Regulatory Requirements

Communications with the Public - FINRA Rule 2210

FINRA Rule 2210 governs all member firm communications with the public. For Series 6 representatives selling mutual funds, variable annuities, and variable life insurance, understanding the distinctions between different types of communications and the rules governing their use is essential. FINRA categorizes communications into three types: retail communications, correspondence, and institutional communications.

Retail Communications

Retail communications are any written or electronic communications distributed or made available to more than 25 retail investors within any 30-calendar-day period. Retail investors include anyone other than institutional investors. Examples of retail communications include advertisements in newspapers or magazines, website content accessible to the public, sales literature, form letters sent to clients, and social media posts accessible to the general public.

Key requirements for retail communications about investment company products:

• Principal approval required: All retail communications must be approved by a registered principal before first use or filing with FINRA. Some firms designate a separate advertising principal for this purpose.
• Filing requirements: Retail communications concerning investment companies and variable contracts must be filed with FINRA's Advertising Regulation Department within 10 business days of first use if the member firm has been in business for less than one year, or if FINRA specifically requests filing.
• Content standards: Communications must be fair, balanced, and not misleading. They cannot make exaggerated or unwarranted claims about investment performance or omit material facts.
• Sound business principles: All communications must be based on principles of fair dealing and good faith and must provide a sound basis for evaluating the facts regarding the investment product.

Correspondence

Correspondence is any written or electronic communication distributed or made available to 25 or fewer retail investors within any 30-calendar-day period. Examples include individual emails to clients, personalized letters to small groups of customers, and direct instant messages.

Correspondence has less stringent requirements than retail communications:

• No pre-approval required: Correspondence does not require principal pre-approval before use, though firms must establish procedures for review and supervision.
• Post-review required: Firms must review correspondence by an appropriately qualified person, but this can occur after the communication is sent.
• No FINRA filing: Correspondence is not filed with FINRA.
• Still subject to content standards: Even though pre-approval is not required, correspondence must still comply with FINRA's standards for fair, balanced, and non-misleading communication.

Institutional Communications

Institutional communications are written or electronic communications distributed or made available only to institutional investors. Institutional investors include banks, insurance companies, registered investment companies, registered investment advisers, government entities, employee benefit plans with at least 100 participants, FINRA member firms, and persons or entities with total assets of at least $50 million.

Institutional communications have the least restrictive requirements:

• No pre-approval or filing: Institutional communications do not require principal pre-approval or FINRA filing, though firms must establish supervisory procedures.
• Content standards apply: They must still meet FINRA's general standards for communications.
• Exception for new firms: If a member has been in business less than one year, institutional communications concerning investment companies must be approved by a principal prior to first use.

Investment Company Advertising - SEC Rule 482 and FINRA Rule 2210

Mutual fund advertising is governed by both SEC Rule 482 (Securities Act of 1933) and FINRA Rule 2210. These rules work together to ensure that advertising for investment companies is fair, balanced, and provides investors with the information they need to make informed decisions.

SEC Rule 482 Requirements

SEC Rule 482 permits mutual funds to advertise as long as they follow specific disclosure requirements. The rule covers advertisements in any medium, including print, broadcast, and online. Key requirements include:

• Prospectus availability: All advertisements must include a statement that the prospectus contains more complete information about charges and expenses and should be read carefully before investing. The ad must explain how to obtain a prospectus.
• Legend requirements: Ads must include a legend stating that an investment in the fund involves risk, including possible loss of principal, and that past performance is no guarantee of future results.
• Sales charge disclosure: If performance is shown, the advertisement must disclose whether the performance figures include or exclude the effect of sales charges.
• No omission of material facts: Advertisements cannot omit material information that would make other statements misleading.
• Filing with SEC: Investment company advertisements must be filed with the SEC as part of the fund's ongoing disclosure obligations.

Required Disclosures in Mutual Fund Advertising

Every mutual fund advertisement, whether in print, online, broadcast, or any other medium, must contain certain disclosures to help investors understand the risks and costs:

• "Past performance does not guarantee future results" (or substantially similar language)
• Statement that investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than original cost
• How to obtain a prospectus (phone number, website, etc.)
• Statement that the prospectus contains more complete information including charges and expenses
• For money market funds: Statement that an investment is not insured or guaranteed by the FDIC or any other government agency and that there is no assurance the fund will maintain a stable $1.00 NAV

Prohibited Advertising Practices

FINRA Rule 2210 and FINRA Rule 2341 (specific to investment company securities) prohibit certain misleading practices in mutual fund advertising:

• Omitting sales charges: Failing to disclose the impact of sales loads on performance calculations.
• Cherry-picking time periods: Showing only favorable time periods without showing less favorable periods or standardized performance.
• Predictions or projections: Making specific predictions about future performance (general statements about investment objectives are permitted).
• Comparing apples to oranges: Comparing a fund to an inappropriate benchmark or index.
• Exaggerated or unwarranted claims: Using superlatives like "best" or "safest" without factual substantiation.
• Omitting fund rankings: Showing that a fund is ranked #1 in one category without disclosing lower rankings in other relevant categories.
• Failing to update performance: Using outdated performance figures that are no longer accurate.

