[Federal Register Volume 65, Number 217 (Wednesday, November 8, 2000)]
[Notices]
[Pages 67025-67028]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-28653]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43507; File No. SR-NASD-98-11]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment Nos. 1, 2, and 3 by the National Association of 
Securities Dealers, Inc. Concerning Related Performance Information

November 2, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ Rule 19b-4 thereunder,\2\ notice is hereby given that on 
February 12, 1998, the National Association of Securities Dealers, Inc. 
(``NASD'' or ``Association''), through its wholly owned subsidiary, 
NASD Regulation, Inc. (``NASD Regulation''), filed with the Securities 
and Exchange Commission (``Commission'' or ``SEC'' ) the proposed rule 
change as described in Items I, II, and III below, which Items have 
been prepared by NASD Regulation. On August 10, 1998, NASD Regulation 
filed an amendment that completely replaced and superseded the original 
proposed rule change.\3\ On October 17, 2000, NASD Regulation again 
amended the proposal.\4\ On October 30, 2000, NASD Regulation filed an 
amendment that made minor, technical changes to the proposed rule 
language.\5\ The Commission is publishing this notice to solicit 
comments on the proposed rule change, as amended, from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See August 7, 1998 letter from Joan C. Conley, Secretary, 
NASD Regulation, and attachments to Katherine A. England, Assistant 
Director, Division of Market Regulation (``Division''), SEC 
(``Amendment No. 1'' )
    \4\ See October 16, 2000 letter (``October 16 Letter'' and 
attachments from Alden S. Adkins, General Counsel and Senior Vice 
President, NASD Regulation, and attachments, to Katherine A. 
England, Assistant Director, Division, SEC (``Amendment No. 2'' ). 
In Amendment No. 2, NASD Regulation proposes that (i) members 
presenting clone performance present total return information for 
all related clone funds; (ii) the predecessor and the advertised 
mutual fund share sub-investment advisers as well as investment 
advisers, and substantially all of the predecessor portfolio's 
assets must have been transferred to the advertised mutual fund, 
upon conversion the predecessor portfolio would have to cease to 
exist as a separate entity, to present predecessor performance; 
(iii) comparison portfolio performance reflect the total return of 
other investment companies as wellas other portfolios managed by the 
investment adviser or sub-investment adviser; (iv) several changes 
be made to the general standards set forth in paragraph (d) of 
proposed IM-2210-5; (v) no material difference may exist between the 
portfolio to which the related performance information refers and 
the advertised mutual fund, except that the portfolio may not have 
been registered under the Investment Company Act of 1940, and 
material difference may exist between the fees and expenses of a 
clone fund and the advertised mutual fund; and (vi) any member 
filing sales material that presents related performance information 
to maintain books and records that demonstrate the basis for and 
calculation of the related performance information.
    The draft notice in Amendment No. 2 includes all of the changes 
implemented in Amendment Nos. 1 and 2. See October 19, 2000 
telephone conversation between Sarah Williams, Assistant General 
Counsel, NASD Regulation and Joseph P. Morra, Special Counsel, 
Division of Market Regulation, SEC.
    \5\ See October 30, 2000 letter from Alden S. Adkins, Senior 
Vice President and General Counsel, NASD Regulation to Katherine A. 
England, Assistant Director, Division, SEC (``Amendment No. 3'' ).
