Unapproved Communications in Securities: Understanding Compliance and Best Practices

3.3.3 Unapproved Communications

In the securities industry, communication with the public is a critical area governed by stringent regulations to ensure transparency, accuracy, and fairness. As a professional preparing for the Series 6 Exam, understanding the concept of unapproved communications is essential. This section delves into the requirements for principal approval, prohibited practices, and the importance of adhering to firm policies and FINRA rules.

Understanding Principal Approval

Principal Approval is a cornerstone of compliant communications in the securities industry. It involves a registered principal reviewing and authorizing certain materials before they are disseminated to the public. This process ensures that communications adhere to regulatory standards and do not mislead or confuse investors.

What Requires Principal Approval?

1. Retail Communications:

   • Any written or electronic communication distributed to more than 25 retail investors within any 30-day period.
   • Includes advertisements, sales literature, and promotional materials.

2. Public Appearances:

   • Seminars, webinars, and public speaking engagements where securities products are discussed.
   • Presentations must be pre-approved to ensure they comply with regulatory guidelines.

3. Social Media Posts:

   • Posts that promote securities products or services on platforms like Facebook, Twitter, or LinkedIn.
   • These require careful oversight to prevent the dissemination of misleading information.

4. New Product Introductions:

   • Materials related to the launch of new investment products.
   • Ensures that all claims are substantiated and risks are adequately disclosed.

The Role of the Principal

The principal’s role is to ensure that all communications are fair, balanced, and in compliance with FINRA rules and the Securities and Exchange Commission (SEC) regulations. They must verify that:

• Accuracy and Clarity: Information is accurate and presented clearly to avoid misinterpretation.
• Risk Disclosure: All potential risks associated with the investment products are disclosed.
• No Misleading Statements: Communications do not contain exaggerated or misleading statements.

Prohibited Practices in Communications

Certain practices are explicitly prohibited to protect investors and maintain market integrity. These include:

Unauthorized Sales Literature

Using sales literature that has not been reviewed and approved by a principal is a significant violation. Unauthorized materials may contain:

• Unverified Claims: Exaggerated performance data or unsubstantiated claims about a product’s benefits.
• Omissions: Failure to disclose material information that could influence an investor’s decision.

Unapproved Public Appearances

Making public appearances without prior approval can lead to the dissemination of inaccurate or misleading information. Key concerns include:

• Inconsistent Messaging: Presentations that deviate from approved content can confuse investors.
• Lack of Disclosure: Failure to disclose conflicts of interest or potential risks.

Misleading Social Media Activity

Social media presents unique challenges due to its rapid dissemination and wide reach. Prohibited activities include:

• Misleading Posts: Posts that overstate product benefits or downplay risks.
• Unverified Endorsements: Sharing testimonials or endorsements without proper verification.

Compliance with Firm Policies

Adhering to firm policies regarding communications is crucial for maintaining regulatory compliance. Firms typically have detailed compliance manuals outlining procedures for communications approval and dissemination. Key components include:

Communication Policies

• Approval Processes: Detailed steps for obtaining principal approval for various types of communications.
• Recordkeeping: Requirements for maintaining records of all communications, including drafts and final versions.

Training and Education

• Regular Training: Ongoing education on compliance policies and regulatory updates.
• Workshops and Seminars: Sessions focused on best practices for compliant communications.

Monitoring and Auditing

• Periodic Audits: Regular audits of communications to ensure compliance with firm policies and regulatory standards.
• Feedback Mechanisms: Systems for reporting and addressing potential compliance issues.

FINRA Communication Rules

The Financial Industry Regulatory Authority (FINRA) sets forth comprehensive rules governing communications with the public. These rules are designed to ensure that all communications are fair, balanced, and not misleading.

Key FINRA Rules

1. FINRA Rule 2210: Communications with the Public

   • Outlines the requirements for different types of communications, including retail, institutional, and correspondence.
   • Emphasizes the need for principal approval and recordkeeping.

2. FINRA Rule 2211: Institutional Communications

   • Focuses on communications with institutional investors, which require a different level of oversight compared to retail communications.

3. FINRA Rule 2212: Use of Investment Analysis Tools

   • Governs the use of tools that project investment outcomes, ensuring they are used in a manner consistent with regulatory standards.

Practical Examples and Scenarios

To better understand these concepts, consider the following scenarios:

Scenario 1: Unauthorized Brochure Distribution

A registered representative distributes a brochure highlighting a mutual fund’s past performance without obtaining principal approval. The brochure contains unverified claims about potential future returns. This action violates firm policies and FINRA rules, as it could mislead investors about the fund’s potential performance.

Scenario 2: Unapproved Seminar Presentation

An advisor conducts a seminar on variable annuities without submitting the presentation for approval. During the seminar, the advisor makes statements about guaranteed returns without disclosing associated risks. This unapproved communication could result in regulatory action due to the omission of critical risk information.

Scenario 3: Misleading Social Media Post

A financial advisor posts on LinkedIn about a new investment product, claiming it has “no risk” and “guaranteed returns.” The post is not pre-approved and violates compliance policies by making misleading statements. Such activity can lead to disciplinary actions and damage the firm’s reputation.

Best Practices for Compliance

To avoid issues related to unapproved communications, consider these best practices:

1. Pre-Approval: Always seek principal approval for all communications that require it.
2. Training: Regularly participate in compliance training sessions to stay updated on firm policies and regulatory changes.
3. Documentation: Maintain thorough records of all communications, including drafts and approval documentation.
4. Clear Disclosures: Ensure all communications include clear and accurate disclosures of risks and potential conflicts of interest.
5. Monitor Social Media: Implement robust monitoring of social media activity to prevent unauthorized posts.

Common Pitfalls and How to Avoid Them

• Overlooking Approval Processes: Ensure you understand the specific approval processes required by your firm and FINRA.
• Inconsistent Messaging: Align all communications with approved messaging to maintain consistency and compliance.
• Neglecting Training: Stay current with training and educational opportunities to ensure compliance with evolving regulations.

Conclusion

Understanding and adhering to the rules surrounding unapproved communications is crucial for anyone in the securities industry. By following firm policies, obtaining necessary approvals, and staying informed about regulatory requirements, you can ensure that your communications are compliant and effective. This not only protects investors but also enhances your professional integrity and success in the industry.

Series 6 Exam Practice Questions: Unapproved Communications

This comprehensive guide on unapproved communications is designed to equip you with the knowledge and skills necessary to excel in the Series 6 Exam and your securities career. By understanding the importance of principal approval, avoiding prohibited practices, and adhering to firm policies, you can ensure compliant and effective communications.