SEC Approves Amendments To Advertising And Sales Literature Filing And Review Requirements

Executive Summary

On August 9, 1995, the Securities and Exchange Commission (SEC) approved amendments to Article III, Section 35 of the NASD^® Rules of Fair Practice and Section 8 of the Government Securities Rules (collectively, the Rules) to broaden the definitions of, and revise the approval and filing requirements for, advertising and sales literature.¹ The amendments also revise the rules relating to recommendations in communications with the public. The amendments became effective on August 9, 1995.

Background And Description Of Amendments

Article III, Section 35 of the Rules of Fair Practice and Section 8 of the Government Securities Rules govern members' communications with the public regarding general securities and government securities, respectively. The Rules contain definitions, internal approval and recordkeeping requirements, and filing requirements and standards applicable to the content of such communications. To codify existing rule interpretations, rectify inconsistencies, and clarify issues that have been the source of member misunderstanding, the NASD is amending the Rules to revise the definitions of, and the internal approval and timeliness of filing requirements for, advertising and sales literature and the scope of rules relating to "Recommendations."

Amendments To Definitions

The NASD is amending the definitions of "Advertisement" and "Sales Literature" in Article III, Subsections 35(a)(1) and (2) of the Rules of Fair Practice and Subsections 8(a)(1) and (2) of the Government Securities Rules to include electronic messages. The NASD has consistently applied its standards for communications with the public to electronic messages sent via computer. Thus, the inclusion of the term "electronic" in the definition of "Advertisement" clarifies the applicability of the Rules to communications available to all computer or electronic network subscribers, including items displayed over network bulletin boards. The new definition of "Advertisement" does not, however, include communications posted by members of the public on electronic bulletin boards sponsored by NASD members; it has never applied to communications by the general public.

The inclusion of the term "electronic" in the definition of "Sales Literature" is intended to clarify the applicability of the Rules to messages sent directly to targeted individuals or groups. The new definition of "Sales Literature" does not, however, include a personalized message sent to a particular individual via electronic mail. Such messages are not treated as sales literature but generally as correspondence under Article III, Section 27(d) of the Rules of Fair Practice.²

The NASD is also amending the definition of "Sales Literature" in Article III, Subsection 35(a)(2) of the Rules of Fair Practice and Subsection 8(a)(2) of the Government Securities Rules to include telemarketing scripts. Members often file telemarketing scripts for review with the NASD Advertising Regulation Department that are to be read to prospects and existing customers or delivered electronically through a telemarketing service. These scripts differ from other forms of telephone prospecting and customer contact in that they are always followed up by the caller or callers. The NASD considers these scripts as comparable to a form letter delivered orally and, by including them in the definition, believes it will reduce confusion among members and promote more consistent application of the Rules.

Member Review Of Advertising And Sales Literature

The NASD is also amending Article III, Subsection 35(b)(1) of the Rules of Fair Practice and Subsection 8(b)( 1) of the Government Securities Rules to require that each item of advertising and sales literature be approved internally before use only by a registered principal. Before these amendments, the Rules allowed a registered principal to perform the review or delegate this responsibility to a designee. The Rules contained no guidelines for the level of experience, expertise, or qualification that the designee must have to assume this compliance responsibility and, in some cases, individuals less qualified than principals have been designated by registered principals to provide internal approval. The amendments eliminate the potential for inconsistent internal standards applied by different members for the review of communications with the public.

The NASD is also amending Article III, Subsection 35(b)(1) of the Rules of Fair Practice and Subsection 8(b)(1) of the Government Securities Rules to require that advertising and sales literature be approved internally by members before being filed with the NASD Advertising Regulation Department. Before these amendments, the Rules for review of advertisements and sales literature required that the material be approved internally by the member before first use, but did not require that material be approved internally by the member before being filed with the NASD. Some members have acknowledged that their internal review sometimes occurs after the NASD response is received. This practice places the NASD in the role of providing the initial compliance review, a role that should, in the NASD's view, be maintained within the member firms' compliance departments. The amendments will ensure that members submit material that conforms to the applicable Rules. It is anticipated that the amendments will reduce the amount of refiling requested by the NASD Advertising Regulation Department due to extensive deficiencies in the original filings.

Filing Requirements

The NASD is also amending Article III, Subsections 35(c)(1), (2), (3)(A), and (4) to the Rules of Fair Practice and Subsections 8(c)( 1)(A) and (B), (c)(2), and (c)(3) of the Government Securities Rules to require that where filings are required to be submitted with certain time frames, the member provide the actual or expected date of first use or publication of the item filed. Before these amendments, the rules required that material be filed within 10 days of first use or 10 days before use, depending on the status of the firm and the subject matter of the communication. Members would file communications for review in various stages of a document's production, ranging from first drafts to finished products, and it was often impossible to determine the date of first use unless the information was provided voluntarily by the member or requested by the NASD reviewer. Because of the extensive volume of filings the NASD Advertising Regulation Department reviews each month, it is impractical to contact members routinely and request that they provide the date of use for each piece filed and, consequently, the NASD has been unable to determine systematically if member firms were meeting their filing obligations. The amendments will enable the NASD to enforce the existing Rules more effectively and consistently.

In addition, the NASD is deleting Article III, Subsection 35(c)(3)(B) to the Rules of Fair Practice. This provision was always intended to be temporary in that it applied the pre-filing requirements of Subsection 35(c)(3)(A) for one year to those firms that had been filing advertisements for less than one year when the pre-filing provisions became effective. The provision ensured that such firms continued to pre-file advertisements for at least one year from the date their first advertisements were filed. As such, the provision became obsolete one year from its effective date.

Standard For Recommendations

Finally, the NASD is amending Article III, Subsection 35(d)(2)(B) to the Rules of Fair Practice and Subsection 8(d)(2)(B) to the Government Securities Rules to specify that the requirement to disclose the price of a security applies only to communications on behalf of corporate equities and to delete the price disclosure requirement entirely from the Government Securities Rules. Before these amendments, the literal language of the Rules would have required price disclosure with respect to all securities products in all communications deemed to be recommendations. However, the NASD has a longstanding practice of not requiring price disclosure on communications for securities products other than corporate equities. Nevertheless, both the Rules of Fair Practice and the Government Securities Rules prohibit members from omitting material information in communications with the public. Therefore, if inclusion of the price of the security is necessary to make the material not misleading, then the member is required to include the price.

Questions regarding this Notice may be directed to Thomas Pappas, Assistant Director, Advertising/ Investment Companies Regulation Department, at (202) 728–8330, and Robert J. Smith, Attorney, Office of General Counsel, at (202) 728–8176.

¹See, Securities Exchange Act Rel. No. 36076 (August 9, 1995).

² Such personalized electronic correspondence is also distinguished from interactive electronic conversations, either through direct links or so-called "chat rooms." Interactive conversations will not generally be regarded as correspondence; however, members should be aware that such "conversations" can easily be recorded or reduced to hard copy. Finally, all communications, whether advertising, sales literature, correspondence, or conversations, regardless of the medium, are subject to the anti-fraud provisions of the federal securities laws, SEC rules, and the rules of the NASD.

Text Of Amendments To Article III, Section 35 Of The Rules Of Fair Practice And Section 8 Of The Government Securities Rules

(Note: New text is underlined; deletions are bracketed.)

ARTICLE III Rules of Fair Practice

Sec. 1 through 34 No change.

Communications With the Public

Sec. 35.

GOVERNMENT SECURITIES RULES

Sec. 1 through Sec. 7 No change.

Communications With the Public

Sec. 8