After much debate and public comment, the Securities and Exchange Commission (“SEC”) has approved the Financial Industry Regulatory Authority’s (“FINRA”) proposed revisions to its rules on Communications with the Public.1 The new rules, first proposed in 2009, are set to become effective on February 4, 2013.2 While the rules make several important changes to the regulatory scheme surrounding communications with the public, many of the existing provisions remain unchanged. This Alert will focus on the primary changes from the old rules to the new.
Reorganization of Rules and Categories
New FINRA Rule 2210 will replace the current NASD Rules 2210 and 2211, Interpretive Materials 2210-1 and 2210-4, and certain provisions of Incorporated NYSE Rule 472. The remaining Interpretive Materials that follow NASD Rule 2210, with the exception of IM-2210-2, will be replaced by FINRA Rules 2212 through 2216. New FINRA Rule 2210 is nearly identical to the version that incorporated FINRA’s December 2011 amendments, which we discussed in a Client Alert dated January 3, 2012.3
The biggest change in the new rules is reducing the categories of communications from six to three. The current rules use six categories: advertisements, sales literature, correspondence, institutional sales material, independently prepared reprints, and public appearances.4 In the new rules those six categories will be replaced by only three: correspondence, retail communications, and institutional communications.
“Correspondence” is “any written (including electronic) communication that is distributed or made available to 25 or fewer retail investors within any 30 calendar-day period.”5
“Retail communication” is “any written (including electronic) communication that is distributed or made available to more than 25 retail investors within any 30 calendar-day period.”6
A “retail investor” is defined as “any person other than an institutional investor, regardless of whether the person has an account with a member.”7
“Institutional communication” is “any written (including electronic) communication that is distributed or made available only to institutional investors, but does not include a member’s internal communications.”8
In general, communications that currently would be considered sales literature or advertisements will be considered “retail communications” under the new rules, as will communications that currently qualify as independently prepared reprints if they are distributed to more than 25 retail investors within a 30 calendar-day period. The definition of “institutional investor” remains largely unchanged from the current rule.9 It is important for clients to examine and reassess their policies and procedures in light of the new communications categories, and to make sure they are compliant with the new rules.
We will look at each of these categories in turn.
Correspondence v. Retail Communications
The changes to the definition of correspondence will have a substantial impact on determining whether a particular communication fits within this category or must instead be classified as a retail communication. The new rule expands the definition of correspondence from written letters, email messages, and market letters to any type of written communication, but narrows the definition to include only those communications that are made available to 25 or fewer retail investors in any 30 calendar-day period.10 Importantly, the rule also eliminates the distinction between existing and prospective retail customers. If a firm distributes any written communication to more than 25 retail investors in a 30 calendar-day period, regardless of whether they are current or prospective customers, the communication is a “retail communication,” not correspondence. Written communications that are sent or given to 25 or fewer retail investors in a 30 calendar-day period—even if some or all of them are not current customers—will be treated as correspondence under the new rule.
Communications that currently qualify as “institutional sales material” will generally be considered “institutional communications” under the new rule.11 The definition of institutional communication explicitly excludes “a member’s internal communications,” meaning that a firm’s internal communications are not subject to the rule since they do not fit within the definitions of correspondence or retail communications and they are specifically carved out of the definition of institutional communications. In its Regulatory Notice FINRA advised, however, that NASD Rule 3010 still requires firms to supervise their internal communications, including internal communications to train and educate registered representatives, which in FINRA’s view effectively amounts to the same or similar conduct standards as the communications rule when combined with other applicable rules, such as FINRA Rule 2010, on just and equitable principles of trade.12 Moreover, FINRA warned that internal communications regarding sales scripts to be used with retail investors will likely be considered retail communications, not institutional communications.13
The rule also states that “[n]o member may treat a communication as having been distributed to an institutional investor if the member has reason to believe that the communication or any excerpt thereof will be forwarded or made available to any retail investor.”14 While this provision is contained in the current rule, FINRA, in the Regulatory Notice, provided some clarification regarding the “reason to believe” standard.15 It “does not impose an affirmative obligation on firms to inquire whether an institutional communication will be forwarded to retail investors every time such a communication is distributed.”16 Firms should have policies and procedures in place that are reasonably designed to prevent institutional communications from being forwarded to retail investors. Such procedures can include using legends indicating that communication is for institutional investors only.17 However, when a firm receives notice that particular institutional investors are forwarding institutional communications to retail investors, the firm “must treat future communications to such institutional investors as retail communications until it reasonably concludes that the improper practice has ceased.”18 In practical terms, this means ceasing the distribution of institutional communications to the offending institutional investor.
