The U.S. Securities and Exchange Commission (SEC) on March 29, 2012 approved new Financial Industry Regulatory Authority, Inc. (FINRA) rules governing communications with the public. The new rules will replace current NASD Rules 2210 and 2211 and the Interpretive Materials that follow NASD Rule 2210, as well as delete portions of Incorporated New York Stock Exchange (NYSE) Rule 472. FINRA plans to announce the implementation date in a Regulatory Notice to be published no later than 90 days following SEC approval, but has stated that the implementation date will be no later than 365 days following SEC approval.
While the new FINRA rules are based upon the current provisions of these rules, there are some notable changes:
- Internal communications will be excluded from the definition of “institutional communication;”
- Public appearances that include recom-mendations of securities will be subject to new disclosure standards;
- All retail communications concerning closed-end funds will need to be filed with FINRA (there is an exception for cer-tain press releases issued by a closed-end fund listed on the NYSE); and
- Certain broadly disseminated “free writing” prospectuses will need to be filed with FINRA.
It is important that firms are aware of the new FINRA rules and that they educate their compliance and marketing professionals regarding the changes to ensure compliant sales communications.
In 2009, FINRA first proposed new FINRA rules governing communications with the public, which would replace current NASD Rules 2210 and 2211 and the Interpretive Materials that follow NASD Rule 2210, as well as delete portions of Incorporated NYSE Rule 472 and certain Supplementary Material and Interpreta-tions that accompany Rule 472. In 2011, FINRA filed the proposed rule changes with the SEC. After several amendments to the pro-posed rule changes, the SEC published a notice to approve the proposed rule changes, as modified by the amendments, on an accele-rated basis on March 29, 2012.1
New FINRA Rule 2210(a) reduces the number of categories of communication with the public from six to three. The rule defines three categories of communication: retail communications, correspon-dence, and institutional communications.
- “Retail communication” is defined as “any written (including electronic) communication that is dis-tributed or made available to more than 25 retail investors2 within any 30 calendar-day period.”3 Communications that currently qualify as “adver-tisements” and “sales literature” under NASD Rule 2210 will generally fall under this definition.
- “Correspondence” is defined as “any written (including electronic) communication that is dis-tributed or made available to 25 or fewer retail investors within any 30 calendar-day period.”4 The definition does not distinguish between exist-ing and prospective retail clients, as NASD Rule 2211(a)(1) currently does.
- “Institutional communication” is defined as “any written (including electronic) communica-tion that is distributed or made available only to institutional investors….”5 Communications that currently qualify as “institutional sales material” under NASD Rule 2211(a)(2) will generally fall under this definition with one notable exception – internal communications will be excluded from the definition.6
The new rule eliminates the terms “public appearance” and “independently prepared reprint.” However, as discussed below, the exceptions from the filing requirements and limited application of the content standards currently applicable to those communication categories are largely incorporated. Also, public appearances that include recommendations of securi-ties will be subject to new disclosure standards, as set forth below.
Pre-Use Approval and Recordkeeping
An appropriately qualified registered principal is required to approve each retail communication before the earlier of its use or filing with FINRA. Subsection (b) of Rule 2210 includes a number of exceptions and modifications to the pre-use approval requirements for certain types of retail communications that are not contained in the current rule.
Pre-use approval is not required by FINRA Rule 2210(b)(1)(D) and it will allow a member to supervise any retail communication in a manner similar to correspondence that: (i) is excepted from the definition of “research report,” unless the communication makes any financial or investment recommendation;7 (ii) any retail communication that is posted on an online interactive electronic forum;8 and (iii) any retail communication that does not make any financial or investment recommendation or otherwise promote a product or service of the member.9 In addition, FINRA Rule 2210(b)(1)(E) authorizes FINRA to grant an exemption from the pre-use approval requirement if good cause is shown.
FINRA Rule 2210(b)(4)(A) sets forth the record- keeping requirements for retail and institutional communications and, generally, these requirements will mirror current recordkeeping requirements. However, it incorporates by reference the recordkeeping format, medium and retention period requirements of Rule 17a-4 under the Securities Exchange Act of 1934.
The current filing requirements are generally incorpo-rated into the new rule, subject to certain changes, in subsection (c), discussed below.
FINRA Rule 2210(c)(1)(A) alters the filing requirements for new firms in two respects. First, it expands the new firm filing requirement to cover all retail communica-tions, rather than just advertisements. Second, the one-year filing requirement begins on the effective date a firm becomes registered with FINRA, rather than on the date an advertisement is first filed with FINRA.
FINRA Rule 2210(c)(1)(B) will carry forward FINRA’s ability to require a member to pre-file communications if FINRA determines that the member has departed from applicable standards. However, the rule will apply to all communications by a member (rather than just advertisements or sales literature, as is currently provided in NASD Rule 2210(c)(5)(B)).