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    NASD Regulation is proposing a new Interpretive Material 2210-5 and 
conforming amendments to existing Rule 2210 and IM-2210-2 of the NASD. 
Below is the text of the proposed rule change, as amended. Proposed new 
language is in italics. Proposed deletions are in brackets.
2200.  Communications with Customers and the Public
2210.  Communications With the Public
    (a) and (b) No change.
    (c) Filing Requirements and Review Procedures.
    (1) Advertisements and sales literature concerning registered 
investment companies (including mutual funds, variable contracts and 
unit investment trusts) not included within the requirements of 
paragraph (c)(2), and public direct participation programs (as defined 
in Rule 2810), and advertisements concerning governments securities (as 
defined in Section 3(a)(42) of the Act) shall be filed with the 
Association's Advertising/Investment Companies Regulation Department 
(Department) within 10 days of first use or publication by any member. 
The member must provide with each filing the actual or anticipated date 
of first use. Filing in advance of use is recommended. Members are not 
required to file advertising and sales literature which have previously 
been filed and which are used without change. Any member filing any 
investment company advertisement or sales literature pursuant to this 
paragraph (c) that includes or incorporates rankings or comparisons of 
the investment company with other investment companies shall include a 
copy of the ranking or comparison used in the advertisement or sales 
literature. Any member filing a mutual fund or variable contract 
advertisement or sales literature that presents Comparison Portfolio 
Performance (as defined by IM 2210-5) shall include a copy of the proof 
of independent verification required by IM 2210-5(c)(1)(B).
    (c)(2) through (f) No change.
IM 2210-2.  Communications With the Public About Variable Life 
Insurance and Variable Annuities
    (a) No change.
    (b) Specific Considerations
    (1) Fund Performance Predating Inclusion in the Variable Product
    In order to show how an existing fund would have performed had it 
been an investment option within a variable life insurance policy or 
variable annuity, communications may contain the fund's historical 
performance that predates its including in the policy or annuity. Such 
performance may only be used provided that no significant changes 
occurred to the fund at the time or after it became part of the 
variable product. However, communications may not include the 
performance of an existing fund for the proposes of promoting 
investment in a similar, but new Investment option (i.e., clone fund or 
model fund) available in a variable contract. The presentation of 
historical performance must conform to applicable Association and SEC 
standards. Particular attention must be given to including all elements 
of return and deducting applicable charges and expenses.
    (b)(2) through (5) No change.
IM-2210-5  Presentation of Mutual Fund Related Performance Information
    Any advertisement or sales literature concerning an open-end 
management investment company (the ``Advertised Mutual Fund'' ) may 
present the following types of performance information (collectively, 
``Related Performance Information'' ).
    (a) ``Clone'' Performance
    The total return of all registered open-end management investment 
companies, calculated in accordance with Item 21 of SEC Form N-1A, that 
have the same investment policies, investment objectives, investment 
strategies, investment adviser and sub-investment adviser as an 
Advertised Mutual Fund, provided that the presentation of this Related 
Performance Information complies with the general standards in 
paragraph (d).

