FINRA’S Box of Chocolates

While we know you prefer a box of chocolates today instead of this industry update on compliance, this one is a gift and hence, will not add to your ever-growing list of compliance duties. Enjoy!

FINRA recently released an interpretive letter to Foreside Fund Services, LLC establishing conditions under which it is permissible for broker-dealers to include pre-inception index performance data in institutional communications concerning passive open-end investment companies. This is an expansion of the 2013 interpretive letter to ALPs Distributors, Inc., which provides similar guidance regarding the use of pre-inception performance (“PIP”) data by the fund, but only as it applies to financial intermediaries. The Foreside letter allows those financial intermediaries to then share the performance with their institutional clients.

The conditions for both scenarios are virtually identical and include:

  1. Any piece of marketing material that includes PIP data will be clearly labeled “For use with institutions only, not for use with retail investors.” If the recipient is a financial intermediary, the recipient will be instructed not to circulate communications containing PIP data to retail investors.
  2. Any PIP data will be used only with respect to the Index, which was created according to a pre-defined set of rules that cannot be altered except under extraordinary market, political or macroeconomic conditions.
  3. PIP data will not be used to market the Fund if the Fund alters its investment strategy to permit active management of the Fund’s securities portfolio.
  4. Any marketing material containing PIP data will include an offer to provide an overview of the methodology of the index upon request and electronic marketing material will include a hyperlink to such information.
  5. The presentation of PIP data will reflect the deduction of fees and charges currently applicable to the Fund.
  6. PIP data will reflect a period of time that includes multiple securities market environments, and at a minimum, ten years of pre-inception data.
  7. PIP data will be current as of the most recently ended calendar quarter.
  8. PIP data will be clearly labeled and shown separately from Fund performance and will be presented along with disclosure of the applicable dates for the PIP data and the dates for actual performance since inception.
  9. As the Fund has been in existence for more than one year, the use of PIP data will be accompanied by the prominent presentation of actual performance of the Fund since inception that reflects the deduction of fees and charges of the Fund.
  10. PIP data will not be inconsistent with information in the prospectus but may be used regardless of whether the fund prospectus contains the data.
  11. PIP data will be accompanied by the following disclosures:
    1. The Fund is a relatively new product and any performance prior to the date of inception is hypothetical;
    2. The identity of the entity that performs the calculation and distribution of the PIP data, and the fact that ABR pays this entity to perform those functions;
    3. The fact that PIP data are based on criteria that has been applied retroactively with the benefit of hindsight, and that these criteria cannot account for all financial risk that may affect the actual performance of the Fund;
    4. The actual performance of the Fund may vary significantly from the PIP data; and
    5. Reasons (if any) why the PIP data would have differed from actual performance during the period shown (e.g., transaction costs, liquidity, or other market factors).

Perhaps the most notable reiteration in the letter, however, is FINRA’s statement that their current position does not affect FINRA’s long standing opinion that the presentation of hypothetical back-tested performance in communications used with retail investors does not comply with the content standards of FINRA rules governing communications with the public.