Document ID: SEC-2005-0210-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: National Association of Securities Dealers, Inc.
Posted Date: 2005-11-07T05:00Z

[Federal Register: November 7, 2005 (Volume 70, Number 214)]
[Notices]               
[Page 67509-67511]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr07no05-110]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52709; File No. SR-NASD-2005-117]

 
Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Notice of Filing of Proposed Rule Change and Amendment 
No. 1 Thereto Seeking Permanent Approval of Rules Concerning Bond 
Mutual Fund Volatility Ratings Prior to Expiration of Pilot

November 1, 2005.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on September 28, 2005 and October 24, 2005 (Amendment No. 1), the 
National Association of Securities Dealers, Inc. (``NASD'') 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 NASD. The Commission is publishing this 
notice to solicit comments on the proposed rule change from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD is seeking permanent approval of NASD Rule 2210(c)(3) and 
Interpretive Material 2210-5 concerning bond mutual fund volatility 
ratings prior to the expiration of the pilot on December 29, 2005.
    Below is the text of the proposed rule change. Proposed new 
language is in italics; proposed deletions are in brackets.
* * * * *

IM-2210-5. Requirements for the Use of Bond Mutual Fund Volatility 
Ratings

[(This rule and Rule 2210(c)(3) will expire on December 29, 2005, 
unless extended or permanently approved by NASD at or before such 
date.)]

    (a) through (c) No change.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NASD included statements 
concerning the purpose of and basis for the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. 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

1. Purpose

Background and Description of NASD's Rules on Bond Mutual Fund 
Volatility Ratings

    On February 29, 2000, the SEC approved on a pilot basis NASD 
Interpretive Material 2210-5, which permits members and their 
associated persons to include bond fund volatility ratings in 
supplemental sales literature (mutual fund sales material that is 
accompanied or preceded by a fund prospectus).\3\ At that time, the SEC 
also approved as a pilot NASD Rule 2210(c)(3), which sets forth the 
filing requirements and review procedures applicable to sales 
literature containing bond mutual fund volatility ratings. Previously, 
NASD staff interpreted NASD rules to prohibit the use of bond fund 
volatility ratings in sales material.
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    \3\ See Securities Exchange Act Release No. 42476 (February 29, 
2000); 65 FR 12305 (March 8, 2000) (SR-NASD-97-89).
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    IM-2210-5 permits the use of bond fund volatility ratings only in 
supplemental sales literature and only if certain conditions are met:
     The word ``risk'' may not be used to describe the rating.
     The rating must be the most recent available and be 
current to the most recent calendar quarter ended prior to use.
     The rating must be based exclusively on objective, 
quantifiable factors.
     The entity issuing the rating must provide to investors 
through a toll-free telephone number or Web site (or both) a detailed 
disclosure on its rating methodology.
     A disclosure statement containing all of the information 
required by the rule must accompany the rating. The statement must 
include such information as the name of the entity issuing the rating, 
the most current rating and the date it was issued, and a description 
of the rating in narrative form containing certain specified 
disclosures.
    Rule 2210(c)(3) requires members to file for approval with NASD's 
Advertising Regulation Department (``Department''), at least 10 days 
prior to

[[Page 67510]]

use, bond mutual fund sales literature that includes or incorporates 
volatility ratings. If the Department requests changes to the material, 
the material must be withheld from publication or circulation until the 
requested changes have been made or the material has been re-filed and 
approved.
    IM-2210-5 and Rule 2210(c)(3) initially were approved on an 18-
month pilot basis that was scheduled to expire on August 31, 2001.\4\ 
NASD subsequently renewed the pilot several times, most recently with a 
proposed rule change that was effective upon filing and extended the 
pilot provisions until December 29, 2005.\5\

