FINRA continues its retrospective review of its communications rules.1 In February 2017, FINRA announced it is seeking comments on proposed amendments to FINRA Rule 2210. The proposal would create an exception to the rule's general prohibition on projecting performance, which would permit a broker-dealer to distribute a customized hypothetical investment planning illustration that includes the projected performance of an asset allocation or other investment strategy. A presentation of this kind would be subject to several conditions set forth in the proposal. The proposal may be found at the following link: http://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-17-06.pdf.
Rule 2210 provides that, as a general matter, communications from broker-dealers may not predict or project performance, imply that past performance will recur, or make any exaggerated or unwarranted claim, opinion, or forecast. This prohibition is mainly intended to protect retail investors from performance projections of individual investments, which may be inaccurate or misleading. In the new proposal, FINRA noted that:
"information regarding the expected performance of an asset allocation or other investment strategy that does not project the performance of individual securities could better inform an investor about assumptions upon which the recommendation to pursue such a strategy is based. Commenters to FINRA's retrospective review of the communications rules suggested that investors would benefit from projections in that more limited context and noted that investment advisers often present performance projections in their communications with their clients, particularly in communications concerning financial planning or asset allocation."
Terms and Conditions of the Proposed Amendments
The amendments would provide an exception to the prohibition of projections for a customized hypothetical investment planning illustration. An illustration could project an asset allocation or other investment strategy; however, it could not project the performance of an individual security (such as, for example, a particular structured note). There would need to be a "reasonable basis" for all assumptions, conclusions, and recommendations. The illustration must clearly and prominently disclose the fact that the illustration is hypothetical and there is no assurance that any described investment performance or event will occur. All material assumptions and limitations applicable to the illustration would have to be disclosed. The proposed rule would also establish specific supervisory requirements for the permitted illustrations. In connection with its proposal, FINRA discussed what would constitute a "reasonable basis," in light of its prior guidance. In doing so, FINRA restated its historical position that hypothetical back-tested performance (sometimes referred to as "preinception performance information") is prohibited in retail communications. However, it is possible that rule proposals of this kind may signal that FINRA is becoming more receptive to the possibility of this type of information being used. FINRA's views in this area may continue to evolve.
Applicability to Structured Product Sales and Marketing
The proposed rule would not permit projections of performance of a particular security, including a structured note. However, many structured notes represent an asset allocation or other investment strategy, such as a note linked to a basket of international indices representing different regions. In connection with discussing the possibility of such an investment, a financial advisor could utilize these rules to show a hypothetical investment planning illustration of how such a strategy might perform in different environments.
The proposed amendment is subject to a comment period, which expires on March 27, 2017.