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NASD Regulatory & Compliance Release – Summer 2000

Performance Graphs, Non-Cash Compensation, Suitability in Multi-Class Funds, and Suitability for Online Firms

By John M. Baker, Esq.


NASD Regulation posted the Summer 2000 issue of its Regulatory & Compliance Alert. This issue of the Alert includes a discussion of the May enforcement action against Kemper Distributors for violating NASD advertising-related rules and areas of concern in the use of graphic presentations of performance:

Labeling: The axes and baselines of graphs must be labeled clearly so that the reader can understand how the performance data relates to the graph, and the increments on the axes must also aid the reader in understanding the significance of the data. Disclosure: The text accompanying a graph must clearly state its purpose and significance, and graphs illustrating the historic performance of a hypothetical investment must disclose the relevant assumptions, such as the initial investment amount, whether dividends and capital gains were reinvested, whether taxes have been reflected, and whether sales loads or other fees were deducted.

Starting Points or Baselines of Graphs: The starting point of a graph must fairly reflect performance without exaggeration, and if a non-zero starting point is used there must be a reasonable basis for choosing such a point.

Scale: Although no specific scale or format is required, care must be exercised in choosing the appropriate scale.

Comparisons: Graphs may compare an investment in a product with a hypothetical investment in a benchmark index over the same time period, but the comparative index must be appropriate and provide the reader with a sound basis for evaluating the facts with respect to the product.

The Alert also discusses a number of other issues, including the following: Advertising of Bonus Credit Variable Annuities: Although advertisements of “bonus credit” variable annuities may include hypothetical illustrations depicting how the bonus credit will affect the contract’s value, the illustrations must meet several conditions in order to avoid being viewed as projections.

Non-Cash Compensation – Training or Education Meetings: Any training meeting should occupy substantially all of the work day, and reimbursement or payment for golf outings, tours, or other forms of entertainment while at a location for the purpose of training or education would not be permissible. NASD Regulation recommends that offerors use their own internal employee expense reimbursement policies as a guide when planning for training or education meetings.

Suitability Issues for Multi-Class Mutual Funds: The same suitability considerations that apply to the recommendation of a fund also apply to the recommendation of the particular class of a multi-class fund. Registered representatives should ask the investor what are his or her investment goals and objectives, including the investor’s time horizon, and it is suggested that members maintain written records of these discussions in their files.

Online Brokerage Services and the Suitability Rule: Even though the traditional application of the suitability rule may not fit squarely within the new online trading environment, it nonetheless remains both applicable to online trading and necessary to protect customers under certain circumstances. In general, the more individualized and specific the communication about a security or group of securities, the closer the communication gets to crossing the line and becoming a recommendation.

Another consideration may be whether the firm unilaterally decides to provide the information to the customer or whether the firm provides the information at the customer’s request. An Electronic Brokerage Committee was formed this year to participate in the development of balanced regulatory approaches that will fully protect investors without unnecessary restrictive regulation.

The Summer 2000 issue of the NASD Regulatory & Compliance Alert is available online at http://www.nasdr.com/rca_summer00.htm


Copyright 2000, John M. Baker, Esq., Stradley, Ronon, Stevens & Young, LLP, 1220 19th Street, N.W., Suite 700, Washington, DC 20036 – (202) 822-9611- Fax (202) 822-0140 This article was originally posted to the FundLaw List, http://www.egroups.com/group/fundlaw. To subscribe to FundLaw, send a blank e-mail to fundlaw-subscribe@egroups.com


Nothing herein is intended as legal or financial advice. The law is different in different jurisdictions, and the facts of a particular matter can change the application of the law. Please consult an attorney or your financial advisor before acting upon the information contained in this article.  


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