9043 - NFA COMPLIANCE RULE 2-29: USE OF PAST OR PROJECTED PERFORMANCE; DISCLOSING CONFLICTS OF INTEREST FOR SECURITY FUTURES PRODUCTS
(Board of Directors, August 21, 2001)
The Commodity Futures Modernization Act of 2000 (CFMA), which was signed into law on December 21, 2000, lifts the 18-year ban on single-stock futures and narrow-based security indices ("security futures products"). Unlike other futures contracts, however, the CFMA provides that security futures products are securities as well as futures. Therefore, under Section 15A(k) of the Securities Exchange Act of 1934 (Exchange Act), NFA is a national securities association (NSA) for the limited purpose of regulating the activities of Members who are registered as brokers or dealers in security futures products under Section 15(b)(11) of the Exchange Act (i.e., FCMs and IBs who "passport" in to broker-dealer registration because they limit their securities activities to security futures products).
NFA Compliance Rule 2-29 imposes high standards on Members' and Associates' communications with the public in connection with any of their futures activities. When regulating the securities futures activities of Members registered as broker-dealers under Section 15(b)(11) of the Exchange Act, however, Section 15A(k)(2)(B) of the Exchange Act requires NFA to impose sales practice and promotional material requirements reasonably comparable to those of national securities associations registered under Section 15A(a) of the Exchange Act. In light of those requirements, this notice reiterates some of the requirements that apply to all products and describes some of the additional requirements imposed by new section (j) of Compliance Rule 2-29. Section (j) applies to the security futures activities of those Members who are registered as broker-dealers under Section 15(b)(11) of the Exchange Act and their Associates. Sections (a)-(i) apply to all Members.
The requirements described in this interpretation are in addition to — and do not in any way limit or amend — any other requirements imposed by NFA rules, including those discussed in other interpretations issued by the Board of Directors.
Use of Misleading Statements
NFA Compliance Rule 2-29(b)(1) prohibits the use of promotional material that is likely to deceive the public. Additionally, NFA Compliance Rule 2-29(b)(2) prohibits the use of promotional material which contains any material misstatement of fact or which the Member or Associate knows omits a fact which causes the material to be misleading. NFA has always considered the following items to be violations of these Rules:
- Promotional material that uses outdated information to support current claims;1
- Promotional material that makes claims regarding research or other facilities beyond those which the Member or Associate actually possesses or has reasonable capacity to provide.2
- Promotional material that makes any statement to the effect that any report, analysis, or other service will be furnished free or without any charge unless such report, analysis or other service actually is or will be furnished entirely free and without condition or obligation.3
Use of Past or Projected Performance
NFA Compliance Rule 2-29 places certain limitations on the use of past or projected performance in communications with the public. Some of those limitations — most of which apply to all futures contracts regardless of the underlying commodity — are discussed in this section.
Provided that the performance is representative of all reasonably comparable accounts, most promotional material may discuss past performance of actual or recommended transactions if it meets a number of standards.
- Performance must be presented in a balanced manner. (See NFA Compliance Rule 2-29(b)(2) and (b)(5).)
- The promotional material must disclose all relevant costs, including commissions and fees. (See NFA Compliance Rule 2-29(b)(2).)
- Any discussion of the past performance of recommended transactions must comply with NFA Compliance Rule 2-29(c).
- For security futures products, the promotional material must indicate the general market conditions during the period covered. (See NFA Compliance Rule 2-29(b)(1) and (2).)
- Performance information used by FCMs, IBs, and their Associates must include the date of each initial recommendation or transaction; the price at that date; and the date and price at the end of the period or when liquidation was suggested or effected, whichever was earlier. If a summary is used, it must be calculated in a manner consistent with CFTC Regulation 4.25(a)(7)(i)(F). (See NFA Compliance Rule 2-29(b)(2) and (5).)
- Performance information used by FCMs, IBs, and their Associates must also be current, meaning that it must cover at least the most recent 12-month period or must include the performance in its entirety if less than 12 months. The Member or Associate must disclose more than the last 12 months of performance if the last 12 months is not representative, and the Member or Associate may not include gaps or otherwise cherry-pick the periods for which it discloses performance. (See NFA Compliance Rule 2-29(b)(1) and (2).)
