FINRA’s communications rules affect the content, required approvals and potential filings of broker-dealer communications relating to structured products.3 FINRA’s 2013 amendments to the communications rules had specific applications to this market, resulting in a variety of changes to the offering process for many structured notes.
In April 2014, FINRA launched a review of its communications rules, as part of an ongoing initiative “to periodically look back at significant groups of rules to ensure they remain relevant and appropriately designed to achieve their objectives, particularly in light of industry and market changes.” The review involved discussions with, and written comment submissions by, a wide variety of market participants.4 In December 2014, FINRA issued its report regarding its review.5 The report describes the responses of market participants and the potential nature of FINRA’s planned rulemaking process. This process may result in changes to the communications rules that would affect the structured products industry.
FINRA Filing Requirement
The 2013 amendments to the communications rules required the filing with FINRA of certain types of materials used in connection with registered public offerings of structured notes. According to the report, many respondents believe that the filing requirements are overbroad in some respects relative to the investor protection they provide. They stated that the filing requirements impose significant direct and indirect costs on firms, and potentially divert FINRA resources from higher-risk matters. Some firms also indicated that the high volume of materials filed with FINRA has resulted in a backlog of filings to be reviewed; stakeholders also expressed some frustration with the turnaround times for review of communications, and encouraged FINRA to explore ways to make more efficient use of its review resources.6 Many broker-dealers suggested that a risk-based approach to filing would be a better use of both broker-dealer and FINRA resources.
Contents and Length of Disclosures
Rule 2210(d) requires disclosures in retail communications to be “fair and balanced,” and not misleading. But of course, in connection with most marketing materials, there are judgments to be made as to what that standard means, and how it should be applied. In connection with its comment process, the FINRA Advertising Department has often requested that broker-dealers expand the content of these documents, particularly with respect to risk factors.
As a result, FINRA indicated in the report that market participants asserted that the amount of required disclosure has become disproportionate to the substance of marketing materials, reducing the value of these materials to investors and potentially giving the impression that the risks of an investment outweigh its benefits. Some also asserted that the FINRA staff expects almost as much risk disclosure in sales material as is contained in the statutory prospectus for the relevant offerings. They further stated that FINRA’s staff interpretations of the content standards do not allow for layered disclosure (such as hyperlinks or references to other sources of information or offering documents), which would be more efficient and effective. They also asserted that these disclosure requirements discourage materials that would educate investors about strategies (e.g., diversification), products, services, fees and expenses.
To date, FINRA has also restricted the use of some types of information, particularly back-tested performance information as to proprietary indices and strategies, in materials intended for retail investors. Accordingly, many respondents favored more permissive use of this type of information.
Clarity and Transparency of FINRA Reviews
According to the report, market participants asserted that the principles-based content standards of the communications rules lead to a variety of challenges. Some asserted that the key content standards—e.g., “principles of fair dealing,” “fair and balanced,” “exaggerated” and “unwarranted”—are too subjective. While they indicated that FINRA’s guidance to date has been helpful, they generally suggested that this type of guidance needs to be more frequent, and needs to capture the Advertising Department’s comments in a consolidated way. For example, unlike in most SEC comment letters to issuers, there is no public source of information for FINRA’s comments, or for the guidance contained in those comments.
Similarly, each broker-dealer has its own assigned reviewer, and it is possible that different reviewers have different opinions and judgments as to these disclosures. Accordingly, some commenters expressed the view that analyst reviews could be performed in a more consistent manner.
Expense of Reviews
Commenters asserted that the direct costs of filing and re-filing, including expedited filing fees when a broker ceases to use materials quickly, can be significant. Many firms also indicated that the indirect costs associated with filing and re- filing exceed those direct costs-- most significantly, the personnel and technology resources needed for the compliance functions required by the rules. One person asserted that the rules are anticompetitive, because they make FINRA a “marketing partner for firms” that file materials and pay a fee to have their communications reviewed.
FINRA believes that its review demonstrates widespread agreement among affected parties that its communications rules “have been largely effective in meeting their intended investor protection objectives. However, the rules and FINRA’s administration of them may benefit from some updating and recalibration to better align the investor protection benefits and the economic impacts.”
With particular relevance to structured products, according to the report, FINRA’s staff recommends the initial consideration of:
- aligning FINRA’s filing requirements and review process with the relative risk of the communications;
- facilitating simplified and more effective risk disclosure; and
- providing more guidance regarding application the of FINRA’s content standards, including exploring the adoption of comprehensive performance standards.
Over the next several months, FINRA expects to explore a combination of guidance, proposed rule modifications and administrative measures to enhance the effectiveness and efficiency of the rules. In the upcoming action phase, FINRA will engage in its typical rulemaking process to propose any amendments to the rules based on the assessments.