Proposed Amendment Regarding Filing of Advertising and Sales Literature for Investment Company Securities; Deadline for Voting: October 3, 1988

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IMPORTANT MAIL VOTE

EXECUTIVE SUMMARY

The NASD invites members to vote on a proposed amendment to Article III, Section 35 of the NASD Rules of Fair Practice.

The amendment would require advertising and sales literature for registered investment company securities to be filed by members with the NASD Advertising Department within 10 days of first use or publication. Currently, the rule requires members that are investment company underwriters to file advertising and sales literature concerning such companies.

The proposed amendment would extend this requirement to all NASD members.

BACKGROUND

Article III, Section 35 of the NASD Rules of Fair Practice regulates members' communications with the public. It requires that all such communications be based on principles of fair dealing and good faith and that they provide a sound basis for evaluating the facts regarding any securities offered by members.

Material facts and qualifications may not be omitted if, in the context of material presented, the omission would make the communication misleading. Exaggerated or misleading statements are prohibited, and members may not publish or distribute any public communication that the member knows or has reason to know contains any untrue statements of material facts or is otherwise false or misleading.

Article III, Section 35 currently requires a member to file all advertisements with the NASD Advertising Department for review 10 days prior to use for one year, commencing with the member's initial advertisement. Under certain circumstances, an NASD District Business Conduct Committee may also require a member to file advertising and/or sales literature with the Advertising Department at least 10 days prior to first use. All members are subject to routine spot-checks of their advertising and sales literature.

Members must also file advertising and sales literature pertaining to direct participation programs within 10 days of first use, and certain options materials must be filed 10 days prior to first use. Also, advertising and sales literature concerning registered investment company securities must be filed within 10 days of first use by members that are underwriters of such companies.

During the past two years, attention has been focused on problems with mutual fund advertising, particularly income fund advertising. The Securities and Exchange Commission (SEC) recently adopted extensive rule amendments governing the presentation of investment company performance (See SEC Release Nos. 33-6753; IC-16245). The NASD Board of Governors also addressed these concerns in Notice to Members 86-41 regarding the presentation of investment companies' yield quotations.

One of the Board's concerns was that the problems were not limited to material prepared by investment company underwriters but were also common in material prepared by dealers. The Board noted that the majority of complaints received by the NASD about investment company communications related to material prepared by dealers. Much of the material was written and published by individual representatives or branch managers and reflected a lack of knowledge or observance of SEC and NASD Rules.

In addition, numerous violations resulted from a dealer inappropriately revising an advertisement that was prepared by the underwriter or using the material long after the information contained therein was current. The NASD has referred such practices to the appropriate District Business Conduct Committee.

The Board of Governors notes that the underwriter or distributor of a fund bears the responsibility to disseminate literature to dealers that has been filed with the NASD and that complies with applicable regulations. The Board is of the opinion that underwriters supplying non-complying material should be referred to the appropriate District Business Conduct Committee for possible disciplinary action. Nevertheless, the Board recognizes that a large number of problems are created after the material is distributed to dealers, or when dealers prepare the material themselves.

Therefore, the Board of Governors has approved the proposed amendment to Article III, Section 35(c)(l) of the NASD Rules of Fair Practice and the amendment is now being submitted for membership approval. Prior to becoming effective, the rule change must also be approved by the Securities and Exchange Commission.

COMMENTS RECEIVED

The proposed amendment to Article III, Section 35(c)(l) of the NASD Rules of Fair Practice was published for comment in NASD Notice to Members 88-20 dated March 14, 1988. The NASD received 34 comments on the proposed amendment. Of these, 16 commentators were generally in favor of the proposed amendment and 16 were generally opposed. Two commented only on proposed procedures.

The most frequent comment made both for and against the proposal was the concern that filings would be duplicated because it would be difficult to ascertain whether a piece had been filed previously by the underwriter.

Additionally, it was noted that the proposed amendment did not clearly state the necessity to refile any communication supplied by the underwriter if the dealer has changed the communication in any way. It was also pointed out that the proposed language exempted from filing only material already filed by "the underwriter or distributor ... or by another member firm." Since the material may be filed by an entity other than an NASD member for subsequent use by NASD members, the proposed language was considered too restrictive.

To deal with these concerns, the Investment Companies Committee recommended that the last sentence of the proposed amendment be further amended as follows:

"Members are not required to file advertising and sales literature which have previously been filed [by the underwriter or distributor of the securities or by another member] and which are used without change."

NOTE: New language underlined; deleted language in brackets.

The Board of Governors approved the recommendation of the Investment Companies Committee.

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The Board of Governors believes that the amendment to Article III, Section 35 of the NASD Rules of Fair Practice is necessary and appropriate and recommends that members vote their approval.

Please mark the enclosed ballot according to your convictions and return it in the enclosed, stamped envelope to "The Corporation Trust Company."

Ballots must be postmarked no later than October 3, 1988.

Questions concerning this notice may be directed to R. Clark Hooper, NASD Advertising Department, at (202) 728-8330.

PROPOSED AMENDMENT TO ARTICLE III, SECTION 35 OF THE NASD RULES OF FAIR PRACTICE

NOTE: New language is underlined; deleted language is in brackets.

Communications with the Public

Sec. 35.

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