As part of its recent efforts to ensure greater oversight and accuracy with respect to member firms’ communications with retail investors,7 FINRA released Regulatory Notice 10-52 in October 2010.8 The notice provides that the content standards, principal review requirements and applicable filing requirements contained in NASD Rules 2210 (Communications with the Public) and 2211 (Institutional Sales Material and Correspondence) will now apply to free writing prospectuses distributed by broker-dealers in a manner reasonably designed to lead to their broad unrestricted dissemination, as described in Rule 433 of the Securities Act. As a result, FINRA is withdrawing, in part, previous interpretive guidance from August 2006 that excluded free writing prospectuses from the requirements of Rules 2210 and 2211.9
As to structured products, the notice will most directly impact FWPs that broker-dealers broadly disseminate, such as through a public website, in order to market their offerings.
Free Writing Prospectuses
Securities Act Rule 405 defines a free writing prospectus (“FWP”) as a written communication, including an electronic communication, that constitutes an offer to sell or a solicitation to buy securities in a registered offering by means other than the statutory prospectus. An FWP may include information that is not included in the registration statement, but it may not conflict with information in the filed registration statement, including any prospectus and any Exchange Act reports incorporated by reference. Securities Act Rule 433 requires any offering participant other than the issuer to file any FWP that is distributed by or on behalf of the offering participant in a manner reasonably designed to lead to its broad unrestricted dissemination. FWPs have become an important means by which structured products are marketed and sold. They are used by a wide variety of market participants to educate investors about these products generally, as well as to offer specific securities.
NASD Rules 2210 and 2211
NASD Rules 2210 and 2211 establish standards for the content of communications with the public by brokerdealers. The rules are designed to ensure that the communications are fair, balanced and not misleading. Rule 2210 specifically covers communications with the public, while Rule 2211 specifically covers institutional sales material and correspondence. Rule 2210(a) defines six main types of communications with the public for purposes of the rules, including advertisements, sales literature, correspondence, institutional sales material, public appearances and independently prepared reprints. “Advertisements” are defined to include any material that is published or used in any electronic or other public media; “sales literature” is defined to include any written or electronic communication that is generally distributed or made generally available to customers or the public; “independently prepared reprints” are defined to include any reprint or excerpt of any article issued by a publisher or any report concerning an investment company registered under the Investment Company Act of 1940, as amended (the “Investment Company Act”); and “institutional sales material” is defined to include any communication that is distributed or made available only to institutional investors.
Rule 2210(b)(1) requires a registered principal10 to review and approve advertisements, sales literature and independently prepared reprints before they are distributed. Rule 2210(b)(2) requires members to maintain all advertisements, sales literature and independently prepared reprints in a separate file (whether in paper or electronic format) for a period beginning on the date of first use and ending three years from the date of last use. Members must also maintain a file containing the source of any statistical table, chart, graph or other illustration used by members in communications with the public. Rule 2210(c)(2) requires member firms to file advertisements and sales literature regarding certain types of securities, including registered investment companies and public direct participation programs, with FINRA within 10 business days of first use.11 Rule 2210(d)(1) sets forth the content requirement for all communications with the public, which generally requires fair and balanced communications with no omission of any material facts or qualifications if the omission, in the light of the context of the material presented, would cause the communication to be misleading.12
Rule 2210(d)(2) sets forth the content requirements for advertisements and sales literature, including prominent disclosure (1) that, if testimonials concerning investment advice or performance are provided, they may not be representative of the experience of other clients and are no guarantee of future success, (2) of material differences between any comparison in advertisements or sales literature between investments or services, and (3) of the name of the member.
