Interpretive Letter to Edward P. Macdonald, Hartford Funds Distributors, LLC

May 12, 2015

Edward P. Macdonald
Executive Vice President, Deputy General Counsel
Hartford Funds Distributors, LLC
5 Radnor Corporate Center
100 Matsonford Road, Suite 300
Radnor, PA  19087

Re: Provision of Related Performance Information to Institutional Investors

Dear Mr. Macdonald:

In your letter of May 7, 2015, you request interpretive guidance on behalf of Hartford Funds Distributors, LLC (“Hartford Funds”), an underwriter and wholesale distributor of registered mutual funds, regarding the use of related performance information (as defined below) in communications that are distributed solely to institutional investors, as that term is defined in FINRA Rule 2210(a)(4).  For purposes of this request, “Related Performance Information” means actual performance of all separate or private accounts or funds that have (i) substantially similar investment policies, objectives, and strategies, and (ii) are currently managed or were previously managed by the same adviser or sub-adviser that manages the registered mutual fund that is the subject of an institutional communication. 

Background

You state that Hartford Funds markets registered mutual funds, on a wholesale basis, to financial intermediaries who qualify as “institutional investors” under FINRA Rule 2210(a)(4).  These intermediaries include registered broker-dealers and investment advisers, who may sell or recommend Hartford Funds’ funds to their customers.  The registered broker-dealers assume related suitability and “know your customer” obligations for any such sales and recommendations.  The financial intermediaries are responsible for conducting due diligence on the mutual funds that Hartford Funds sells and, in some cases, determining whether to include these funds on various types of platforms. 

You state that, in addition to providing mutual fund offering materials, Hartford Funds provides financial intermediaries with written and electronic communications regarding the mutual funds, which assist these intermediaries in understanding the funds.  As the marketplace for fund information has evolved, Hartford Funds increasingly is receiving requests from financial intermediaries for Related Performance Information. 

You state that intermediaries request Related Performance Information to analyze and conduct due diligence on mutual funds, portfolio managers, accounts, or particular investment strategies, and to determine if funds and strategies are appropriate and suitable investments for their customers.  You further state that, in cases where a mutual fund has no or only a limited performance history, Related Performance Information may be a particularly critical data point in evaluating the fund.

Hartford Funds proposes to use Related Performance Information only under the following conditions:

  1. This performance information may be provided only if it is actual performance of all separate or private accounts or funds that have (i) substantially similar investment policies, objectives, and strategies, and (ii) are managed or were previously managed by the same adviser or sub-adviser that manages the registered mutual fund that is the subject of an institutional communication.
  2. Hartford Funds will provide materials with Related Performance Information only to persons who qualify as “institutional investors” under FINRA Rule 2210(a)(4), excluding institutional investors who intend to share the Related Performance Information with persons other than institutional investors.
  3. The presentation of Related Performance Information will include all accounts described in the first condition ("Related Accounts"). If there are multiple Related Accounts, the investment performance of such accounts will be presented in a composite or a list (in which the investment performance of each account will be displayed with equal prominence).
  4. Any institutional communication with Related Performance Information will be clearly labeled “for use with institutions only, not for use with retail investors.”  Hartford Funds will instruct institutional investors who receive such materials not to provide them to current or prospective customers or others who are not institutional investors. 
  5. The presentation of Related Performance Information will disclose performance information that is net of fees and expenses of Related Accounts, or net of a model fee that is the highest fee charged to any account managed in the strategy.  If gross performance information is also provided, the institutional communication will prominently disclose that (i) the performance information does not reflect the deduction of fees and expenses, (ii) different funds and accounts have different fees and expenses, and (iii) that the Related Performance Information would have been lower to the extent the related funds or accounts were subject to higher fees and expenses.  The fees and expenses of the registered fund that is the subject of the institutional communication will be prominently disclosed and this fund’s performance information will reflect all fees and expenses.  If the fees and expenses are higher than the fees and expenses of the Related Accounts, that fact will be disclosed.
  6. Related Performance Information will (i) include the performance of each Related Account, (ii) be for a period of at least one year and since the inception of the investment strategy, and (iii) be current as of the most recently-ended calendar quarter.
  7. Related Performance Information will be clearly labeled as such and contain clear disclosure of the applicable dates for the performance.
  8. For a mutual fund in existence for more than one year, its actual performance will be displayed more prominently than the Related Performance Information.
  9. The institutional communications will disclose any material differences between the funds or accounts for which Related Performance Information is provided and the mutual fund that is the subject of the institutional communication. 
  10. All institutional communications that contain Related Performance Information shall comply with all other applicable FINRA rules and federal securities laws and be subject to the same supervisory requirements that Hartford Funds applies to all other firm communications.

