71fr49387

foi060823a[Federal Register: August 23, 2006 (Volume 71, Number 163)]

[Proposed Rules]

[Page 49387-49391]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[DOCID:fr23au06-25]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 4

RIN 3038-AC35

Advertising by Commodity Pool Operators, Commodity Trading

Advisors, and the Principals Thereof

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rules.

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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)

is proposing to amend Regulation 4.41, which governs advertising by

commodity pool operators (CPOs), commodity trading advisors (CTAs) and

the principals thereof, (1) To restrict the use of testimonials, (2) to

clarify the required placement of the prescribed simulated or

hypothetical performance disclaimer, and (3) to include within the

regulation's coverage advertisement through electronic media

(Proposal). This action is in furtherance of the Commission's

longstanding position that CPOs, CTAs, and their principals may not

advertise in a false, deceptive or misleading manner.

DATES: Comments must be received on or before September 22, 2006.

ADDRESSES: Comments on the Proposal should be sent to Eileen Donovan,

Acting Secretary, Commodity Futures Trading Commission, Three Lafayette

Centre, 1155 21st Street, NW., Washington, DC 20581. Comments may be

sent by facsimile transmission to (202) 418-5528, or by e-mail to

[[Page 49388]]

[email protected] Reference should be made to "Advertising by

Commodity Pool Operators, Commodity Trading Advisors, and the

Principals Thereof." Comments may also be submitted by connecting to

the Federal eRulemaking Portal at http://www.regulations.gov and

following the comment submission instructions.

FOR FURTHER INFORMATION CONTACT: Barbara S. Gold, Associate Director,

or Peter B. Sanchez, Staff Attorney, Division of Clearing and

Intermediary Oversight, Commodity Futures Trading Commission, Three

Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581,

telephone number: (202) 418-5450 or (202) 418-5237, respectively;

facsimile number: (202) 418-5528; and electronic mail: [email protected]

or [email protected], respectively.

SUPPLEMENTARY INFORMATION:

I. Background

Part 4 of the Commission's regulations governs the operations and

activities of CPOs and CTAs.\1\ In particular, Regulation 4.41 pertains

to advertising by CPOs, CTAs, and the principals \2\ thereof, an issue

first addressed by the Commission over 25 years ago. The Commission

originally proposed that CPOs, CTAs, and their principals could not

advertise their actual past performance results in a format other than

that which the CPO or CTA was required to use in its Disclosure

Document,\3\ and that the presentation of simulated or hypothetical

performance of a CPO, CTA, or the principals thereof would be

prohibited.\4\ In response to the comments received and its further

deliberations on these proposals, the Commission adopted less

restrictive advertising regulations.\5\

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\1\ 17 CFR Part 4 (2006). The Commodity Exchange Act (Act) and

the Commission's regulations issued thereunder may be accessed

through the Commission's Web site, at http://www.cftc.gov/cftc.cftclawreg.htm.

\2\ The definition of the term "principal" is set forth in

Regulation 4.10(e)(1), which cross-references the definition of the

term in Regulation 3.1(a). An example of a principal of a CPO

organized as a corporation would be the corporation's chief

executive officer.

\3\ Regulations 4.21-4.26 and 4.31-4.26 respectively concern the

Disclosure Document that registered CPOs and CTAs must prepare,

deliver, and file.

\4\ 45 FR 51600 (Aug. 4, 1980).

\5\ 46 FR 26004 (May 8, 1981).

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With respect to the presentation of actual past performance, the

Commission explained that it had adopted in Regulation 4.41(a) "a rule

that leaves to the discretion of the [CPO, CTA, or principal]

advertising performance results--whether actual, simulated or

hypothetical--the format of that presentation, so long as that format

is not false, misleading or deceptive." \6\ As for the presentation of

simulated or hypothetical performance results, the Commission explained

that it had adopted in Regulation 4.41(b) "a rule that allows the

presentation of those results, provided that the presentation is

accompanied by the statement prescribed in the rule (emphasis

supplied)," whose purpose was "to alert prospective customers to the

limitations inherent in simulated and hypothetical past performance

results." \7\ The Commission also noted the scope of new Regulation

4.41--that it applied to both oral and written communications and

regardless of whether a CPO or a CTA was exempt from registration under

the Act.\8\

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\6\ While acknowledging that it was not possible to identify

every advertisement that was prohibited by new Regulation 4.41, the

Commission nonetheless gave notice in the Federal Register release

announcing the adoption of the rule that it would consider the

following, non-exclusive list of advertisements, to be prohibited:

(1) References only to successful trades, if during the same

time period, trades which were unsuccessful were also recommended or

executed; (2) references to the results during a specific time

period, if the results claimed were not fairly representative of

results achieved for comparable periods; (3) suggestions, assurances

or claims of profit potential that do not also fairly present the

possibility of loss; (4) statements of opinions or predictions which

are not clearly labeled as such or which have no reasonable basis in

fact; and (5) failure to disclose whether, and to what extent, fees,

commissions and other expenses are reflected in the past performance

results. Id. at 26012.

