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92-36 Proposed Amendment to Article III, Section 35 of the NASD's Rules of Fair Practice And Section 8 of the NASD's Government Securities Rules to Require Members to Prefile Advertisements for Collateralized Mortgage Obligations; Last Voting Date: Aug

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MAIL VOTE

EXECUTIVE SUMMARY

The NASD invites members to vote on proposed amendments to Article III, Section 35 of the NASD's Rules of Fair Practice and Section 8 of the NASD's Government Securities Rules to require members to file advertisements pertaining to corporate and government collateralized mortgage obligations (CMOs) for review and approval by the NASD's Advertising Department prior to use or publication. The amendments would take effect immediately on approval by the Securities and Exchange Commission (SEC). However, the rule will be temporary, remaining in effect for one year. The Association will evaluate the efficacy of the rule near the end of the first year and determine whether to extend it permanently. The last voting date is August 21, 1992.

The text of the proposed rule change follows this Notice.

BACKGROUND

The NASD is proposing to amend Article III, Section 35 of the NASD's Rules of Fair Practice and Section 8 of the NASD's Government Securities Rules to require members to file advertisements concerning collateralized mortgage obligations (CMOs) issued by a corporation or an agency of the United States government with the Association prior to use. The requirement would be temporary, lasting for one year. Near the end of the first year, the Association will evaluate the efficacy of the rule and determine whether to continue or eliminate it.

The proposed amendments resulted from the NASD's increasing concern about misleading advertisements for CMOs and an increase in the number of complaints associated with advertisements for CMOs. The NASD believes that CMOs are extremely complex and require full and fair disclosure to assist the investor in understanding them. CMO advertisements generally are brief and emphasize high yields, safety, government guarantees (where applicable), and liquidity. The NASD has found, however, that it is difficult to distinguish between CMOs based on the content of such advertisements. Even though two CMOs have the same underlying collateral, they may differ substantially in their prepayment predictability or volatility. In particular, the terms "interest only" or "principal only" are generally inadequately explained.

As a result of these concerns, the NASD issued Notice to Members 92-27 (May 1992) detailing the problems relating to CMO advertising and recommending that members' CMO advertisements comply with certain standards set forth in the Notice. For example, the NASD believes that an advertisement including the "yield" of a CMO is misleading without disclosure of the prepayment assumption used to calculate the yield and disclosure that the anticipated yield and average life of the security will fluctuate depending on the actual prepayment experience and current interest rates.

The NASD also recommended in Notice to Members 92-27 that CMO advertisements not contain comparisons between CMOs and any other investment vehicles. The NASD is particularly concerned that advertising CMOs as alternatives to certificates of deposit (CDs) falsely implies that CMOs offer the same level of safety and guarantee of interest and principal as do CDs.

The NASD believes that CMO advertisements should be subject to preuse filing to provide NASD staff an opportunity to comment on the fairness and reasonableness of such advertisements prior to use, and to permit potentially misleading advertisements to be identified and withheld from publication. At present, advertisements concerning government securities must be filed with the NASD within 10 days of first use or publication. In addition, advertisements and sales literature concerning registered investment companies and direct participation programs must be filed within 10 days of first use. Advertising and sales literature pertaining to options must be approved in advance of its use or publication.

The NASD believes that a preuse filing requirement for CMO advertisements, similar to the requirement for options advertising, is appropriate, provided that the proposed rule would be effective for one year only. Toward the end of the year, the effect of the rule will be evaluated to determine if sufficient improvements in CMO advertising have been achieved and whether the rule should be repealed or adopted permanently.

DESCRIPTION OF PROPOSED AMENDMENT

The NASD is proposing to amend Article III, Section 35 of the NASD's Rules of Fair Practice to consolidate the current filing requirements with respect to registered investment companies and public direct participation programs set forth in Subsections (c)(1) and (2), respectively, into new Subsection (c)(1). The Association is not proposing to change the requirements regarding registered investment companies and public direct participation programs.

The suggested new requirement with respect to CMO advertising is set forth in proposed new Subsection (c)(2) of Section 35. The new provision would require that all advertisements concerning corporate CMOs be filed with the Association's Advertising Department at least 10 days prior to first use unless the Department permits a shorter period in particular circumstances. The advertisement must be approved prior to use and, if changed or expressly disapproved by the Association, shall be withheld from publication or circulation until any changes specified by the Association have been made.