(b) ``Predecessor'' Performance

    The total return of an Advertised Mutual Fund, calculated in 
accordance with Item 21 of SEC Form N-1A, that includes the performance 
of an insurance company separate account,

[[Page 67026]]

common trust fund or private investment company that had been converted 
into, and had the same investment adviser and sub-investment adviser 
as, the Advertised Mutual Fund; that had investment policies, 
investment objectives and investment strategies that were in all 
material respects equivalent to those of the Advertised Mutual Fund; 
and that was not created in order to establish a performance record, 
provided that:
    (1) in the conversion, substantially all of the assets of the 
predecessor portfolio were transferred to the Advertised Mutual Fund 
and upon conversion the predecessor portfolio ceased to exist as a 
separate entity;
    (2) the performance of the predecessor portfolio is adjusted as of 
the conversion date only, to reflect all current fees and expenses of 
the Advertised Mutual Fund, as disclosed in the fee table in the 
Advertised Mutual Fund's current prospectus, but not reflecting any fee 
waiver or expense reimbursement for the Advertised Mutual Fund; and
    (3) the presentation of this Related Performance Information 
complies with the general standards in paragraph (d).

(c) ``Comparison Portfolio'' Performance

    (1) The total return of a composite of other portfolios, including 
other investment companies, managed by the investment adviser (or, as 
appropriate, the sub-investment adviser) of an Advertised Mutual Fund, 
provided that:
    (A) The composite:
    (i) Consists of all actual fee-paying, discretionary portfolios 
managed by the investment adviser (or sub-investment adviser) with 
substantially similar investment policies, investment objectives, and 
investment strategies to the Advertised Mutual fund, including the 
Advertised Mutual Fund itself;
    (ii) Excludes terminated portfolios after the last full performance 
measurement period the portfolios were under management, but includes 
terminated portfolios or all periods prior termination;
    (iii) Does not reflect any portfolio that has been switched into 
the composite or exclude any portfolio that had been switched into the 
composite or exclude any portfolio that had been switched from the 
composite, unless documented changes in guidelines communicated by the 
client made the switching appropriate; and
    (iv) Adjusts the gross performance information of any portfolio to 
reflect all current fees and expenses of the Advertised Mutual Fund, as 
disclosed in the fee table in the Advertised Mutual Fund's current 
prospectus;
    (B) The investment adviser (or sub-investment adviser) has obtained 
verification from an independent third party that the creation and 
maintenance of the composite complies with paragraph (1)(A) and proof 
of this independent verification, current as of the investment 
adviser's (or sub-investment adviser's) most recently ended fiscal 
year, has been field with the Advertising/Investment Companies 
Regulation Department; and
    (C) The presentation of this Related Performance Information 
complies with the general standards in paragraph (d).
    (2) No member may imply that the Association or any of its 
affiliates endorses or approves of any composite or the manner in which 
it was created or maintained.

(d) General Standards

    (1) No material difference may exist between the portfolio to which 
the Related Performance Information refers and the Advertised Mutual 
Fund, except;
    (A) The portfolio may not have been registered under the Investment 
Company Act of 1940 and therefore may not be subject to the 
restrictions that the Investment Company Act and the Internal Revenue 
Code impose; and
    (B) Material differences may exist between the fees and expenses of 
an investment company reflected in Clone Performance and the Advertised 
Mutual Fund.
    (2) Any Related Performance Information presented in an 
advertisement or sales literature:
    (A) Must be, at a minimum, current to the most recent calendar 
quarter ended prior to submission for publication (in the case of an 
advertisement) or prior to use (in the case of sales literature); and
    (B) Must be accompanied by Related Performance Information for one, 
five and ten years periods, provided that if the Related Performance 
Information is available for less than one, five or ten years, the time 
period during which the Related Performance Information is available 
must be substituted for the period otherwise prescribed.
    (3) Any advertisement or sales literature that presents Related 
Performance Information:
    (A) Must identify the length of, and the date of the last day in, 
the period used to compute the Related Performance Information:
    (B) Must present, in a more prominent manner than the Related 
Performance Information, the total return of the Advertised Mutual 
Fund(excluding the performance of any predecessor portfolio) calculated 
and presented in accordance with the applicable SEC rules, provided 
that the registration statement for the Advertised Mutual Fund has been 
effective for at least one year;
    (C) When applicable, mut prominently disclose that the Advertised 
Mutual Fund has been in operation for less than one year;
    (D) Must disclose;
    (i) Any material difference between the fees and expenses of an 
investment company reflected in Clone Performance and the Advertised 
Mutual Fund;
    (ii) In the case of all Related Performance Information:
    a. That the Related Performance Information is not the 
performance of the Advertised Mutual Fund and should not be 
considered indicative of or a substitute for that performance and;
    b. When applicable, that some or all of the portfolios reflected 
in the Related Performance Information (including any predecessor 
portfolios) are not registered under the Investment Company Act of 
1940 and therefore were not subject to certain investment 
restrictions that the Investment Company Act and the Internal 
Revenue Code impose, and that the performance of those portfolios 
may have been adversely affected had they been registered under the 
Investment Company Act; and
    (iii) Any other information that may be necessary to ensure that 
the Related Performance Information is not presented in a misleading 
manner;
    (E) May not refer to the Related Performance Information in any 
headline or other prominent statement;
    (F) May not contain any ranking based on the Related Performance 
Information; and
    (G) Must accompany any graph or illustration concerning Related 
Performance Information with a more prominent graph or illustration 
concerning the total return of the Advertised Mutual Fund, 
calculated and presented in accordance with applicable SEC rules, 
provided that the registration statement for the Advertised Fund has 
been effective for at least one year.
    (4) No advertisement or sales literature for a money market fund 
may present Related Performance Information.
    (5) Any member filing an advertisement or sales literature 
presenting Related Performance with the Department must maintain 
books and records that demonstrate the basis for and calculation of 
the Related Performance Information. Retention by the member of 
copies of all such records maintained by any investment advisers 
under Rule 204-2(16) of the Investment Advisers Act of 1940 would 
satisfy this requirement. Such records must be maintained for three 
years following the last distribution or publication of the 
advertisement or sales literature.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NASD Regulation included 
statements