\7\ Id.

\8\ Section 4m(1) of the Act, 7 U.S.C. 6m(1) (2000), generally

requires the registration of CPOs and CTAs. Regulation 4.13 provides

an exemption from CPO registration for certain persons, and Sections

4m(1) and 4m(3) and Regulation 4.14 provide an exemption from CTA

registration for certain other persons.

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Based on its experience with the operation of Regulation 4.41 over

the course of the past 25 years, the Commission today is proposing

certain amendments as described below.

II. The Proposal

A. Presentation of Actual Past Performance: Proposed Addition of

Regulation 4.41(a)(3)

The Commission is proposing to add a new paragraph (a)(3) to

Regulation 4.41, which would address the use of testimonials by a CPO,

CTA, or a principal thereof. Proposed Regulation 4.41(a)(3) would

require advertisements that refer to a testimonial to prominently

disclose that the testimonial may not be representative of the

experience of other clients; that the testimonial is no guarantee of

future performance or success; and, if more than a nominal sum is paid,

the fact that it is a paid testimonial.\9\ The

[[Page 49389]]

Commission believes that advertisements that do not contain this

information may provide potential CPO and CTA customers with a

misleading assessment about the quality of services being offered or

the motivation of the person providing the testimonial--and, thus,

violate the Commission's intent that these advertisements not be

"false, misleading or deceptive."

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\9\ The Commission has modeled this proposal upon NASD Rule

2210(d)(2), which sets similar limits on the use of testimonials in

advertisements and other marketing materials applicable to NASD

members, as follows:

(2) Standards Applicable to Advertisements and Sales Literature

(A) Advertisements or sales literature providing any testimonial

concerning the investment advice or investment performance of a

member or its products must prominently disclose the following:

(i) The fact that the testimonial may not be representative of

the experience of other clients.

(ii) The fact that the testimonial is no guarantee of future

performance or success.

(iii) If more than a nominal sum is paid, the fact that it is a

paid testimonial.

The potential of testimonials to mislead customers has been

recognized by other Federal regulatory agencies. The Securities and

Exchange Commission (SEC) has promulgated a rule that declares any

use of testimonials in advertising by investment advisers to be "a

fraudulent, deceptive or manipulative act, practice or course of

business within the meaning of the [Investment Advisers] Act [of

1940] (15 U.S.C. 80b-6(4))". 17 CFR 275.206(4)-1(a)(1). In its

release promulgating the rule, the SEC found that "such

advertisements are misleading; by their very nature they emphasize

the comments and activities favorable to the investment adviser and

ignore those which are unfavorable." 26 FR 10548, 10549 (November

9, 1961).

Testimonials also are subject to the Federal Trade Commission's

(FTC) Guides Concerning Use of Endorsements and Testimonials in

Advertising, which are not limited to a specific industry. 16 CFR

255, http://www.ftc.gov/bcp/guides.endorse.htm. The FTC Guides

provide, for example, that:

An advertisement employing an endorsement reflecting the

experience of an individual or a group of consumers on a central or

key attribute of the product or service will be interpreted as

representing that the endorser's experience is representative of

what consumers will generally achieve with the advertised product in

actual, albeit variable, conditions of use. Therefore, unless the

advertiser possesses and relies upon adequate substantiation for

this representation, the advertisement should either clearly and

conspicuously disclose what the generally expected performance would

be in the depicted circumstances or clearly and conspicuously

disclose the limited applicability of the endorser's experience to

what consumers may generally expect to achieve. See 16 CFR 255.2(a).

The FTC Guides are an administrative interpretation of section 5

of the Federal Trade Commission Act, 15 U.S.C. 45(a), which

prohibits "unfair or deceptive acts or practices in or affecting

commerce." See Porter & Dietsch, Inc. v. Federal Trade Comm'n, 605

F.2d 294, 303 (7th Cir. 1979) (sustaining FTC's finding that

advertisements were deceptive where the typical experiences of

consumers did not parallel the experiences reported in

testimonials); Federal Trade Comm'n v. Ken Roberts Company, 276 F.3d

583 (DC Cir. 2001)(FTC's authority to investigate deceptive

advertising extended to, among other things, testimonials used by

seller of courses in commodities and securities investing and was

not clearly preempted by overlapping authority of CFTC or SEC).

