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Interpretive Letter to Jason P. Ellison, Foreside Fund Services, LLC

A member firm may include related performance information in institutional communications concerning Section 3(c)(1) Funds, subject to the stated conditions discussed in the letter.


Dear Mr. Ellison:

In your letter dated August 31, 2020, you have requested interpretive guidance on behalf of Foreside Fund Services, LLC (“Foreside”), a registered broker-dealer, regarding the use of related performance information in communications concerning private unregistered funds excluded from the definition of “investment company” under section 3(c)(1) of the Investment Company Act of 1940 (“ICA”)1 (“3(c)(1) Funds”) that are distributed solely to institutional investors as defined in FINRA Rule 2210(a)(4).2  

Background

You state that Appleseed Pioneer, LP (the “Fund”) is a Delaware limited partnership relying on the Section 3(c)(1) exclusion from the definition of investment company under the ICA and has not registered its securities pursuant to Rule 506(b) of Regulation D under the Securities Act of 1933.3  You state that sales of the Fund’s interests are restricted to investors who are accredited investors as defined by Rule 501 of Regulation D.4  You further state that the Fund seeks capital appreciation generally using a long-short strategy -- making long-term investments in public environmental, social and governance (“ESG”) companies that Pekin Hardy Strauss, Inc. (the “Investment Adviser”) believes are undervalued, while also shorting non-ESG companies that are overvalued.

You state that the Fund was formed on August 18th, 2016, and commenced sales of its shares on October 3rd, 2016, and that the minimum initial subscription for an interest in the Fund is $500,000.  Persons interested in subscribing in the Partnership are required to complete, execute and return subscription agreements to Appleseed Pioneer GP, LLC.  You also state that individuals employed by the Investment Adviser who promote or intend to promote the Fund are registered as representatives of Foreside. 

You state that communications concerning the Fund (“Marketing Materials”), which will be distributed solely to institutional investors as defined in FINRA Rule 2210(a)(4), may include the past performance information of a separately managed account (the “SMA”) with substantially similar investment objectives, policies and strategies as the Fund and that was managed by the Investment Adviser (“Related Performance Information”).  You state that the Related Performance Information reflects the performance of an investment strategy that began trading in the SMA on December 17th, 2014 and ended on June 19th, 2017, at which time the SMA was closed (the “SMA Performance Period”).  You further state that the SMA is the only separate or private account or fund managed by the Investment Adviser that had or has substantially similar investment objectives, policies and strategies as the Fund.

You state that the Marketing Materials will be labeled “For institutional investor use only.  Not for use with retail investors,” and that recipients of the Marketing Materials will be instructed not to provide the communication to non-institutional investors.  You represent that the Related Performance Information will be shown net of SMA fees with additional disclosure regarding the reflection of fees in the calculation of the performance included.

You also state that the Fund’s actual performance is shown net of Fund fees and its fees and expenses are further explained in the disclosures section of the Marketing Materials.  You also provide that the Marketing Materials will disclose the material differences between the SMA and the Fund, such as differences in cash flows, fees, expenses, performance calculation, portfolio size, and investment limitations. 

You represent that Related Performance Information will be used in Marketing Materials for the Fund only under the following conditions:

  1. The Related Performance Information may be provided only if it is the actual performance of all separate or private accounts or funds (other than the Fund) that have (i) substantially similar investment policies, objectives, and strategies of the Fund, and (ii) are managed or were previously managed by the Investment Adviser.  The SMA is the only separate or private account or fund that meets these criteria.
  1. The Marketing Materials with Related Performance Information will be provided only to persons who qualify as “institutional investors” under Rule 2210(a)(4), excluding institutional investors who intend to share the Related Performance Information with persons other than institutional investors.
  1. The presentation of Related Performance Information will include all performance of the SMA during the SMA Performance Period.
  1. Any institutional communication with Related Performance Information will be clearly labeled “for use with institutional investors only, not for use with retail investors.” The Marketing Materials will instruct institutional investors who receive such materials not to provide them to current or prospective customers or others who are not institutional investors.
  1. The presentation of Related Performance Information will disclose performance information that is net of fees and expenses of the SMA.
  1. Gross performance of the SMA may be shown alongside the net performance described above.  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, and (ii) that the Related Performance Information would have been lower if the SMA were subject to higher fees and expenses.
  1. The fees and expenses of the Fund will be prominently disclosed, and the Fund’s performance information will reflect all fees and expenses.  If the fees and expenses are higher than the fees and expenses of the SMA, that fact will be disclosed.
  1. Related Performance Information will be clearly labeled as such and contain clear disclosure of the applicable dates for the performance.  Because the SMA Performance Period does not reflect current performance, the institutional communication will disclose that the Related Performance Information must be viewed in the context of economic and market conditions that existed during that period, and that there is no assurance that the SMA would have continued to achieve similar performance results going forward had it not closed.
  1. Because the Fund has been in existence for more than one year, the Marketing Materials will present the Fund’s actual performance more prominently than the Related Performance Information.  The Fund’s actual performance will be current as of the most recently-ended calendar quarter.
  1. The institutional communications will disclose any material differences between the SMA and the Fund.
  1. 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 Foreside 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 based on principles of fair dealing and good faith, 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, and may not include any false, exaggerated, unwarranted, promissory or misleading statements.5  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.6

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).7  However, FINRA also has 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 members to provide related performance information to institutional investors with appropriate safeguards. 

