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95-74 SEC Approves Amendments To Advertising And Sales Literature Filing And Review Requirements

SUGGESTED ROUTING

Senior Management
Advertising
Government Securities
Legal & Compliance

Executive Summary

On August 9, 1995, the Securities and Exchange Commission (SEC) approved amendments to Article III, Section 35 of the NASD® Rules of Fair Practice and Section 8 of the Government Securities Rules (collectively, the Rules) to broaden the definitions of, and revise the approval and filing requirements for, advertising and sales literature.1 The amendments also revise the rules relating to recommendations in communications with the public. The amendments became effective on August 9, 1995.

Background And Description Of Amendments

Article III, Section 35 of the Rules of Fair Practice and Section 8 of the Government Securities Rules govern members' communications with the public regarding general securities and government securities, respectively. The Rules contain definitions, internal approval and recordkeeping requirements, and filing requirements and standards applicable to the content of such communications. To codify existing rule interpretations, rectify inconsistencies, and clarify issues that have been the source of member misunderstanding, the NASD is amending the Rules to revise the definitions of, and the internal approval and timeliness of filing requirements for, advertising and sales literature and the scope of rules relating to "Recommendations."

Amendments To Definitions

The NASD is amending the definitions of "Advertisement" and "Sales Literature" in Article III, Subsections 35(a)(1) and (2) of the Rules of Fair Practice and Subsections 8(a)(1) and (2) of the Government Securities Rules to include electronic messages. The NASD has consistently applied its standards for communications with the public to electronic messages sent via computer. Thus, the inclusion of the term "electronic" in the definition of "Advertisement" clarifies the applicability of the Rules to communications available to all computer or electronic network subscribers, including items displayed over network bulletin boards. The new definition of "Advertisement" does not, however, include communications posted by members of the public on electronic bulletin boards sponsored by NASD members; it has never applied to communications by the general public.

The inclusion of the term "electronic" in the definition of "Sales Literature" is intended to clarify the applicability of the Rules to messages sent directly to targeted individuals or groups. The new definition of "Sales Literature" does not, however, include a personalized message sent to a particular individual via electronic mail. Such messages are not treated as sales literature but generally as correspondence under Article III, Section 27(d) of the Rules of Fair Practice.2

The NASD is also amending the definition of "Sales Literature" in Article III, Subsection 35(a)(2) of the Rules of Fair Practice and Subsection 8(a)(2) of the Government Securities Rules to include telemarketing scripts. Members often file telemarketing scripts for review with the NASD Advertising Regulation Department that are to be read to prospects and existing customers or delivered electronically through a telemarketing service. These scripts differ from other forms of telephone prospecting and customer contact in that they are always followed up by the caller or callers. The NASD considers these scripts as comparable to a form letter delivered orally and, by including them in the definition, believes it will reduce confusion among members and promote more consistent application of the Rules.

Member Review Of Advertising And Sales Literature

The NASD is also amending Article III, Subsection 35(b)(1) of the Rules of Fair Practice and Subsection 8(b)( 1) of the Government Securities Rules to require that each item of advertising and sales literature be approved internally before use only by a registered principal. Before these amendments, the Rules allowed a registered principal to perform the review or delegate this responsibility to a designee. The Rules contained no guidelines for the level of experience, expertise, or qualification that the designee must have to assume this compliance responsibility and, in some cases, individuals less qualified than principals have been designated by registered principals to provide internal approval. The amendments eliminate the potential for inconsistent internal standards applied by different members for the review of communications with the public.

The NASD is also amending Article III, Subsection 35(b)(1) of the Rules of Fair Practice and Subsection 8(b)(1) of the Government Securities Rules to require that advertising and sales literature be approved internally by members before being filed with the NASD Advertising Regulation Department. Before these amendments, the Rules for review of advertisements and sales literature required that the material be approved internally by the member before first use, but did not require that material be approved internally by the member before being filed with the NASD. Some members have acknowledged that their internal review sometimes occurs after the NASD response is received. This practice places the NASD in the role of providing the initial compliance review, a role that should, in the NASD's view, be maintained within the member firms' compliance departments. The amendments will ensure that members submit material that conforms to the applicable Rules. It is anticipated that the amendments will reduce the amount of refiling requested by the NASD Advertising Regulation Department due to extensive deficiencies in the original filings.

