Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by National Association of Securities Dealers, Inc. Relating to Guidelines Regarding the Use of Rankings in Mutual Fund Advertisements and Sales Literature

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-33606; File No. SR-NASD-93-69]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

Change by National Association of Securities Dealers, Inc. Relating to

Guidelines Regarding the Use of Rankings in Mutual Fund Advertisements

and Sales Literature

February 9, 1994.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on November

22, 1993, the National Association of Securities Dealers, Inc.

(``NASD'' or ``Association'') filed with the Securities and Exchange

Commission (``SEC'' or ``Commission'') the proposed rule change as

described in Items I, II, and III below, which Items have been prepared

by the NASD. The Commission is publishing this notice to solicit

comments on the proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance

of the Proposed Rule Change

The NASD is proposing to adopt Guidelines Regarding the Use of

Rankings in Mutual Fund Advertisements and Sales Literature. Below is

the text of the proposed rule change. Proposed new language is

italicized.

Guidelines for the Use of Rankings in Mutual Fund Advertisements and

Sales Literature

I. Definition of ``Ranking Entity''

For purposes of these guidelines, the term ``Ranking Entity''

refers to any entity that provides general information about mutual

funds to the public, that is independent of the mutual fund and its

affiliates, and whose services are not procured by the mutual fund or

any of its affiliates to assign the fund a ranking. Examples of

``Ranking Entities'' include services such as Morningstar and Lipper

and financial publications such as Money and Barron's.

II. Required Disclosures

A. Headlines/Prominent Statements.

1. A headline or other prominent statement must not state or imply

that a mutual fund is the best performer in a category unless it is

actually ranked first in the category.

2. Prominent disclosure of the mutual fund's ranking, the total

number of mutual funds in the category, the name of the category, and

the period on which the ranking is based (i.e., the length of the

period and the ending date; or, the first day of the period and the

ending date), must appear in close proximity to any headline or other

prominent statement that refers to a ranking.

B. All advertisements and sales literature containing a mutual fund

ranking must disclose, with respect to the ranking:

1. the name of the category (e.g., growth funds);

2. the number of funds in the category;

3. the name of the Ranking Entity;

4. the length of the period and the ending date, or, the first day

of the period and the ending date;

5. criteria on which the ranking is based;

6. for load funds, whether the ranking takes into account sales

charges;

7. if fees have been waived or expenses advanced during the period

on which the ranking is based, and the waiver or advancement had a

material effect on the ranking, a statement to that effect; and

8. the publisher of the ranking data (e.g., ``ABC Magazine, June

1993'').

The disclosure required by B1, B2 and B3 must be set forth

prominently in the body of the advertisement or sales literature.

C. If the mutual fund ranking consists of a symbol (e.g., a star

system) rather than a number, the advertisement or sales literature

also must disclose the meaning of the symbol (e.g., a four-star ranking

indicates that the fund is in the top 30% of all mutual funds).

D. All advertisements and sales literature containing a mutual fund

ranking must disclose that past performance is no guarantee of future

results.

III. Time Periods

A. Any mutual fund ranking set forth in an advertisement or sales

literature must be, at a minimum, current to the most recent calendar

quarter ended prior to the submission for publication.

B. Except for money market mutual funds;

1. advertisements and sales literature must not use any ranking

based on a period of less than one year.

2. a mutual fund ranking based on total return must be accompanied

by rankings based on total return for the one, five and ten year

periods (or life of the fund) supplied by the same Ranking Entity in

the category and based on the same time period; and,

3. a mutual fund ranking based on the current SEC standardized

yield must be accompanied by rankings based on total return for the

one, five and ten year periods (or life of the fund) supplied by the

same Ranking Entity in the category and based on the same time period.

IV. Categories

A. The choice of category (including a subcategory of a broader

category) on which the mutual fund ranking is based must be one that

provides a sound basis for evaluating the performance of the fund.

B. Subject to the standards below, a mutual fund ranking must be

based only on (1) a published category or subcategory created by a

Ranking Entity or (2) a category or subcategory created by a fund or a

fund affiliate, but based on the performance measurements of a Ranking

Entity.

C. When the mutual fund ranking is based on a subcategory, the

advertisement or sales literature must disclose the name of the full

category and the fund's ranking and the number of funds in the full

category. This requirement does not apply if the subcategory is (1)

based solely on the investment objectives of the funds included and (2)

created by a Ranking Entity. This disclosure could be included in a

footnote.