Performance Advertising Standards

FINRA Rule 2210 and Rule 2341 impose strict standards on how mutual funds can advertise performance. Because performance figures are among the most persuasive elements in investment advertising, these rules ensure that performance presentations are standardized, fair, and comparable.

Total Return Calculation

When advertising performance, mutual funds must calculate total return, which reflects both income and capital appreciation. Total return must include:

• All distributions: Both dividend income and capital gains distributions must be included.
• Reinvestment assumption: All calculations must assume reinvestment of dividends and capital gains at NAV.
• Effect of sales charges: The fund must disclose whether performance shown includes or excludes maximum sales charges. If excluded, there must be a prominent disclosure.
• Time periods: Performance must be shown for 1-year, 5-year, and 10-year periods (or life of fund if shorter), ending on the most recent quarter or month.

Standardized and Non-Standardized Performance

FINRA distinguishes between two types of performance presentations:

• Standardized performance: Calculated according to specific SEC formulas, shows average annual total return for 1-year, 5-year, and 10-year periods (or life of fund). Includes the impact of maximum front-end sales charges. Must be current within the most recent quarter.
• Non-standardized performance: Any performance calculation that does not conform to the standardized formula. If non-standardized performance is shown, standardized performance must also be shown with equal or greater prominence.

Required Performance Disclosures

Performance advertisements must include specific disclosures to provide context and prevent misunderstanding:

• Impact of sales charges: Clear statement of whether sales charges are included or excluded and the effect on return.
• Time period: The beginning and ending dates of the performance measurement.
• Comparison to appropriate index: If a fund is compared to a benchmark, the index must be appropriate and relevant to the fund's investment objective.
• Fund expenses: Acknowledgment that performance reflects deduction of fund expenses (management fees, 12b-1 fees, etc.).
• Volatility disclosure: For funds showing high returns, a statement about increased volatility and risk.

Use of Rankings and Third-Party Ratings

Mutual funds often cite rankings from organizations like Morningstar or Lipper. When using third-party ratings or rankings in advertising:

• Complete disclosure required: The name of the ranking organization, the category in which the fund was ranked, the number of funds in the category, and the criteria for the ranking must be disclosed.
• Cannot cherry-pick: If a fund is ranked highly in one category but poorly in another relevant category, both must be disclosed.
• Must be current: Rankings must be updated as new rankings become available.
• Cannot imply endorsement: Using a rating cannot suggest that the rating organization endorses the fund.

Sales Load Disclosure Requirements

The Investment Company Act of 1940, Section 12(b), regulates sales charges (loads) that investment companies can charge. FINRA rules supplement these requirements by mandating full disclosure of all charges to investors.

Maximum Sales Charges

FINRA rules limit the total sales charges that can be assessed on mutual fund shares:

• Maximum front-end load: 8.5% of the public offering price (POP), but only if the fund offers breakpoints and rights of accumulation.
• If no breakpoints: The maximum front-end load is reduced to 6.25% of POP.
• Maximum 12b-1 fees: 0.75% annually for distribution fees, plus 0.25% for service fees, for a total of 1.00%.
• Maximum total charges: Over the life of an investment, total sales charges (front-end load, back-end load, and 12b-1 fees) cannot exceed 8.5% of total dollars invested.

Breakpoint Disclosure Obligations - FINRA Rule 2341

FINRA Rule 2341 specifically addresses sales of investment company securities and imposes strict obligations regarding breakpoint disclosure. This is one of the most heavily tested areas on the Series 6 exam.

Fee Disclosure Requirements

All fees and charges must be prominently disclosed to investors:

• Prospectus fee table: Every mutual fund prospectus must contain a standardized fee table near the front showing all shareholder fees (sales loads, redemption fees, exchange fees) and annual fund operating expenses (management fees, 12b-1 fees, other expenses, total annual expenses).
• Expense example: The prospectus must include a dollar example showing the cumulative expense an investor would pay on a $10,000 investment over 1, 3, 5, and 10 years, assuming a 5% annual return and redemption at the end of each period.
• Confirmation disclosure: Trade confirmations must disclose any sales charges, commissions, or other remuneration received by the firm and its representatives.
• Account statements: Ongoing disclosure of fees and expenses is required in periodic account statements.

Customer Complaint Procedures

FINRA rules require member firms to have written procedures for handling customer complaints. Every registered representative must understand how complaints should be documented, escalated, and resolved.

Definition of a Complaint

A complaint is any written statement by a customer or person acting on behalf of a customer alleging a grievance involving the activities of the member firm or its associated persons. The complaint must be in writing (including email) to be considered a formal complaint under FINRA rules. Oral complaints, while they should be taken seriously and addressed, are not subject to the same regulatory reporting requirements.

