In this, the first of a two-part series, the focus is on communications with the public. While many of these points below appear more important to managing broker-dealers and product manufacturers (sponsors), retail broker-dealers may value the information in connection with their own materials and review of materials provided by sponsors. Retail firms’ obligations are independent – if your registered reps are distributing a piece of marketing material, you are on the hook for it. Don’t let anybody tell you otherwise. A retail firm may have some mitigating factors that help it avoid a big problem (like pointing back at the sponsor), but use of problematic material nonetheless will cause the firm grief.
In the broker-dealer business, marketing materials are a formidable source of risk exposure. What you say – and what your registered representatives hand out – can and will be used against you in… an arbitration brought by the formerly nicest little old lady who trots out her old and tattered Salvation Army uniform to wear at every hearing session for the all-public panel of arbitrators (new rule!).(1) Our firm has been assisting several clients and hearing from industry friends of FINRA’s focus of late on sales literature and advertising material.(2) Given the aggressiveness that we have seen in connection with both routine examinations and more focused reviews, we thought that we would take this opportunity to cover some general principles of marketing and disclosure.
At the risk of grossly oversimplifying the complex regulatory requirements surrounding sales literature and advertising, you should strive to create and use material that is fair, balanced, accurate and complete. The rules and regulations are designed to push you in that direction,(3) so it is good to know where you are trying to go.
In general, all communications with the public (you know the difference between advertising, sales literature, correspondence, institutional sales material and independently prepared reprints, right?) are to be based on principles of fair dealing and good faith, must be fair and balanced and must provide a sound basis for evaluating the facts in regard to any particular security, industry or service. You may not:
- Omit any material fact or qualification if the omission, in light of the context of the material presented, would cause the communication to be misleading;
- Make any false, exaggerated, unwarranted or misleading statement or claim; or
- Produce any communication that you know or have reason to know contains any untrue statement of a material fact or is otherwise false or misleading.
You should seek to weave balancing information and disclosure into the text of the material. Do not try to relegate the disclosure to a little space on the bottom of the last page – it does not work. The rules provide that information may be placed in a legend or footnote only in the event that such placement would not inhibit the recipient’s understanding of the communication. Better results are achieved by drafting in a balanced manner from the start and then sprinkling disclosure throughout; some on the front, some in the middle and some on the back. Make disclosure proximate to what it is balancing and also consider different techniques to cause disclosure to be more prominent where warranted. Boxes, borders, bolding, typeface and color changes and other types of ‘set-off’ should be considered where disclosure is separated and not incorporated in with text. And, don’t cheat on the size of the text – your disclosure should be near the size of the main text or maybe just a point or two smaller.
Should you have bullet point disclosures? Regulators have been known to ignore claims that the PPM/prospectus “always accompanied the color marketing material” when alleging that same marketing material had thin disclosure. Reasonable or not, there have been enforcement actions basically asserting that the marketing material must be able to stand on its own. I call the remedy “Altegris factors” after the enforcement case from many years ago.(4) Where appropriate, it may be helpful to bullet point the biggest and most relevant risk factors right in the marketing material. While I am sure that every PPM/prospectus always stays together with the color materials, just in case they get separated on accident there are sufficient risks disclosed in the color materials to give an investor – or a regulator wanting to bring an enforcement action – pause before they decide to come after you.
Context counts. You must ensure that statements in the material are not misleading within the context in which they are made. A statement made in one context may be misleading even though such a statement could be appropriate in another context. An essential test in this regard is the balanced treatment of risks and potential benefits. Communications should be consistent with the risks of fluctuating prices and the uncertainty of distributions and rates of return inherent to investments.
Speaking of context, I found it to be helpful to always consider the “Mom Test,” whether working on an issuer communication or something subject to FINRA rules. If mom isn’t going to understand it, then you have an ineffective piece of communication that you should change before wasting your money. If it is not clear, make it clear. If mom is going to be misled or duped by what is in the material, you’ll need to fix it. If you are going to feel guilty because mom is missing some key facts that have been omitted, you’ll need to include them.
Simple? Unfortunately, simple-sounding concepts obscure the complexity of communications with the public. Also working against you is a relatively short rule containing somewhat mushy language that gives the regulators a lot of flexibility to find a part of the material to be unhappy about.
More to follow next week…
- As of January 31, 2011, FINRA Rule 12403 allows customers the option in three panel member arbitrations to either choose the customary “majority public panel” with one non-public arbitrator or the “optional all public panel” that guarantees that any party could select an all public panel.
- See also FINRA’s Targeted Examination Letters regarding the “Sale and Promotion of Non-Traded REITs” (located at http://www.finra.org/Industry/Regulation/Guidance/TargetedExaminationLetters/P118545) and “Spot-check of Hedge Fund Advertisements and Sales Literature” (http://www.finra.org/Industry/Regulation/Guidance/TargetedExaminationLetters/P118544)
- In particular, see NASD Rule 2210 and related interpretative material.
- See “NASD Fines Altegris Investments for Hedge Fund Sales Violations” (located at http://www.finra.org/Newsroom/NewsReleases/2003/p002940)
Contact Evans & Kob for experienced regulatory and legal counsel regarding any sales literature or advertising review and filing, responding to any regulatory inquiry, or any other regulatory or arbitration related legal matter at info@eklawpc.com.