- The Member or Associate must keep records showing how it calculated the performance numbers used in the promotional material. These records must identify the trades and accounts that were used in calculating performance, describe how and why those transactions and accounts were selected, and demonstrate how the results are representative of all reasonably comparable accounts. (See NFA Compliance Rule 2-29(f).)
- A person who is authorized to approve the promotional material must determine that the performance information is accurate and is presented in a manner that is not misleading. (See NFA Compliance Rules 2-9(a) and 2-29(e).)
Promotional material that discusses projected performance must also meet a number of standards.
- The promotional material must disclose, and the projected performance must be adjusted for, all relevant costs, including commissions and fees. (See NFA Compliance Rule 2-29(b)(2).)
- The projected performance must have a reasonable basis in fact. (See NFA Compliance Rule 2-29(d).)
- All material assumptions made in projecting performance must be clearly identified. (See NFA Compliance Rule 2-29(b)(2).)
- The risks must be discussed and balanced with the discussion of projected profits. (See NFA Compliance Rule 2-29(b)(3).)
Annual rates of return may not be used in any promotional material unless they are based on 12 consecutive months of actual performance, and they must be calculated in a manner consistent with CFTC Regulation 4.25(a)(7)(i)(F). (See NFA Compliance Rule 2-29(b)(5).) Furthermore, the promotional material must state that past results are not necessarily indicative of future results. (See NFA Compliance Rule 2-29(b)(4).)
NFA Compliance Rule 2-29(j) imposes additional restrictions on promotional material of Members registered as broker-dealers under Section 15(b)(11) of the Exchange Act and their Associates if the promotional material specifically refers to security futures products. Where the promotional material is accompanied or preceded by the disclosure statement for security futures products, references to past recommendations must include all of the information described in Compliance Rule 2-29(j)(9), and references to current recommendations must include instructions on how to obtain that information. However, promotional material for these products may not contain any discussion of past or projected performance unless accompanied or preceded by the disclosure statement for security futures products. This means that most forms of mass media advertising cannot discuss past or projected performance.
Research reports for underlying securities are not promotional material under NFA Compliance Rule 2-29 merely because the customers who receive the reports may trade security futures products in those securities. Compliance Rule 2-29 does, however, cover any research report that mentions security futures products or discusses any strategy that includes using security futures products.
Disclosing Conflicts of Interest in Security Futures Products by Members Registered as Broker-Dealers Under Section 15(b)(11) of the Exchange Act
Due to the nature of the securities markets, Members may have special conflicts of interest that may not necessarily be known to their customers. NFA Compliance Rule 2-29(j)(11) - which applies to Members registered as broker-dealers under Section 15(b)(11) of the Exchange Act - provides that promotional material that makes a recommendation regarding security futures products must disclose material conflicts of interest that the Member may have due to its activities in the underlying security. In particular, the promotional material must disclose any of the following conflicts, if applicable:
- The Member and/or its officers or partners own options, rights, or warrants to purchase any of the securities of the issuer whose securities underlie the security futures product being recommended, unless the ownership is nominal; and
- Within the last three years, the Member was manager or co-manager of a public offering of any securities of the issuer whose securities underlie the security futures product being recommended.
1 See, In the Matter of MBH Commodity Advisors, Inc., NFA Case No. 96-BCC-015 (Hearing Panel, May 5, 1998), aff'd, NFA Case No. 98-APP-001 (App. Comm., Feb. 19, 1999); aff'd, CFTC Docket No. CRAA 99-3 (CFTC, Mar. 31, 2000), aff'd, MBH Commodity Advisors, Inc. v. Commodity Futures Trading Commission, No. 00-1957, 7th Cir., May 7, 2001.
2See, In re Universal Commodity Corporation, NFA Case No. 95-BCC-20 (Hearing Panel, Feb. 3, 1998), aff'd, In re Parks, NFA Case Nos. 98-APP-1, 98-APP-2, and 98-APP-3 (App. Comm., Mar. 14, 2000); In re JCC, Inc., NFA Case No. 90-BCC-30 (Aug. 25, 1992); aff'd, NFA Case Nos. 92-APP-2 through 92-APP-8 (App. Comm., July 19, 1993); aff'd, CFTC Docket No. CRAA 93-6 (CFTC, June 29, 1994).
3 See, In re Filler Zaner & Associates, NFA Case No. 89-BCC-32 (BCC, Nov. 30, 1989).