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 ICA,8 if the information was made available only to qualified purchasers, as defined in the ICA,9 and the member firm complied with all other applicable standards in Rule 2210.10  

Additionally, in 2015 and 2017, FINRA issued interpretive letters in which it recognized that, under conditions similar to those contained in this letter, the use of related performance information in institutional communications as defined in FINRA Rule 2210(a)(4) concerning open-end registered investment companies or continuously offered registered closed-end investment companies would not be inconsistent with the applicable standards of Rule 2210.11  

FINRA believes that the same policy rationale and analysis in the Davis Polk Letter, the Hartford Letter, and the K&L Gates Letter apply in this context.12  Accordingly, FINRA staff believes that the use of Related Performance Information in institutional communications concerning Section 3(c)(1) Funds such as the Fund in the manner proposed in your letter is consistent with the applicable standards of Rule 2210.13  

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) 386-4534.

Sincerely,

/s/ Joseph P. Savage

Joseph P. Savage

 

1 15 U.S.C. 80a-3(c)(1).  Section 3(c)(1) excludes from the definition of “investment company” under the ICA “[a]ny issuer whose outstanding securities (other than short-term paper) are beneficially owned by not more than one hundred persons and which is not making and does not presently propose to make any public offering of its securities.”

2 Under FINRA Rule 2210(a)(4), the term "institutional investor" means any person described in FINRA Rule 4512(c), regardless of whether that person has an account with the FINRA member; governmental entity or subdivision thereof; employee benefit plan that meets the requirements of Section 403(b) or Section 457 of the Internal Revenue Code and has at least 100 participants, but does not include any participant of such a plan; qualified plan, as defined in Section 3(a)(12)(C) of the Securities Exchange Act of 1934, as amended, that has at least 100 participants, but does not include any participant of such a plan; FINRA member or registered associated person of such a member; and person acting solely on behalf of any such institutional investor.

3 17 CFR 230.506(b).

4 17 CFR 230.501(a).

5 See Rule 2210(d)(1)(A) and (B).

6 See Rule 2210(b)(3).

7 See, e.g., “Adviser Performance Prohibited in New Fund Advertising,” NASD Regulatory & Compliance Alert (June 1992), at 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), at footnote 2; see also MassMutual Institutional Funds, SEC staff no-action letter (September 28, 1995).

8 15 U.S.C. 80a-3(c)(7).  Section 3(c)(7) excludes from the definition of “investment company” under the ICA “[a]ny issuer, the outstanding securities of which are owned exclusively by persons who, at the time of the acquisition of such securities, are qualified purchasers, and which is not making and does not at that time propose to make any public offering of its securities.”

9 “Qualified purchaser” for purposes of the ICA includes, among others, any natural person who owns not less than $5,000,000 in investments, and any person, acting for its own account or the accounts of other qualified purchasers, who in the aggregate owns and invests on a discretionary basis, not less than $25,000,000 in investments.  15 U.S.C. 80a-2(a)(51).

10 See Letter from Thomas M. Selman, NASD, to Yukako Kawata, Davis Polk & Wardwell (Dec. 30, 2003) (“Davis Polk Letter”), available at www.finra.org.

11 See Letter from Joseph E. Price, FINRA, to Edward P. Macdonald, Hartford Funds Distributors, LLC (May 12, 2015) (“Hartford Letter”), and letter from Joseph P. Savage, FINRA, to Clair Pagnano, K&L Gates LLP (June 9, 2017) (“K&L Gates Letter”), available at www.finra.org.  See also Letter from Joseph P. Savage, FINRA, to Joan E. Boros, Stradley Ronon Stevens & Young, LLP (April 16, 2018) (opining that related performance information may be presented in institutional communications concerning variable annuity and life insurance contracts subject to specified representations). 

12 The Hartford and K&L Gates Letters included representations that the related performance information would be current as of the most recently-ended calendar quarter.  The Related Performance Information will not be current given that the SMA Performance Period ended in 2017.  FINRA is permitting Foreside to present non-current related performance information because both the SMA and the Fund had or has been in existence for over one year, the Fund’s performance will be current as of the most recently-ended calendar quarter, and its performance period overlaps with the SMA Performance Period.

13 In 2004, FINRA issued an interpretive letter responding to a request to permit the distribution of communications concerning 3(c)(1) Funds that included related performance information only to qualified institutional buyers as defined in Rule 144A(a)(1) under the Securities Act of 1933 (“QIBs”).  FINRA concluded that the requested interpretation raised numerous concerns, including that potential investors that qualify as QIBs would be treated differently than, and have access to informational not available to, other potential investors, and declined to permit the use of related performance under those facts.  See Letter from Gary L. Goldsholle, NASD, to Budge Collins, Collins/Bay Island Securities (September 14, 2004) (“Collins/Bay Letter”).  FINRA believes that the guidance provided in the Collins/Bay Letter is distinguishable from the guidance provided in this letter, as FINRA Rule 2210 recognizes that institutional communications may include information that is not made available to retail investors.  Rule 2210 does not create the same dichotomy between communications distributed only to QIBs and those distributed to non-QIB investors.