New FINRA Rule 2210-Simplification Whose Time Has Come

For years, the NASD (now FINRA) advertising rules have been the most subjective aspect of broker-dealer regulation. What is an advertisement? What is sales literature? When does a letter become sales literature, or an advertisement, for that matter? Is simple correspondence actually a brochure? These questions have plagued the industry for decades. Every attempt to “simplify” the rules seemed to muddle the water even further. As a result, the current regulatory scheme has morphed into a complex mass of categories that often overlap, making industry marketing professionals and compliance officers shake their heads and reach for the Advil.

Now FINRA offers to finally simplify the advertising rules once and for all. They promise Windows 7, but will it be Vista in practice, appearing to relieve the uncertainty only to create more issues? Let’s take a look.

New Rule 2210 consolidates the current 6 categories of communications with the public into 3 neat little boxes;

•  Institutional communications, which would include communications that fall under the current definition of “institutional sales material” - i.e., communications that are distributed or made available only to institutional investors. “Institutional investor” would have the same definition as under NASD Rule 2211(a)(3);
  
• Retail communications, which would include any written (including electronic) communication that is distributed or made available to more than 25 retail investors. “Retail investor”would include any person other than an institutional investor, regardless of whether the person is an existing or prospective customer; and
  
• Correspondence, which would include any written (including electronic) communication that is distributed or made available to 25 or fewer retail investors, regardless of whether they are existing or prospective customers.
  

The housecleaning doesn’t stop there. The old definitions for terms such as “advertisement,” “sales literature,” “institutional sales material,” “public appearance” (which always presented a minefield requiring Herculean mental gymnastics to figure out), and perhaps the most cogent of the group, the “independently prepared reprint,” will be shuffled off to regulatory purgatory. In addition, all the definitions in old Rule 2211 will go the way of the dinosaur.

The person who currently is charged with approving retail communications might change at your shop. The new rule requires that such communications be approved by “an appropriately registered principal.” Only certain registered principals whose license covers the subject of the communication may approve it. This change may result in firms amending their supervisory designations from the current “primary approver” to several principals, some of whom may have never engaged in the exercise of determining what constitutes a permissible communication.

New firms will be saddled with more onerous requirements, but can also take advantage of a curious loophole. Under the old regime, new firms had to file their “advertisements” 10 days prior to first use, and the clock ran for 12 months from that inaugural filing. Under the new rule, all “retail communications” must be filed. However, the filing period begins to run upon membership, so presumably, a firm could hold off on retail communications if it so chose until near the end of their first year, or could choose not to advertise at all, relieving themselves of the “file everything” requirement. For large firms, this may be impossible, but for small broker-dealers, the exception could be something to consider.

The new rule also adds new product categories in response to the financial crisis. Retail communications concerning any registered investment company that include self-created rankings, retail communications concerning CMOs and security futures, and retail communications that include bond mutual fund volatility ratings will have to be filed pre-use. In addition, retail communications concerning any publicly offered securities derived or based on a single security, a basket of securities, an index, a commodity, a debt issuance or a foreign currency will require filing on a pre-use basis as well.

Filing requirements for closed-end funds will be more burdensome. Because a closed-end fund is in effect a continuous offering of securities, FINRA staffers believe that all advertisements to downstream investors are entitled to the same level of scrutiny, so all retail communications proffered by such funds will have to be filed pre-use for the life of the fund.

But before you begin dashing off your comment letter, FINRA may have provided some relief. For firms that use the same advertising format repeatedly, the rule contains an exclusion for previously-filed templates in which the changes are limited to statistical data. Closed-end funds may find a safe harbor there. However, due to the prevalence of the Internet, which seemed to escape regulators’ notice for so long, the press release exclusion will be no more, since they figured out that most firms post their releases on their website, taking them out of the “media only” exclusion anyway. If passed, requests for No-Action relief won’t be far behind.

The proposed content standards offer some relief as well. Maximum sales charges and expense ratios used in performance presentations will be based on the most current of the prospectus or annual report, rather than the last prospectus. This change makes sense for obvious reasons, and should have been instituted long ago.

