The self-regulatory organization has filed with the Securities and Exchange Commission (SEC) a proposed rule change allowing broker-dealers to provide projections of performance in institutional communications and specified communications to qualified purchasers.
More specifically, the proposal (SR-FINRA-2023-016) released Nov. 13 seeks to amend FINRA Rule 2210 (Communications with the Public) to allow a member to project the performance or provide a targeted return with respect to a security or asset allocation or other investment strategy in an institutional communication or a communication distributed solely to qualified purchasers (QPs) who have at least $5 million in investments.
Rule 2210 currently prohibits projections of performance or targeted returns in member communications, subject to specified exceptions. The general prohibition against performance projections is intended to protect investors who may lack the capacity to understand the risks and limitations of using projected performance in making investment decisions.
FINRA notes that the proposed changes are, in many respects, consistent with the SEC’s investment adviser marketing rule, which permits advisers to present hypothetical performance, including “targeted or projected performance returns with respect to any portfolio or to the investment advisory services with regard to the securities offered” in an advertisement if the investment adviser meets specified conditions and does not violate the marketing rule’s other requirements.
As to the need for an additional exception, FINRA understands that some broker-dealer customers—in particular institutional investors—request other types of projected performance that the current rules do not allow. “Because Rule 2210 generally precludes a member from providing projected performance or targeted returns in marketing communications distributed to institutional investors and QPs, these investors cannot obtain a member’s potentially different and valuable perspective,” the self-regulatory organization explains.
For example, projected performance may be useful for institutional investors and QPs that have either financial expertise to evaluate investments or that have resources that provide them with access to financial professionals who possess this expertise.[1] Such investors often test their own opinions against performance projections they receive from other sources, including issuers and investment advisers, the proposal further notes.
Proposed Amendments
As such, the proposed rule change is narrowly tailored to address the need for projections or targeted returns by restricting their use only in specified scenarios involving institutional investors or QPs.
First, the proposed rule change would permit institutional communications to include projections of performance or targeted returns. An 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.
Second, the proposed rule change would permit projected performance and targeted returns in communications that are distributed or made available only to QPs and that promote or recommend a private placement that is sold solely to QPs.
Even within these narrow circumstances, the proposed rule change would impose additional investor protection obligations. To that end, the proposal explains that the exception would be conditioned on:
- the member adopting and implementing written policies and procedures reasonably designed to ensure that the communication is relevant to the likely financial situation and investment objectives of the investor receiving the communication and to ensure compliance with all applicable requirements and obligations;
- the member having a reasonable basis for the criteria used and assumptions made in calculating the projected performance or targeted return, and retaining written records supporting the basis for these criteria and assumptions;
- the communication prominently disclosing that the projected performance or targeted return is hypothetical in nature and that there is no guarantee that the projected or targeted performance will be achieved; and
- the member providing sufficient information to enable the investor to understand (i) the criteria used and assumptions made in calculating the projected performance or targeted return, including whether the projected performance or targeted return is net of anticipated fees and expenses; and (ii) the risks and limitations of using the projected performance or targeted return in making investment decisions, including reasons why the projected performance or targeted return might differ from actual performance.
Not Applicable
As a general matter, the proposed rule change would not alter the current prohibitions on including projections of performance or targeted returns in most types of retail communications, the summary explanation notes.
In addition, even in situations where a natural person qualifies as an institutional investor or QP, the SEC’s Regulation Best Interest would still require members to act in the investor’s best interest when making a recommendation of a securities transaction or investment strategy involving securities, regardless of whether a projection is used as a basis for the recommendation.
What’s more, FINRA notes that the proposed amendments to Rule 2210 would not impact members that are required to provide annual lifetime income disclosures in retirement plan benefit statements, as required by ERISA under amendments made by the SECURE Act. In this regard, FINRA historically has interpreted Rule 2210’s filing and content standards as not applying to communications that are required by other regulatory agencies, including communications required by DOL rules.
What’s Next?
Under FINRA’s rulemaking process, the SEC staff will now review the proposal to determine whether it is consistent with the requirements of the Securities Exchange Act of 1934. The SEC will then file a notice of the proposal in the Federal Register with a request for public comment. Depending on the comments received, the SEC staff typically requests that FINRA respond to the comments. FINRA may then decide to propose amendments to the proposal as a result of the comments.
If the commission approves the proposed rule change, FINRA will announce the implementation date in a regulatory notice.
[1] Rule 2210 provides that an “institutional investor” includes, among others, a qualified plan or multiple qualified plans offered to employees of the same employer, that in the aggregate have at least 100 participants, but does not include any participant of such plans.
