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Mutual Funds

FINRA does not regulate mutual funds directly, but regulates the broker-dealers and registered representatives that sell mutual funds.  In this capacity, FINRA enforces rules on mutual fund advertising, sales practices, including the sales loads that broker-dealers may charge, the incentives provided to registered representatives and the execution of mutual fund portfolio transactions.  FINRA’s regulatory purview covers the following areas:

Advertisements

Under FINRA Rule 2210, firms must ensure that their mutual fund communications with the public are based on principles of fair dealing and good faith, are fair and balanced, and provide a sound basis to evaluate the facts about any particular security or type of security, industry or service.  No broker-dealer may omit any material fact or qualification if the omission, in light of the context of the material presented, would cause the communications to be misleading.  No broker-dealer may make any false, exaggerated, unwarranted, promissory or misleading statement or claim in any communication with the public, or publish, circulate or distribute any communication that the broker-dealer knows or has reason to know contains any untrue statement of a material fact or is otherwise false or misleading.

Members generally must file their retail communications concerning mutual funds with the FINRA Advertising Regulation Department within 10 business days of first use, unless a filing exception applies.  A retail communication is defined as any written (including electronic) communication that is distributed or made available to more than 25 retail investors within any 30 calendar-day period.

FINRA Rule 2210 also requires an appropriately registered principal of a firm to approve each retail communication before the earlier of its use or filing with FINRA.  While the rule does not require principal pre-approval for correspondence and institutional communications, firms must establish and maintain written procedures for their supervision and review.  In addition, the Rule has a recordkeeping requirement mandating firms maintain files that contain its communications with the public.

Sales Charges and Breakpoints

Breakpoint discounts are volume discounts to the front-end sales load charged to investors who purchase Class A mutual fund shares. The extent of the discount depends on the amount invested in a particular family of funds.  FINRA Rule 2342 prohibits sales of mutual funds shares in amounts below a breakpoint if the sales are made “so as to share in higher sales charges.”

FINRA has observed that in some instances customers have not received breakpoint discounts.  FINRA has addressed this issue through examinations and enforcement actions.  Multiple enforcement actions in 2015 resulted in millions of dollars in fines and restitution to customers.  These actions underscore the need for firms to establish and maintain systems and controls to ensure that customers receive the breakpoint discounts they are due. 

A firm’s procedures should include training for staff involved in the sale of Class A shares of front-end mutual funds.  FINRA provides a training outline, which includes important breakpoint topics that firms should address in their training.  FINRA also developed a checklist and worksheet that can assist firms gather the necessary information in order to ensure customers receive their breakpoint discounts.   FINRA also recommends that firms provide investors with a Written Disclosure Statement explaining the availability of breakpoint discounts either at the time of purchase or shortly thereafter. 

Cash & Non-Cash Compensation

FINRA members and their registered representatives are compensated for the sale of mutual fund shares in various ways, and the disclosure that investors receive depends upon the particular compensation arrangement.  For example, member compensation that is deducted from the initial investment or from fund assets, such as sales charges and Rule 12b-1 fees, is disclosed in the fee table that appears in the mutual fund prospectus.  Other forms of member compensation, such as payments from a mutual fund adviser for "shelf space," should also be disclosed.

NASD Rule 2830 regulates cash and non-cash compensation arrangements in connection with the sale and distribution of mutual funds.  The Rule contains broad prohibitions on the payment or receipt of non-cash compensation by FINRA members and their associated persons, and allows such compensation to be awarded only if it is structured in accordance with one of several limited exceptions.  The Rule prohibits firms or their associated persons, directly or indirectly, from giving anything of value in excess of $100 per year to any person where such payment relates to the business of the recipient’s employer.  The Rule also requires firms to maintain records regarding gifts and gratuities.   

In addition, the Rule prohibits firms from accepting cash compensation in connection with the distribution of mutual funds unless the compensation arrangement is disclosed in the prospectus.

FINRA reminds members that compensation arrangements may never undermine a member’s obligation to properly supervise its registered representatives, or a registered representative's obligation to make only suitable recommendations to customers.  Members must adopt and implement procedures reasonably designed to ensure that all communications of their registered representatives concerning investment company products, whether written or oral, are fair and balanced.  In recommending an investment company, registered representatives must disclose all material information, including the fund’s expenses and sales charges, investment objectives and risks.

