In a January 2019 interpretative letter, the Financial Industry Authority (FINRA) provided guidance to a registered broker-dealer as to the use of pre-inception index performance (PIP) data relating to a proprietary index. The broker-dealer sought to use the information in communications about open-end investment companies, which would be distributed solely to "institutional investors." The full text of the letter may be found here.
The letter restates and updates FINRA's prior guidance as to the use of back-tested index information, including its historic position that the use of this type of information would be inappropriate in communications provided to retail investors. FINRA's previous advice was set forth in a 2013 letter to ALPS Distributors. The guidance in the letter is useful to some extent to issuers of structured notes and structured CDs that are linked to new or proprietary indices.
In the new letter, FINRA approved of the use of the PIP data, subject to a number of conditions, including:
- Marketing materials that include PIP data must be labelled "For use with institutions only, not for use with retail investors." Financial intermediary recipients must be instructed not to circulate these materials to retail investors. If such a recipient distributes the information to retail investors, the broker-dealer must cease distributing the materials to that recipient.
- The PIP data can only be used with respect to an index that was created according to fixed rules that cannot be changed except under extraordinary conditions.
- Marketing materials containing PIP data must include an offer to provide an overview of the methodology of the index upon request, and electronic marketing material must include a hyperlink to that information.
- The presentation of the PIP data must reflect the deduction of fees and charges that are currently applicable to the relevant investment funds.
- The PIP data must reflect a period of time that includes multiple securities market environments and, at a minimum, 10 years of pre-inception data.
- The PIP data must be current as of the most recently ended calendar quarter.
- The PIP data must be clearly labelled and shown separately from the relevant fund's performance; it must be presented along with disclosure of the applicable dates for the PIP data and the dates for actual performance since inception.
- Because the fund in question was in existence for more than one year, the PIP data must be accompanied by the prominent presentation of the actual performance of the fund since inception, which reflects the deduction of fees and charges of the fund.
- The PIP data should not be inconsistent with information in the fund prospectus. (However, the PIP data may be used with institutional investors, regardless of whether the fund prospectus includes the data.)
- The PIP data should be accompanied by a few disclosures:
- that the fund in question is a relatively new product, and any performance prior to the date of inception is hypothetical;
- the identity of the entity that performs the calculation and distribution of the PIP data, and the fact that the relevant investment advisor pays this entity to perform those functions;
- the fact that the PIP data are based on criteria that has been applied retroactively with the benefit of hindsight, and that these criteria cannot account for all of the financial risk that may affect the actual performance of the fund;
- that the actual performance of the fund may vary significantly from the PIP data; and
- the reasons (if any) why the PIP data would have differed from actual performance during the period shown (e.g., transaction costs, liquidity, or other market factors).
As noted above, FINRA also restated in the letter its historic position that the use of hypothetical backtested performance information in communications with retail investors does not comply with FINRA's content rules.
The letter does not materially change FINRA's guidance for the use of this type of information; however, it remains useful guidance as to the issues to consider when presenting the information in an offering document or marketing materials.