FINRA Manual: Contents
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86-41 Presentations of Yield Quotations for Investment Company Shares in Communications With the Public
TO: All NASD Members and Other Interested Persons
The methods used in calculating yields on mutual funds and unit investment trusts, whose primary objective is the provision of income, and the manner in which such are presented to the public have been the subject of mounting interest and comment during the past year. The NASD has received complaints from its members, the staff of the Securities and Exchange Commission (SEC) and the public. In addition, articles have appeared in the media drawing attention to the disparate methods used in calculating yields.
The NASD Board of Governors and the Investment Companies Committee, a standing committee of the Board, are deeply concerned that as the result of such presentations, the investing public may be ill informed about the nature of such yields and the risks associated with the purchase of unit investment trust or income fund shares. The Board, based upon information presented by the Investment Companies Committee, has concluded that the two major issues involved are the lack of uniformity in the methods used to calculate such yields and the lack of adequate disclosure in such presentations.
The NASD recently received a copy of a proposal developed by the Investment Company Institute (ICI), the trade association of the mutual fund industry, which addresses both of these issues. The proposal requests that the SEC adopt a rule that, among other things, would require certain disclosures in advertisements for income funds and would also mandate a uniform method of calculating income fund yields for all communications with the public. The Board applauds this initiative by the ICI and supports the general thrust of its proposals.
However, the Board believes that it must address the disclosure issue in a much broader context than that of advertisements. NASD members who offer income funds have a duty to provide prospective investors with adequate information about the nature of the securities being offered.
The following are some of the major disclosure issues that the Board wishes to bring to the attention of NASD members that offer income funds and unit investment trusts to provide guidance in their presentations:
Many mutual funds investing in securities where the timely payment of interest and principal is guaranteed by the U.S. Government or its agencies have been brought to the market in recent years.
The Board is convinced that many investors in such funds, particularly those who have purchased shares with proceeds derived from the sale of investment instruments that guarantee principal and/or interest, do not understand that the claimed guarantees do not extend to the shares of the "government securities" or "GNMA" fund that they have purchased. The Board believes that this problem is exacerbated by advertising and sales material that contains inappropriate comparisons between these funds and certificates of deposit. The Board is of the opinion that members that offer such funds should ensure that their customers fully understand the nature of such guarantees by adequately explaining and disclosing these differences.
Historically, yield is the relation of the interest and dividends distributed to the capital value of the security. Many current "yield" figures include distributions from sources other than interest and dividends. The implication that must not be left with investors is that a return of capital or a similar component is no different than the other components of the yield figure. The Board considers that when such "yields" include distributions other than dividends or interest, such should be fully explained to prospective investors.
Current yield quotations on income funds express the relationship of distributions to capital values at one point in time. They are a "snapshot" of the current yield situation and have no predictive value. The Board is concerned that in a period of declining interest rates, current yield presentations based on the previous 12 months' distributions may give customers the impression that the illustrated yield is likely to be achieved in the future, absent an explanation by the member of the effect of market conditions on such yields. It is the Board's opinion that members should ensure that their customers fully understand the effects of market conditions on yields.
Under current market conditions, disclosure to income fund investors of the risk to principal is of paramount importance. The decline in interest rates has enhanced capital values. NASD members should advise their customers that if the direction of interest rates reverses, capital values will decline.
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These issues and others not described fall within the purview of paragraph (d) of Article III, Section 35 of the NASD Rules of Fair Practice — Standards Applicable to Communications With the Public. These standards require members to disclose all facts material to the offer of an issue of securities. The omission of material information may result in a violation of the rule and subsequent disciplinary action.
Apart from possible rule violations, lack of adequate disclosure and information will eventually result in customer dissatisfaction as market conditions change. The resulting loss in investor confidence could be extremely serious for the mutual fund distribution system and NASD members.
It is apparent to the Board from the nature of the complaints received thus far that some NASD members are engaging in sales practices in the offer of income funds which are not in accord with the high standards expected of NASD members. The Board urges members that offer such funds to review their practices and procedures with regard to disclosure to ensure that customers have no basis for claiming that they were misled or inadequately informed about the nature or characteristics of income funds.
Questions concerning this notice may be directed to R. Clark Hooper, Director, NASD Advertising, at (202) 728-8330.
Frank J. Wilson
Executive Vice President
Legal and Compliance