Projections and Performance Data: Understanding Rules and Best Practices

20.2.2 Projections and Performance Data

In the realm of securities and investments, communicating with customers about potential returns and past performance is a critical aspect of a General Securities Representative’s role. However, this communication must be handled with care, adhering to stringent regulations and ethical standards to ensure transparency and protect investors. This section will delve into the rules governing the use of predictions, projections, and performance statistics, explain the prohibition on implied guarantees, and detail the requirements for presenting historical performance. Additionally, we will provide guidelines for effectively using charts and graphs to convey this information.

Understanding Projections and Performance Data

Projections and performance data are powerful tools in the financial industry, used to help investors make informed decisions. However, they must be presented accurately and in compliance with regulatory standards to prevent misleading investors.

Rules Governing Projections and Performance Data

The Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) have established clear rules regarding the use of projections and performance data in customer communications. These rules are designed to ensure that all representations made to investors are fair, balanced, and not misleading.

1. Prohibition on Implied Guarantees: One of the fundamental rules is the prohibition on implied guarantees. Representatives cannot suggest or imply that a particular investment will achieve a certain level of performance. This includes avoiding language that suggests certainty in future returns, as all investments carry some level of risk.

2. Hypothetical Performance: When discussing potential outcomes, it is crucial to distinguish between hypothetical performance and actual results. Hypothetical performance refers to potential results based on assumptions and must be clearly disclosed as such. This type of performance data should be accompanied by a disclaimer stating that the results are not guaranteed and that actual performance may differ.

3. Historical Performance: When presenting historical performance data, it is essential to provide a comprehensive view that includes both positive and negative periods. This ensures a balanced perspective and prevents investors from forming unrealistic expectations based on selective data.

4. Use of Charts and Graphs: Charts and graphs can be effective tools for illustrating performance data, but they must be used responsibly. They should be clearly labeled, and any assumptions or limitations should be disclosed. Additionally, they should not exaggerate or distort the data being presented.

Prohibition on Implied Guarantees

The prohibition on implied guarantees is a cornerstone of ethical communication in the securities industry. This rule prevents representatives from making statements that could lead investors to believe that certain outcomes are assured. Here are some key aspects to consider:

• Language and Tone: Avoid using language that suggests certainty, such as “will achieve” or “guaranteed return.” Instead, use terms like “potential,” “may achieve,” or “historically.”

• Disclaimers: Always include disclaimers that clarify the inherent risks in investing and the fact that past performance is not indicative of future results.

• Scenario Analysis: When discussing potential outcomes, provide a range of scenarios, including best-case, worst-case, and most likely outcomes. This helps set realistic expectations and highlights the uncertainty involved in investing.

Requirements for Presenting Historical Performance

Historical performance data is a valuable tool for assessing an investment’s track record. However, it must be presented in a way that is fair and not misleading:

• Time Periods: Include performance data over various time periods, such as 1-year, 5-year, and 10-year returns. This provides a more comprehensive view of the investment’s performance.

• Market Conditions: Discuss the market conditions during the periods being presented. This context helps investors understand the factors that influenced performance and assess whether similar conditions might occur in the future.

• Comparative Benchmarks: When possible, compare the investment’s performance to relevant benchmarks. This allows investors to gauge how the investment has performed relative to the broader market or similar investments.

• Disclosure of Fees and Expenses: Clearly disclose any fees and expenses that may have impacted historical performance. This transparency ensures that investors understand the net returns they might expect.

Guidelines for Using Charts and Graphs

Visual aids like charts and graphs can enhance the understanding of performance data, but they must be used with care to avoid misleading investors:

• Accuracy and Clarity: Ensure that all data presented in charts and graphs is accurate and clearly labeled. Avoid using complex or cluttered visuals that may confuse investors.

• Consistent Scales: Use consistent scales and intervals to prevent exaggerating the performance of an investment. Inconsistent scales can distort the perception of growth or decline.

• Contextual Information: Provide context for the data being presented. For example, if showing a graph of stock performance, include information about major market events that may have impacted the stock’s value.

• Disclosure of Assumptions: Clearly disclose any assumptions underlying the data in the charts or graphs. For example, if projecting future performance, explain the assumptions about market conditions or economic factors.

