accompanying
text.
---------------------------------------------------------------------------
2. Economic Baseline
The economic baseline used to evaluate the impact of the proposed
amendments is the current regulatory framework. This baseline serves as
the primary point of comparison for assessing economic impacts,
including the incremental benefits and costs of the proposed rule
change.
FINRA believes that many members providing products and services to
Projection-Eligible Investors would likely choose to rely on the
proposed exception for projections. FINRA estimates that there are a
significant number of such members.\52\
---------------------------------------------------------------------------
\52\ Based on Consolidated Audit Trail (CAT) data for 2021,
there were 1,169 firms that conducted equity transactions for
customers. Of those 1,169 firms, 859 firms conducted equity
transactions for institutional customers in 2021. It is not known
how many firms conducted equity transactions for QPs. Also, it is
not known how many firms conducted debt and OTC transactions for
customers. However, based on Rule 5122/5123 filings, it is known
that about 360-380 firms were involved in private placement
offerings to accredited investors in any given year between 2018 and
2021. While not all accredited investors are QPs, the information
from Rule 5122/5123 filings in 2018-2021 indicates how many firms
may have been in involved in private placement offerings to QP
customers.
---------------------------------------------------------------------------
Some of these members may have Projection-Eligible Investor
customers that already have access to or are receiving projections-
related communications from a member that is dually registered, a
member's advisory affiliate, or an investment adviser owned by an
associated person of the member, as part of the clients' investment
advisory relationship. For example, some dually registered members and
dually registered representatives communicate information regarding
projected performance to their investment advisory clients already.\53\
Similarly, members that are not registered as investment advisers may
still have registered representatives that have customers with access
to investment advisory services.\54\ Members and their registered
representatives that are investment advisers that provide projections
of performance of, among other things, individual securities (such as
investments in private funds managed by the member of a related
investment adviser) to their advisory clients may not be impacted by
the proposal, since they are already able to provide this information
in some circumstances when acting as an investment adviser.
---------------------------------------------------------------------------
\53\ FINRA estimates that, as of December 31, 2021,
approximately 480 member firms are dually registered as broker-
dealers and investment advisers. FINRA further estimates that these
dually registered firms have approximately 421,000 registered
representatives, and 241,000 (or about 57 percent) of these
individuals are dually registered as both investment adviser and
broker-dealer representatives. FINRA estimates that approximately
160-170 of the dually registered firms have a total of 1,600-1,700
representatives that are solely registered as investment adviser
representatives. FINRA notes that in addition to the dually
registered representatives, these investment adviser representatives
may also be communicating projections-related communications to
their investment advisory clients.
\54\ FINRA estimates that, as of December 31, 2021,
approximately 2,900 member firms are only registered as broker-
dealers and these firms have approximately 267,000 registered
representatives. FINRA further estimates that approximately 73,000
of these individuals are registered both as investment adviser and
broker-dealer representatives. These dually registered
representatives may have customers with access to projections-
related communications through their investment advisory
relationships with other firms.
---------------------------------------------------------------------------
FINRA also notes that Projection-Eligible Investors may be
solicited to purchase individual securities directly by an issuer
without the involvement of a broker-dealer, and that issuers often use
performance projections and targeted returns in their communications
with Projection-Eligible Investors.\55\
---------------------------------------------------------------------------
\55\ See Exchange Act Rule 3a4-1, 17 CFR 240.3a4-1.
---------------------------------------------------------------------------
3. Economic Impacts
FINRA anticipates that the proposed rule change will impact
primarily Projection-Eligible Investors and those broker-dealer firms
that serve these customers. Retail investors could be impacted if an
institutional investor receives a projection for an investment that the
retail investor is also considering. In these situations, the retail
investor may receive relatively less information regarding performance
projections or targeted returns for the investment than their
institutional counterparts. However, Reg BI is designed to mitigate
this potential harm by requiring a broker-dealer to act in a retail
customer's best interest when recommending a securities transaction or
investment strategy involving securities.
Anticipated Benefits
The proposed rule change would allow members to communicate, for
example, information regarding the projected performance of an
individual security to Projection-Eligible Investors. Such
communications have the potential to better inform Projection-Eligible
Investors about the individual security and the underlying assumptions
upon which the recommendations are based.\56\ FINRA anticipates that
these benefits primarily would accrue to customers that either do not
make their own performance projections or wish to compare their own
projections against projections furnished by their broker-dealer, and
do not have an investment advisory relationship with the member, and
thus are not already receiving communications related to anticipated
returns. For these benefits to accrue, the performance projections or
targeted returns must be objectively informative, and the magnitude of
benefit depends on the extent to which customers value these
communications and find them informative. Additionally, the proposed
rule change would benefit dually registered firms by creating
comparable investment adviser and broker-dealer standards for
communications that include performance projections and targeted
returns to customers who have both investment advisory and brokerage
accounts with such firms. This would
[[Page 82490]]
eliminate confusion for customers that have both types of accounts and
reduce the effort needed for dually registered firms to comply with two
separate sets of requirements related to such communications. Finally,
the proposed rule change would contribute to investor protection by
reducing the incentive for issuers to use unregistered firms or to
market securities directly to potential investors instead of using
registered broker-dealers.