FINRA Rule 2210(c)(2) will revise the categories of communication that fall within this pre-use filing requirement. The requirement to file retail communica-tions concerning security futures prior to first use will not apply to: (i) retail communications that are submit-ted to another self-regulatory organization having comparable standards pertaining to such communica-tions, and (ii) retail communications in which the only reference to security futures is contained in a listing of the services of a member.
FINRA Rule 2210(c)(3) will revise the categories of communication that must be filed within 10 business days of first use or publication. For the first time, all retail communications concerning closed-end funds will need to be filed with FINRA. Currently, NASD Rule 2210 requires members to file only advertisements and sales literature concerning closed-end funds, which are distributed during the fund’s initial public offering period, as well as all advertisements and sales litera-ture concerning continuously offered (interval) closed-end funds.
In addition, communications concerning government securities will no longer be required to be filed with FINRA. Under NASD Rule 2210, members are currently required to file advertisements related to government securities. Also, retail communications concerning collateralized mortgage obligations (CMOs) that are registered under the Securities Act of 1933 will be subject to the post-use filing requirement. Currently, members are required only to file advertisements concerning CMOs, but must file such advertisements at least 10 business days prior to first use. Finally, retail communications concerning publicly offered structured products, such as exchange-traded notes or registered grantor trusts, will need to be filed with FINRA. Under current NASD rules, structured products are not subject to a filing requirement.
FINRA Rule 2210(c)(7) generally duplicates the current exclusions from the filing requirements under NASD Rule 2210(c)(8), with certain modifications. The following exclusions have been added:
Templates. Retail communications that are based on templates that were previously filed with FINRA, where the only changes are to up-date statistical or other non-narrative informa-tion, will not be required to be filed. This filing exception is based in part on an earlier staff interpretation concerning how NASD Rule 2210’s approval, recordkeeping and filing requirements apply to statistical updates contained in pre-existing templates.10
Communications that do not make recommendations. Retail communications that do not make any financial or investment recommenda-tion or otherwise promote a product or service of the member will not be required to be filed. This is a new exclusion.
Interactive Electronic Communications. Retail communications that are posted on online interactive electronic forums will not be re-quired to be filed. Currently, these types of communication are considered “public appear-ances” under NASD Rule 2210, which are not subject to the filing requirement.
Closed-end Fund Communications. Press releases concerning closed-end funds listed on the NYSE that are issued pursuant to Section 202.06 of the NYSE Listed Company Manual will not be required to be filed. This is a new exclusion.
Also, the exclusion covering documents filed with the SEC has been modified. This exclusion will not cover broadly disseminated free writing prospectuses that are filed with the SEC. This will codify the guidance previously provided by FINRA.11
FINRA Rule 2210(c)(9) will permit FINRA to exempt: (i) a member from the pre-use filing requirements; and (ii) a specific category of retail communications from the filing requirements. In each case, the exemption is dependent upon a showing of good cause by the member.
The current content standards applicable to communi-cations with the public are largely incorporated into the new rule, subject to certain changes in Rule 2210(d).
FINRA Rule 2210(d)(1)(B) will expressly prohibit promissory statements or claims. FINRA staff already interprets NASD Rule 2210(d)(1)(B) to prohibit promissory language in firm communications, and Incorporated NYSE Rule 472(i) specifically prohibits promissory statements.
FINRA Rule 2210(d)(1)(F) will carry forward the current prohibition of performance predictions and projections, as well as the allowance for hypothetical illustrations of mathematical principles. However, FINRA has clarified that it will allow two additional types of projections of performance in communications with the public that are not reflected currently in NASD Rule 2210(d)(1)(D). First, projections of performance in reports produced by investment analysis tools that meet the require-ments of FINRA Rule 2214 will be permitted. Second, research reports on debt or equity securities that include price targets will be permitted under certain circumstances.
FINRA Rule 2210(d)(3) will apply the standards concerning disclosures of a firm’s name to correspon-dence as well as to retail communications.
FINRA Rule 2210(d)(4) will generally carry forward the content standards and disclosure requirements regarding certain retail communications and corres-pondence that discuss tax considerations of invest-ments and investment accounts currently found in NASD IM-2210-1. However, FINRA Rule 2210 will add new language concerning comparative illustrations of the mathematical principles of tax-deferred versus taxable compounding. Much of this language reflects previous guidance that FINRA has provided regarding tax-deferral illustrations.12
FINRA Rule 2210(d)(6) carries forward the disclosure requirements related to testimonials, currently found in NASD Rule 2210(d)(2). However, a member will be required to include disclosure regarding payment if more than $100 in value (rather than a “nominal sum”) is paid for the testimonial.