[[Page 67027]]

concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. NASD Regulation has prepared summaries, set forth in 
sections A, B, and C below, of the most significant aspects of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Rule 2210 requires the filing of various forms of advertisement and 
sales literature with the Advertising/Investment Companies Regulation 
Department of NASD Regulation. NASD Regulation staff reviews these 
filings to determine whether they meet applicable standards in the NASD 
Conduct Rules, which are generally designed to ensure that sales 
material is fair, balanced and not misleading.
    The SEC's Division of Investment Management recently issued a 
series of ``no-action letters'' that essentially permit mutual funds to 
present a range of performance information in their sales material and 
prospectuses, subject to specific factual circumstances and regulatory 
conditions. These letters generally permit the presentation of the 
performance of (i) a mutual fund from which the offered fund has been 
``cloned''; (ii) a non-investment company account that had been 
converted into the advertised mutual fund; (iii) private, investment 
company or institutional accounts that are managed by the mutual fund's 
adviser; and (iv) a mutual fund that was previously managed by the 
offered fund's portfolio manager (``manager performance''). (Together, 
these types of performance information will be referred to as ``Related 
Performance Information.'')
    The SEC's no-action letters note that the NASD Conduct Rules impose 
standards on mutual fund and variable product sales material separate 
from the Commission rules, and the Commission staff reached no 
conclusion concerning whether the presentation of Related Performance 
Information under the conditions imposed by the no-action letters would 
comply with the NASD Conduct Rules.
    Historically, the NASD has prohibited the presentation of any 
Related Performance Information, except predecessor performance, in 
mutual fund and variable product sales material. In light of the 
Commission staff's recent no-action letters and apparent public 
interest in the potential benefits and concerns with the presentation 
of Related Performance Information in mutual fund and variable product 
sales material, NASD Regulation requested comment in August 1997 on 
whether the NASD should permit Related Performance Information to be 
included in advertisements or sale literature (Notice to Members 97-
47).
    NASD Regulation received 55 comment letters from investors, 
Chartered Financial Analysts, mutual funds, money managers, and trade 
associations. Forty-four commenters supported the presentation of some 
type of Related Performance Information, while 11 opposed the 
presentation of any Related Performance Information. Commenters 
disagreed about the types of Related Performance Information that NASD 
Regulation should permit. The highest level of opposition was raised to 
the presentation of manager performance information. Indeed, even some 
of those who otherwise supported the presentation of Related 
Performance Information opposed the presentation of portfolio manager 
performance. Of the 44 commenters who generally supported the 
presentation of Related Performance Information, 11 specifically 
discussed the presentation of manager performance. Of these 11, six 
opposed any presentation of manager performance information.
    The proposed rule change would permit the presentation of Related 
Performance Information (other than manager performance information) in 
mutual fund and variable product sales material, subject to certain 
conditions designed to make the presentation fair, balanced and not 
misleading. The proposed rule change would generally permit, subject to 
certain conditions, the presentation of the performance of (i) a mutual 
fund from which the offered fund had been ``cloned''; (ii) a non-
investment company account that had been converted into the advertised 
mutual fund; and (iii) private, investment company or institutional 
accounts that are managed by the mutual fund's adviser. The proposed 
rule change thus represents a significant liberalization of the types 
of performance information that members may present in mutual fund and 
variable product sales material, subject to conditions designed to 
protect investors.
    At the same time, the NASD Board of Directors reaffirmed the NASD's 
longstanding policy of prohibiting the presentation of manager 
performance in mutual fund advertisements and sales literature. The 
NASD believes that the presentation of manager performance could 
mislead or confuse investors about the contributions of other personnel 
of the investment adviser to the mutual fund's performance, such as 
research analysts who recommend securities to the portfolio manager and 
traders who obtain best execution. The efforts of these personnel and 
the resources of the investment adviser are, in most cases, critical to 
the mutual fund's performance. Moreover, a relatively long time period 
may elapse between the departure of a portfolio manager from the 
previous mutual fund and the advertisement of the new mutual fund's 
performance, thus rendering the manager performance information 
stale.\6\
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    \6\ The position of the Commission's staff continues to be that 
manager performance information in a mutual fund's prospectus, 
advertisements or sales literature is not per se misleading under 
the federal securities laws, provided that the performance is not 
presented in a misleading manner and is not presented as a 
substitute for the advertised mutual fund's performance. See 
Bramwell Growth Fund (pub. avail. August 7, 1996); ITT Hartford 
Mutual Funds (pub. avail. February 7, 1997). The Commission's staff 
believes that whether manager performance information is misleading 
depends on the totality of the circumstances, including the manner 
in which it is presented. Id.
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2. Statutory Basis
    NASD Regulation believes that the proposed rule change is 
consistent with the provisions of Section 15A(b)(6) of the Act,\7\ in 
that the proposed rule change is designed to prevent fraudulent acts 
and practices, and to promote just and equitable principles of trade. 
In particular, NASD Regulation believes the proposal would establish 
conditions designed to ensure that the presentation of Related 
Performance Information is fair, balanced, and not misleading.
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    \7\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD Regulation does not believe that the proposed rule change will 
result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act, as amended.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    See discussion of comment letters in Item II(A)(1) above.