---------------------------------------------------------------------------
\56\ Similar benefits would apply to the proposed amendments
that would allow members to communicate information to institutional
investors regarding the projected performance of a particular asset
allocation or other investment strategy.
---------------------------------------------------------------------------
Anticipated Costs
The proposed rule change would impose costs on members that choose
to rely on the exception and communicate performance projections or
targeted returns for an individual security or asset allocation or
other investment strategy to Projection-Eligible Investors. Hence,
FINRA anticipates that only members expecting the benefits to exceed
the implementation costs would choose to incur these costs.
Members that would rely on the proposed exception to distribute
communications to Projection-Eligible Investors that contain
performance projections or targeted returns would incur costs
associated with supervising these communications and complying with the
proposed rule change's conditions. However, the proposed rule change
does not alter the existing core supervision requirements for the
review and supervision of institutional communications and QP private
placement communications, thereby allowing members to adopt procedures
that are appropriate to their business.
As discussed above, to the extent that performance projections are
reliable and informative, allowing members to provide projected
performance or targeted returns for an investment opportunity only to
institutional investors may create an information imbalance as compared
to retail investors who are considering the same investment
opportunity. Because such retail investors will not be eligible to
receive these communications, they may be at an informational
disadvantage when making investment decisions. In developing the
proposed changes, FINRA carefully considered the risks, and associated
costs, of presenting targeted returns or performance projections to
retail investors. FINRA believes that it is appropriate, through this
proposed rule change, to permit members to provide communications
containing performance projections and targeted returns to
institutional investors and QP private placement investors.
Competitive Effects
Currently, members that are dually registered or that employ dually
registered persons may provide customers with performance projections
in their other registered capacity. Thus, the proposed rule change may
improve the competitive position of members that are not dually
registered or that do not employ dually registered persons since the
amendments will allow them to provide a potentially valuable service to
their Projection-Eligible Investor customers.
4. Alternatives Considered
In considering how to best meet its regulatory objectives, FINRA
considered alternatives to certain aspects of this proposed rule
change.
In this regard, FINRA considered whether members should be
permitted to provide projections of performance or targeted returns in
all retail communications, including for asset allocation, other
investment strategies or for single investment products, such as mutual
funds and ETFs. FINRA carefully weighed the potential benefit of
providing such a communication to persons other than Projection-
Eligible Investors against the potential harm. FINRA has chosen to
focus this proposed rule change on communications to Projection-
Eligible Investors because they are more likely to have the
sophistication and resources to evaluate any performance projections or
targeted returns they receive in the context of other information they
are evaluating when making an investment decision.
FINRA also considered whether the proposed rule change should
require members to provide a range of targets or projections, rather
than a single projection, for investment planning illustrations. FINRA
believes that, while a range of projections would be useful in
particular situations, it is not necessary in all situations and can be
confusing in certain situations. For these reasons, FINRA decided to
give members the flexibility to determine whether a range of
projections would be useful.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Background
In February 2017, FINRA published Regulatory Notice 17-06 (the
``Notice''), requesting comment on proposed amendments that would have
created an exception to the rule's prohibition on projecting
performance to permit members to distribute customized hypothetical
investment planning illustrations that include the projected
performance of an asset allocation or other investment strategy, but
not an individual security, subject to specified conditions (the
``Notice proposal''). A copy of the Notice is available on FINRA's
website at http://www.finra.org.
The comment period expired on March 27, 2017. FINRA received 23
comments in response to the Notice. Twenty One commenters supported the
proposal and two commenters opposed the proposal. A list of the
commenters in response to the Notice and copies of the comment letters
received in response to the Notice are available on FINRA's
website.\57\ A summary of the comments and FINRA's response is provided
below.
---------------------------------------------------------------------------
\57\ See SR-FINRA-2023-016 (Form 19b-4, Exhibit 2b) for a list
of abbreviations assigned to commenters (available on FINRA's
website at http://www.finra.org).
---------------------------------------------------------------------------
Comments on Proposal
Comparison to Investment Adviser Advertising Standards
Supporters noted that the rule change would lessen the regulatory
inconsistencies regarding the use of performance projections between
broker-dealers and stand-alone investment advisers and would eliminate
the current opportunities for regulatory arbitrage.\58\ Commenters also
observed that allowing dually registered representatives to use
projections in investment planning illustrations with customers would
remove the current compliance difficulty with such situations. This
difficulty arises particularly when it is uncertain at the time of the
illustration's use whether the customer will open a fee-based or
commission-based account.\59\
---------------------------------------------------------------------------
\58\ See EDA, Fidelity, FSI, ICI, IRI, IPA, M Holdings,
Wellington, Wells Fargo.
