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89-11 SEC Approval of Rule Amendment Requiring Filing of Advertising and Sales Literature for Investment Company Securities — Effective March 1, 1989

SUGGESTED ROUTING*

Legal & Compliance
Mutual Fund

*These are suggested departments only. Others may be appropriate for your firm.

EXECUTIVE SUMMARY

The Securities and Exchange Commission recently approved an amendment to Article 111, Section 35 of the NASD Rules of Fair Practice. The amendment requires that advertising and sales literature for registered investment company securities be filed by members with the NASD Advertising Department within 10 days of first use or publication. The requirement will be effective March 1, 1989.

BACKGROUND

Article III, Section 35 of the NASD Rules of Fair Practice regulates members' communications with the public. It requires that all such communications be based on principles of fair dealing and good faith and that they provide a sound basis for evaluating the facts regarding any securities offered by members.

Material facts or qualifications may not be omitted if, in the context of the material presented, the omission would make the communication misleading. Exaggerated or misleading statements are prohibited, and members may not publish or distribute any public communication that the member knows, or has reason to know, contains any untrue statement of a material fact or is otherwise false or misleading.

Article HI, Section 35 currently requires a member, for one year, to file all advertisements with the NASD Advertising Department for review 10 days prior to use, commencing with the member's initial advertisement. Under certain circumstances, an NASD District Business Conduct Committee (DBCC) also may require a member to file advertising and/or sales literature with the Advertising Department at least 10 days prior to first use. All members are subject to routine spot checks of their advertising and sales literature.

Members also must file advertising and sales literature pertaining to direct participation programs and government securities within 10 days of first use, and certain options-related materials must be filed 10 days prior to first use. Also, advertising and sales literature concerning registered investment company securities must be filed within 10 days of first use by members that are principal underwriters of such companies.

During the past three years, attention has been focused on problems with mutual fund advertising, particularly income fund advertising. The Securities and Exchange Commission (SEC) recently adopted extensive rule amendments governing the presentation of investment company performance (see SEC Release Nos. 33-6753; IC-16245). One purpose of such rules and amendments is to enhance investors' ability to compare and evaluate investment company performance claims. The rules and amendments (1) standardize the computation of mutual fund performance data in advertising and sales literature; (2) require certain risk and other disclosures in sales material; and (3) eliminate the requirement to file sales material with the SEC if it is filed with the NASD.

The NASD Board of Governors also addressed these concerns in Notice to Members 86-41 regarding the presentation of investment companies' yield quotations. One of the Board's concerns was that the problems were not limited to material prepared by investment company underwriters but also were common in material prepared by dealers. The Board noted that the majority of complaints received by the NASD about investment company communications related to material prepared by dealers. Much of the material was written and published by individual representatives or branch managers and reflected a lack of knowledge or observance of SEC and NASD rules.

In addition, numerous violations resulted from dealers inappropriately revising advertisements prepared by underwriters or using material that contained information that was no longer current. The NASD has referred such practices to the appropriate DBCC.

The Board of Governors notes that the underwriter or distributor of a fund bears the responsibility for disseminating to dealers literature that has been filed with the NASD and that complies with applicable regulations. It is also the responsibility of the underwriter or distributor, when disseminating the material, to inform the dealer when information contained in such material is outdated and thus no longer should be used.

The Board believes that underwriters supplying noncomplying material should be referred to the appropriate DBCC for possible disciplinary action. Nevertheless, the Board recognizes that a large number of problems are created after the material is distributed to dealers, or when dealers prepare the material themselves. Therefore, the Board believes that the filing requirement for all investment company advertising and sales literature is necessary.

SUMMARY

The amendment, which was approved by the SEC November 28, 1988, becomes effective March 1, 1989. It requires that advertising and sales literature used in conjunction with registered investment companies be filed with the NASD Advertising Department within 10 days of first use or publication by a member. Filing prior to use is recommended. The NASD will review the material for conform ance with the standards contained in Article III, Section 35 of the NASD Rules of Fair Practice as well as with applicable SEC regulations.

The responsibility of members to comply with the filing requirement applies regardless of whether advertising and/or sales literature is prepared by the member, the underwriter, the distributor, or another entity. However, the member need not file material that has been filed previously and that is used without change.

ADVERTISING SERVICE CHARGE

Members also are reminded that, in January 1988, the Board of Governors amended Schedule A of the NASD By-Laws to establish a service charge of $15 for each item of advertising and/or sales literature filed with or submitted to the NASD, except for items submitted in response to a written request from the NASD Advertising Department issued pursuant to Article III, Section 35(C)(6) of the NASD Rules of Fair Practice (see Notice to Members 88-14, dated February 10, 1988). Members may pay by check or money order made payable to the NASD, Inc. In addition, members anticipating regular filing activity may elect to establish an advertising account from which deductions for each filing will be made.

Any material submitted without a fee will be returned to the member, and any applicable filing requirement will not be considered fulfilled. If multiple copies of identical material are submitted as one package, one filing has been made and one $15 fee should be paid. If several distinct items are submitted in one package, a separate $15 fee should be included for each individual piece in the package.

Questions concerning this notice can be directed to R. Clark Hooper, Director, NASD Advertising Department, at (202) 728-8330.

AMENDMENT TO ARTICLE III, SECTION 35 OF THE NASD RULES OF FAIR PRACTICE

(Note: New language is underlined; deleted language is in brackets.)

Communications with the Public

Sec. 35
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(c) Filing Requirements and Review Procedures
(1) Advertisements and sales literature concerning registered investment companies (including mutual funds, variable contracts and unit investment trusts) shall be filed with the Association's Advertising Department within 10 days of first use or publication by any member, [who has utilized or distributed such material in connection with the offer or sale of such securities issued by companies for which such member is a principal underwriter.] Filing in advance of use is recommended [optional]. Members are not required to file advertising and sales literature which have previously been filed and which are used without change.

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