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93-76 Mail Vote—NASD Solicits Member Vote On Filing Requirements For Use of Mutual Fund Rankings and Elimination Of Sunset Provisions in Prefiling Requirements For CMO Advertisements;
Last Voting Date: December 31, 1993
The NASD invites members to vote on an amendment to Article III, Section 35(c) of the Rules of Fair Practice that would require a member using mutual fund rankings in advertisements or sales literature to submit copies of the rankings and the data on which the rankings are based to the NASD Advertising Regulation Department for review. The amendment will also eliminate the sunset provisions in Article III, Subsection 35(c)(2) of the Rules of Fair Practice and in Subsection 8(c)(1)(B) of the Government Securities Rules, thereby making the prefiling requirement for advertisements relating to collateralized mortgage obligations (CMOs) permanent. The text of the proposed rule changes follow this Notice.
Background and Description Of the Proposal
The increasing number of mutual funds in recent years has been accompanied by an increasing number of mutual fund ranking entities (Ranking Entities). Ranking Entities, as well as mutual funds and fund affiliates, categorize and rank mutual funds by various criteria, including fund type; performance over a given period of years; total return; standardized yield calculated pursuant to Securities and Exchange Commission (SEC) rules; the variations in sales charges; and, risk/reward. References to such rankings in mutual fund advertisements and sales literature have also increased substantially in recent years as members try to sell mutual fund shares by promoting fund performance.
The NASD Board of Governors believes that it is important for the NASD to be able to review and regulate the use of ranking materials and the development of customized rankings to prevent the misleading use of such rankings. The NASD is, therefore, proposing to amend Article III, Section 35(c) of the NASD Rules of Fair Practice to require that copies of mutual fund rankings and the data on which the rankings are based be submitted to the NASD Advertising Regulation Department for review.
The NASD is also adopting mutual fund ranking guidelines (Guidelines) governing the NASD review. Although attached to this Notice, the Guidelines do not require member vote.
Subsection 35(c)(1) is proposed to be amended to require any member that files advertisements or sales literature pursuant to Subsection 35(c)(1) that include or incorporate rankings or comparisons of the investment company with other investment companies, to include a copy of the ranking or comparison used in the advertising or sales literature. The requirements of this provision will permit the NASD staff to determine immediately whether the use of the ranking complies with the Guidelines and to avoid the need to research the ranking or obtain a copy of the source information to verify the accuracy of the material.
Subsection 35(c)(2) currently requires that certain advertisements be filed 10 days before use. The NASD is proposing to amend the section to apply the preuse requirement to all investment company advertisements or sales literature that incorporate rankings or comparisons either generally published or created directly or indirectly by the investment company, its underwriter, or an affiliate.1 While the NASD is concerned about permitting investment companies or their affiliates to create ranking categories, rather than a Ranking Entity, it recognizes that a customized ranking may provide meaningful information to the investor. Such filings must also include a copy of the data, ranking, or comparison on which the ranking or comparison is based.
The NASD is also proposing to amend Article III, Subsection 35(c)(2) of the Rules of Fair Practice and Subsection 8(c)(1)(B) of the Government Securities Rules to eliminate sunset provisions that cause the prefiling requirements relating to CMOs to expire on November 16, 1993. This change will make the prefiling requirement for CMO advertisements permanent.2
Request for Vote
The Board of Governors believes that requiring members to include rankings, comparisons, and data used when submitting for review advertisements and sales literature that incorporate mutual fund rankings or comparisons will enhance member compliance. The information provided to the NASD Advertising Regulation Department will assist it in assuring that the use of such information is accurate and presents investors with fair and meaningful data on which to make an informed investment decision. The NASD considers the proposed rule change necessary and appropriate and recommends that members vote their approval.
As to the proposed elimination of the sunset provisions for the prefiling of collateralized mortgage obligation advertisements, the Board believes that the positive regulatory benefits seen since implementation of the provision (i.e., the reduction in misleading advertising) justifies a permanent prefiling requirement.
The text of the proposed rule change that requires member vote is below. Please mark the attached ballot according to your convictions and mail it in the enclosed, stamped envelope to the Corporation Trust Company. Ballots must be postmarked by no later than December 31, 1993. The amendment will not be effective until it is filed with and approved by the SEC.
Also included below is the text of the Guidelines For the Use of Rankings in Mutual Fund Advertisements and Sales Literature being filed separately with the SEC. The Guidelines are included for members' information and do not require member vote before submission to the SEC.
Questions regarding this Notice should be directed to Thomas A. Pappas, Assistant Director, Advertising/Investment Companies Regulation Department, at (202) 728-8330; Elliott R. Curzon, Senior Attorney, Office of General Counsel, at (202) 728-8451; and Robert J. Smith, Attorney, Office of General Counsel, at (202) 728-8176.
1 The proposed Guidelines permit the use of a ranking based on a category or subcategory created by a fund affiliate rather than by a Ranking Entity, so long as the ranking is based on the performance measurements of a Ranking Entity.
2 To provide sufficient time for membership vote and SEC approval of the elimination of the sunset provisions, the NASD has submitted a rule change to the SEC to extend the sunset provisions temporarily.
Text of Proposed Amendment to Section 35(c) of the Rules of Fair Practice
Communications With the Public
(Note: New language is underlined; deletions are in brackets.)
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Text of Proposed Amendment To Section 8(c)(1)(B) of the Government Securities Rules
Communications With the Public
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Guidelines for the Use of Rankings in Mutual Fund Advertisements and Sales Literature
For purposes of these guidelines, the term "Ranking Entity" refers to any entity that provides general information about mutual funds to the public, that is independent of the mutual fund and its affiliates, and whose services are not procured by the mutual fund or any of its affiliates to assign the fund a ranking. Examples of "Ranking Entities" include services such as Morningstar and Lipper and financial publications such as Money and Barron's.
Mutual Fund rankings for more than one class or fund with the same portfolio must be accompanied by prominent disclosure of the fact that the funds or classes have a common portfolio.