\59\ See FSI, IPA, M Holdings.
---------------------------------------------------------------------------
However, some commenters contended that, even with this proposed
changes, the FINRA communications rules still would impose greater
burdens on broker-dealers than communications standards governing other
financial intermediaries, such as SEC guidance applicable to investment
advisers or the CFTC rules governing commodity pool operators.\60\
WealthForge noted that FINRA's prohibition on projections of
performance puts broker-dealers that are offering private funds under
Securities Act Regulation D at a disadvantage as compared to Regulation
D offerings that are not made through a broker-dealer, since no express
restrictions on
[[Page 82491]]
projections on performance apply to an issuer's communications.
---------------------------------------------------------------------------
\60\ See MMI, SIFMA.
---------------------------------------------------------------------------
As discussed above, subsequent to FINRA's publication of the Notice
proposal for comment, the SEC adopted the IA Marketing Rule, which
permits the presentation of performance, including hypothetical
targeted or projected performance returns, in investment adviser
advertisements, provided that the adviser meets specified conditions
and does not violate the IA Marketing Rule's other requirements.\61\
---------------------------------------------------------------------------
\61\ See 17 CFR 275.206(4)-1(d); see also 17 CFR 275.206(4)-
1(a).
---------------------------------------------------------------------------
The proposed rule text incorporates much of the rule text in the IA
Marketing Rule's provisions permitting the presentation of hypothetical
performance. A key difference is that the IA Marketing Rule does not
expressly prohibit including hypothetical performance in retail
investment adviser advertisements; instead, these provisions impose
conditions based on the ``intended audience'' of an investment adviser
advertisement. In this regard, the IA Marketing Rule Release states
that ``[w]e intend for advertisements including hypothetical
performance information to only be distributed to investors who have
access to resources to independently analyze this information and who
have the financial expertise to understand the risks and limitations of
these types of presentations.'' \62\ In contrast, the proposed rule
change expressly would permit the presentation of projected or targeted
returns only in institutional communications and QP private placement
communications.
---------------------------------------------------------------------------
\62\ See IA Marketing Rule Release, supra note 40, 86 FR 13024,
13078.
---------------------------------------------------------------------------
Despite these differences, however, in practice both rules are
intended to limit the use of projected or targeted returns to
communications that are distributed to persons who have the resources
or financial expertise to understand the risks and limitations
associated with such performance. As noted above, the IA Marketing Rule
is intended to ensure that advertisements containing hypothetical
performance only be distributed to persons possessing the resources and
expertise to understand such performance's risks and limitations.\63\
---------------------------------------------------------------------------
\63\ See supra note 62, 86 FR 13024, 13083.
---------------------------------------------------------------------------
The proposed rule change also would require members to have a
reasonable basis for the criteria and assumptions used to calculate the
projected or targeted returns, and the Supplementary Material would
list factors, among others, that a member should consider in forming
such a reasonable basis. While the IA Marketing Rule does not expressly
require targeted or projected performance returns to have a reasonable
basis, it requires performance presentations to be fair and balanced
and not misleading, requires all investment adviser advertisement
discussions of potential benefits to clients or investors also to
provide fair and balanced treatment of material risks and limitations
associated with the potential benefits, and requires that any material
statement of fact have a reasonable basis that the adviser can
substantiate upon SEC demand.\64\
---------------------------------------------------------------------------
\64\ 17 CFR 275.206(4)-1(a)(2) and (4).
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In addition, investment adviser communications that include
targeted or projected performance returns must provide sufficient
information to enable the intended audience to understand the risks and
limitations of relying on targeted or projected performance returns to
make investment decisions, which likely would require similar
disclosures regarding the hypothetical nature of such performance.
Accordingly, FINRA believes that the proposed rule change generally
would not impose substantially greater burdens on broker-dealers that
present projections of performance or targeted returns as compared to
investment advisers that present such performance.
Projections of Single Security Performance
The Notice proposal would have prohibited the projection of
performance of a single security regardless of whether an illustration
is used with a retail investor or an institutional investor. The Notice
requested comment on whether the proposed rule change should permit the
use of performance projections for single investment products that
operate like an asset allocation or other investment strategy for which
projections might be appropriate. A number of commenters responded that
the proposal should allow projections for single investment products
that operate similar to a diversified asset allocation model (such as
ETFs, diversified mutual funds, unit investment trusts, variable
annuities, and private equity and real estate funds).\65\
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\65\ See CAI, EDA, IRI, Monument, NYSBA Committee, 3PM,
WealthForge. FINRA heard similar views from parties that commented
on FINRA's retrospective review of the communications rules. See
Regulatory Notice 14-14 (April 2014). The Financial Services
Roundtable recommended that FINRA permit projections of performance,
since in its view projections play an important role in educating
investors and allowing them to compare products, and they provide an
important insight into what an investment manager seeks to achieve.
