FINRA Permits Related Performance Information in Institutional Communications for Registered Closed-End Funds

by Morrison & Foerster LLP - Broker-Dealer Compliance + Regulation
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Introduction

In an interpretive guidance letter issued to a registered closed-end fund on June 9, 2017, FINRA permitted the use of “related performance information” in communications that are distributed solely to institutional investors.

For purposes of the interpretive letter, “related performance information” is the actual performance of separate or private accounts or funds:

  1. that have substantially similar investment policies, objectives, and strategies to those of a registered closed-end fund; and
  2. are currently managed or were previously managed by the same adviser or sub-adviser that manages the applicable fund.

In connection with their marketing processes, funds with limited or no track records often seek to leverage the performance history of other accounts managed by the adviser and employing a substantially similar investment strategy.  Generally, substantial disclaimers and disclosures accompany these communications so that investors are aware that the differences in fees, expenses, investment restrictions, and flows, among other things, may result in performance differences.

Background

Generally, FINRA Rule 2210 (the “Rule”) governs broker-dealers’ communications with the public, including communications with institutional and retail investors.  The Rule defines communications as either: (1) retail communication, (2) correspondence, or (3) institutional communication.

In 2003, FINRA issued an interpretive guidance letter (the “2003 Letter”) stating that it would not object if a member firm included related performance information in sales materials for private funds relying on Section 3(c)(7) of the Investment Company Act of 1940 (the “1940 Act”), if the information was made available only to “qualified purchasers,” as defined in the 1940 Act, and the member firm complied with all other applicable standards in the Rule.

In 2015, FINRA issued an interpretive guidance letter (the “Hartford Letter”) to an underwriter and wholesale distributor of registered mutual funds, in which FINRA took the position that the use of related performance information in institutional, but not retail, communications concerning open-end registered investment companies would be consistent with the applicable standards of the Rule.

Application to Closed-End Funds

According to the June 9, 2017 letter, the fund offers two separate classes of shares, Class A shares and Class I shares, to “accredited investors” as defined in Regulation D under the Securities Act of 1933, as amended.  The shares are offered on a continuous basis and, subject to any applicable sales loads, may be purchased on a monthly basis at the then-current net asset value. The shares may be purchased from the fund or through advisers, brokers, or dealers that have entered into agreements with the fund’s principal underwriter.  The fund is not listed on an exchange and, to provide liquidity to shareholders, may conduct periodic repurchase offers.

The fund’s marketing material is often presented to advisers and broker-dealers that qualify as “institutional investors,” as defined in the Rule, that may in turn recommend the fund to their advisory or brokerage customers.  These intermediaries are subject to suitability obligations and often request related performance information to assist in their evaluation of a fund’s strategy and performance of the fund’s adviser.

Based upon the rationale applied in the 2003 Letter and the Hartford Letter, and under the conditions enumerated in the June 9, 2017 letter, FINRA believes that the use of related performance information in institutional communications concerning continuously offered closed-end funds is consistent with the applicable standards of the Rule.  FINRA noted, however, that the guidance letter “does not affect FINRA’s longstanding position that the presentation of related performance information . . . in communications used with retail investors does not comply with FINRA Rule 2210(d).”

Our Take

This is a logical next step in the application of FINRA’s interpretation of Rule 2210 since both the 2003 Letter and the Hartford Letter left open the interpretation of the Rule as applied to closed-end funds.  Importantly, however, nothing in this interpretation changes existing no-action positions taken by the SEC’s staff with respect to the use of related performance in certain advertisements.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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