D. The advertisement or sales literature must not use any category

or subcategory that is based upon the mutual funds' asset size (whether

or not it has been created by a Ranking Entity).

E. If an advertisement uses a category created by the mutual fund

or a fund affiliate, including a ``subcategory'' of a category

established by a Ranking Entity, the advertisement must prominently

disclose:

1. the fact that the fund or its affiliate has created the ranking

category;

2. the number of funds in the category;

3. the basis for selecting the category; and

4. the Ranking Entity that developed the research on which the

ranking is based.

E. An advertisement or sales literature containing a headline or

other prominent statement that proclaims a mutual fund ranking created

by a fund or its affiliate must indicate, in close proximity to the

headline or statement, that the mutual fund ranking is based upon a

category created by the fund or its affiliate.

V. Multiple Class/Two-Tier Funds

Mutual Fund rankings for more than one class or fund with the same

portfolio must be accompanied by prominent disclosure of the fact that

the funds or classes have a common portfolio.

II. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, the NASD included statements

concerning the purpose of and basis for the proposed rule change and

discussed any comments it received on the proposed rule change. The

text of these statements may be examined at the places specified in

Item IV below. The NASD has prepared summaries, set forth in sections

(A), (B), and (C) below, of the most significant aspects of such

statements.

(A) Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

Ranking entities, mutual funds and fund affiliates categorize and

rank mutual funds in various ways such as, for example, according to

fund type, performance over a given period of years, total return, SEC

standardized yield, with and without sales charges and risk/reward.

Article III, Section 35(d)(2)(M) of the NASD Rules of Fair Practice\1\

sets forth the specific standard in communications with the public that

a member who makes investment comparisons, directly or indirectly, must

ensure that the purpose of the communication is clear and that the

comparison is fair and balanced, including any material differences

between the subjects of the comparisons. The use of mutual fund

rankings prepared by ranking entities, mutual funds and fund affiliates

to demonstrate mutual fund performance qualifies as such a comparison.

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\1\NASD Manual, Rules of Fair Practice, Art. III, Sec.

35(d)(2)(M), (CCH)  2195.

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As the number of mutual funds has increased substantially in recent

years, so have the number of mutual fund ranking entities. As the

number of ranking entities has increased, the NASD has observed an

increased reference to mutual fund rankings in fund advertisements and

sales literature. In response to the increasing reference by mutual

fund groups to such mutual fund rankings in mutual fund advertisements

and sales literature, the NASD determined to provide guidance on the

use of fund rankings and is proposing a comprehensive set of guidelines

to be used when mutual fund advertisements and sales literature include

references to mutual fund rankings.

Guidelines for Use of Rankings in Advertising and Sales Literature

Definition of Ranking Entity

The term ``Ranking Entity,'' for purposes of the Guidelines, refers

to an entity that provides general mutual fund information to the

public, is independent of the fund and its affiliates\2\ and whose

services are not used by the fund or its affiliates to assign the fund

a ranking. The definition encompasses entities formed specifically to

provide such information as well as financial publications and

periodicals which include such a service in their publications.

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\2\With respect to any fund, a Ranking Entity will be deemed to

be independent of that fund and its affiliates for the purposes of

these Guidelines only if it is not an ``affiliated person'' of that

fund and its affiliates as such term is defined in Section 2(a)(3)

of the Investment Company Act of 1940, 15 U.S.C. 80a-2(a)(3) (1988).

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Required Disclosures

The Guidelines contain certain required disclosures. All

advertisements and sales literature containing a ranking must disclose

the name of the mutual fund category, the number of funds in the

category, the name of the Ranking Entity, the period on which the

ranking is based, the criteria on which the fund is ranked, whether,

for load funds, the ranking takes into account sales charges, a

statement as to the material effect, if any, of fees waived or expenses

advanced during the period on which the ranking is based, and the

publisher of the ranking data. Disclosure of the publisher allows the

reader to obtain further information, if desired.

Additionally, because prominent statements often command the same

attention as headlines, the name of the mutual fund category, the total

number of funds in the category, and the period on which the ranking is

based must be disclosed in close proximity to any headline or prominent

statement. Such statement or headline may not state or imply that a

fund is ranked first in a category when it is not.

All advertising or sales literature using a ranking system

consisting of a symbol must disclose the meaning of the symbol.

Finally, all advertising and sales literature containing a ranking must

disclose that past performance is no guarantee of future results.