Similarly, the SIFMA observed that data about targeted returns are
highly material to potential investors.
---------------------------------------------------------------------------
For the reasons discussed above, FINRA does not agree that the
proposed rule change should be revised to permit members to distribute
communications to retail investors that include performance projections
for single securities whose returns depend on the performance of an
underlying investment portfolio, such as an ETF, mutual fund, UIT,
variable annuity, or private or real estate fund.
Many commenters stated that FINRA should either amend the proposal,
or issue a new proposal, to allow members to use performance
projections in any type of communication with institutional investors,
including sales literature concerning single securities.\66\ These
commenters noted that a broker-dealer that is raising capital for a new
private equity fund may not include projected performance returns for
existing investments in the new fund's pitch book and other marketing
materials, due to FINRA rules.\67\ 3PM noted that this approach would
be consistent with the differentiation of institutional investors under
FINRA's suitability rule and FINRA's interpretive letters permitting
the use of related performance in institutional communications.
---------------------------------------------------------------------------
\66\ See ACA, Credit Suisse, EDA, IPA, MMI, Monument, SIFMA,
3PM, Wellington.
\67\ See ACA, Monument.
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Commenters stated that institutional investors often ask to see
projected performance, and that the risk of investor harm from such use
is diminished, since institutional investors either have investment
sophistication or can hire someone who does.\68\ These commenters noted
that PPMs often contain performance projections, so it would make sense
to allow these projections in sales material.\69\ Multiple commenters
requested that FINRA permit the use of projected performance of a
single security in institutional communications since the rules
governing capital acquisition brokers do not prohibit the use of
projections of performance in private placement marketing materials,
and the same justifications exist for permitting projections of
performance in institutional communications.\70\
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\68\ See MMI, 3PM.
\69\ See ACA, Monument.
\70\ See IPA, Monument, NYSBA Committee.
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Several commenters further stated that FINRA should permit
projections of performance in communications
[[Page 82492]]
distributed to QPs.\71\ These commenters noted that capital acquisition
brokers (``CABs'') already may distribute communications that include
projections of performance to QPs, as CAB Rule 016(i) defines
``institutional investor'' to include qualified purchasers.\72\ NYSBA
commented that ``[r]egular FINRA members should have the same freedom
to provide projected performance information to Rule 016(i)
institutional investors as CABs, not merely for reasons of competitive
fairness and equal treatment, but because the same fundamental
principle applies: institutional investors have sufficient
sophistication to evaluate the projected performance and the weight to
be given to it in the overall investment decision.''
---------------------------------------------------------------------------
\71\ See IPA, Monument, NYSBA Committee.
\72\ See Capital Acquisition Broker Rule 016(i)(6).
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As discussed above, FINRA recognizes that projections of issuer
performance or targeted returns are more common in offering documents,
such as PPMs, for unregistered securities offerings. FINRA also
believes that institutional investors, as defined in FINRA Rule
2210(a)(4), and QP private placement investors often either have the
investment sophistication and experience, or are able to hire advisers
with investment acumen, necessary to avoid the potential harm that may
occur when single security performance projections or targeted returns
are presented in retail communications.\73\ While FINRA does not
necessarily agree that non-CAB members should have the same rules
governing their communications as CABs, in this circumstance FINRA
believes that there is no additional risk to investors for a non-CAB
firm to distribute communications with projections of performance or
targeted returns to QP private placement investors than for a CAB's
similar communication to QPs. In this regard, a CAB is already
permitted to include projections of performance in its communications
to QPs to whom it is seeking to sell newly issued unregistered
securities.\74\
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\73\ As discussed above, in addition to the requirement that the
recipient be either an institutional investor or QP private
placement investor, the proposed rule change would require members
to have written policies and procedures reasonably designed to
ensure that the communication containing the projection or targeted
return is relevant to the likely financial situation and investment
objectives of the investor receiving the communication.
\74\ Among other things, a CAB is permitted to act as a
placement agent or finder on behalf of an issuer in connection with
the sale of newly issued, unregistered securities to institutional
investors. See CAB Rule 016(c)(1)(F)(i) (definition of ``Capital
Acquisition Broker''). The term ``institutional investor'' includes
persons meeting the definition of ``qualified purchaser'' in section
2(a)(51) of the Investment Company Act. See CAB Rule 016(i)(6).