Standards for establishing unlawful deception under the Federal

Trade Commission Act are broadly similar to those for establishing

unlawful deception by commodity trading advisors and commodity pool

operators under the Commodity Exchange Act. Compare Federal Trade

Comm'n v. Tashman, 318 F.3d 1273, 1275-77 (11th Cir. 2003)

(unsupported earnings claims by business opportunity firm were

material misleading representations that violated Federal Trade

Commission Act) with CFTC v. Heffernan, 245 F. Supp. 2d 1276, 1290-

91, 1294-96 (S.D.Ga. 2003)(unsupported earnings claims by commodity

trading advisor were material misleading representations that

violated Commodity Exchange Act if they were made with scienter or

had an impact on prospective customers).

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B. Simulated or Hypothetical Performance Presentation: Proposed

Amendments to Regulation 4.41(b)

Regulation 4.41(b)(1) requires that simulated or hypothetical

performance results "be accompanied by" a prescribed statement,\10\

and Regulation 4.41(b)(2) requires that this statement be "prominently

disclosed" if that performance is presented other than orally.

Nonetheless, the Commission has encountered numerous instances where

persons were not adequately identifying their trading results as

simulated or hypothetical,\11\ or were not appropriately locating the

disclaimer,\12\ and thus were not providing those results as the

Commission had contemplated--i.e., in a manner intended "to alert

prospective customers to the limitations inherent in simulated and

hypothetical past performance results." The Commission therefore is

proposing to amend Regulation 4.41(b)(1) to clarify the meaning of the

term "accompanied by," especially in light of the popularity of

electronic means of communication that were not in existence 25 years

ago when the Commission adopted Regulation 4.41.

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\10\ This statement may be the text contained in Regulation

4.41(b)(1)(i) or it may be a statement prescribed by a registered

futures association pursuant to Section 17(j) of the Act, 7 U.S.C.

21(j). In this regard, the National Futures Association (NFA) has

adopted a Risk Disclosure Statement, the text of which is contained

in NFA Compliance Rule 2-29(c) and may be accessed at

http://www.nfa.futures.org/nfaManual/manualCompliance.asp#2-29.

\11\ See, e.g., CFTC v. R&W Technical Servs. Ltd., 205 F.3d 165

(5th Cir. 2000) (hypothetical trading results presented as real

trading results); CFTC v. Skorupskas, 605 F. Supp. 923, 933 (E.D.

Mich. 1985) (performance tables not based on real or actual

trading).

\12\ See, e.g., CFTC v. Vartuli, 228 F.3d 94 (2d Cir. 2000)

(disclaimer appears on a separate page from the hypothetical trading

results); Heffernan at 1286, 1296-1297, 1299 (disclaimer on a

webpage, but not included in the original advertisement containing

the hypothetical performance); In re Martin, [1999--2000 Transfer

Binder] Comm. Fut. L. Rep. (CCH) ] 28,239 (CFTC Sept. 6, 2000)

(hypothetical performance results on a Web page, but disclaimer on a

separate page accessible by hyperlink).

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Specifically, the Commission is proposing to amend Regulation

4.41(b)(1)(i) by including in the prescribed disclaimer references to

"these results" when discussing the simulated or hypothetical

performance results being presented.\13\ Additionally, the Commission

is proposing to amend Regulation 4.41(b)(2) by adding to the existing

requirement that the prescribed disclaimer must be prominently

disclosed, the requirement that the prescribed disclaimer also must be

"in immediate proximity to the simulated or hypothetical performance

being presented." \14\

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\13\ The Commission also is proposing a few non-substantive

changes to the prescribed disclaimer. The text of Regulation

4.41(b)(1)(i) would thus read as follows:

"These results are based on hypothetical or simulated

performance results that have certain inherent limitations. Unlike

the results shown in an actual performance record, these results do

not represent actual trading. Also, because these trades have not

actually been executed, these results may have under- or over-

compensated for the impact, if any, of certain market factors, such

as lack of liquidity. Hypothetical or simulated trading programs in

general are also subject to the fact that they are designed with the

benefit of hindsight. No representation is being made that any

account will or is likely to achieve profits or losses similar to

these being shown."

\14\ See, e.g. supra note 12 for situations in which the

required disclaimer was not in immediate proximity to the

hypothetical performance.

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C. The Scope of Regulation 4.41: Proposed Amendment to Regulation

4.41(c)(1)

As originally adopted by Congress in 1974, the term "commodity

trading advisor" included any person who provided commodity interest

trading advice "either directly or through publications or writings."