FINRA Rule 2210(d)(7) will revise in several ways the standards currently found in NASD IM2210-1(6) applicable to communications that contain a recom-mendation. First, FINRA Rule 2210(d)(7) will apply these standards to retail communications and public appearances. Currently, the standards apply only to advertisements and sales literature. Second, FINRA Rule 2210(d)(7)(A) will carry forward the conflict of interest disclosures currently required NASD IM-2210-1(6)(A), with one modification. The disclosure related to whether the member or any associated person has a financial interest in the securities of the recommended issuer will be limited to a member or associated person that is directly and materially involved with the preparation of the content of the communication. This change will substantially narrow the number of parties whose financial interests have to be disclosed. Third, FINRA Rule 2210(d)(7)(C) will amend the provisions governing communications that include past recommendations to mirror those found in Rule 206(4)-1(a)(2) under the Investment Advisers Act of 1940, which apply to investment adviser advertise-ments that contain past recommendations. Finally, FINRA Rule 2210(d)(7)(D) expressly will exclude from its coverage communications that meet the definition of “research report” and that include all of the applicable disclosures required by that rule. It also will exclude any communication that recommends only registered investment companies or variable insurance products.
FINRA Rule 2210(e) will replace current NASD IM-2210-4, which addresses limitations on firms’ use of FINRA’s name and any other corporate name owned by FINRA. This provision adds language that codifies FINRA’s current position that any reference to FINRA staff’s review of a communication is limited to either “Reviewed by FINRA” or “FINRA Reviewed.”
As noted earlier, “public appearance” is no longer a separate communication category and instead will be governed by FINRA Rule 2210(f). Public appearances will have to meet the general “fair and balanced” standards of FINRA Rule 2210(d)(1). Unlike the current rules governing public appearances, the disclosure requirements applicable to recommendations set forth in FINRA Rule 2210(d)(7) will apply if the public appearance includes a recommendation of a security. Additionally, the speaker will have to disclose any material conflict of interest he or she knows or has reason to know exists at the time of the public appear-ance. FINRA noted that these disclosure requirements will not apply to any public appearance by a research analyst for purposes of NASD Rule 2711 that includes all of the applicable disclosures required by that rule. FINRA further noted that the disclosure requirements will not apply to a recommendation of investment company securities or variable insurance products; provided, however, that the associated person has a reasonable basis for the recommendation. Firms will also be required to establish appropriate written policies and procedures to supervise public appear-ances. Finally, FINRA Rule 2210(f) makes clear that scripts, slides, handouts or other written (including electronic) materials used in connection with public appearances are considered communications for purposes of FINRA Rule 2210.
Use of Investment Company Rankings in Retail Communications
FINRA Rule 2212 will replace NASD IM-2210-3 with regard to standards applicable to the use of investment company rankings in retail communications. The standards generally will remain the same. A new paragraph has been added that will exclude indepen-dently prepared reprints from the rule’s coverage.
Requirements for the Use of Bond Mutual Fund Volatility Ratings
FINRA Rule 2213 will replace NASD IM-2210-5 with regard to standards applicable to the use of bond mutual fund volatility ratings in communications. The standards will remain the same.
Requirements for the Use of Investment Analysis Tools
FINRA Rule 2214 will replace NASD IM-2210-6 with regard to standards applicable to the use of investment analysis tools with retail customers. The standards will remain the same, but some language that is currently contained either in NASD IM-2210-6’s text or in footnotes will be moved to supplementary material.
Communications With the Public Regarding Security Futures
FINRA Rule 2215 will replace NASD IM-2210-7 with regard to standards applicable to communications concerning security futures. It will revise the current standards in several respects. First, FINRA Rule 2215 will apply to all retail communications unlike NASD IM-2210-7, which applies only to advertisements. Second, it amends the provisions that require commu-nications concerning security futures to be accompa-nied or preceded by the security futures risk disclosure document under certain circumstances. As revised, a communication concerning security futures will have to be accompanied or preceded by the risk disclosure document if it contains the names of specific securities. Third, FINRA Rule 2215(b)(4)(D) will clarify that communications that contain the historical perfor-mance of security futures must disclose all relevant costs, which must be reflected in the performance.
Communications With the Public About Collateralized Mortgage Obligations
FINRA Rule 2216 will replace NASD IM-2210-8 with regard to standards applicable to retail communica-tions concerning CMOs. The standards will remain the same.
FINRA has stated that the implementation date will be no later than 365 days following SEC approval. How-ever, FINRA has the ability to set the compliance date sooner if it so chooses. FINRA has indicated that it will announce the implementation date in a Regulatory Notice to be published no later than 90 days following SEC approval of the FINRA Rules.