Filing Requirements

The NASD is also amending Article III, Subsections 35(c)(1), (2), (3)(A), and (4) to the Rules of Fair Practice and Subsections 8(c)( 1)(A) and (B), (c)(2), and (c)(3) of the Government Securities Rules to require that where filings are required to be submitted with certain time frames, the member provide the actual or expected date of first use or publication of the item filed. Before these amendments, the rules required that material be filed within 10 days of first use or 10 days before use, depending on the status of the firm and the subject matter of the communication. Members would file communications for review in various stages of a document's production, ranging from first drafts to finished products, and it was often impossible to determine the date of first use unless the information was provided voluntarily by the member or requested by the NASD reviewer. Because of the extensive volume of filings the NASD Advertising Regulation Department reviews each month, it is impractical to contact members routinely and request that they provide the date of use for each piece filed and, consequently, the NASD has been unable to determine systematically if member firms were meeting their filing obligations. The amendments will enable the NASD to enforce the existing Rules more effectively and consistently.

In addition, the NASD is deleting Article III, Subsection 35(c)(3)(B) to the Rules of Fair Practice. This provision was always intended to be temporary in that it applied the pre-filing requirements of Subsection 35(c)(3)(A) for one year to those firms that had been filing advertisements for less than one year when the pre-filing provisions became effective. The provision ensured that such firms continued to pre-file advertisements for at least one year from the date their first advertisements were filed. As such, the provision became obsolete one year from its effective date.

Standard For Recommendations

Finally, the NASD is amending Article III, Subsection 35(d)(2)(B) to the Rules of Fair Practice and Subsection 8(d)(2)(B) to the Government Securities Rules to specify that the requirement to disclose the price of a security applies only to communications on behalf of corporate equities and to delete the price disclosure requirement entirely from the Government Securities Rules. Before these amendments, the literal language of the Rules would have required price disclosure with respect to all securities products in all communications deemed to be recommendations. However, the NASD has a longstanding practice of not requiring price disclosure on communications for securities products other than corporate equities. Nevertheless, both the Rules of Fair Practice and the Government Securities Rules prohibit members from omitting material information in communications with the public. Therefore, if inclusion of the price of the security is necessary to make the material not misleading, then the member is required to include the price.

Questions regarding this Notice may be directed to Thomas Pappas, Assistant Director, Advertising/ Investment Companies Regulation Department, at (202) 728–8330, and Robert J. Smith, Attorney, Office of General Counsel, at (202) 728–8176.


1 See, Securities Exchange Act Rel. No. 36076 (August 9, 1995).

2 Such personalized electronic correspondence is also distinguished from interactive electronic conversations, either through direct links or so-called "chat rooms." Interactive conversations will not generally be regarded as correspondence; however, members should be aware that such "conversations" can easily be recorded or reduced to hard copy. Finally, all communications, whether advertising, sales literature, correspondence, or conversations, regardless of the medium, are subject to the anti-fraud provisions of the federal securities laws, SEC rules, and the rules of the NASD.


Text Of Amendments To Article III, Section 35 Of The Rules Of Fair Practice And Section 8 Of The Government Securities Rules

(Note: New text is underlined; deletions are bracketed.)

ARTICLE III Rules of Fair Practice

Sec. 1 through 34 No change.

Communications With the Public

Sec. 35.