Discussion

FINRA Rule 2210 subjects institutional communications to certain content and supervision standards.  In particular, institutional communications must be fair and balanced and must provide a sound basis for evaluating the facts in regard to any particular security.  Institutional communications may not omit material information, include false, exaggerated, or misleading statements, or misstate material facts.  A firm must establish written procedures for the review of institutional communications by a registered principal that are appropriate to the firm’s business, size, structure, and customers.  When those procedures do not require prior-to-use review, the firm must adopt training and surveillance procedures to ensure compliance with the rule.

FINRA has taken the position in the past that the presentation of Related Performance Information in communications with the public, in some cases, may be inconsistent with the content standards of Rule 2210(d)(1).1 However, FINRA has also recognized that communications provided solely to institutional investors do not raise the same investor protection concerns as sales materials provided to retail investors, and FINRA has permitted member firms to provide certain related performance information to certain institutional investors, with appropriate safeguards.  In particular, in 2003, FINRA stated 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 (“ICA”), if the information was made available only to qualified purchasers, as defined in the ICA and the member firm complied with all other applicable standards in NASD Rule 2210.2

FINRA staff believes that the same rationale used in the 2003 interpretive letter to conclude that it was consistent with the applicable standards of NASD Rule 2210 to include Related Performance Information in sales material for private funds relying on Section 3(c)(7) of the ICA applies in this context.  Accordingly, FINRA staff believes that the use of Related Performance Information in institutional communications in the manner proposed in your letter is consistent with the applicable standards of FINRA Rule 2210.  While we do not object to the use of Related Performance Information in institutional communications as discussed herein, this letter does not affect FINRA’s longstanding position that the presentation of related performance information, other than the performance of a predecessor private account or fund as described above, in communications used with retail investors does not comply with FINRA Rule 2210(d).

The opinions expressed in this letter are staff opinions only and have not been reviewed or endorsed by the FINRA Board of Governors.  This staff letter responds only to the issues raised, and does not address any other rule or interpretation of FINRA, or all the possible regulatory and legal issues involved.

If you have any questions regarding this letter, please contact me at (240) 386-4623, or Joe Savage at (240) 386-4534.

Sincerely,

 

Joseph E. Price

cc:  Matthew Chambers, WilmerHale
      Stephanie Nicolas, WilmerHale
      Elizabeth Page, Vice President & Director
      FINRA Boston District Office
      Joseph P. Savage, FINRA

 


1 See, e.g., “Adviser Performance Prohibited in New Fund Advertising,” NASD Regulatory & Compliance Alert (June 1992) p. 7.  FINRA has permitted members, under appropriate conditions, to describe predecessor performance (concerning insurance company separate accounts, private investment companies or common trust funds) in their sales materials, consistent with the SEC staff’s no-action letter issued to MassMutual Institutional Funds.  See Notice to Members 97-47 (August 1997), footnote 2; see also MassMutual Institutional Funds, SEC staff no-action letter (September 28, 1995). 

2 See Letter from Thomas M. Selman, Senior Vice President, NASD, to Yukako Kawata (Davis Polk & Wardwell) (Dec. 30, 2003), available at www.finra.org.