FINRA Proposal Would Allow Broker/Dealers to Use Projected Performance in Marketing to Retirement Plans

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The Financial Industry Regulatory Authority proposed a new rule Friday that would permit broker/dealers to use projected performance in their marketing communications to institutional investors and qualified purchasers, such as retirement plan investment fiduciaries. Currently, projected performance is not permitted by FINRA.

The proposal would permit broker/dealers to make projections on investments or investment strategies and use those in communicating with institutional investors with at least $25 million in assets under management. Broker/dealers would be permitted to do the same for qualified purchasers with at least $5 million in investments for private placements only.

“FINRA understands that some broker/dealer customers, in particular institutional investors, request other types of projected performance that the current rules do not allow,” states the rule proposal. “These customers may request information that includes projections of performance or targeted returns concerning investment opportunities to help them make informed investment decisions but are unable to receive this information from members due to the prohibition on projections.”

The proposal goes on to state that the proposed rule change is “narrowly tailored” to address the need for projections or “targeted returns” for institutional investors or qualified purchasers who have investing expertise.

“As a general matter, the proposed rule change would not alter the current prohibitions on including projections of performance or targeted returns in most types of retail communications,” FINRA wrote.

Break In Tradition

The proposed rule represents a break with FINRA’s traditional skepticism of hypothetical performance, says Lance Dial, a partner in K&L Gates LLP, which explains why the proposal is “only with respect to the highest and most sophisticated investors.”

Or, as Jay Gould, a special counsel at Baker Botts, puts it, FINRA “didn’t want to turn brokers loose on retail investors.”

Dial says retirement plans would not need to change anything if the rule is finalized, but they will “be able to get more details from their brokers” and can use projections and targets in their investment decisions.

Gould says that since the projected performance may be used for institutional eyes only, plan fiduciaries will have to be sure not to include it in communications with participants: “Plan sponsors can get this information, but they can’t pass it down to the participants.” In other words, it can inform menu creation, but not participant selection.

When making projections, broker/dealers “are required to have a reasonable basis for their projections.” The proposal lists 13 factors broker/dealers can consider when building a projection, which includes items such as “the industry’s and sector’s current market conditions and the state of the business cycle,” as well as “the historical performance and performance volatility of the same or similar asset classes.”

Marketing Rule Alignment

Julia Reyes, a partner with ACA Group, says there is a disclosure requirement in the proposal, and “documentation is going to be really important in assessing the reasonableness of any projection.”

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 hypothetical performance to be used, but has requirements for documentation and disclosure to substantiate any marketing claim.

Dial notes that projection information can be valuable to a wide range of institutional investors who may seek out projected returns because they are sophisticated enough to understand it, but they may lack the expertise to produce it themselves.

Dial says that if the SEC approves the proposal, which he considers likely, it will be sent for a 21-day public comment period. The SEC does not have a timeline for approving FINRA proposals.