(a) Definitions
(1) Advertisement—For purposes of this section and any interpretation thereof, "advertisement" means material published, or designed for use in, a newspaper, magazine or other periodical, radio, television, telephone or tape recording, videotape display, signs or billboards, motion pictures, telephone directories (other than routine listings), electronic or other public media.
(2) Sales literature—For purposes of this section and any interpretation thereof, "sales literature" means any written or electronic communication distributed or made generally available to customers or the public, which communication does not meet the foregoing definition of "advertisement." Sales literature includes, but is not limited to, circulars, research reports, market letters, performance reports or summaries, form letters, telemarketing scripts, seminar texts, and reprints or excerpts of any other advertisement, sales literature or published article.
(b) Approval and Recordkeeping
(1) Each item of advertising and sales literature shall be approved by signature or initial, prior to use or filing with the NASD, by a registered principal f (or his designee)] of the member.
(2) No change.
(c) Filing Requirements and Review Procedures
(1) Advertisements and sales literature concerning registered investment companies (including mutual funds, variable contracts and unit investment trusts) not included within the requirements of Subsection (c)(2) of this section, 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 Regulation Department within 10 days of first use or publication by any member. The member must provide with each filing the actual or anticipated date of first use. 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. Any member filing any investment company advertisement or sales literature pursuant to this Subsection that includes or incorporates rankings or comparisons of the investment company with other investment companies shall include a copy of the ranking or comparison used in the advertisement or sales literature.
(2) Advertisements concerning collateralized mortgage obligations registered under the Securities Act of 1933, and advertisements and sales literature concerning registered investment companies (including mutual funds, variable contracts and unit investment trusts) that include or incorporate rankings or comparisons of the investment company with other investment companies where the ranking or comparison category is not generally published or is the creation, either directly or indirectly, of the investment company, its underwriter or an affiliate, shall be filed with the Association's Advertising Regulation 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], if expressly disapproved, until the advertisement has been refiled for, and has received, Association approval. The member must provide with each filing the actual or anticipated date of first use. Any member filing any investment company advertisement or sales literature pursuant to this Subsection shall include a copy of the data, ranking or comparison on which the ranking or comparison is based.
(3)
(A) Each member of the Association which has not previously filed advertisements with the Association (or with a registered securities exchange having standards comparable to those contained in this section) shall file its initial advertisement with the Association's Advertising Department at least ten days prior to use and shall continue to file its advertisements at least ten days prior to use for a period of one year. The member must provide with each filing the actual or anticipated date of first use.
(B) [Each member which, on the effective date of this section, had been filing advertisements with the Association (or with a registered securities exchange having standards comparable to those contained in this section) for a period of less than one year shall continue to file its advertisements, at least ten days prior to use, until the completion of one year from the date the first advertisement was filed with the Association or such exchange.]
[(C)] Except for advertisements related to municipal securities, direct participation programs or investment company securities, members subject to the requirements of subparagraphs (c)(3)(A) or (c)(3)(B) of this section may, in lieu of filing with the Association, file advertisements on the same basis, and for the same time periods specified in those subparagraphs, with any registered securities exchange having standards comparable to those contained in this section.
(4) Notwithstanding the foregoing provisions, any District Business Conduct Committee of the Association, upon review of a member's advertising and/or sales literature, and after determining that the member has departed and there is a reasonable likelihood that the member will again depart from the standards of this section, may require that such member file all advertising and/or sales literature, or the portion of such member's material which is related to any specific types or classes of securities or services, with the Association's Advertising Department and/or the District Committee, at least ten days prior to use. The member must provide with each filing the actual or anticipated date of first use.

The Committee shall notify the member in writing of the types of material to be filed and the length of time such requirement is to be in effect. The requirement shall not exceed one year, however, and shall not take effect until 30 days after the member receives the written notice, during which time the member may request a hearing before the District Business Conduct Committee, and any such hearings shall be held in reasonable conformity with the hearing and appeal procedures of the Code of Procedure.
(5) through (7) No change.
(d) Standards Applicable to Communications With the Public
(1) No change.
(2) Specific Standards

In addition to the foregoing general standards, the following specific standards apply:
(A) No change.
(B) Recommendations: In making a recommendation, whether or not labeled as such, a member must have a reasonable basis for the recommendation and must disclose [the price at the time the recommendation is made, as well as] any of the following situations which are applicable:
(i) that the member usually makes a market in the securities being recommended, or in the underlying security if the recommended security is an option, and/or that the member or associated persons will sell to or buy from customers on a principal basis;
(ii) that the member and/or its officers or partners own options, rights or warrants to purchase any of the securities of the issuer whose securities are recommended, unless the extent of such ownership is nominal;
(iii) that the member was manager or co-manager of a public offering of any securities of the recommended issuer within the last 3 years.
The member shall also provide, or offer to furnish upon request, available investment information supporting the recommendation. Recommendations on behalf of corporate equities must provide the price at the time the recommendation is made.