\15\ With the subsequent advent of electronic media and the increasing

use of such media by CTAs, in 1982 Congress amended the CTA definition

to include any person providing commodity interest trading advice

"either directly or through publications, writings or electronic

media" (emphasis supplied).\16\ In turn, the Commission amended the

definition of the term "commodity trading advisor" in Regulation

1.3(bb) to conform to the statutory amendment.\17\ CPOs, like CTAs,

typically solicit customers based on their performance results. The

Commission accordingly is proposing to amend Regulation 4.41(c)(1) in

order to clarify that advertisements by "electronic media, or

otherwise, including information provided via internet or e-mail" are

within the scope of Regulation 4.41.

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\15\ Pub. L. 93-463, 88 Stat. 1389, Sec. 202 (Oct. 23, 1974).

\16\ Pub. L. 947-444, 96 Stat. 2294, Sec. 201 (Jan. 11, 1983).

\17\ 48 FR 35248 (Aug. 3, 1983).

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In this regard, the Commission emphasizes that it interprets

Regulation 4.41 in its current form as applying to the presentation of

past performance results by CPOs, CTAs, and their principals made

through electronic media. The Proposal is intended to make this

interpretation explicit.

The Commission believes that the Proposal is fully consistent with

the First Amendment. False, deceptive or misleading commercial speech--

even of, for example, those CTAs that provide advice on a non-

personalized basis--is not protected by the First Amendment.\18\

Moreover, even where commercial speech is only potentially misleading,

the government can use disclosure requirements to make sure that the

public is not, in fact, misled.\19\

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\18\ Indeed, the Commission may constitutionally prohibit the

dissemination of commercial speech that is "false, deceptive, or

misleading." Zauderer v. Office of Disciplinary Counsel, 471 U.S.

626, 638 (1985).

\19\ See, e.g. Pearson v. Shalala, 164 F.3d 650 (D.C. Cir. 1999)

(disclosure can be required to cure possibility of misleading public

that would not just justify prohibition).

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III. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA) \20\ requires that agencies,

in proposing rules, consider the impact of those rules on small

businesses. The Commission has previously established certain

definitions of "small entities" to be used by the Commission in

evaluating the impact of its rules on such entities in accordance with

the RFA.\21\

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\20\ 5 U.S.C. 601 et seq.

\21\ 47 FR 18618 (April 30, 1982).

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With respect to CTAs, the Commission has previously stated that it

would evaluate within the context of a particular rule proposal whether

all or some affected CTAs would be considered to be small entities and,

if so, the economic impact on them of the proposal.\22\ Moreover, the

Commission stated that CPOs would be considered small entities if they

are exempt from registration by virtue of Regulation 4.13(a).\23\ The

Commission does not believe that the proposed amendments to Regulation

4.41 would have a significant impact on affected CTAs, CPOs, and their

principals. This is because the only burden that would be imposed by

the Proposal would be the obligation to comply with the antifraud

provisions of Section 4o of the Act

[[Page 49390]]

when presenting the past performance of CTAs, CPOs, and their

principal--whether by way of actual or hypothetical performance or

through the use of testimonials. Assuming arguendo, however, that

compliance with Section 4o would constitute a significant burden, the

burden is neither new nor additional, because the proposed revisions to

Regulation 4.41 are consistent with the Commission's longstanding

interpretation of Section 4o as applicable to all advertisements by

CTAs, CPOs, and their principals, including advertisements that are

viewed electronically, and that such advertisements must not be false

or misleading.

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\22\ Id. at 18620.

\23\ Id.

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Accordingly, the Chairman, on behalf of the Commission, certifies

pursuant to Section 605(b) of the RFA \24\ that the Proposal will not

have a significant economic impact on a substantial number of small

entities. However, the Commission invites the public to comment on this

finding.

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\24\ 5 U.S.C. 605(b).

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B. Paperwork Reduction Act

The Paperwork Reduction Act of 1995 (PRA) imposes certain

requirements on Federal agencies (including the Commission) in

connection with their conducting or sponsoring any collection of

information as defined by the PRA. The Proposal does not require a new

collection of information on the part of any entities. Accordingly, for

purposes of the PRA, the Commission certifies that the proposed rule

amendments, if promulgated in final form, would not impose any new

reporting or recordkeeping requirements.

C. Cost-Benefit Analysis

Section 15(a) of the Act \25\ requires the Commission to consider

the costs and benefits of its action before issuing a new regulation

under the Act. By its terms, Section 15(a) does not require the

Commission to quantify the costs and benefits of a new regulation or to

determine whether the benefits of the proposed regulation outweigh its

costs. Rather, Section 15(a) simply requires the Commission to

"consider the costs and benefits" of its action.

