Finra, the self-regulatory body for the brokerage industry, is pushing for a groundbreaking change that would allow brokers to promote investment strategies and products using hypothetical performance and return targets. This move aims to bring broker regulation in line with marketing rules already in place for registered investment advisors.
Bridging the Gap
The Securities and Exchange Commission (SEC) introduced its new Marketing Rule a year ago, permitting advisors to advertise hypothetical returns under specific conditions. Seeking consistency, Finra has submitted an amendment to its Rule 2210, which covers "communications with the public," to the SEC.
Opening New Horizons
Currently, brokers are only permitted to use historical performance results presented in a "fair and balanced manner." However, if the proposed rule change is approved, brokers will be able to project performance or target returns for securities, asset allocation, or other investment strategies.
Know Your Audience
It's important to note that these communications would only be allowed for institutional investors or qualified purchasers — individuals or entities with at least $5 million in investments. Both Finra and the SEC's Marketing Rule emphasize the importance of providing sufficient context and avoiding false or misleading statements.
The Road Ahead
Finra's proposal is now under review by the SEC, awaiting comments from the public. If approved, this rule change would likely benefit brokers working with private funds, as pointed out by Issa Hannah, a partner at Eversheds Sutherland.
Stay tuned for further updates on this exciting development in the brokerage industry.
Compliance Risks
The proposed Marketing Rule, if enacted, would introduce compliance risks for sponsors of private funds and their advisors. In the past, the SEC has taken enforcement actions against advisors who promoted hypothetical performance in a manner that did not comply with the rule. These actions highlight the SEC's concern about misleading unsophisticated investors with performance projections.
The Current Challenge
According to Hannah, a ban on advertising performance is in place for broker-dealers under existing Finra rules. This restriction poses a challenge when private-equity fund sponsors want to hire broker-dealer placement agents to market their funds and attract investors. Any demonstration of target returns, even when conversing with potential investors, is strictly prohibited.
SEC's Concerns
The concern for the SEC lies in the potential for unsophisticated investors to be misled by hypothetical performance presentations. This issue has long been a policy concern not only for the SEC but also for Finra. To address these concerns, the SEC may evaluate the public comments and request Finra to make revisions to its proposal before giving its approval.
Potential Approval
While nothing is certain, Hannah believes that it is likely the SEC will approve the proposal. However, the exact timeline remains uncertain. If approved, it is reasonable to expect that the rule will be implemented within a year.
Only time will tell how the SEC ultimately perceives and handles the proposal.
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