On March 29, 2012, the SEC approved various new FINRA advertising rules. The rules had been proposed as part of FINRA’s ongoing process of updating and consolidating various NASD rules and interpretations, as well as rules incorporated from the New York Stock Exchange, into a more logical and coordinated format. The most significant change is the amendment of Rule 2210, which would reduce the number of defined categories of communication from six in the current rule to three. The three new categories are: (1) institutional communications; (2) retail communications; and (3) correspondence. (The prior categories were advertisement, sales literature, correspondence, institutional sales material, public appearance, and independently prepared reprint.) The proposal would also set forth requirements governing pre-use principal approval of communications, recordkeeping, filing with FINRA’s Advertising Regulation Department, and content standards.
Additional rule changes would establish guidelines and restrictions governing the use of investment companies rankings in retail communications; the use of bond mutual fund volatility ratings; the use of investment analysis tools; communications with the public regarding security futures; and communications with the public about collateralized mortgage obligations.
Retail communications would include any written communication that is distributed or made available to more than 25 retail investors within any 30 calendar-day period. Institutional investors include various entities, including those with at least $50 million in total assets.
The proposal also provides 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 any retail investor,” and this is known as the “reason to believe” standard. FINRA has indicated that a member firm should not be able to treat a communication as an institutional communication in circumstances where, despite any policies or procedures to the contrary, the firm becomes aware that previous institutional communications have been routinely redistributed to retail investors.
As a practical matter, this will require tracking of known non-compliance by each institutional recipient, which may be burdensome. The implications of repeated non-compliance by an institutional recipient are that the member would no longer be able to treat communications sent to that recipient as institutional communications, but would be required to treat them as retail communications, which would likely change both content and filing requirements. A member would be required to reasonably conclude that the improper practice has ceased before being permitted to consider future communications sent to that recipient to qualify as institutional communications. Similarly, where the member firm is a fund underwriter and the recipient is a brokerdealer, if there are red flags indicating that the broker-dealer has used or intends to use an institutional communication provided by the member firm with retail investors, the member firm would be expected to discontinue distribution of such materials to that broker-dealer until the underwriter reasonably concludes that the broker-dealer has adopted appropriate measures to prevent future redistribution of such communications to retail investors.
These requirements heighten compliance responsibilities to monitor for and follow up on red flags, document the investigative process and findings, and implement necessary corrective actions. In addition, members will be required to evaluate any reform measures adopted by non-compliant recipients in order to determine whether or not to reinstitute distribution of institutional communications to them. We anticipate additional guidance from FINRA on these issues when the rule changes are ultimately adopted. However, it is clear that the compliance bar with respect to limitations on the distribution of institutional communications is being raised for institutions, broker-dealers and member firms.
SEC Release No. 34-66681, File No. SR-FINRA-2011-035 (Mar. 29, 2012), available at http://www.sec.gov/rules/sro/finra/2012/34-66681.pdf.