Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the National Association of Securities Dealers, Incorporated Amending the Requirements for the Use in Advertisements and Sales Literature of Investment Company Rankings

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-37987; File No. SR-NASD-96-39]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

Change by the National Association of Securities Dealers, Incorporated

Amending the Requirements for the Use in Advertisements and Sales

Literature of Investment Company Rankings

November 25, 1996.

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 October

17, 1996,\1\ the National Association of Securities Dealers, Inc.

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

Commission (``Commission'') the proposed rule change as described in

items I, II, and III below, which Items have been prepared by the self-

regulatory organization. The Commission is publishing this notice to

solicit comments on the proposed rule change from interested persons.

---------------------------------------------------------------------------

\1\ On November 21, 1996, the NASD filed Amendment No. 1 with

the Commission. The amendment clarified that rankings based on yield

may be based on periods of less than one year. The amendment also

made technical amendments to the text of the rule. See Letter from

John Ramsay, Deputy General Counsel, NASD Regulation, Inc. to

Katherine A. England, Assistant Director, Division of Market

Regulation, Commission, dated November 20, 1996.

---------------------------------------------------------------------------

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

Substance of the Proposed Rule Change

The NASD is herewith filing a proposed rule change to Rule IM-2210-

3 of the NASD's Conduct Rules to allow for the use in advertisements

and sales literature of investment company rankings that represent

short, medium and long term performance. Below is the text of the

proposed rule change. Proposed new language is italicized; proposed

deletions are in brackets.

IM-2210-3. Use of Rankings in Investment Companies Advertisements and

Sales Literature

(d) Time Periods

(1) Any investment company ranking set forth in an advertisement

or sales literature must be, at a minimum, current to the most

recent calendar quarter ended, in the case of advertising, prior to

the submission for publication, or, in the case of sales literature,

prior to use.

(2) Except for money market mutual funds:

(A) advertisements and sales literature must not use any

rankings, other than rankings based on yield, based on a period of

less than one year.

(B) any investment company ranking based on total return must be

accompanied by rankings based on total return for [the] a one year

period for investment companies in existence for one year; [the] one

and five year periods for investment companies in existence for at

least five years; and [the] one, five and ten year periods for

investment companies in existence for at least ten years supplied by

the same Ranking Entity [in the category], relating to the same

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

that, if rankings for such one, five and ten year time periods are

not published by the Ranking Entity, then rankings representing

short, medium and long term performance must be provided in place of

rankings for the required time periods.

(C) an investment company ranking based on yield may be based

only on the current SEC standardized yield. An investment company

ranking based on the current SEC standardized yield must be

accompanied by rankings based on total return for [the] a one year

period for investment companies in existence for one year; [the] one

and five year periods for investment companies in existence for at

least five years; and [the] one, five and ten year periods for

investment companies in existence for at least ten years supplied by

the same Ranking entity [in the category], relating to the same

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

that, if rankings for such, one, five and ten year time periods are

not published by the Ranking Entity, then rankings representing

short, medium and long term performance must be provided in place of

rankings for the required time periods.

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 self-regulatory organization

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 self-regulatory organization

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

1. Purpose

In 1994, the Commission approved what is now IM-2210-3 of the NASD

Conduct Rules, which provides guidelines for the use of rankings in

investment companies' advertisements and sales literature

(``Guidelines'').\2\ Among other things, the Guidelines require that

all rankings used in advertising and sales literature by member firms

to promote non-money market mutual fund performance include rankings

over one, and, if available, five and ten year periods. Prior to the

Guidelines, there were no specific standards for the use of rankings.

Members generally had selected rankings for whatever time period that

produced the most favorable rankings for an investment company.

