FINRA recently published a Regulatory Notice to announce that it is currently soliciting comment on proposed amendments to FINRA Rule 2210 (Communications with the Public). Rule 2210 provides that communications may not predict or project performance, imply that past performance will recur or make any exaggerated or unwarranted claim, opinion or forecast.
The general prohibition against performance projections is largely intended to protect retail investors from performance projections of individual investments, which often prove to be spurious, inaccurate or otherwise misleading.
On the other hand, information regarding the expected performance of an asset allocation or other investment strategy that does not project the performance of individual securities could better inform an investor about assumptions upon which the recommendation to pursue such a strategy is based.
Proposed Amendments
The proposal would provide an exception to the prohibition of projections for a customized hypothetical investment planning illustration. The exception would be available for all firms, including firms that operate only an online platform, and could be used with both current and prospective customers. The illustration may project an asset allocation or other investment strategy, but not the performance of an individual security.
The proposal would require that there be a reasonable basis for all assumptions, conclusions and recommendations, and that the illustration clearly and prominently disclose the fact that the illustration is hypothetical and there is no assurance that any described investment performance or event will occur. All material assumptions and limitations applicable to the illustration would have to be disclosed.
A “reasonable basis” might be established, for example, by reference to the historical performance and performance volatility of asset classes, the duration of fixed income investments, the effects of macroeconomic factors such as inflation and changes in currency valuation, the impact of fees, costs and taxes, and expected contribution and withdrawal rates by the customer. An unreasonable emphasis on any one of these factors might cause the projection to be noncompliant. Moreover, basing a projection upon hypothetical back-tested performance (which FINRA has interpreted the communications rules to prohibit in retail communications) or the past performance of particular investments by an asset manager would not be reasonable.
The proposal also would establish specific supervisory requirements for the permitted illustrations. A firm could use a template, such as one provided by a reliable off-the shelf software package, to generate the permitted illustration. In that case a registered principal would be required to approve the template before use or distribution, and the illustrations would have to be reviewed in a manner similar to correspondence under FINRA Rule 3110 (Supervision). A firm that does not employ a template would be required to have a registered principal review and approve each illustration before use or distribution.
Comments must be received by March 27, 2017. For further guidance, please refer to FINRA Regulatory Notice 2017-06.