Proposed Rule Change To Make Permanent IM-2110-5 and Rule 2210(c)(3)
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    \4\ Id.
    \5\ See Securities Exchange Act Release No. 52372 (Aug. 31, 
2005); 70 FR 53405 (Sept. 8, 2005) (SR-NASD-2005-104); Securities 
Exchange Act Release No. 48353 (Aug. 15, 2003); 68 FR 50568 (Aug. 
21, 2003) (SR-NASD-2003-126); NASD Notice to Members 03-48 (Aug. 
2003); Securities Exchange Act Release No. 44737 (August 22, 2001); 
66 FR 45350 (August 28, 2001) (SR-NASD-2001-49); NASD Notice to 
Members 01-58 (Sept. 2001).
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    As indicated in the SEC's original order approving IM-2210-5 and 
Rule 2210(c)(3) on a pilot basis and the NASD Notice to Members 
announcing such approval,\6\ NASD requested the 18-month pilot period 
to consider whether:
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    \6\ See Securities Exchange Act Release No. 42476 (February 29, 
2000); 65 FR 12305 (March 8, 2000) (SR-NASD-97-89); NASD Notice to 
Members 00-23 (April 2000).
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     The rule has facilitated the dissemination of useful, 
understandable information to investors;
     The rule has prevented the dissemination of inappropriate 
or misleading information by members and associated persons;
     Additional guidance concerning the use of certain 
terminology may be necessary;
     The rule should apply to in-house ratings;
     The rule should apply to all investment companies; and
     Additional standards or guidance is needed to prevent 
investor confusion or minimize excessive variability among ratings of 
similar portfolios.
    Due to the small number of bond volatility ratings filings received 
during the Rule's initial 18-month pilot, NASD extended the pilot to 
accumulate more data with which to evaluate the program. Ultimately, 
during the entire period from February 2000, when the Rule was first 
approved, until the present, NASD has received a total of 47 
submissions from seven NASD members. In general, the filings of sales 
material that contained bond fund volatility ratings have met the 
Rule's requirements.
    Based on its findings during this period, NASD has concluded that 
the Rule's provisions are appropriate and do not require further 
amendment before being made permanent. In particular, NASD believes 
that the Rule has facilitated the dissemination of useful and 
understandable information to investors and has prevented the 
dissemination of inappropriate or misleading information. In this 
regard, virtually all of the filings NASD has received under the Rule 
have met the Rule's requirements, and NASD is not aware of any investor 
complaints concerning sales material that contains volatility ratings. 
The level of member compliance with the Rule also suggests that members 
do not require additional guidance concerning the use of certain 
terminology in the Rule. Similarly, NASD is not aware of any concerns 
that investors may be confused or that there may be excessive 
variability among ratings or similar portfolios.
    NASD also has examined the issue of whether the Rule should apply 
to in-house ratings. At the time the Rule was approved, NASD observed 
that the Rule should not apply to in-house ratings on the grounds that 
they are not procured for a fee, are used primarily by fund investors 
as an aid in distinguishing between risk levels within a family of 
funds, and may be calculated using different methods from those used in 
calculating volatility ratings.\7\ NASD continues to believe that those 
are persuasive reasons to not apply the Rule to in-house ratings. NASD 
believes that in-house ratings do not raise the same concerns as third-
party ratings, and thus do not merit application of the bond fund 
volatility ratings rule.
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    \7\ See Securities Exchange Act Release No. 42476 (February 29, 
2000); 65 FR 12305 (March 8, 2000) (SR-NASD-97-89).
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    NASD also believes that it is unnecessary at this time to apply the 
rule to other types of investment companies, such as unit investment 
trusts. At no time throughout the extended pilot period has a member 
requested that the rule apply to such material, and NASD is not aware 
of third-party volatility ratings that are being used to assess other 
types of investment companies. Accordingly, NASD sees no need to expand 
the rule's scope in this manner. NASD has stated its willingness to re-
evaluate this conclusion if comments on the proposal suggest that the 
Rule should be expanded to cover other types of investment companies.
    NASD believes that the rule strikes an appropriate balance between 
the desire of some funds to advertise volatility ratings and the need 
to include appropriate disclosures related to those ratings in sales 
material. Accordingly, NASD believes that the Commission should approve 
the Rule, as is, on a permanent basis.
    Nevertheless, NASD suggests that the Commission seek comment on 
whether the timeliness requirements of IM-2210-5 continue to be 
appropriate in light of changes to SEC Rule 482 under the Securities 
Act of 1933 that have occurred since the adoption of IM-2210-5 and Rule 
2210(c)(3). In this regard, IM-2210-5(b)(2) requires supplemental sales 
literature that includes bond fund volatility ratings to present the 
most recently available rating that ``reflects information that, at a 
minimum, is current to the most recently completed calendar quarter 
ended prior to use.''
    At the time IM-2210-5 was adopted, this standard mirrored the 
timeliness standard for mutual fund performance advertising under Rule 
482. However, in 2003, the SEC amended Rule 482 to require mutual fund 
performance advertising to show performance that is current to the most 
recent calendar quarter ended prior to submission of an advertisement 
for publication, and to indicate where the reader may obtain 
performance that is current to the most recent month ended seven 
business days prior to use through a toll-free (or collect) telephone 
number or web site, or to present performance that meets this most 
recent month-end standard.\8\
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    \8\ SEC Rule 482(g).
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    Accordingly, NASD suggests that the Commission seek comment on 
whether the timeliness requirements of IM-2210-5(b)(2) should be 
modified to mirror those of amended Rule 482. More specifically, should 
the rule require all supplemental sales literature that includes a bond 
fund volatility rating either to show a rating that is current to the 
most recent calendar quarter ended prior to use, and disclose where the 
reader may find the most recent month-end rating, or provide the most 
recent month-end rating in the sales literature? NASD understands that 
rating agencies typically monitor bond funds on a monthly basis, but 
that it is quite rare for such agencies to revise a volatility rating 
on a month-to-month basis. Accordingly, NASD does not believe that it 
is necessary to require that volatility ratings be current as of the 
most recent month end given that, among other things, unlike fund