---------------------------------------------------------------------------

\2\ Securities Exchange Act Release No. 34354 (July 12, 1994),

59 FR 36461 (July 18, 1994).

---------------------------------------------------------------------------

Since the approval of the Rankings Guidelines, staff of NASD

Regulation, Inc. (``NASDR'') have considered the issue of whether to

allow for greater flexibility in the use of time periods other than

those prescribed by the Guidelines. The staff notes that some rankings,

which are based on adjusted total return to reflect criteria and

methodologies established and imposed by the ranking entities, use time

periods that do not meet the three specifically prescribed time periods

contained within the Guidelines. For example, one ranking entity has

developed a ranking system that summarizes an investment company's

risk/reward profile for 3, 5 and 10 year periods. This system provides

a composite ranking that seeks to measure how well an investment

company has balanced return and risk in the past. This ranking entity

does not intend that its risk adjusted rankings measure one year time

periods and considers such measurements to be statistically meaningless

and potentially misleading.

NASDR believes that performance-adjusted rankings which use

different time periods than those prescribed by the Guidelines can help

investment company investors make informed investment decisions if

presented in a way that is not misleading. NASDR staff determined that

the Guidelines, as originally approved, should be revised consistent

with the original goal that would prevent selectivity of time periods.

The proposed rule change revises subparagraphs (2) (B) and (C) to

[[Page 64186]]

paragraph (d) of IM-2210-3. The proposed rule change clarifies that the

use of one, five and ten year time periods is required if such time

periods are published by the ranking entity.\3\ If rankings for the

required time periods are not published by the ranking entity, the

proposed rule change provides that rankings representing short, medium

and long term performance must be provided in place of rankings for the

required time periods. In its discussions of how the terms ``short,''

``medium'' and ``long term'' might be interpreted, NASDR staff

considered time frames of 1-4 years, 5-5 years and 10 years or more,

respectively, as an acceptable interpretation. The proposed rule change

also replaces the phrase ``in the category,'' in subparagraphs (2) (B)

and (C) with the phrase ``relating to the same investment category.''

to clarify that when members provide rankings for advertisements and

sales literature, rankings for the prescribed time periods must be for

the same investment category of subcategory as the total return ranking

that is being accompanied by the prescribed ranking.

---------------------------------------------------------------------------

\3\ The Guidelines define ``Ranking Entity'' as ``* * * any

entity that provides general information about investment companies

to the public, that is independent of the investment company and its

affiliates, and whose services are not procured by the investment

company or any of its affiliates to assign the investment company a

ranking.''

---------------------------------------------------------------------------

The proposed rule change makes clear that the Guidelines apply to

rankings that use time periods other than the one, five, and ten year

periods prescribed in the Guidelines if rankings for the required time

periods are not published by the ranking entity. On the one hand, the

proposed rule change provides an option that relaxes the requirement to

use standardized time periods. At the same time, this option still

assures that rankings will continue to be reflected over an extended

period and therefore provide more than just a ``snapshot'' view. NASDR

believes that the proposed rule change provides a flexible framework

within which ranking entities using different methodologies can provide

useful information to investors in a way that is not harmful or

misleading.

2. Statutory Basis

The proposed rule change is consistent with the provisions of

Sections 15A(b)(6) of the Act, \4\ which require that the Association

adopt and amend its rules to promote just and equitable principles of

trade and generally provide for the protection of customers and the

public interest, in that the proposed rule change continues to prohibit

the use in advertising and sales literature of rankings containing

arbitrarily selected time periods while allowing time periods other

than those originally prescribed by the rule in a way that is not

misleading.

---------------------------------------------------------------------------

\4\ 15 U.S.C. Sec. 78o-3.

---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

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

any inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed

Rule Change Received From Members, Participants, or Others

No written comments were either solicited or received by the NASD.

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

Commission Action

Within 35 days of the 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 the 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, N.W., Washington, D.C. 20549.

Copies of the submission, all subsequent amendments, all written

statements with respect to the proposed rule change that are filed 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 at the

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

available for inspection and copying at the principal office of the

NASD. All submissions should refer to File No. SR-NASD-96-39 and should

be submitted by December 24, 1996.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\5\

---------------------------------------------------------------------------

\5\ 17 CFR 200.30-3(a)(12).

---------------------------------------------------------------------------

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 96-30676 Filed 12-2-96; 8:45 am]

BILLING CODE 8010-01-M