Because CAB Rule 221 (Communications with the Public) does not
prohibit CABs from including projections of performance in their
communications with the public, QPs may already receive projected
performance from a CAB in connection with the offer or sale of newly
issued unregistered securities.
---------------------------------------------------------------------------
For these reasons, FINRA has amended the Notice proposal to create
a new exception that permits institutional communications and QP
private placement communications to project the performance or provide
a targeted return of a single security,\75\ as well as the performance
of an asset allocation or other investment strategy, subject to
specified conditions.
---------------------------------------------------------------------------
\75\ The proposed rule change would allow institutional
communications to include hypothetical projections of performance of
any single security, including stocks as well as registered
investment companies.
---------------------------------------------------------------------------
Requiring a Range of Outcomes
The Notice also asked whether the proposal should require members
to provide a range of projections in investment planning illustrations,
rather than permitting a single projection of performance. Industry
commenters noted that, while members should be allowed to provide a
range of performance projections in illustrations rather than a single
performance figure, FINRA should not require a range. Instead, these
commenters recommended that FINRA allow members to have the flexibility
to determine whether providing a range of performance projections makes
sense in particular situations.\76\ Other commenters recommended that
FINRA require projections to include a range of outcomes, including
outcomes that assume a declining market.\77\
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\76\ See EDA, IRI, M Holdings.
\77\ See GSU, PIABA, 3PM.
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FINRA believes that it is not necessary to require in all cases
that institutional communications and QP private placement
communications that include projections of performance present a range
of possible outcomes. FINRA believes that members should have the
flexibility to determine whether a range of outcomes would be useful in
particular situations.
Reasonable Basis Standard
M Holdings supported the reasonable basis standard because it
provides members with flexibility given that investment strategies have
different features and costs. However, many commenters requested that
FINRA provide more clarity as to the ``reasonable basis'' standard. In
addition, commenters asked that FINRA allow a portfolio manager's
previous performance record with particular investments to be one
factor of a reasonable basis for projecting future performance.\78\
Other commenters expressed concern that the proposal would allow too
much leeway as to what is considered a reasonable basis, and that FINRA
needs to provide specific guidance as to what would be permissible.\79\
---------------------------------------------------------------------------
\78\ See MMI, SIFMA.
\79\ See NASAA, PIABA.
---------------------------------------------------------------------------
3PM noted that the use of specific and relevant market indices,
peer group comparisons, and other widely acceptable absolute and
relative historical investment performance of a specific investment
strategy should be considered as factors supporting a projection of
performance. 3PM also noted that a fund manager may need to adjust its
projected performance if a fund grows to a point where the manager will
no longer be able to find enough appropriate investments that meet the
fund's investment criteria (i.e., the fund experiences ``style
drift'').
GSU urged FINRA to require the communication to unambiguously and
specifically disclose all information used to generate the projection,
including an explanation of the reasonable basis behind the projection.
CAI requested that FINRA simply eliminate the requirement that
projections have a reasonable basis on the ground that it is too
subjective, and that the proposal's required disclosures are sufficient
to protect investors.
FINRA disagrees that the proposed rule should not require
performance projections to have a reasonable basis. As discussed above,
both the SEC and FINRA already apply a reasonable basis standard in
other contexts involving forecasts and projections. Additionally, FINRA
would be concerned that, absent such a requirement, members could
include wildly optimistic projections in communications solely for the
purpose of promoting the sale of a security or an investment planning
service, rather than providing useful information to an investor.
As discussed above, FINRA agrees that many factors may provide a
reasonable basis for a performance projection, which will vary
depending on the context. The proposed rule change would include
factors, among others, that a member should consider in forming such a
reasonable basis. In addition, a reasonable basis might be established,
for example, by reference to the historical performance and performance
volatility of asset classes, the duration of fixed income investments,
the effects of
[[Page 82493]]
macroeconomic factors such as inflation and changes in currency
valuation, the impact of fees, costs and taxes, and expected
contribution and withdrawal rates by the customer. A more detailed
discussion of the factors a member should use in forming a reasonable
basis can be found above in the Purpose section of this proposed rule
change.
Customized Illustrations
The Notice proposal would have permitted ``a customized
hypothetical investment planning illustration that projects performance
of an asset allocation or other investment strategy and not an
individual security,'' subject to specified conditions. Multiple
commenters asked that the proposal be amended not to require that
illustrations be ``customized,'' or that FINRA provide more clarity as
to what ``customized'' means. These commenters stated that many
investors may fit the same investment profile, and thus arguably a
member should be able to present these investors with the same
projections of performance.\80\ They also noted that performance
projections for particular asset classes are often based on generally
accepted investment theory and are not customized for individual
accounts. Fidelity suggested using language from FINRA Rule
2211(b)(5)(B), which permits the use of a personalized hypothetical
variable product illustration ``which reflects factors relating to an
individual customer's circumstances.''