[[Page 67511]]

performance, such ratings do not frequently change once they are 
issued.
    NASD will announce the effective date of the proposed rule change 
in a Notice to Members to be published no later than 30 days following 
Commission approval. If the Commission approves the proposed rule 
change without material amendment, NASD is proposing that the rule 
change become effective immediately upon Commission approval, since the 
proposed rule is already in effect on a pilot basis. If the proposed 
rule change is approved only after material amendment that would 
require members to substantially modify their compliance systems or 
procedures, NASD will propose a later effective date to provide 
adequate time for such modifications.
2. Statutory Basis
    NASD believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act, which requires, among other 
things, that NASD rules must be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. NASD believes that making IM-2210-5 and Rule 
2210(c)(3) effective on a permanent basis will allow members to 
continue to publish sales material that contains bond fund volatility 
ratings in a manner that will protect investors and serve the public 
interest.

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

    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

    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 such proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. The Commission particularly urges 
commenters to consider the proposed rule change in light of the 
specific comments that the NASD urged the Commission to seek.
    Specifically, the Commission requests comment on whether the 
timeliness requirements of IM-2210-5(b)(2) should be modified to mirror 
the requirements pursuant to Rule 482 under the Securities Act of 1933. 
In other words, should the rule require all supplemental sales 
literature that includes a bond fund volatility rating either to show a 
rating that is current to the most recently ended calendar quarter 
prior to use, and disclose where the reader may find the most recent 
month-end rating, or provide the most recent month-end rating in the 
sales literature?
    Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml.
); or     Send an e-mail to rule-comments@sec.gov. Please include 

File Number SR-NASD-2005-117 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-9303.
    All submissions should refer to File Number SR-NASD-2005-117. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). 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 in the Commission's Public Reference Room, 100 F Street, 
NE., Washington, DC 20549. Copies of such filing also will be available 
for inspection and copying at the principal office of NASD. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to the File Number SR-NASD-2005-117 and should 
be submitted on or before November 28, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\9\
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    \9\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 05-22178 Filed 11-4-05; 8:45 am]

BILLING CODE 8010-01-P