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93-36 Codification of Investment Company Advertising Guidelines

SUGGESTED ROUTING

Senior Management
Legal & Compliance
Mutual Fund

Executive Summary

On April 30, 1993, the Securities and Exchange Commission (SEC) approved an amendment to Article III, Section 35 of the Rules of Fair Practice and the Investment Company Securities section of the NASD Manual. The amendment adds language relating to investment companies to Article III, Section 35 of the Rules of Fair Practice, as set forth below, and deletes the Guidelines Regarding Communications With the Public About Investment Companies and Variable Contracts published at ¶5286 of the NASD Manual. The amendments are effective July 1, 1993. The text of the amendments follows this Notice.

Background

On April 30, 1993, the SEC approved an amendment to the NASD's rules codifying several of the Guidelines Regarding Communications With the Public About Investment Companies and Variable Contracts published at ¶5286 of the NASD Manual (Guidelines). The amendment deletes the Guidelines and amends Article III, Section 35 of the Rules of Fair Practice.

The Guidelines were adopted by the NASD® in 1982 following the SEC's 1979 repeal of its Statement of Policy on Investment Company Sales Literature and are set forth at ¶5286 of the NASD Manual. When the SEC amended Rule 482 under the Securities Act of 1933 and Rule 34b-1 under the Investment Company Act of 1940 relating to the communication of investment company performance to the public, many of the provisions of the Guidelines were rendered obsolete.

Accordingly, in the amendment approved by the SEC, the NASD has rescinded the Guidelines and amended Article III, Section 35 of the Rules of Fair Practice by adding those provisions of the Guidelines that imposed general standards for communications and certain specific standards for communications concerning claims of tax free or tax exempt returns, comparisons, and predictions and projections. The amended provisions apply to advertisements for all types of investments, while the Guidelines applied only to investment company and variable contract products.

New Subsection 35(d)(1)(D) incorporates the entire provision set forth as "General Considerations," currently included in the first section of the Guidelines, under the Section 35 provision that imposes general "Standards Applicable to Communications With the Public." The first standard under new paragraph 35(d)(1)(D)(i) relates to the overall context of a statement and requires members to consider that a statement may be misleading in one context while being perfectly appropriate in another context. The principal test of this standard is whether the statement adequately balances the potential risks with the potential benefits. This provision is identical to the language currently contained in the Guidelines.

The standard set forth in new paragraph 35(d)(1)(D)(ii) relates to the importance of the target audience as a factor in evaluating the communication. The provision requires varying levels of explanation or detail in a communication depending on the audience and the member's ability to restrict the communication to the intended audience. Members are required to consider the likelihood that the communication could be received by persons for whom the explanations or information are inadequate or misleading. This provision incorporates rule language identical to that currently contained in the Guidelines.

The standard set forth in new paragraph 35(d)(1)(D)(iii) requires all statements in communications to be made clearly and cautions against complex or overly technical explanations, and the inclusion of material information in legends or footnotes. This provision incorporates rule language identical to that currently contained in the Guidelines.

New Subsections 35(d)(2)(L), (M), and (N) incorporate a number of concepts contained in other parts of the Guidelines into the requirements set forth as "Specific Standards" for communications with the public in Section 35. Subsection 35(d)(2)(L) prohibits members from stating that an investment is "tax free" or "tax exempt" if income tax liability is merely postponed or deferred, and requires that if there are references to tax free/tax exempt current income or if income taxes are payable on redemption, those facts and any applicable income taxes must be adequately disclosed. The rule language of this provision is drawn from the last paragraph of the section in the Guidelines titled "4. Specific Considerations in Presenting Yield Data or Illustrations."

Subsection 35(d)(2)(M) requires members, when using comparisons, to ensure that the comparisons are clear, fair, balanced, and include any material differences between the subjects of the comparison such as liquidity, safety, investment objectives, and fees, among others. The rule language of this provision is drawn from the first three paragraphs of the section in the Guidelines titled "5. Considerations Regarding Comparisons."

Subsection 35(d)(2)(N) prohibits members from predicting or projecting future performance on any basis, including past performance. Hypothetical illustrations of mathematical principles such as dollar cost averaging, however, are not considered projections of performance. The rule language of this provision is based on that included in the section in the Guidelines titled "Adequacy of Information Concerning the Relevance of Results Illustrated to Probable Future Results."

The amendments are effective July 1, 1993. Questions concerning this Notice may be directed to the NASD's Advertising Regulation Department at (202) 728-8330, or to Elliott R. Curzon, Senior Attorney, Office of General Counsel, (202) 728-8451.

Text of Amendment to Article III, Section 35 of the Rules of Fair Practice

(Note: New text is underlined.)

Communications With the Public

Sec. 35.

* * * * *

(d) Standards Applicable to Communications With the Public
(1) General Standards

* * * * *
(D) In judging whether a communication or a particular element of a communication may be misleading, several factors should be considered, including but not limited to:
(i) The Overall Context in Which the Statement or Statements Are Made: A statement made in one context may be misleading even though such a statement could be perfectly appropriate in another context. An essential test in this regard is the balance of treatment of risks and potential benefits.
(ii) The Audience to Which the Communication Is Directed: Different levels of explanation or detail may be necessary depending on the audience to which a communication is directed, and the ability of the member given the nature of the media used, to restrict the audience appropriately. If the statements made in a communication would be applicable only to a limited audience, or if additional information might be necessary for other audiences, it should be kept in mind that it is not always possible to restrict the readership of a particular communication.
(iii) The Overall Clarity of the Communication: A statement or disclosure made in an unclear manner obviously can result in a lack of understanding of the statement, or in a serious misunderstanding. A complex or overly technical explanation may be worse than too little information. Likewise material disclosure relegated to legends or footnotes realistically may not enhance the reader's understanding of the communication.
(2) Specific Standards

In addition to the foregoing general standards, the following specific standards apply:

* * * * *
(L) Claims of Tax Free/Tax Exempt Returns: Income or investment returns may not be characterized as tax free or exempt from income tax where tax liability is merely postponed or deferred. If taxes are payable upon redemption, that fact must be disclosed. References to tax free/tax exempt current income must indicate which income taxes apply or which do not unless income is free from all applicable taxes. For example, if income from an investment company investing in municipal bonds may be subject to state or local income taxes, this should be stated, or the illustration should otherwise make it clear that income is free from federal income tax.
(M) Comparisons: In making a comparison, either directly or indirectly, the member must make certain that the purpose of the comparison is clear and must provide a fair and balanced presentation, including any material differences between the subjects of comparison. Such differences may include investment objectives, sales and management fees, liquidity, safety, guarantees or insurance, fluctuation of principal and/or return, tax features, and any other factors necessary to make such comparisons fair and not misleading.
(N) Predictions and Projections:Investment results cannot be predicted or projected. Investment performance illustrations may not imply that gain or income realized in the past will be repeated in the future. However, for purposes of this rule, the following types of information are not considered projections of performance; hypothetical illustrations of mathematical principles, (e.g., illustrations designed to show the effects of dollar cost averaging, tax-free compounding, or the mechanics of variable annuity contracts or variable life policies).

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