NASD Issues Interpretive Guidance Regarding Recent Amendments to NASD Rules Governing Communications with the Public Relating to Mutual Fund Performance

On September 1, 2006, NASD issued Notice to Members 06-48 to provide guidance on the new “text box” amendments to NASD Rules 2210 and 2211. The new amendments impose certain disclosure and presentation requirements for communications with the public, other than institutional sales material and public appearances, regarding performance data for mutual funds other than money market funds (performance sales material). The new requirements will apply to performance sales material used on or after April 1, 2007.

Currently, performance sales material used by NASD member firms is governed by NASD Rules 2210 and 2211, Rule 482 of the Securities Act of 1933 (Rule 482), and Rule 34b-1 of the Investment Company Act of 1940 (Rule 34b-1). In this regard, NASD Rules 2210 and 2211 provide that communications with the public should provide a sound basis for evaluating information relating to any particular security and incorporate information required by SEC rules, as applicable.

Disclosure Requirements

Legends and Standardized Performance

The new amendments require that performance sales material include certain disclosures and standardized performance presentation mandated by SEC Rules 482 and 34b-1 including:

1. Legends indicating:

  • quoted performance information reflects past performance and does not guarantee future results,
  • investment return and principal value will fluctuate such that when shares are redeemed they may be worth more or less than their original cost,
  • current performance may be lower or higher than the quoted performance data, and
  • more complete information about the mutual fund may be obtained by calling a toll-free number or accessing a publicly available website where an investor may obtain performance data current to the most recent month-end (unless the sales material includes quotations of average annual total return for 1, 5 and 10 year periods current to the most recent month ended seven business days prior to the date of use);

2. Maximum amount of front-end and back-end sales charges; and

3. Whether performance information reflects the deduction of such sales charges and, if not, a statement indicating that fact and that inclusion of sales charges would reduce the quoted performance.

Annual Operating Expense Ratio

Importantly, the new amendments provide that performance sales material must include the “total annual fund operating expense ratio, gross of fee waivers or expense reimbursements,” as printed in the fee table of the mutual fund’s prospectus (the unsubsidized expense ratio). Although the unsubsidized expense ratio must be included, NASD member firms also may present the "total annual fund operating expense ratio, net of fee waivers and expense reimbursements" (the subsidized expense ratio) in performance sales material as long as both ratios are presented in a fair and balanced manner consistent with the content standards of NASD Rule 2210. While the NASD did not specify how unsubsidized and subsidized expense ratios should be presented, it would not be unreasonable to assume that, similar to existing presentation requirements for standardized and nonstandardized performance discussed in further detail below, subsidized and unsubsidized expense ratios should generally be presented with equal prominence and within close proximity to each other. The NASD did clarify, however, that it would expect presentations of subsidized expense ratios to be accompanied by disclosures indicating whether fee waivers and expense reimbursements are voluntary or mandatory based on contract and the length of time during which such fee waivers or expense reimbursements remain in effect.

Presentation Requirements

The new amendments will require NASD member firms to prominently present the unsubsidized expense ratio, as well as the legends and standardized performance information required by Rules 482 and 34b-1, in all performance sales material. In print materials, standardized performance information, sales charges, and the applicable expense ratio must appear in a prominent text box.

The NASD explained that the standard of “prominence” in the new amendments will be construed in much the same manner as the existing “equal prominence” and “proximity” standards for disclosures and sales charges under SEC rules. For example, the equal prominence standard generally translates into a broad requirement that presentations of standardized and nonstandardized performance information appear in the same font size and with no differentiation in the type face, color, or features (e.g., underlining or highlighting) designed to draw a reader’s attention to the nonstandardized information and away from the standardized information. Similarly, the prominence standard is usually interpreted as mandating that required legends appear in a print style different from, but at least as prominent as, that used in the major portion of the advertisement. In addition, such legends also are typically required to be in close proximity to the performance information in a print advertisement and must be presented in the body of the advertisement, rather than in a footnote.

The NASD clarified that the “text box” requirement applies only to print advertisements, such as a print newspaper, magazine, or other periodical. It does not apply to printed sales literature, such as fund fact sheets, brochures, or form letters, nor does it apply to websites, television, radio, or other electronic communications. Finally, the NASD reminded members that any performance sales materials that are modified to conform with the new amendments must be refiled with the NASD’s Advertising Regulation Department.

Please click here to view Notice to Members 06-48.

Investment Management and Securities Industry FYI is a service of the Investment Management and Securities Industry Practice Groups of Morgan Lewis. If you have any questions concerning these important legal developments, please contact any member of Morgan Lewis’ Investment Management and Securities Industry Practice Groups, including:

John V. Ayanian
Morgan, Lewis & Bockius LLP
1111 Pennsylvania Ave, NW
Washington, DC 20004
Telephone: 202.739.5946
Fax: 202.739.3001
[email protected]

Beth D. Kiesewetter
Morgan, Lewis & Bockius LLP
1111 Pennsylvania Ave, NW
Washington, DC 20004
Telephone: 202.739.5127
Fax: 202.739.3001
[email protected]

Catherine A. Courtney
Morgan, Lewis & Bockius LLP
1111 Pennsylvania Ave, NW
Washington, DC 20004
Telephone: 202.739.5674
Fax: 202.739.3001
[email protected]

Morgan, Lewis & Bockius LLP