Publications

Overview

On December 27, 2005, the Securities and Exchange Commission approved a proposed rule change filed by the National Association of Securities Dealers, Inc. (“NASD”) relating to bond mutual fund volatility ratings.¹ The approval makes permanent NASD Rule 2210(c)(3) and Interpretive Material IM-2210-5, which permit the use of bond mutual fund volatility ratings in supplemental sales literature under certain conditions. Rule 2210(c)(3) and IM-2210-5 initially were approved on an 18 month pilot basis that was scheduled to expire on August 31, 2001.² The NASD subsequently renewed the pilot several times, most recently with a proposed rule change that was effective upon filing and that extended the pilot provisions until December 29, 2005.

Permanent Rule

Use of Bond Mutual Fund Volatility Ratings

IM-2210-5 permits a NASD member and persons associated with a NASD member to use bond mutual fund volatility ratings in supplemental sales literature, provided the following requirements are satisfied:³

• The rating does not identify or describe volatility as a “risk” rating;
• The most recently available rating is used in the supplemental sales literature and reflects information that, at a minimum, is current to the most recently completed calendar quarter ended prior to use;⁴
• The criteria and methodology used to determine the rating is based exclusively on objective, quantifiable factors;
• The entity issuing the rating provides investors with a toll-free telephone number, a website or both, through which investors may request detailed disclosure on the rating methodology;
• The rating is clear, concise and understandable; and
• The supplemental sales literature conforms to certain disclosure requirements, which are discussed below.

M-2210-5 and Rule 2210(c)(3) apply only to open-end management investment companies. During the pilot period the NASD determined that it was unnecessary to expand the scope of IM-2210-5 and Rule 2210(c)(3) to apply to all investment companies. In addition, IM- 2210-5 and Rule 2210(c)(3) do not apply to in-house ratings because the NASD does not believe that inhouse ratings raise the same concerns as third-party ratings.

Disclosure Requirements

Supplemental sales literature using a bond mutual fund volatility rating must include a Disclosure Statement, and the volatility rating must be contained within the text of the Disclosure Statement. The following disclosures must be provided with respect to each rating:

• The name of the entity issuing the rating;
• The most current rating and the date of the current rating, with an explanation of the reason for any change in the current rating from the most recent prior rating; and
• A description of the rating in narrative form, containing the following disclosures:
  1. A statement that there is no standard method for assigning ratings;
  2. A description of the criteria and methodologies used to determine the rating;
  3. A statement that not all bond funds have volatility ratings;
  4. Whether the fund or another party paid the entity providing the rating for the issuance of the rating;
  5. A description of the types of risks the rating measures (e.g., short-term volatility);
  6. A statement that the portfolio may have changed since the date of the rating; and
  7. A statement that there is no guarantee that the fund will continue to have the same rating or perform in the future as rated.

A bond mutual fund may receive volatility ratings from multiple entities. IM-2210-5 requires all supplemental sales literature using bond mutual fund volatility ratings to contain all ratings that have been issued for a particular fund. A fund that has received multiple ratings may combine the ratings in a single Disclosure Statement, provided that the applicability of the disclosure to each rating is clear. This document may be considered attorney advertising in some jurisdictions. Some of the design images and photographs in this document may be of actors depicting fictional scenes.

Filing and Review Requirements

Rule 2210(c)(3) requires NASD members to file bond mutual fund sales literature that contains volatility ratings with the NASD’s Advertising Regulation Department at least 10 days prior to use. If the NASD requests changes to the material, the material must be withheld from publication or circulation until the changes have been made or, if expressly disapproved, the sales literature has been re-filed and approved. Members do not need to f ile sales literature which has been filed previously and is used without change.

Footnotes

1. Securities Exchange Act Release No. 34-53027; SR-NASD-2005-117.
2. Securities Exchange Act Release No. 34-42476; SR-NASD-97-89.
3. IM-2210-5 defines the term “bond mutual fund volatility ratings” as a description issued by an independent third party relating to the sensitivity of the net asset value of a portfolio of an open-end investment company that invests in debt securities to changes in market conditions and the general economy, and is based on an evaluation of objective factors, including the credit quality of the fund’s individual portfolio holdings, the market price volatility of the portfolio, the fund’s performance, and specific risks, such as interest rate risk, prepayment risk and currency risk.
4. Rule 482 under the Securities Act of 1933, as amended, requires mutual fund performance advertising to show performance that is current to the most recent calendar quarter ended prior to submission of the advertisement for publication, and to either indicate where the investor may obtain performance that is current to the most recent month ended seven business days prior to use or present performance that meets this most recent month-end standard. IM-2210-5 does not include this requirement because the NASD believes that, unlike mutual fund performance information, bond mutual fund volatility ratings do not frequently change once they are issued.

For More Information

Please contact Richard S. Heller, James P. Jalil, Donald S. Mendelsohn, JoAnn M. Strasser, or Michael V. Wible or any member of our Corporate Transactions & Securities practice group for more information.

Disclosure

This advisory may be reproduced, in whole or in part, with the prior permission of Thompson Hine LLP and acknowledgement of its source and copyright. This publication is intended to inform clients about legal matters of current interest. It is not intended as legal advice. Readers should not act upon the information contained in it without professional counsel. This document may be considered attorney advertising in some jurisdictions. Some of the design images and photographs in this document may be of actors depicting fictional scenes.