Time Periods

The NASD believes that the use of rankings which are current

reduces the possibility that such rankings will be deceptive or

misleading. The NASD recognizes that different Ranking Entities provide

rankings with varying frequencies, but believes that the industry

should be provided with a minimum standard of what is current.

Therefore, rankings should be at least current to the most recent

calendar quarter, though use of more current ranking data would be

permissible. The NASD believes that the current standard of the most

recent calendar quarter is reasonable and not misleading.

The NASD is concerned about a member's ability to select a ranking

based on a time period that would show the fund in the best light

without providing balancing information. Thus, the NASD believes that,

for all mutual funds except money market mutual funds, rankings based

on a period of less than one year are not meaningful, could be

misleading and, therefore, should not be used. Additionally, rankings

based on either total return or the SEC standardized yield must be

accompanied by rankings based on the total return for the one, five and

ten year (or mutual fund life) periods supplied by the same Ranking

Entity and must be based on the same time period. This requirement

parallels the SEC requirement that performance information must be

accompanied by one, five and ten year (or mutual fund life) total

return performance figures.

Categories

Recognizing the many ways in which data on mutual fund performance

can be presented, the NASD believes it is important to set standards

for methods of fund categorization which provide a sound basis for

evaluating the performance of a fund. Generally, advertisements and

sales literature must use only categories or subcategories created by

the Ranking Entities. Advertisements or sales literature using rankings

based only on a subcategory must disclose the name of the full

category, the fund's ranking and the number of funds in the full

category, unless the subcategory is based solely on the investment

objectives of the funds and is created by a Ranking Entity.

However, categories or subcategories created by a fund or fund

affiliate may be used as long as performance is measured by the

performance measurements of a Ranking Entity. Additionally, categories

or subcategories created by a fund or its affiliate must also

prominently disclose the fact that the fund or its affiliate has

created the ranking category, the number of funds in the category, the

basis for selecting the category, and the identity of the Ranking

Entity that developed the research on which the ranking is based.

Headlines and prominent statements using a ranking created by a fund or

its affiliate must also disclose in close proximity to the headline or

prominent statement that the ranking is based on a category created by

the fund or its affiliate.

Finally, advertisements or sales literature may not use any ranking

category based on the fund's asset size since such information would

not provide a meaningful basis upon which the fund's performance could

be evaluated.

Multiple Class/Two-Tier Funds

Advertisements or sales literature containing rankings for more

than one class or fund with the same portfolio must disclose the fact

that the funds or classes have a common portfolio.

The NASD believes that the proposed rule change is consistent with

the provisions of Section 15A(b)(6) of the Act\3\ in that the

guidelines will work to protect investors and the public interest by

establishing a baseline of standards to guide the use of mutual fund

rankings in advertising and sales literature in promoting the sale of

mutual funds and by preventing the misleading use of such rankings.

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\3\15 U.S.C. Sec. 78o-3.

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(B) Self-Regulatory Organization's Statement on Burden on Competition

The NASD does not believe that the proposed rule change will result

in any burden on competition that is not necessary or appropriate in

furtherance of the purposes of the Act, as amended.

(C) Self-Regulatory Organization's Statement on Comments on the

Proposed Rule Change Received From Members, Participants, or Others

The Guidelines, which are not subject to NASD member vote, were

circulated to members in NASD Notice to Members 93-76 (November 1993).

Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for

Commission Action

Within 35 days of the date of publication of this notice in the

Federal Register, or within such longer period (i) as the Commission

may designate up to 90 days of such date if it finds such longer period

to be appropriate and publishes its reasons for so finding or (ii) as

to which the self-regulatory organization consents, the Commission

will:

A. By order approve such proposed rule change, or

B. Institute proceedings to determine whether the proposed rule change

should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views, and

arguments concerning the foregoing. Persons making written submissions

should file six copies thereof with the Secretary, Securities and

Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549.

Copies of the submission, all subsequent amendments, all written

statements with respect to the proposed rule change that are field with

the Commission, and all written communications relating to the proposed

rule change between the Commission and any person, other than those

that may be withheld from the public in accordance with the provisions

of 5 U.S.C. 552, will be available for inspection and copying in the

Commission's Public Reference Room. Copies of such filing will also be

available for inspection and copying at the principal office of the

NASD. All submissions should refer to File Number SR-NASD-93-69 and

should be submitted by March 8, 1994.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority, 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 94-3425 Filed 2-14-94; 8:45 am]

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