---------------------------------------------------------------------------
\80\ See Fidelity, ICI, MMI.
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Wells Fargo recommended that FINRA expand the rule to allow members
to provide customers with non-customized asset allocation projections
based on ``firm capital market assumptions.'' Wells Fargo stated that
forward-looking illustrations of an asset allocation strategy's
projected growth rate, volatility measures, yield and downside risk
would be vital information to help investors understand their
portfolios.
As discussed above, FINRA has determined not to proceed with
amendments that would permit the use of ``a customized hypothetical
investment planning illustration'' with retail investors. Instead,
FINRA has determined to amend the Notice proposal to permit
institutional communications and QP private placement communications to
project performance or provide a targeted return, subject to specified
conditions. Accordingly, the comments on the meaning of ``customized''
in the proposed amendments are now irrelevant to this proposed rule
change.
Interplay With Other Projections Exceptions
Fidelity recommended that FINRA amend both FINRA Rule
2210(d)(1)(F)(i) (permitting hypothetical illustrations of mathematical
principles) and proposed Rule 2210(d)(1)(F)(iv) to refer to a
``specific investment'' rather than ``investment'' or ``specific
security,'' respectively, and to delete the reference to ``investment
strategy'' in paragraph (d)(1)(F)(i) so that there is no conflict with
the language in proposed paragraph (d)(1)(F)(iv).
Commenters also asked that FINRA clarify how this rule change would
impact communications that rely on other provisions that permit
performance projections, such as reports generated by investment
analysis tools pursuant to FINRA Rule 2214, or hypothetical
illustrations of mathematical principles, or hypothetical illustrations
concerning variable insurance products.\81\ In particular, IRI
requested clarification on whether an investment analysis tool report
generated pursuant to Rule 2214 may project the performance of a single
security, and whether projections of an asset allocation strategy's
performance in a personalized illustration may also show the
performance of specific securities. The ICI requested clarification as
to whether Rule 2214 would apply to illustrations of different asset
allocations and different withdrawal rates in retirement in educational
material.
---------------------------------------------------------------------------
\81\ See CAI, ICI, IRI.
---------------------------------------------------------------------------
FINRA does not intend to modify the requirements of other
exceptions to the prohibition on projections contained in Rule
2210(d)(1)(F) as part of creating a new exception for projected
performance and targeted returns in institutional communications and QP
private placement communications. Accordingly, FINRA does not believe
it is necessary or appropriate to modify the current language contained
in these exceptions. A communication that qualifies under another
exception to the prohibition on performance projections would not need
to be modified to meet the requirements for including performance
projections or targeted returns in institutional communications or QP
private placement communications pursuant to proposed Rule
2210(d)(1)(F)(iv). FINRA has included in the Purpose section above a
detailed discussion of the differences between the proposal and Rule
2214.\82\ To the extent that members need further guidance regarding
Rule 2214, FINRA believes that such guidance should be provided
separately from this rule filing.
---------------------------------------------------------------------------
\82\ See Comparison to Projections Permitted by FINRA Rule 2214,
supra.
---------------------------------------------------------------------------
CAI inquired how the proposal would impact existing FINRA staff
guidance on communications with the public, such as a 1998 letter
interpreting the application of FINRA communications rules to
communications of members that are dually registered as broker-dealers
and investment advisers, and guidance that permitted the use of blended
fund performance in specified asset allocation illustrations.\83\ CAI
suggested that FINRA withdraw or modify the 1998 interpretive letter to
clarify that member communications promoting investment advisory
services are not subject to FINRA's communications rules.
---------------------------------------------------------------------------
\83\ See Interpretive Letter to Dawn Bond, FSC Securities
Corporation (July 30, 1998), https://www.finra.org/rules-guidance/guidance/interpretive-letters/dawn-bond-fsc-securities-corporation
and ``Blended Fund Family Performance Concerns NASD Regulation,''
NASD Regulatory & Compliance Alert, Vol. 10, No. 3 at p. 10
(November 1996), https://www.finra.org/sites/default/files/RCA/p524569.pdf.
---------------------------------------------------------------------------
FINRA does not intend for the proposed rule change to impact prior
guidance on the application of Rule 2210 to communications made by
dually registered members or the use of blended performance.
Accordingly, FINRA does not believe it is necessary to withdraw the
1998 interpretive letter or provide additional guidance about the
presentation of blended performance.
Supervision of Communications With Projections
CAI opposed the proposed requirement that a registered principal
either approve each investment planning illustration that includes
projected performance or a template on which such projections are
based. Instead, it suggested that members should be able to supervise
all illustrations, including those not based on a template, in the same
manner as correspondence. In contrast, 3PM recommended that FINRA
require a registered principal to approve any performance projections
prior to use based on whether there is a reasonable basis to rely on
the methodology, assumptions and limitations provided with the
projected performance. Wells Fargo asked for clarification as to
whether the proposed rule change would alter how a member is required
to supervise electronic communications that include a performance
projection under FINRA Rule 3110.