Next is a proposal that has been long-awaited by the industry and people who love trees. Instead of listing every person at the firm who might have a financial interest in the securities of a recommended issuer, a real burden for large houses, the new rule will limit disclosure to the firm or any associated person with the ability to influence the substance of the communication who also has a financial interest in the recommended issuer. Look for this as a test question on your next qualification exam.

From now on, anyone speaking on behalf of the firm who recommends securities will be held to the same standard that applies to research analysts. WSPs must address scripts, slides, handouts or other written and electronic materials used in connection with public appearances, which will be considered retail communications under the new rule.

Finally, also due the financial crisis, the new rule addresses communications regarding securities futures. All retail communications discussing futures, not just advertisements, will be covered. And more importantly, a risk disclosure document not unlike the current OCC brochure will have to be provided prior to or in conjunction with any communication discussing futures if specific securities are mentioned. Also, any promise about liquidity for such futures will be prohibited, and balancing statements concerning the risks and merits of futures must be presented with equal prominence.

There you have it. The proposed changes appear to offer a kinder, gentler world to those who spend their days reading tea leaves trying to predict how FINRA will react to their enticements for their financial products or services. It should be easier for marketing gurus and compliance officers to communicate with management and sales staff, who often drive the language that ends up in our newspapers, magazines, web sites and those reassuring commercials that appear during golf tournaments. Unlike health care reform, which may never see resolution in our lifetimes, this new rule does what it sets out to do, making life a little simpler while providing the investing public with more effective disclosures. I give it a thumbs up.

Antoine M. Devine is an attorney and author who resides in Phoenix, Arizona. Mr. Devine provides services as a consultant and expert witness on compliance issues affecting broker-dealers and investment advisers. He is a member of the California State Bar. You can email him at antoinemdevine@bluquillpublishing.com.

4th & Goal?-Give it to the Offense

I was watching the Steelers-Giants game Sunday, and when the Steelers mounted a successful goal line stand, resulting in possession of the ball inside their own 1, an issue that has resided in my mind's recesses reemerged. Why does the offense get penalized when the defense makes a great play (or series of plays) to keep the opponent out of the end zone? It does not seem like justice when the offense's reward is to get the ball at or inside the 1 yard line, immediately giving their opponent a decided advantage.

The NFL should seriously consider a new rule rewarding the team for their efforts by giving them the ball at the 10 yard line. A similar rule already exists for missed field goals. Any field goal try that is missed at or inside the 20 yard line results in the opposing team getting the ball at the 20 to start a new drive. So why does the team whose defense just put it all on the line to keep the opponent out of the end zone have to start their next possession where their defense stopped them?

The new rule would provide that anytime the defense prevents the offense from getting a touchdown or a 1st down on a 4th down try inside the 5 yard line, their offense is awarded the ball at the 10, giving them an opportunity to start their drive outside the shadow of the goalposts. The rule would add a new wrinkle to a coaches decision to go for it. How many times have we heard, "The coach believes in his defense, so he thinks that even if they don't make it, the defense will keep them bottled up." With the new rule, going for it on 4th down inside the 5 will bring a whole new level of drama to the NFL. I believe placing the ball at the 10 is generous enough-otherwise too many coaches will back down from going for the touchdown/first down, removing a thrilling and potentially historical moment from the game.

I'm tired of seeing teams, even good ones, stuck inside their own 1 or 2 yard line, forced to punt, giving the ball right back to the team they just stopped, usually in great field position. The defense, still high-fiving over their hard work, has to go right back out there. Viewed from this perspective, the current rules penalize the offense AND the defense for making a great play. Although there is no official stat available, fans might be curious to know how many times a team went 3 and out after starting a drive inside their own 1 or 2 yard line following a goal-line stand, and how many times a goal line stand was followed by a score on the next possession by the team that was stopped.

Note to Mr. Goodell and the Competition Committee - it's time to loosen things up a bit for the offense, and truly reward the defense for a job well done. Give it to the offense-on the 10.