Brokers would be able to provide investors with performance projections under a rule change being proposed by the U.S. Financial Industry Regulatory Authority Inc. (FINRA).
Currently, the self-regulatory organization’s (SRO) rules generally prohibit brokers from using projections of performance or targeted returns in communications to investors — an investor protection measure that aims to protect investors from being misled by projections to guard against exaggerated forecasts, or the implication that past performance will be repeated.
“The general prohibition against performance projections is intended to protect investors who may lack the capacity to understand the risks and limitations of using projected performance in making investment decisions,” the SRO said in a notice detailing the proposed rule change.
However, there are already a couple of exceptions to that general rule, and now FINRA is proposing a rule change that would allow brokers to use projections and targeted returns, subject to certain conditions.
The SRO said it has determined a rule change is warranted, as some investors (such as institutional and sophisticated investors) request performance projections from firms that they’re currently prevented from providing.
For instance, it points to a private offering as a situation where investors want projections from their broker. And, it said that projected performance can be useful when investors have the expertise to evaluate investments, or access to advice from financial professionals that have this expertise.
“Such investors often test their own opinions against performance projections they receive from other sources, including issuers and investment advisers,” it noted, but “these investors cannot obtain a member’s potentially different and valuable perspective” due to the existing prohibition.
Additionally, registered investment advisers can provide projections under the U.S. Securities and Exchange Commission’s rules, which “can lead to investor confusion,” it said, as investors can get different information about the same investments, depending on the type of financial professional they engage.
“Accordingly, the proposed rule change would lessen the regulatory inconsistencies regarding the use of performance projections between broker-dealers and stand-alone investment advisers and would minimize the current opportunities for regulatory arbitrage,” the SRO said.
The proposed rule change would set various conditions on brokers’ use of projections — including that the broker adopts written policies and procedures that are designed to ensure that the communication is “relevant to the likely financial situation and investment objectives of the intended audience”; that the firm has a “reasonable basis” for the assumptions made in calculating the projected performance; and, that these assumptions are disclosed to investors, along with the risks of relying on projected returns.
The proposed change is out for a 21-day comment period.