As discussed above, FINRA has determined not to proceed with a new
exception from the prohibitions on
[[Page 82494]]
projecting performance in non-QP retail communications; however, a QP
private placement communication that includes a projection or targeted
return may fall within the definition of retail communication to the
extent that it is distributed or made available to more than 25 QP
private placement investors that are not institutional investors under
Rule 2210 within a 30-day period. Accordingly, to the extent that a
member distributes such a retail communication to QP private placement
investors, a registered principal will be required to review and
approve the communication prior to use. In addition, members must adopt
written policies and procedures reasonably designed to ensure
compliance with all applicable requirements and obligations, including
the obligation for the member to have a reasonable basis for the
criteria used and assumptions made in calculating the projected
performance or targeted return.\84\
---------------------------------------------------------------------------
\84\ See proposed Rule 2210(d)(1)(F)(iv)b. and c.
---------------------------------------------------------------------------
The proposed rule change would not alter the standards for review
of electronic communications. Thus, the proposed rule change's review
standards would apply equally to paper and electronic personalized
illustrations that include performance projections.
Required Disclosures
Two commenters stated that, if FINRA moves forward with the
proposal, FINRA should clarify with specificity the required
disclosures that must be given to investors, and provide guidance on
how members may calculate and present projections.\85\ For example,
NASAA noted that FINRA should state how members calculate fees, costs
or commissions in relation to hypothetical performance, how members
must compose an asset allocation or investment strategy, and how a
projection would have a reasonable basis where it was inconsistent with
the historical performance of the asset allocation. NASAA also
recommended that FINRA require disclosure of the underlying securities
that make up the customized hypothetical illustration, and if
applicable, that the broker-dealer's past projections proved to be
inaccurate.
---------------------------------------------------------------------------
\85\ See GSU, NASAA.
---------------------------------------------------------------------------
PIABA expressed concern that retail investors will regard
projections of performance of asset classes as forecasts or predictions
of how their investments will perform going forward, and that
boilerplate disclaimers are insufficient to avoid investor confusion.
3PM recommended that FINRA require, in addition to the proposal's
disclosure standards, a statement that the broker-dealer believes there
is a reasonable basis to believe the projected performance is
representative of the security or fund it represents, a description of
the methodology used to develop the projected performance, and an
explanation as to why the methodology used is a good predictor of the
projected performance.
As discussed above, FINRA no longer proposes to permit projections
of performance of an asset allocation or other investment strategy in
non-QP retail communications beyond what is currently permitted under
Rule 2210(d)(1)(F). Nevertheless, FINRA has modified the disclosure
requirements in the proposed rule with respect to institutional
communications and QP private placement communications. In this regard,
institutional communications and QP private placement communications
that include projections of performance or targeted returns would have
to prominently disclose that the projected performance or targeted
return is hypothetical in nature and that there is no guarantee that
the projected or targeted performance will be achieved. Members also
would have to provide sufficient information to enable the Projection-
Eligible Investor to understand the criteria used and assumptions made
in calculating the projected performance or targeted return, and to
understand the risks and limitations in using projected performance or
targeted returns in making investment decisions. FINRA believes that
these required disclosures strike an appropriate balance of alerting
Projection-Eligible Investors to the hypothetical nature and
uncertainty of such a projection without providing so much disclosure
that its effectiveness is diminished.
FINRA does not believe it is either appropriate or feasible to
create more detailed requirements on how members should calculate
performance projections or targeted returns. Because these projections
or targeted returns may occur in a variety of contexts, FINRA believes
it is better to allow members to create their own standards provided
that they have a reasonable basis. As discussed above, members still
would be required to make all presentations consistent with Rule 2210's
fair and balanced standard,\86\ and FINRA believes that it is better to
consider these communications on a case-by-case basis.
---------------------------------------------------------------------------
\86\ See FINRA Rule 2210(d)(1)(A).
---------------------------------------------------------------------------
Other Comments
Several commenters contended that an investment adviser's fiduciary
duty under the Advisers Act provides greater investor protections than
the suitability standard applicable to broker-dealers under FINRA
rules, and that this higher standard mitigates the potential risks of
advisers using projections.\87\ NASAA stated that past SEC no-action
letters to investment advisers, such as Clover Capital,\88\ provide
more ``regulatory rigor'' than the FINRA rule proposal with regard to
hypothetical performance. NASAA also stated that, despite FINRA's
statement that back-tested performance typically is not a reasonable
basis for a projection, it is ``virtually inevitable'' that back-
testing would be used. Several commenters recommended that FINRA keep
its current prohibitions on projections to avoid potential
manipulations or bias by brokers, at least until broker-dealers are
subject to a fiduciary duty.\89\
---------------------------------------------------------------------------
\87\ See GSU, NASAA.