[[Page 67028]]

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which NASD Regulation consents, the Commission will:
    A. By order approve such proposed rule change, or
    B. Institute proceedings to determine whether the proposed rule 
change should be disapproved.
    NASD Regulation has requested that the Commission provide the 
public with at least 45 days in which to comment on the proposed rule 
change.\8\ The Commission agrees to allow a 45-day comment period on 
the proposed rule change.
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    \8\ See October 16, 2000 Letter at page 1. NASD Regulation also 
consents to an extension of the time period for Commission action to 
30 days after the expiration of the 45-day comment period. The 
Commission notes that a further extension of the time period for 
Commission action may be needed to allow for Commission analysis of 
comment letters, and to allow NASD Regulation to provide a response 
to comment letters.
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Additionally, as previously noted, 
the Commission's staff disagrees with the NASD's decision to per se 
exclude manager performance information from the rule. Interested 
persons are specifically invited to comment on this issue.
    Persons making written submissions should file six copies thereof 
with the Secretary, Securities and Exchange Commission, 450 Fifth 
Street, N.W., Washington, DC 20549-0609. Copies of the submission, all 
subsequent amendments, all written statements with respect to the 
proposed rule change that are filed with the Commission, and all 
written communications relating to the proposed rule change between the 
Commission and any person, other than those that may be withheld from 
the public in accordance with the provisions of 5 U.S.C. 552, will be 
available for inspection and copying in the Commission's Public 
Reference Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the NASD. All 
submissions should refer to file number SR-NASD-98-11 and should be 
submitted by December 26, 2000.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\9\
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    \9\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-28653 Filed 11-7-00; 8:45 am]
BILLING CODE 8010-01-M