Similar to the current treatment of advertisements and sales literature, FINRA Rule 2210(b)(1)(A) will require that an “appropriately qualified registered principal of the member . . . approve each retail communication before the earlier of its use or filing with FINRA’s Advertising Regulation Department.” A Series 16 supervisory analyst can approve research reports on debt and equity securities, as well as the retail communications described in NASD Rule 2711(a)(9), “and other research that does not fall within NASD Rule 2711’s definition of ‘research report,’ provided that the supervisory analyst has technical expertise in the particular product area.”19
The new rule maintains several exceptions to the preapproval requirement for:
• Retail communications another firm filed with FINRA and FINRA approved as long as the firm does not materially alter the communication.20
• Market letters.21
• “[A]ny retail communication that is posted on an online electronic forum.”22
• “[A]ny retail communication that does not make any financial or investment recommendation or otherwise promote a product or service of the firm.”23
As is currently the case, these last three communications under the new rule will still need to be supervised as if they are correspondence. While these materials do not necessarily need to be preapproved, firms must have and enforce policies regarding their creation and must train their personnel to comply with regulatory and firm requirements. The supervision and review standards for correspondence and institutional communications will generally remain the same.24
For new member firms, the rules will make slight changes to the initial filing requirements. The one-year period for filing retail communications with FINRA prior to use will begin on the date that the firm’s FINRA membership became effective, according to the firm’s CRD.25 This year-long filing requirement is limited to “broadly disseminated retail communications, such as generally accessible websites, print media communications, and television and radio commercials.”26
Prior to Use
The rule also makes some minor revisions to the communications that must be filed with FINRA before use. In the new rule there are three types of retail communications that will need to be filed with FINRA at least 10 business days prior to first use: (1) communications concerning registered investment companies that include self-created rankings; (2) communications regarding securities futures; and (3) communications that include bond mutual fund volatility ratings.27 Firms will no longer be required to file retail communications regarding collateralized mortgage obligations before first use.
Within 10 Days of First Use
The changes regarding the communications that need to be filed within 10 business days of first use are somewhat more extensive. The rule keeps the requirements for filing of retail communications regarding public direct participation programs and templates for investment analysis tools.
The new rule, however, modifies the filing requirement as it applies to registered investment companies.28 While the existing rule defines registered investment companies as “mutual funds, variable contracts, continuously offered close-end funds and unit investment trusts,” the new rule contains no similar limitation, effectively extending coverage to retail communications concerning closed-end funds, including those distributed after the fund’s IPO period.29
The rule adds a new required filing category for publicly offered structured or derivative products.30 There is no analogous provision under the current rule. As noted above, while CMO advertisements currently must be filed before first use, retail communications concerning registered CMOs will only need to be filed within 10 days of first use.31
Finally, although advertisements regarding government securities currently must be filed within 10 days of first use, retail communications concerning government securities will no longer have to be filed with FINRA once the new rule takes effect.32
Exclusions from Filing Requirements
The new rule generally carries forward the exclusions from the filing requirements found in the current rule, with some modifications. For instance:
• The new rule adds an exclusion for retail communications based on templates that were previously filed with FINRA where the changes are limited to updating statistical or “other non-narrative information.”33
• The new rule eliminates the exclusion for advertisements or sales literature regarding a firm’s recruitment, changes to the firm’s name, and the like, but adds a more general exclusion for retail communications that “do not make any financial or investment recommendation or otherwise promote a product or service of the member.”34
• Consistent with the current rule, the new rule excludes from its filing requirements prospectuses, fund profiles, and similar documents that have been filed with the SEC or any state, but not investment company “omitting prospectuses” published pursuant to Securities Act Rule 482 or free writing prospectuses that are filed with the SEC pursuant to Securities Act Rule 433(d)(1)(ii).35
• The new rule keeps the approval and filing exception for retail communications that have been filed with and approved by FINRA.36
• While postings on an electronic forum are now considered retail communications (rather than public appearances as in the current rule), such communications are excluded from the filing requirements.37
The new rule continues the same general content standards as the current rule. For instance, communications “must be based on principles of fair dealing and good faith, [and] must be fair and balanced.”38 Additionally, members cannot “make any false, exaggerated, unwarranted, promissory or misleading statement.”39 Like other portions of the rule, the content standards that currently apply to sales literature and advertisements have been incorporated into the standards for retail communications.40
