FINRA does not regulate mutual funds directly, but does regulate the broker-dealers and registered representatives that sell mutual funds. In this capacity, FINRA enforces rules on mutual fund point-of-sale disclosure and other sales practices.
FINRA Rule 2210 prohibits firms and registered representatives selling mutual funds from making false, exaggerated, unwarranted or misleading claims in communications with the public. The rule requires firms to file certain communications involving registered investment companies, including mutual funds, and exchange-traded funds (ETFs), with FINRA’s Advertising Regulations Department. Similarly, FINRA Rule 2211 governs this area for institutional sales material and correspondence.
These rules also require disclosure of fees, expenses and standardized fund performance in mutual fund performance sales materials. This requirement improves investor awareness of the costs of buying and owning a mutual fund. It facilitates the comparison of funds and makes the presentation of standardized performance data more prominent in the sales material.
FINRA currently is conducting a retrospective review of its communications rules to determine whether the rules are meeting their intended investor protection. In the ensuing action phase, FINRA staff intends to consider specific rule proposals or other initiatives resulting from its review assessment.
FINRA has highlighted sales practice concerns with certain complex funds products, including alternative mutual funds and non-traditional ETFs. Alternative mutual funds, or alt funds, have seen a significant increase in sales over the past several years. They often are marketed as a way for retail investors to invest in sophisticated, actively-managed hedge fund like strategies that will perform well in a variety of market environments. Many of the funds use various non-traditional asset classes and strategies.
FINRA recommends that firms refer to such funds based on their specific strategies, instead of bundling them under one umbrella category, such as alternative mutual funds. Firms must ensure that their communications about alternative funds accurately and fairly describe how the products work. The descriptions of the funds in sales material must be consistent with the representations in a fund’s prospectus.
FINRA has provided guidance to firms on their sales practice obligations relating to leveraged and inverse ETFs. While these ETFs may be useful in some sophisticated trading strategies, they are typically designed to achieve their stated objectives on a daily basis. They are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets.
Recently FINRA sanctioned firms for selling leveraged and inverse ETFs without reasonable supervision and without having a reasonable basis for recommending the securities. FINRA found that the firms had failed adequate due diligence regarding the risks and features of the ETFs.
Learn how mutual fund breakpoint discounts work. FINRA recommends that firms at the time of purchase of a mutual fund or periodically thereafter provide investors with a Written Disclosure Statement explaining the availability of breakpoint discounts.