In the event of disapproval by the Association, the advertisement must be refiled for and have received Association approval prior to publication or circulation. The proposed new provision is similar to that previously adopted with respect to options advertisements and is contained in Subsection (c)(1) to Article III, Section 35 A of the Rules of Fair Practice.

A similar provision is proposed to be adopted as new Subsection 8(c)(1)(B) to the NASD Government Securities Rules with respect to CMOs issued by an agency of the United States government. A technical amendment is also proposed to delete current Subsection 8(c)(2)(B), which applied to the filing of advertisements concerning government securities during the first year of the operation of the Government Securities Rules that were adopted by the NASD in 1989.

REQUEST FOR VOTE

The NASD Board of Governors believes that the proposed amendments to the Rules of Fair Practice and Government Securities Rules are important to prevent misleading advertising and to protect investors with respect to the advertising of CMOs. The Board considers the proposed amendment necessary and appropriate and recommends that members vote their approval. The text of the proposed amendments that require 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 no later than August 21, 1992. The amendment will not be effective until it is filed with and approved by the SEC.

Questions concerning this Notice should be directed to R. Clark Hooper, Director, Advertising, at (202) 728-8330, or Elliott R. Curzon, Office of General Counsel, at (202) 728-8451.

TEXT OF PROPOSED AMENDMENTS TO ARTICLE III, SECTION 35 OF THE RULES OF FAIR PRACTICE AND SECTION 8 OF THE NASD's GOVERNMENT SECURITIES RULES

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

RULES OF FAIR PRACTICE

Communications With the Public

Sec. 35.

* * * * *

(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. Filing in advance of use is recommended. Members are not required to file advertising and sales literature which have previously been filed and which are used without change.]
[(2) Advertising and sales literature concerning public direct participation programs as defined in Article III, Section 34 of the Rules of Fair Practice shall be filed with the Association's Advertising Department for review within 10 days of first use or publication. Filing in advance of use is recommended. Members need not file for review advertising and sales literature which has been filed by the sponsor, general partner or underwriter of the program or by another member.]
(1) Advertisements and sales literature concerning registered investment companies (including mutual funds, variable contracts and unit investment trusts) and public direct participation programs (as defined in Article III, Section 34 of the Rules of Fair Practice) shall be filed with the Association's Advertising Department within 10 days of first use or publication by any member. Filing in advance of use is recommended. Members are not required to file advertising and sales literature which has previously been filed and which is used without change, or which has been filed by the sponsor, general partner or underwriter of the program or by another member.
(2) Advertisements concerning collateralized mortgage obligations registered under the Securities Act of 1933 shall be filed with the Association's Advertising Department for review at least 10 days prior to use (or such shorter period as the Department may allow in particular circumstances) for approval and, if changed or expressly disapproved by the Association, shall be withheld from publication or circulation until any changes specified by the Association have been made or, in the event of disapproval, until the advertisement has been refiled for, and has received, Association approval.

GOVERNMENT SECURITIES RULES

Communications With the Public

Sec. 8

(c) Filing Requirements and Review Procedures
(1) Members shall file advertisements for review with the Association's Advertising Department as follows:
(A) Advertisements concerning government securities (as defined in Section 3(a)(42) of the Securities Exchange Act of 1934) other than collateralized mortgage obligations shall be filed by members with the Association's Advertising Department for review within 10 days of first use or publication; and
(B) Advertisements concerning collateralized mortgage obligations shall be filed with the Association's Advertising Department for review at least 10 days prior to use (or such shorter period as the Department may allow in particular circumstances) for approval and, if changed or expressly disapproved by the Association, shall be withheld from publication or circulation until any changes specified by the Association have been made or, in the event of disapproval, until the advertisement has been refiled for, and has received, Association approval.
(2)
[(A)] Each member of the Association that has not previously filed advertisements with the Association shall file its initial advertisement concerning government securities with the Association's Advertising Department at least 10 days prior to use and shall continue to file its advertisements concerning government securities at least 10 days prior to use for a period of one year.
[(B) Each member that, on the effective date of this section, had been filing advertisements with the Association for a period of less than one year shall continue to file its advertisements concerning government securities at least 10 days prior to use, until the completion of one year from the date the first advertisement was filed with the Association.]

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