Practical Examples and Case Studies

To illustrate these principles, let’s consider a few practical examples and case studies:

Example 1: Mutual Fund Performance Presentation

A mutual fund representative is preparing a presentation for potential investors. The fund has performed well over the past five years, but the representative knows that past performance is not indicative of future results. To comply with regulations, the representative:

• Includes a disclaimer stating that past performance does not guarantee future results.
• Provides performance data over multiple time periods, including 1-year, 5-year, and 10-year returns.
• Compares the fund’s performance to a relevant benchmark index.
• Discloses all fees and expenses that may affect net returns.

Example 2: Hypothetical Performance Scenario

A financial advisor is discussing a new investment strategy with a client. The strategy involves a combination of stocks and bonds, and the advisor wants to show potential outcomes. To ensure compliance:

• The advisor creates a hypothetical performance chart showing potential returns under different market conditions.
• Clearly labels the chart as “hypothetical” and includes a disclaimer that actual results may vary.
• Discusses the assumptions underlying the hypothetical performance, such as expected interest rates and economic growth.

Case Study: Misleading Performance Data

A brokerage firm was fined by FINRA for presenting misleading performance data in its marketing materials. The firm had used selective data to highlight only the best-performing periods of its investment products, leading investors to believe that similar returns were likely in the future. This case underscores the importance of providing a balanced view of performance data and avoiding selective presentation.

Real-World Applications and Regulatory Scenarios

In the securities industry, understanding and applying the rules for projections and performance data is crucial for maintaining trust and compliance. Here are some real-world applications and regulatory scenarios:

• Client Meetings: When meeting with clients, always present performance data in a balanced manner, highlighting both positive and negative periods. Use disclaimers to clarify the uncertainty of future returns.

• Marketing Materials: Ensure that all marketing materials comply with FINRA and SEC regulations. This includes using clear language, providing disclaimers, and avoiding exaggerated claims.

• Regulatory Audits: Be prepared for regulatory audits by maintaining accurate records of all communications with clients. This includes documentation of disclaimers, assumptions, and any hypothetical performance scenarios presented.

Best Practices, Common Pitfalls, and Strategies

To effectively communicate projections and performance data, consider these best practices, common pitfalls, and strategies:

Best Practices

• Transparent Communication: Always be transparent about the risks and uncertainties associated with investments. This builds trust and helps clients make informed decisions.

• Balanced Presentation: Present both positive and negative performance data to provide a balanced view. This prevents unrealistic expectations and aligns with regulatory requirements.

• Regular Updates: Provide regular updates to clients on their investments’ performance. This keeps them informed and engaged, reducing the likelihood of misunderstandings.

Common Pitfalls

• Selective Data Presentation: Avoid presenting only the best-performing periods of an investment. This can mislead investors and lead to regulatory penalties.

• Lack of Disclaimers: Failing to include disclaimers about the uncertainty of future performance can result in compliance issues.

• Complex Visuals: Using overly complex charts and graphs can confuse investors and obscure important information. Keep visuals simple and clear.

Strategies for Success

• Education and Training: Regularly educate yourself and your team on the latest regulations and best practices for communicating performance data.

• Compliance Checks: Implement regular compliance checks to ensure that all communications meet regulatory standards. This includes reviewing marketing materials, client presentations, and internal reports.

• Client Engagement: Engage clients in discussions about their investment goals and risk tolerance. This helps tailor communications to their specific needs and ensures they understand the potential risks and rewards.

Conclusion

Effectively communicating projections and performance data is a vital skill for securities professionals. By adhering to regulatory standards, providing balanced and transparent information, and using clear and accurate visuals, you can build trust with clients and help them make informed investment decisions. Remember, the key to success is transparency, compliance, and a commitment to ethical communication.

Glossary

• Hypothetical Performance: Potential results based on assumptions, which require clear disclosure. It is important to distinguish hypothetical performance from actual results and provide appropriate disclaimers.

References

• FINRA Rules: Refer to FINRA Rule 2210 for detailed guidelines on communications with the public.
• SEC Regulations: Review the SEC’s guidelines on performance presentation and disclosure requirements.
• Investment Company Act of 1940: Understand the requirements for presenting performance data for investment companies.

Series 7 Exam Practice Questions: Projections and Performance Data