SEC Approves Guidelines Relating To The Use Of Rankings In Investment Company Advertisements And Sales Literature
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Executive Summary
On July 12, 1994, the Securities and Exchange Commission (SEC) approved amendments adopting Guidelines to Article III, Section 35 of the NASD Rules of Fair Practice that prohibit members from using investment company rankings in advertisements and sales literature unless certain requirements are met. The requirements include, among other things, that the ranking is accurate, is accompanied by certain minimum informational disclosures, includes certain minimum time frames, and is based on a category or subcategory that provides a sound basis for evaluating investment company performance. The text of the amendments, which took effect July 12, 1994, follows the discussion below.
Background
On July 12, 1994, the SEC approved amendments adopting Guidelines to Article III, Section 35 of the NASD Rules of Fair Practice (Guidelines) that prohibit members from using investment company rankings in advertisements and sales literature unless certain requirements are met.
Article III, Section 35(d)(2)(M) of the NASD Rules of Fair Practice requires that a member that makes investment comparisons, directly or indirectly, must ensure that the purpose of the comparison is clear. The comparison must be fair, balanced, and disclose any material differences between the subjects of the comparison. The use of investment company rankings to demonstrate performance qualifies as such a comparison.
As the number of investment companies has increased substantially in recent years, so has the number of investment company ranking entities. The NASD has observed increased references to rankings in investment company advertisements and sales literature. In response to the increased use of investment company rankings, the Investment Company Institute, the national association of the American mutual fund industry, submitted to the NASD suggested standards for the use of rankings in sales materials that served as the foundation for the NASD proposal. The NASD proposed, and the SEC approved, comprehensive Guidelines to be used when investment company advertisements and sales literature include references to investment company rankings.
Description Of The Amendments
The Guidelines apply to all registered investment companies, including open-end and closed-end management companies as defined in Sections 3,4, and 5 of the Investment Company Act of 1940.
Definition Of Ranking Entity The term "ranking entity," refers to an entity that provides general investment company information to the public, is independent of the investment company and its affiliates, and whose services are not procured by the investment company or its affiliates to assign a ranking. The definition encompasses entities formed specifically to provide such information as well as financial publications and periodicals that include such a service in their publications.
General Prohibition Members are prohibited from using investment company rankings in advertising and sales literature unless the rankings were developed by entities that meet the definition of ranking entity. When members use rankings developed by ranking entities, the rankings must conform to the requirements of the Guidelines.
Required Disclosures All advertisements and sales literature containing a ranking must disclose the name of the investment company category, the number of investment companies in the category, the name of the ranking entity, the period on which the ranking is based, the criteria on which the investment company is ranked, and, for investment companies with front-end sales loads, whether the ranking takes into account sales charges. Also, for advertisements and sales literature containing rankings based on total return or the SEC standardized yield, the advertisements and sales literature must contain a statement as to the material effect on total return or yield, if any, of fees waived or expenses advanced during the period on which the ranking is based. The amendments also require disclosure of the publisher of the ranking data.
Prominent statements and headlines that include or refer to rankings must disclose the name of the investment company category, the total number of investment companies in the category, and the period on which the ranking is based, in close proximity to the headline or prominent statement. Such statement or headline may not state or imply that an investment company is ranked first in a category when it is not.
All advertising or sales literature using a ranking system consisting of a symbol must disclose the meaning of the symbol. All advertising and sales literature containing a ranking must disclose that past performance is no guarantee of future results.
Time Periods
To ensure that rankings are based on meaningful, not misleading, information, the Guidelines require that the information be current and provide a minimum standard of what is current. Rankings should be at least current to the most recent calendar quarter, though use of more current ranking data is permissible.
For all investment companies except money market mutual funds, rankings based on a period of less than one year can be misleading and, therefore, are prohibited. Additionally, for all investment companies except money market mutual funds, rankings based on total return or the SEC standardized yield must be accompanied by rankings based on total return for the one-year period for investment companies in existence for one year; the one- and five-year periods for investment companies in existence for at least five years; and the one-, five-, and 10-year periods for investment companies in existence for at least 10 years. The ranking information for the periods must be supplied by the same ranking entity and the periods must end on the same date.
The NASD believes that a meaningful comparison of rankings in excess of one year should include multiple time periods for comparison to avoid the possibility of selecting only those time periods in which an investment company was highly ranked. Also, the required use of the one-year period prohibits a member from using a ranking that ranks investment companies over, for example, a three-year period only.
Categories
The NASD believes it is important to set standards for methods of investment company categorization that provide a sound basis for evaluating investment company performance. Generally, advertisements and sales literature must use only categories or subcategories created by a ranking entity. Advertisements or sales literature using rankings based on a sub-category must disclose the name of the full category, the investment company's ranking and the number of investment companies in the full category, unless the subcategory is based solely on the investment objectives of the investment company and is created by a ranking entity.
Categories or subcategories created by an investment company or its affiliate may be used as long as performance is measured by the same performance measurements as those used by a ranking entity. However, categories or subcategories created by an investment company or its affiliate must also prominently disclose the fact that the investment company or its affiliate has created the ranking category, the number of investment companies in the category, the basis for selecting the category, and the identity of the ranking entity that developed the performance measurements and data on which the ranking is based. Headlines and prominent statements using a ranking created by an investment company or its affiliate must indicate in close proximity to the headline or statement that the ranking is based on a category created by the investment company or its affiliate.
Advertisements or sales literature must not use any ranking category based on the investment company's asset size because such information does not provide a meaningful basis on which the investment company's performance can be evaluated.
Multiple Class/Two-Tier Investment Companies Advertisements or sales literature containing rankings for more than one class or investment company with the same portfolio must disclose the fact that the investment companies or classes have a common portfolio.
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The NASD believes that by establishing a baseline of standards for the use of investment company rankings in advertising and sales literature, the amendments will prevent the misleading use of such rankings and will help investment company investors make informed investment decisions based on information set forth in a clear and uniform manner.
Questions regarding this Notice may be directed to R. Clark Hooper, Vice President, Advertising/Investment Companies Regulation Department, at (202) 728-8325; Thomas A. Pappas, Assistant Director, Advertisement/Investment Companies Regulation Department, at (202) 728-8330; or Robert J. Smith, Attorney, Office of General Counsel, at (202) 728-8176.
Approved Amendments To Article III, Section 35 Of The NASD Rules Of Fair Practice.
(Note: New text is underlined.)
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Guidelines For The Use Of Rankings In Investment Company Advertisements And Sales Literature
For purposes of these guidelines, the term "Ranking Entity" refers to any entity that provides general information about investment companies to the public, that is independent of the investment company and its affiliates, and whose services are not procured by the investment company or any of its affiliates to assign the investment company a ranking.
Members shall not use in investment company advertisements, sales literature or general promotional material any investment company rankings other than those developed and produced by entities that meet the definition of "Ranking Entity." and which conform to the requirements of the Guidelines herein.
Investment company rankings for more than one class or investment company with the same portfolio must be accompanied by prominent disclosure of the fact that the investment companies or classes have a common portfolio.