Under Rule 2211(d)(1), institutional sales material also is subject to the content standards of Rule 2210(d)(1) and the applicable interpretive materials under Rule 2210. In addition, all related correspondence is subject to the content standards of Rule 2210(d)(3). The definitions of “sales literature” and “institutional sales material” do not expressly exclude issuer-created offering materials, such as FWPs. However, as a matter of practice, FINRA does not apply any of the provisions of Rule 2210, including the content requirements, to issuer-created materials, such as prospectuses.13
Rationale for Withdrawing Previous Interpretive Guidance
FINRA’s previous interpretive guidance specifically excluded from the provisions of Rules 2210 and 2211 all FWPs, whether created by the issuer or another offering participant. However, in the recent notice, FINRA indicated that while its previous interpretive guidance was intended to promote the objectives of Rule 433, that guidance has led to inconsistent regulatory treatment of communications that present similar investor protection concerns. First, FINRA noted that there have been cases where sales material that appeared to be in material non-compliance with the content standards of Rule 2210 were excluded from the application of the rule merely because the broker-dealer asserted that the sales material constituted an FWP.14 Second, FINRA noted that investment companies registered under the Investment Company Act are not eligible to use an FWP under Rule 164(f) of the Securities Act. Thus, a communication regarding an exchange traded fund (“ETF”) that is a registered investment company must comply with the content, registered principal approval and filing requirements of Rule 2210, while an FWP regarding an ETF that is not a registered investment company would be exempt from the application of the rule. Third, FINRA noted that because broker-dealers are already required to file broadly-disseminated FWPs with the SEC, filing them with FINRA will not cause delays in the offering process.
Other Issues: Broad Unrestricted Dissemination, Preliminary Prospectuses and Grandfathering
In the notice, FINRA also pointed out that the SEC has provided guidance regarding the meaning of the term “broad unrestricted dissemination” and that it would explicitly incorporate that guidance. Specifically, the SEC has noted that examples of broad unrestricted dissemination of an FWP by a broker-dealer would include posting such prospectus on an unrestricted website or releasing it to the media. Conversely, the SEC has stated that a brokerdealer would not be making a broad unrestricted dissemination if an FWP is posted to a restricted website (e.g., password protected) or sent directly to its customers, regardless of the number of customers.
FWPs prepared by issuers that are in essentially the form of, and used in lieu of preliminary prospectuses (commonly referred to as “red herrings”), would presumably continue to be subject to FINRA’s prior practice of excluding issuer-created materials, such as prospectuses, from Rules 2210 and 2211. Investors who receive these documents will continue to obtain the protections of the Securities Act as to any misleading content in these documents.
Furthermore, there will be no “grandfathering” of the new FINRA guidance. If an FWP has been posted by a brokerdealer on a public website, it should meet the content requirements and have been approved and filed (if required) in the proper manner if that has not already occurred.
In the structured products area, the notice will principally impact brochures and other sales material that brokerdealers broadly disseminate to inform investors about their offerings. In particular, materials made available on a public website will be covered. In addition to the approval and recordkeeping requirements of Rule 2210(b), the notice will provide FINRA with the ability to “police” these materials for content.
On the one hand, limiting the dissemination of materials of this kind would remove a document from the specific requirements of Rule 2210 or 2211. On the other hand, even in the absence of these FINRA provisions, these types of documents are subject to potential liability for misleading statements under the Securities Act; accordingly, underwriters and their counsel review these documents with a fair degree of caution.15
In September 2009, FINRA issued Regulatory Notice 09-55,16 requesting comments on proposed new FINRA Rule 2210 governing communications with the public by FINRA member broker-dealers. The proposed rule would amend the previous NASD Rule 2210 regarding filing requirements that brokers must comply with in connection with certain retail communications. Under the proposed new FINRA Rule 2210(c)(2), a broker-dealer must file retail communications with FINRA at least 10 business days prior to first use or publication, and may not publish or circulate such materials until any changes by FINRA have been made.
Issuers of registered structured notes would be exempt from filing prospectuses under this proposed rule because those documents are filed with the SEC. However, certain documents used in the marketing of structured product offerings could be subject to the filing requirement if the rules are adopted in the originally-proposed form. Accordingly, although final rules have not been proposed, they could significantly affect the use of the offering documents covered by Notice 10-52.