The financial industry regulator proposed a new rule on Friday that would allow broker/dealers to use forecasted performance in their marketing communications to institutional investors and qualified buyers, such as investment fiduciaries of pension plans. Scheduled performance is not currently permitted by FINRA.
The proposal would allow broker/dealers to make investment forecasts or investment strategies and use them in communicating with institutional investors with at least $25 million in assets under management. Broker/dealers will be permitted to do the same for qualified buyers with at least $5 million in investments for private placements only.
“FINRA understands that some broker/dealer clients, particularly institutional investors, require other types of projected performance that the current rules do not allow,” the proposed rule states. “These clients may request information that includes performance forecasts or target returns on investment opportunities to help them make informed investment decisions, but cannot obtain this information from members due to the forecast ban.”
The proposal states that the proposed rule change is “narrowly tailored” to address the need for projections or “targeted returns” for institutional investors or qualified buyers who have investment experience.
“As a general matter, the proposed rule change would not change the current prohibitions on including performance forecasts or target returns in most types of retail communications,” FINRA wrote.
Breaking tradition
The proposed rule represents a break with FINRA’s traditional skepticism about hypothetical performance, says Lance Dial, a partner at K&L Gates LLP, which explains why the proposal is “only relevant to the highest and most sophisticated investors.”
Or, as Jay Gould, special counsel at Baker Botts, puts it, FINRA “didn’t want to make brokers target retail investors.”
Dial says pension plans won’t have to change anything if the rule is finalized, but they “will be able to get more details from their brokers” and can use forecasts and targets in their investment decisions.
Gould says that because projected performance can only be used for institutional eyes, plan fiduciaries will need to be sure not to include it in communications with participants: “Plan sponsors can get that information, but they can’t hand it over to the participants.” In other words, it can inform the creation of a menu, but not the selection of participants.
When making predictions, broker/dealers “are required to have a reasonable basis for their predictions.” The proposal lists 13 factors that broker/dealers can consider when constructing a forecast, which includes items such as “current industry and sector market conditions and the state of the business cycle,” as well as “the historical performance and variability of performance of the same or similar asset classes.’
Marketing Rules Alignment
Julia Reyes, a partner at ACA Group, says there is a disclosure requirement in the proposal and “documentation is going to be really important in evaluating the reasonableness of any forecast.”
Reyes sees the proposal as an effort by FINRA to align its rules with the Securities and Exchange Commission’s marketing rule for advisers, which allows the use of hypothetical performance but has documentation and disclosure requirements to substantiate any marketing claim.
Dial notes that forecast information can be valuable to a wide range of institutional investors, who may seek forecasted returns because they are sophisticated enough to understand it but may lack the expertise to generate it themselves.
Dial says that if the SEC approves the proposal, which he believes is likely, it will be sent out for a 21-day public comment period. The SEC has no timetable for approving FINRA’s proposals.
Tags: FINRA, marketing, SEC