A member may use material referring to past recommendations if it sets forth all recommendations as to the same type, kind, grade or classification of securities made by a member within the last year. Longer periods of years may be covered if they are consecutive and include the most recent year. Such material must also name each security recommended and give the date and nature of each recommendation (e.g., whether to buy or sell), the price at the time of the recommendation, the price at which or the price range within which the recommendation was to be acted upon, and indicate the general market conditions during the period covered.

Also permitted is material which does not make any specific recommendation but which offers to furnish a list of all recommendations made by a member within the past year or over longer periods of consecutive years, including the most recent year, if this list contains all the information specified in the previous paragraph. Neither the list of recommendations, nor material offering such list, shall imply comparable future performance. Reference to the results of a previous specific recommendation, including such a reference in a follow-up research report or market letter, is prohibited if the intent or the effect is to show the success of a past recommendation, unless all of the foregoing requirements with respect to past recommendations are met.
(C) through (N) No change.

GOVERNMENT SECURITIES RULES

Sec. 1 through Sec. 7 No change.

Communications With the Public

Sec. 8

(a) Definitions
(1) Advertisement—For purposes of this section and any interpretation thereof, "advertisement" means material published, or designed for use in, a newspaper, magazine or other periodical, radio, television, telephone or tape recording, videotape display, signs or billboards, motion pictures, telephone directories (other than routine listings), electronic or other public media.
(2) Sales Literature—For purposes of this section and any interpretation thereof, "sales literature" means any written or electronic communication distributed or made generally available to customers or the public that does not meet the foregoing definition of "advertisement." Sales literature includes, but is not limited to, circulars, research reports, market letters, performance reports or summaries, form letters, standard forms of option worksheets, telemarketing scripts, seminar texts, and reprints or excerpts of any other advertisement, sales literature, or published article.
(b) Approval and Recordkeeping
(1) Each item of advertising and sales literature shall be approved by signature or initial, prior to use or filing with the NASD, by a registered principal [(or designee)] of the member.
(2) No change.
(c) Filing Requirements and Review Procedures
(1) Members shall file advertisements for review with the Association's Advertising Regulation Department as follows:
(A) Advertisements containing 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 within 10 days of first use or publication; and
(B) advertisements concerning collateralized mortgage obligations shall be filed with the Association's Advertising Regulation 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] if expressly disapproved, until the advertisement has been refiled for, and has received, Association approval. The member must provide with each filing concerning government securities and collateralized mortgage obligations the actual or anticipated date of first use.
(2) 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. The member must provide with each filing the actual or anticipated date of first use.
(3) Notwithstanding the foregoing provisions, any District Business Conduct Committee of the Association, upon review of a member's government securities advertising and/or sales literature, and after determining that the member will again depart from the standards of this section, may require that such member file all government securities advertising and/or sales literature, or the portion of such member's material that is related to any specific types or classes of securities or services, with the Association's Advertising Department and/or the District Committee, at least 10 days prior to use. The member must provide with each filing the actual or anticipated date of first use.

The Committee shall notify the member in writing of the types of material to be filed and the length of time such requirement is to be in effect. The requirement shall not exceed one year, however, and shall not take effect until 30 days after the member receives the written notice, during which time the member may request a hearing before the District Business Conduct Committee, and any such hearings shall be held in reasonable conformity with the hearing and appeal procedures of the Code of Procedure.
(4) through (5) No change.
(d) Standards Applicable to Communications With the Public
(1) No change.
(2) Specific Standards

In addition to the foregoing general standards, the following specific standards apply:
(A) No change.
(B) Recommendations: In making a recommendation, whether or not labeled as such, a member must have a reasonable basis for the recommendation made and must disclose [the price at the time the recommendation is made, as well as] any of the following situations which are applicable:
(i) through (iii) No change.

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