The new rule also, with only minor changes, preserves other elements of the current content standards:
• The new rule preserves the current rule’s prohibition against predictions or projections of performance, and continues to allow hypothetical illustrations of mathematical principles, while it clarifies the use of two further types of projections.41 The new rule expressly permits projections in reports produced by an investment analysis tool that meets the requirements of FINRA Rule 2214 (currently NASD IM-2210-6) and price targets in research reports on debt or equity securities, “provided that the price target has a reasonable basis, the report discloses the valuation methods used . . . and the price target is accompanied by disclosure concerning the risks that may impede achievement of the price target.”42
• The new rule also continues existing requirements that correspondence and retail communications prominently disclose the firm’s name, reflect any relationship between the member and any non-member or individual who is also named in the communication, and reflect which products or services are being offered by the member if the communication contains other names.43
• The disclosures required in sales literature or advertisements that include a testimonial have also been carried forward for retail communications and correspondence.44 However, the firm must disclose if it is using a paid testimonial and it paid more than $100, replacing the current “nominal sum” standard.45
• The requirements for retail communications that contain a recommendation have been altered in one potentially significant way. The current rule requires disclosure if “the member and/or its officers or partners have a financial interest in the securities of the recommended issuer.”46 Under the new rule, disclosure of the financial interest must be made only if “the member or any associated person that is directly and materially involved in the preparation of the content of the communication has a financial interest in any of the securities of the issuer whose securities are recommended.”47 This narrowing of the disclosure requirements will likely have a significant effect on the disclosures required of larger firms.
• The rule also replaces the current standards regarding communications containing past recommendations. The new rule mirrors the standards found in Investment Advisers Act Rule 206(4)-1(a)(2).48 Generally, a “retail communication or correspondence may not refer, directly or indirectly, to past specific recommendations . . . that were or would have been profitable to any person.”49 However, the retail communication “may set out or offer to furnish a list of all recommendations as to the same type . . . of securities made by the member within the immediately preceding period of not less than one year,” with certain stipulations.50
Under the new rule, public appearances will no longer be a separate category of communications. However, the new rule contains provisions specific to public appearances. Although the public appearance itself is not considered a communication, associated persons making a public appearance must abide by the general content standards that apply to all other communications.51 The rule also contains specific provisions regarding recommendations made during public appearances and requires members to “establish written procedures . . . to supervise its associated persons’ public appearances.”52 Finally, scripts, handouts, or other written materials “used in connection with” public appearances are communications under the new rule, and “must comply with all applicable provisions.”53 Whether they are retail communications, institutional communications, or correspondence will depend on who attended the appearance, and, in the case of retail investors, how many of them received these materials.
This Alert has discussed the primary changes to the communications rules that will be a part of FINRA Rule 2210. However, FINRA Rules 2212 through 2216 will replace the Interpretive Materials that follow NASD Rule 2210, with the exception of IM-2210-2. NASD IM-2210-5 covers the use of bond mutual fund volatility ratings and that will become FINRA Rule 2213 without change.54 Likewise, NASD IM-2210-8, which deals with communications regarding CMOs, will become FINRA Rule 2216 with only superficial changes relating to the new categories of communications.55 FINRA Rule 2212 replaces NASD IM-2210-3 regarding the use of investment company rankings in communications and maintains the same standards except for two changes—adding a disclosure requirement regarding the different expense structures of multiple class funds and adding a paragraph to specify that the rule does not apply to certain independently prepared reprints.56
NASD IM-2210-6, which covers the use of investment analysis tools, will map to FINRA Rule 2214. FINRA Rule 2214 generally maintains the same standards as IM-2210-6, but clarifies that the filing timeframe is within 10 “business” days, adds that firms must disclose if the tool in any way favors securities for which the member “serves as underwriter,” and stipulates that certain disclosures must be made in communications that make more than an incidental reference to the tool without providing access to the tool or its results.57
Lastly, FINRA Rule 2215 on securities futures communications will replace NASD IM-2210-7 and revise the applicable standards in several ways. For instance, certain provisions of the current rule that only apply to “securities futures sales literature and correspondence” will apply to the broader “securities futures communications” under the new rule.58 Additionally, securities futures communications need to be accompanied or preceded by the securities futures risk disclosure statement if the communication names specific securities.59 Clients who deal with these types of communications should more closely examine the new rule.
*This alert was co-authored by David Boch, Robert Buhlman, W. Hardy Callcott, Michael Weissmann and Justin Millette.