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93-85 SEC Approves Amendments to CMO Advertising Guidelines:

Effective Immediately

SUGGESTED ROUTING

Senior Management
Advertising
Legal & Compliance

Executive Summary

The Securities and Exchange Commission (SEC) recently approved amendments to the Guidelines Regarding Communications With the Public About Collateralized Mortgage Obligations (CMO Guidelines) at Article III, Section 35 of the Rules of Fair Practice. The amendments add a definition of the term collateralized mortgage obligation (CMO) to the CMO Guidelines and require members to offer to customers educational material on CMOs which conveys certain important information. The text of the amendments, which are effective immediately, follows this Notice.

Background

The SEC recently approved amendments to the CMO Guidelines, adding a definition of the term collateralized mortgage obligation (CMO) and requiring members to offer to customers educational material on CMOs that conveys certain important information. The amendments result from the NASD's continuing program to enhance the regulation of sales practices in marketing CMOs to retail customers.

Definition of CMO

The CMO Guidelines adopted in early 1993 did not define the term "collateralized mortgage obligation." The NASD believes that defining the term collateralized mortgage obligation aids in understanding and interpreting the Guidelines. Accordingly, the amendments define the term. The definition is substantially identical to the one that is used by the Public Securities Association (PSA) in its educational materials. Under the definition, a CMO is a "multiclass bond backed by a pool of pass-through securities or mortgage loans." The relationship between a CMO and a real estate mortgage investment conduit (REMIC) is also described. For purposes of the NASD's rules, the terms CMO and REMIC are used interchangeably.

Educating Customers

The NASD believes the complexity of CMOs mandates that members take steps to ensure their customers are fully educated about CMOs. Accordingly, the amendments require members to offer investors an educational document or other material about CMOs. The amendment specifies that the document: (1) explain CMOs, including the various types of tranches; (2) discuss mortgage loans and mortgage securities; (3) explain the features of CMOs, including credit quality, prepayment rates and average lives, interest rates (including effect on values and prepayment rates), tax considerations, minimum investments, transaction costs, and liquidity; (4) discuss the questions an investor should ask before investing; and (5) contain a glossary of terms that may be helpful to an investor considering an investment.

The educational document may be similar to the PSA brochure, An Investor's Guide to Real Estate Mortgage Investment Conduits REMICs. In adopting the educational material provision, the NASD notes that the PSA brochure meets all of the requirements for an acceptable customer education document. The foregoing, however, does not constitute a recommendation or endorsement of the PSA brochure.

Questions regarding this Notice may be directed to R. Clark Hooper, Vice President, Advertising/Investment Companies Regulation Department, (202) 728-8329, or Elliott R. Curzon, Senior Attorney, Office of General Counsel, (202) 728-8451.

Text of Amendment to the Guidelines Regarding Communications With the Public About Collateralized Mortgage Obligations at Article III, Section 35 of the Rules of Fair Practice

(Note: New text is underlined.)

Guidelines Regarding Communications With the Public About Collateralized Mortgage Obligations

1. General Considerations

For purposes of these Guidelines and the NASD's Rules, the term "collateralized mortgage obligation" (CMO) refers to a multiclass bond backed by a pool of mortgage pass-through securities or mortgage loans. CMOs are also known as "real estate mortgage investment conduits" (REMICs). As a result of the 1986 Tax Reform Act, most CMOs are issued in REMIC form to create certain tax advantages for the issuer. The terms CMO and REMIC are now used interchangeably.

In order to prevent a communication about CMOs from being false or misleading, there are certain factors to be considered, including, but not limited to, the following.

Product Identification

In order to assure that investors understand exactly what security is being discussed, all communications concerning CMOs should clearly describe the product as a "collateralized mortgage obligation." Member firms should not use proprietary names for CMOs as they do not adequately identify the product.

To prevent confusion and the possibility of misleading the reader, communications should not contain comparisons between CMOs and any other investment vehicle, including Certificates of Deposit.

Educational Material

In order to ensure that customers are adequately informed about CMOs, members are required to offer to customers educational material which covers the following matters:
  • A discussion of CMO characteristics as investments and their attendant risks

  • An explanation of the structure of a CMO, including the various types of tranches

  • A discussion of mortgage loans and mortgage securities

  • Features of CMOs, including: credit quality, prepayment rates and average lives, interest rates (including effect on values and prepayment rates), tax considerations, minimum investments, transactions costs and liquidity

  • Questions an investor should ask before investing, and a glossary of terms that may be helpful to an investor considering an investment.
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