FINRA Requirements for the Use of Bond Mutual Fund Volatility Ratings

Instructor: LeRoy Rands

Bill has taught college undergraduate and MBA classes in finance, economics & management, 40 years of finance experience and has a MBA degree.

FINRA oversees all investment brokers and dealers. One of its functions is to make rules regulating broker/dealer activities and behavior. Rule 2213 governs the use of bond mutual fund volatility ratings in public communications.

Role of FINRA

Harry is a stockbroker with ABC Financial. He was just given a new job marketing bond mutual funds that ABC sells to customers. He was wondering what he could say and not say in communications with clients.

FINRA is a non-profit, self-governing agency who has been given the responsibility to oversee all investment brokers and dealers and their employees. They oversee the actions, behavior and communications of all investment firms involved in the securities exchanges particularly involving dealing with customers making investments.

Their basic role is to ensure:

  • every investor receives all the protection they deserve
  • anyone who sells a securities product is tested, qualified and licensed
  • every securities advertisement is truthful and not misleading in anyway
  • any securities product sold to an investor is suitable for the investor's needs
  • investors receive complete disclosure about the investment product

One of the functions of FINRA is to make rules regulating what broker/dealers can and can't do. Harry decided the best place to start was reading the rules that FINRA had issued regarding bond mutual funds.

Rule 2213

One rule Harry found was Rule 2213. Rule 2213 dealt with communicating the volatility rating on a bond mutual fund to a customer while discussing or marketing that fund.

A volatility rating is a measure of the sensitivity of the net asset value of a portfolio, in this case a bond mutual fund, to changes in market and economic conditions. In the case of bonds, net asset values always fluctuates in response to changes in market interest rates.

Harry realized that FINRA was fulfilling one of its basic roles in passing Rule 2213. When he or another broker used volatility ratings to discuss a bond mutual fund's future performance, Rule 2213 required that the broker provide complete disclosure of all the information concerning that volatility rating

Prohibitions on Use of Bond Volatility Ratings

After studying Rule 2213, Harry realized he could not disclose a bond mutual fund volatility rating to a customer either orally or in writing until he fulfilled the following requirements.

  • The volatility rating does not identify or describe 'volatility' as a risk rating.
  • The communication or disclosure has the most recently available rating and the rating at a minimum is less than 90 days old.
  • The rating must be based on objective, quantifiable factors. The disclosure accompanying the rating must be clear, concise and understandable.
  • Harry's communications must also include the disclosures outlined below.
  • The firm that issued the rating provides detailed disclosure on its rating methodology by allowing investors access by a toll-free telephone number or a website, or both.

Harry knows he has some work to do before talking to his first customer to make sure that he has meant all the above requirements before using volatility ratings to help customers understand how the bond mutual funds will react to future market conditions.

Required Disclosures

A stockbroker must provide the following disclosures when using a bond volatility rating:

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