Complex Products

FINRA has highlighted sales practice concerns with certain complex fund products, including alternative mutual funds and non-traditional ETFs.  While there is no standard definition of alternative mutual funds, if a fund’s strategy involves non-traditional asset classes, non-traditional strategies or illiquid assets, the fund may be considered an alternative fund.  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 these 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 with the public regarding alternative funds present a fair and balanced picture of both the risks and benefits of the funds, and may not omit any material facts or qualifications.

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 highly complex financial products typically designed to achieve their stated objectives on a daily basis.  Due to the effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective.  As such, inverse and leveraged ETFs that are reset daily may be unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets.

FINRA has sanctioned firms for selling leveraged and inverse ETFs without reasonable supervision and without having a reasonable basis for recommending the securities. 

Related: Breakpoints | Advertising Regulation

FINRA Provides Guidance on Application of Communications Rules to Disclosures Required by Department of Labor
January 13, 2012
FINRA Provides Guidance on Advertising Regulation Issues
October 27, 2011
FINRA Clarifies Guidance Relating to SEC Regulation S-P under Notice to Members 07-06 (Special Considerations When Supervising Recommendations of Newly Associated Registered Representatives to Replace Mutual Funds and Variable Products)
August 13, 2007
SEC Approves Amendments to NASD Rules 2210 and 2211 to Require Disclosure of Fees and Expenses in Mutual Fund Performance Sales Material
September 1, 2006
Special Considerations When Supervising Recommendations of Newly Associated Registered Representatives to Replace Mutual Funds and Variable Products
February 13, 2006
SEC Approves Amendments to NASD Rule 2830(k) to Strengthen Prohibitions on Investment Company Directed Brokerage Arrangements
January 14, 2005
Impermissible Use of Negative Response Letters for the Transfer of Mutual Funds and Variable Annuities (Changes in Broker-Dealer of Record)
October 5, 2004
NASD Reminds Firms of Sales Practice Obligations In Sale of Bonds and Bond Funds
April 13, 2004
Disclosure of Mutual Fund Expense Ratios in Performance Advertising: NASD Requests Comment on Proposed Amendments to Rules 2210 (Communications With the Public) and 2211 (Institutional Sales Material)
December 9, 2003
NASD Reminds Member Firms of their Obligations Regarding Mutual Fund Transactions and Directs Review of Policies and Procedures
September 5, 2003
SEC Approves Extension of Pilot Relating to Bond Mutual Fund Volatility Ratings
August 28, 2003
Refunds to Customers Who Did Not Receive Appropriate Breakpoint Discounts in Connection with the Purchase of Class A Shares of Front-End Load Mutual Funds and the Capital Treatment of Refund Liability
August 25, 2003
NASD Requires Immediate Member Firm Action Regarding Mutual Fund Purchases and Breakpoint Schedules
December 23, 2002
NASD Adopts Exemption From The Corporate Financing Rule for Interval Funds
August 10, 2000
NASD Regulation Reminds Members of Their Responsibilities When Advertising Recent Mutual Fund Performance
April 10, 2000
SEC Approves Rule Change Relating to Non-Cash Compensation for Mutual Funds and Variable Products
September 1, 1998
Targeted Examination Letter
In connection with the Mutual Fund Waiver Sweep and pursuant to FINRA Rule 8210, FINRA requests that the Firm provide the following documents and information to FINRA staff on or before June 10, 2016 regarding the above referenced Sweep.
May 16, 2016
FAQ
Questions and answers regarding the Mutual Fund Breakpoint Assessment

Guidance
The Joint NASD/Industry Task Force urges mutual funds to include these definitions in their prospectuses and other relevant materials as soon as is reasonably practicable.

Tool
Fund Analyzer
The Fund Analyzer offers information and analysis on over 18,000 mutual funds, Exchange Traded Funds (ETFs) and Exchange Traded Notes (ETNs). This tool estimates the value of the funds and impact of fees and expenses on your investment and also allows you the ability to look up applicable fees and available discounts for funds.

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