The Financial Industry Regulatory Authority (“FINRA”) has recently issued interpretive guidance clarifying that under certain circumstances, financial firms may use “pre-inception index performance” data (“PIP data”) in marketing exchange-traded funds (“ETFs”) to institutional investors without violating FINRA’s standards on advertising communications with investors under FINRA Rule 2210. PIP data is sometimes used to model the performance of an exchange-traded product as though it existed prior to its launch. The hypothetical performance figures generated by this type of back testing can potentially be substantially better than actual results of an ETF after its launch, because portfolio managers have the benefit of market hindsight in selecting the components of the ETF index.
Financial firms have emphasized that PIP data is a valuable tool for analyzing potential fund performance, particularly for institutional investors that tend to better understand the drawbacks of such data. In its guidance, FINRA generally agreed with this position, but clarified that PIP data is appropriate only for institutional investors of passively-managed exchange-traded products and not retail investors. FINRA also noted that in presenting PIP data to institutional investors, firms must meet certain standards that include, among other things, clearly labeling communications as applying to institutional investors, offering to provide the methodology of the ETF index upon request, and delivering data that covers a period including multiple securities and market environments. The text of FINRA’s guidance on communications regarding PIP data is available here.