\88\ See Clover Capital Management, Inc., 1986 SEC No-Act. LEXIS
2883 (October 28, 1986).
\89\ See GSU, NASAA, PIABA.
---------------------------------------------------------------------------
While FINRA disagrees that the Notice proposal lacked regulatory
rigor as compared to standards under the Advisers Act, as discussed
above, the revised proposal incorporates many of the same requirements
for the presentation of targeted or projected performance returns that
are contained in the IA Marketing Rule, which has supplanted past SEC
no-action letters concerning the presentation of performance in
investment adviser advertisements. In addition, the proposed rule
change includes specific disclosure and reasonableness requirements
that members must meet to use this exception to the prohibition on
performance projections. As discussed above, FINRA does not propose to
allow members to use back-tested performance as one of the bases for
creating a performance projection.
GSU recommended that all projections-related communications, and
the means by which they are generated, must be subject to stringent
document retention guidelines, and that these communications be
presumptively discoverable in case of a dispute and explicitly included
in FINRA's Discovery List 1. IPA urged FINRA to adopt the proposal
because it appeared that the Department of Labor's (``DOL'') Fiduciary
Rule proposal will require members to include projections of
performance in retirement plan statements.
Members that distribute institutional communications and QP private
[[Page 82495]]
placement communications that include projections of performance or
targeted returns will be required to retain records related to their
activities in this area as required by Exchange Act Rules 17a-3 and
17a-4. FINRA does not believe that the proposed rule change should
address discovery rules used in arbitration, as they are beyond its
scope.
FINRA notes that, subsequent to the publication of the Notice,
Congress passed the Setting Every Community Up for Retirement
Enhancement Act of 2019 (``SECURE Act'').\90\ Among other things, the
SECURE Act amended the Employee Retirement Income Security Act
(``ERISA'') to require an annual lifetime income disclosure in
statements sent to participants in benefit plans governed by ERISA.
Pursuant to the SECURE Act, the DOL adopted an interim final rule that
specifies the requirements for such lifetime income stream
disclosures.\91\ The proposed amendments to Rule 2210 would not impact
members that are required to provide such disclosures in plan benefit
statements. In this regard, FINRA historically has interpreted Rule
2210's filing and content standards as not applying to communications
that are required by other regulatory agencies, including
communications required by DOL rules.\92\
---------------------------------------------------------------------------
\90\ The SECURE Act was enacted as Division O of the Further
Consolidated Appropriations Act, 2020, Public Law 116-94 (2019).
\91\ See Department of Labor, ``Pension Benefit Statements--
Lifetime Income Illustrations,'' 85 FR 59132 (September 18, 2020).
\92\ See, e.g., Regulatory Notice 12-02 (January 2012).
---------------------------------------------------------------------------
Credit Suisse requested a number of new rules and guidance
addressing the use of performance information in communications,
including: (1) allowing institutional communications to show both
actual and related performance on a gross basis; (2) clarifying that
targeted returns contained in fund promotional material are not
projections of performance, or permit the use of targeted returns in
institutional communications; (3) confirming that estimated returns
about underlying fund investments are not subject to the prohibitions
on projections of performance; and (4) clarifying that model returns
and back-tested performance can provide a reasonable basis for
projected performance and targeted returns in institutional
communications. Fidelity urged FINRA to focus on harmonizing its rules
governing related performance with SEC staff interpretations under the
Advisers Act, and to focus on principles-based disclosure solutions
across all forms of communications, including social media and mobile
devices.
While FINRA appreciates these suggestions, it believes that some of
these recommendations (such as those concerning related or back-tested
performance) extend beyond the scope of the proposal's intent, and thus
are not germane to this proposed rule filing. FINRA believes that it
has addressed the other comments, such as those concerning targeted
returns.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 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 or disapprove 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. 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 email to [email protected]. Please include
File Number SR-FINRA-2023-016 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number SR-FINRA-2023-016. This
file number should be included on the subject line if email 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 website (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 website viewing and printing in
the Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549, on official business days between the hours of 10 a.m. and 3
p.m. Copies of such filing also will be available for inspection and
copying at the principal office of FINRA. Do not include personal
identifiable information in submissions; you should submit only
information that you wish to make available publicly. We may redact in
part or withhold entirely from publication submitted material that is
obscene or subject to copyright protection.
All submissions should refer to File Number SR-FINRA-2023-016 and
should be submitted on or before December 15, 2023.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\93\
---------------------------------------------------------------------------
\93\ 17 CFR 200.30-3(a)(12).
Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2023-25881 Filed 11-22-23; 8:45 am]
BILLING CODE 8011-01-P