Interpretive Letter to Dawn Bond, FSC Securities Corporation
July 30, 1998
Ms. Dawn Bond
RIA Compliance Director
FSC Securities Corporation
2300 Windy Ridge Parkway
Atlanta, Georgia 30339
Re: Clarification of NASD Rules as to Certain Advisory Activity of Registered Persons
Dear Ms. Bond:
We are in receipt of your letter to Mr. Sibears, NASD Regulation, Inc. which was referred to our office for a response. Based on your letter and our subsequent telephone conversation, we understand that you have a number of questions seeking clarification on how various NASD rules apply to certain materials and information that may be provided to advisory clients of the firm.
According to your letter and our subsequent telephone conversation, the relevant facts are as follows: FSC Securities Corporation (FSC) is a registered investment adviser with the Securities & Exchange Commission (SEC), a registered broker/dealer with the SEC and a member of the NASD. FSC's registered persons may offer advisory services through their own registered investment adviser entity or through third party advisers.
Use of Investment Projections
According to your letter, you state that, although NASD Conduct Rule 2210 (Communications with the Public) prohibits a member from distributing projections and predictions of investment results, the Investment Advisers Act of 1940 does not have a specific provision that prohibits the use of projections by advisory representatives. According to your letter, projections may be used in financial plans to demonstrate the difference between a client's current portfolio and a proposed portfolio. In addition, you state that many financial planning software packages offer the ability to project the results of a recommended investment portfolio for a client receiving financial planning services through a registered investment adviser. Further, you stated that the use of these financial plans may result in securities transactions being executed through FSC.
As a result of the above, you ask whether investment projections can be included in a client's financial plan if the plan: (1) does not include specific investment recommendations but simply allocates among objectives (i.e., growth, income, etc.) and uses index projections, or (2) includes specific investment recommendations (i.e., Putnam Growth Opportunities, Franklin Age, etc.).
Response: NASD Conduct Rule 2210 (Rule) sets forth specific requirements on the use of advertisements and sales literature by members when communicating with the public. In addition, paragraph (d)(2)(N) of the Rule states, among other things, that investment results cannot be predicted or projected. Investment performance illustrations may not imply that gain or income realized in the past will be repeated in the future.
As a registered broker/dealer and member of the NASD, FSC and its registered representatives are subject to all of the requirements in the NASD Conduct Rules, including the prohibition on predictions provided in NASD Conduct Rule 2210(d)(2)(N).
Your letter states that the SEC regulations and rules require investment advisers to provide clients with a disclosure brochure no later than the time at which the client executes the client agreement identifying the service to be provided. In addition, you represent that this brochure would disclose to each advisory client that representatives of the adviser are also registered representatives with FSC.
Based on the above, you ask whether financial plans that are prepared for a fee with no specific investment recommendations, other than possibly a fund family, are required to disclose the broker/dealer affiliation. In addition, you ask whether the disclosure is required on registered investment advisory client statements or performance reports prepared for a client's existing account.
Response: FSC is both a registered broker/dealer and a registered investment adviser and is subject to both the broker/dealer and investment adviser regulations. Because these questions specifically request guidance as to SEC rules and regulations, you should discuss this question with the SEC's Division of Investment Management.
Regarding NASD rules, it is important to determine if these materials are being used by registered persons of the member and may be considered advertisements or sales literature related to promoting the member's securities business. For example, some dually registered persons engage in activities limited to writing financial plans for a fee that do not include references to specific securities or executions through the member. The NASD has not required that the member name be included on such financial plans. If, however, particular securities are recommended or securities transactions are being executed through FSC by customers who purchased the plans, NASD Conduct Rule 2210 would require disclosure of the member's name on the materials.
Filing Requirements for Third Party Manager Marketing Material
According to your letter, registered representatives of FSC may work through FSC's investment adviser or their own investment adviser with various third party managers and asset allocators. In addition, many of the third party managers prepare marketing material that can be used by registered persons and registered advisory representatives to solicit advisory clients. FSC has various relationships with third party managers. In some cases, the activities are strictly fee based and the third party manager does not direct any securities business through FSC. In these cases, FSC and the advisory representative are paid a portion of the manager's advisory fee. In other cases, FSC and the advisory representative are paid a portion of the manager's fee. In addition, the registered person/ registered advisory representative may effect securities transactions and earn securities commissions in addition to the advisory fee. When the FSC representative works with individual managers of stocks and bonds, the third party manager conducts all securities transactions and may direct these transactions through FSC. The FSC registered person/registered advisory representative is compensated either on a fee basis, or based on transactions placed by the third party manager.
Based on the above representations, you question if the marketing material created by third party managers, which contain references to mutual funds or variable annuities (under three described arrangements), are used by an FSC registered person/registered advisory representative to solicit advisory clients for a manager are subject to NASD advertising filing requirements.
Response: NASD Conduct Rule 2210 governs all member communications with the public, including all third party materials used by a member or its registered persons. In administering the rule, however, NASD Regulation has not required the filing of marketing materials that are used exclusively to solicit on behalf of an advisory business. In accordance with this policy, the staff has not required filing of third-party marketing materials that: (i) purport to solicit customers for investment advisory services; (ii) do not include the member's name; and (iii) do not contain references to mutual funds, variable annuities or other securities.
If the third party marketing materials are used to solicit customers for wrap fee programs or other arrangements in which the member or its registered representatives participate in the execution of securities transactions and receive transaction-based compensation in lieu of or addition to an advisory fee, the materials are being used to solicit for the member's securities business and they are subject to all of the requirements, including the filing requirements where appropriate, provided in NASD Conduct Rule 2210.
According to your letter, you represent that certain advisory activities of FSC advisory representatives do not involve a representative's direct participation in securities transactions. Instead, a third party manager is engaged to manage the client's account and determine and execute all securities transactions. FSC representative would assist the client in determining their investment objective, investment goals, risk tolerance and time horizon for investing. Additionally, they may assist the client in developing an investment policy statement, choosing a manager, and provide ongoing monitoring of the third party manager's trading activities on the client's account. Further, you represent that FSC representatives are compensated for their services by receiving an ongoing fee which is based upon a percentage of the value of the account being managed.
According to your letter, you represent that FSC has to date required its advisory representatives to obtain the appropriate licenses for securities transactions that will be executed and managed by third party managers. Specifically, you question whether advisory representatives participating in the above described activity would be required to obtain a series 7 license. In addition, you question whether advisory representatives participating in wrap fee programs in which the representative participation is limited to soliciting the client for advisory services would also be required to obtain a series 7 license.
Response: Under the circumstances described above, if the advisory representative is conducting a supervisory role over the securities executions of the third party manager and may exercise some discretion over the timing of executions or the nature of securities transactions being executed on behalf of the customer, especially transactions that may be executed by the manager through FSC as a registered broker/dealer, then the advisory representative would be required to be series 7 licensed. As to other circumstances, it is difficult to say definitively whether an individual is required to be licensed. The analysis requires a specific fact and circumstance evaluation in reaching a determination of whether a particular individual requires licensing. As a result, we recommend that you contact the Qualifications Department of NASD Regulation at (301) 590-7900 in assisting you in determining the various licensing requirements of your advisory representatives.
I trust that this information is helpful. Please note that the opinions expressed herein are staff opinions only and have not been reviewed or endorsed by the Board of Directors of NASD Regulation, Inc. This letter responds only to the issues that you have raised based on the facts as you have described them, and does not address any other rule or interpretation of the Association or all the possible regulatory and legal issues. If you have any questions, please call me at (202) 728-8014.
David A. Spotts
Office of General Counsel, NASD Regulation