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\25\ 7 U.S.C. 19(a).

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Section 15(a) further specifies that costs and benefits must be

evaluated in light of five broad areas of market and public concern:

protection of market participants and the public; efficiency,

competitiveness, and financial integrity of futures markets; price

discovery; sound risk management practices; and other public interest

considerations. Accordingly, the Commission could in its discretion

give greater weight to any one of the five enumerated areas and could

in its discretion determine that, notwithstanding its costs, a

particular rule was necessary or appropriate to protect the public

interest or to effectuate any of the provisions or to accomplish any of

the purposes of the Act.

The Commission is considering the costs and benefits of this rule

in light of the specific provisions of Section 15(a) of the Act as

follows:

1. Protection of Market Participants and the Public

Because the Proposal discusses the use of testimonials and the

placement of the prescribed hypothetical disclaimer, and specifically

includes advertisement via electronic media by CPOs, CTAs, and their

principals, the Proposal should enhance the Commission's ability to

protect market participants and the public.

2. Efficiency and Competition

The Proposal should have no effect, from the standpoint of imposing

costs or creating benefits, on efficiency or competition.

3. Financial Integrity of Futures Markets and Price Discovery

The Proposal should have no effect, from the standpoint of imposing

costs or creating benefits, on the financial integrity or price

discovery function of the commodity futures and option markets.

4. Sound Risk Management Practices

The Proposal should have no effect, from the standpoint of imposing

costs or creating benefits, on the available range of sound risk

management alternatives.

5. Other Public Interest Considerations

The Proposal should have no effect, from the standpoint of imposing

costs on, and may create public interest benefits to, consumers as a

result of their having more honest information.

After considering these factors, the Commission has determined to

propose the amendments to Regulation 4.41 discussed above. The

Commission invites public comment on its application of the cost-

benefit provision. Commenters also are invited to submit any data that

they may have quantifying the costs and benefits of the Proposal with

their comment letters.

List of Subjects in 17 CFR Part 1

Advertising, Brokers, Commodity futures, Commodity pool operators,

Commodity trading advisors, Consumer protection, Reporting and

recordkeeping requirements.

For the reasons presented above, the Commission proposes to amend

17 CFR part 1 as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

1. The authority citation for part 1 continues to read as follows:

Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,

6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a,

13a-1, 16, 16a, 19, 21, 23 and 24, as amended by the Commodity

Futures Modernization Act of 2000, Appendix E of Pub. L. 106-554,

114 Stat. 2763 (2000).

2. Section 4.41 is amended by removing "or" at the end of

paragraph (a)(1), removing the period and adding a semi-colon and

"or" at the end of paragraph (a)(2), adding new paragraph (a)(3), and

revising paragraphs (b)(1)(i), (b)(2) and (c)(1) to read as follows:

Sec. 4.41 Advertising by commodity pool operators, commodity trading

advisors, and the principals thereof.

(a) * * *

(3) Refers to any testimonial, unless the advertisement or sales

literature providing the testimonial prominently discloses:

(i) That the testimonial may not be representative of the

experience of other clients;

(ii) That the testimonial is no guarantee of future performance or

success; and

(iii) If, more than a nominal sum is paid, the fact that it is a

paid testimonial.

(b) * * *

(1) * * *

(i) The following statement: "These results are based on

hypothetical or simulated performance results that have certain

inherent limitations. Unlike the results shown in an actual performance

record, these results do not represent actual trading. Also, because

these trades have not actually been executed, these results may have

under-or over-compensated for the impact, if any, of certain market

factors, such as lack of liquidity. Hypothetical or simulated trading

programs in general are also subject to the fact that they are designed

with the benefit of hindsight. No representation is being made that any

account will or is likely to achieve profits or losses similar to these

being shown"; or

* * * * *

(2) If the presentation of such simulated or hypothetical

performance is other than oral, the prescribed statement must be

prominently disclosed and in immediate proximity

[[Page 49391]]

to the simulated or hypothetical performance being presented.

(c) * * *

(1) To any publication, distribution or broadcast of any report,

letter, circular, memorandum, publication, writing, advertisement or

other literature or advice, whether by electronic media or otherwise,

including information provided via internet or e-mail, the texts of

standardized oral presentations and of radio, television, seminar or

similar mass media presentations, and

* * * * *

Issued in Washington, DC, on August 17, 2006, by the Commission.

Eileen Donovan.

Acting Secretary of the Commission.

[FR Doc. E6-13946 Filed 8-22-06; 8:45 am]

BILLING CODE 6351-01-P

Updated August 23, 2006

Last Updated: June 26, 2007