Complaint Handling Requirements

FINRA Rule 4513 requires firms to maintain specific records related to customer complaints:

• Complaint log: Firms must maintain a separate file or log containing all written customer complaints received, along with any actions taken in response.
• Record retention: Customer complaint records must be retained for at least four years.
• Reporting to FINRA: Certain complaints (particularly those alleging sales practice violations, fraud, or theft) must be reported to FINRA on Form U4 or U5 for the associated person involved.
• Principal review: A principal must review all written complaints and the firm's response.
• Customer notification: The firm must respond to the customer in writing, though the specific timeframe is determined by the firm's procedures.

Arbitration Disclosure

FINRA arbitration is a forum for resolving disputes between customers and member firms or their representatives. Key points about arbitration:

• Voluntary for customers: Customers cannot be required to arbitrate disputes as a condition of opening an account. Pre-dispute arbitration agreements are prohibited.
• Binding on firms: If a customer chooses to arbitrate, the member firm must participate. FINRA arbitration decisions are binding and enforceable in court.
• Streamlined process: Arbitration is generally faster and less expensive than litigation.
• Three-member panel (usually): Disputes involving more than $100,000 are typically heard by a panel of three arbitrators. Smaller claims may be decided by a single arbitrator or through simplified arbitration.
• Award publication: Arbitration awards involving public customers are made public through FINRA's arbitration award database.

Recordkeeping Requirements

SEC Rules 17a-3 and 17a-4 establish the recordkeeping requirements for broker-dealers. These rules specify what records must be maintained and how long they must be kept. FINRA Rule 4511 requires member firms to make and preserve books and records as required under the FINRA rules, the Exchange Act, and the applicable Exchange Act rules.

SEC Rule 17a-3: Records to Be Made

SEC Rule 17a-3 specifies the types of records that broker-dealers must create. Key records include:

• Blotters (trade journals): A chronological record of all purchases and sales of securities, receipts and deliveries of securities, and receipts and disbursements of cash.
• Customer account records: Records containing the name and address of each customer, whether the customer is of legal age, the name of the registered representative, signature of the principal who approved the account, and documentation of suitability information.
• Stock records (securities records): Records showing separately for each security all long and short positions, location of securities, and securities held for customers vs. the firm.
• Order tickets: A record of each order, including the account for which entered, whether discretionary, time of execution, price, and identifying information about the representative who accepted the order.
• Trade confirmations and account statements: Copies of confirmations sent to customers and periodic account statements.

SEC Rule 17a-4: Records Retention Periods

SEC Rule 17a-4 specifies how long different types of records must be retained. This is frequently tested on the Series 6 exam.

FINRA Rule 4513: Records Requirements

FINRA Rule 4513 supplements the SEC requirements with additional recordkeeping obligations specific to FINRA member firms:

• Complaint records: As discussed above, a separate record or log of all written customer complaints.
• Email and electronic communications: All business-related emails and electronic communications must be retained in a format that permits them to be reviewed and produced.
• Supervision records: Records documenting the firm's supervisory system and the supervisory reviews conducted.
• Training records: Documentation of continuing education compliance and firm element training.

Settlement and Delivery Rules for Mutual Funds

The settlement rules for mutual fund transactions differ from those for most other securities. Understanding these timing requirements is important for the Series 6 exam and for properly advising clients.

Mutual Fund Settlement: T+1

Mutual fund transactions settle on a T+1 basis, meaning settlement occurs one business day after the trade date. This is different from most equity and corporate bond transactions, which settle T+2 (two business days after the trade date).

• Purchase settlement: When a customer purchases mutual fund shares, payment is due by the end of the business day following the trade date (T+1).
• Redemption settlement: When a customer redeems mutual fund shares, the fund must send payment within seven calendar days of receiving a proper redemption request, though most funds settle redemptions much faster (typically T+1).
• Trade date: The trade date for mutual funds is the date on which the order is received by the fund in proper form, assuming it is received before the fund calculates its NAV for that day (typically 4:00 PM ET).

Proper Form for Redemptions

For a redemption request to be considered "in proper form," it must include:

• The customer's account number or other identifying information
• The number of shares or dollar amount to be redeemed
• The customer's signature (if required by the fund)
• Signature guarantee (if required, typically for large redemptions)

If a redemption request is not in proper form, the fund is not obligated to process it until the deficiencies are corrected.

Forward Pricing and Settlement

As discussed in earlier chapters, mutual fund transactions are executed at the next calculated NAV after the order is received (forward pricing). This has important implications for settlement:

• An order received before 4:00 PM ET on Monday receives Monday's NAV (calculated at 4:00 PM) and settles T+1 on Tuesday.
• An order received after 4:00 PM ET on Monday receives Tuesday's NAV (calculated at 4:00 PM Tuesday) and settles T+1 on Wednesday.
• Orders received on weekends or holidays receive the NAV calculated on the next business day.