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Notice To Members 91-39

Limitations on Use of "Negative Response" Letters in Switching Customers From One Mutual Fund to Another

Published Date:


Senior Management
Legal & Compliance
Mutual Fund
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The NASD has recently received information about the increasing use of so-called "negative response" letters. These letters are used to facilitate members' recommendations that customers switch from one mutual fund to another.

The letters contain a recommendation that customers redeem mutual fund shares and invest the proceeds in another fund. The reasons for the recommendation, which usually are related to investment performance, are stated. And the letter also says that if the customer does not respond by a specific date, the exchange will be executed automatically (the negative response feature).

The NASD reminds members that engage in this practice that, in addition to the suitability, prospectus delivery, and disclosure requirements governing such recommendations, no member may exercise discretion in a customer's account without obtaining prior written authorization from the customer (Article III, Section 15, NASD Rules of Fair Practice).

Thus, the lack of a response would preclude the automatic exchange of shares unless the member has on file prior written authorization from the customer permitting the member to exercise discretion in the account.

Discretionary authority would not be required in situations where a mutual fund states in the prospectus that it reserves the right to redeem shares without customer permission if the value of the shares owned by the customer falls below a specific minimum amount.

Questions regarding this notice may be directed to A. John Taylor, Vice President, Investment Companies/Variable Contracts at (202) 728-8328.