Speech by SEC Commissioner:
Mutual Fund Performance Advertising:
Is It in Overdrive?
Commissioner Paul R. Carey
U.S. Securities & Exchange Commission
At SEC Speaks
March 2, 2001
I would like to talk to you today about mutual fund performance advertising. I remind you that the views I express are mine and mine alone and are not meant to reflect the views of the Commission or its staff.
Recently, I was reading the Wall Street Journal and a mutual fund advertisement caught my eye. This advertisement showcased the absolutely spectacular performance of a fund. Funny thing, though, this fund was in a sector that even the most casual market observer knew had taken a sharp downturn. Could it be that this fund was managed by a veritable stock picking genius who somehow managed to maintain high performance in the face of market declines? Upon closer inspection of the ad, I realized that the fund performance highlighted was calculated as of a date two months earlier, before the market had taken the sharp downturn. I later found out that the fund's one-year performance as of the date of the ad was significantly lower. In fact, the fund's more current one-year performance was negative. Clearly, an investor could be misled by this advertisement.
As we all know, in recent years, many mutual funds have enjoyed extraordinary performance results. Not surprisingly, funds have sought to attract more investors by advertising these results. SEC rules provide guidance on what information may appropriately be contained in a fund ad.
Rule 482 of the Securities Act permits funds to advertise their performance, without first having to provide investors with a copy of their prospectus, if they comply with the conditions of the rule. In overly simplistic terms, the rule permits, among other things, funds to include their 1, 5 and ten-year total returns, if these returns are calculated in a standardized manner. The total returns must be calculated as of the most recently completed calendar quarter. If funds include this standardized performance information, they also can include additional, nonstandardized performance information in their ads.
Fund advertisements that comply with this rule, however, may still run afoul of the antifraud rules. The antifraud rules make it unlawful for a fund advertisement to omit to state any fact necessary to prevent the statements made from being materially misleading. Thus, mere disclosure of standardized performance information, even though literally true, may, nonetheless, materially mislead an investor if it does not include additional facts necessary to provide an investor with a more accurate picture of the fund's performance.
For example, if a fund publishes an advertisement today, March 2nd, but only includes its positive 1-year performance as of December 31st, the end of the most recently completed calendar quarter, and fails to include its more recent negative performance, the ad could be materially misleading. In other words, if the performance of the fund has declined significantly, mere recitation of the stronger, one-year performance in an ad, without reference to more current performance, may be misleading. The NASD has emphasized this point in advertising alerts and in Notices reminding its members of their responsibilities to present fund performance information in a fair and balanced manner. The NASD indicated that, depending on the circumstances, it may be necessary to include in an advertisement information beyond what is required under Rule 482. Use of the most recent quarter-end data alone, may mislead if the fund's performance suffers materially prior to updating at the next quarter end. Similarly, if a fund's positive 1-year performance is attributable to an event that is unlikely to reoccur, disclosure of 1-year performance, without more, also may be misleading.
Thus, mere compliance with Rule 482 by using standardized total returns that are calculated as of the most recently completed calendar quarter does not necessarily mean that the ads, when taken as a whole, are still not materially misleading.
Let me further illustrate what I mean by describing two enforcement actions, both of which involved, at least in part, misleading advertising. Both of these cases, Van Kampen and Dreyfus, involved a fund's failure to disclose the effect of "hot" IPOs on performance results, and that the fund would be unlikely to sustain the good performance.
In Van Kampen, the fund advertised a 61% one-year return and a #1 Lipper ranking, but did not disclose that investments in IPOs had a large impact on the fund's return, and that it was unlikely that the fund could sustain that performance as the fund grew in size.
In Dreyfus, like Van Kampen, the fund advertised its spectacular one-year return, without disclosing the large impact that IPO investments had on the fund's return and without disclosing that it was unlikely that the fund could replicate its prior performance as the fund grew in size. In Dreyfuss, the Commission specifically stated that the ads were materially misleading and failed to comply with the antifraud provisions of the federal securities laws, even though the fund's ads complied with Rule 482.
In these actions, the Commission specifically found that certain "boilerplate" disclosure in the ads were insufficient to avoid misleading investors. Such boilerplate disclosure included:
- disclosure that the fund's return should not be regarded as routine; and
- disclosure that the fund's relatively small asset size, combined with a period of high stock market performance, may have contributed to the fund's success and may not be replicated over the long term.
In other words, general, broad boilerplate disclaimers are insufficient if circumstances indicate other significant factors, which contributed to the good performance, are no longer present. Thus, in both Van Kampen and Dreyfus, the Commission found that additional disclosure was needed to inform investors that the factors which produced the prior performance would no longer be present when the fund's asset size grew.
In addition to bringing enforcement actions, the Commission has taken other actions to curb the use of misleading ads. We have cautioned members of the industry to be more judicious in their advertising practices. A year ago, former Chairman Levitt spoke to a group of mutual fund directors and warned against the use of advertisements that offer quick returns or instant wealth where performances are not sustainable. The Division of Investment Management, similarly has publicly expressed concerns that advertised historical performance, without reference to current performance, may be misleading and unsustainable.
Believing that an educated investor is the best defense against misleading sales practices, we have sought to raise the awareness of investors by advising them that ads that promise returns that seem too good to be true may be just that. To that end, the Commission issued an investor bulletin, entitled Mutual Fund Investing: Look at More than a Fund's Past Performance, and a Special Review of Fund Advertising Fact Sheet, both of which caution investors to take factors other than just performance into account when considering fund investments. Both the bulletin and the fact sheet are available on the Commission's website.
Our examination staff and our disclosure review staff have undertaken a special review of fund marketing including fund advertisements and fund prospectus disclosure in hopes of identifying and curbing overly aggressive practices.
More recently, our IM staff has been working on a legal bulletin which should soon be released. This bulletin will remind funds that their advertisements should not mislead investors and that mere compliance with Rule 482 is not necessarily sufficient to avoid misleading investors. Advertisements must be written in a manner consistent not only with the specific fund advertising rules, but also with the more general antifraud rules of the federal securities laws. General market declines, industry specific declines or other special circumstances that make it unlikely that a fund will be able to sustain previous performance must be disclosed. This disclosure cannot be meaningless boilerplate, but must be clear and understandable.
Our rulemaking staff is also working on proposed rule amendments to be sent to the Commission for consideration. These proposed amendments will be designed to promote the use of current performance information, emphasize the applicability of the antifraud rules and encourage responsibility with respect to fund advertising.
We are not in the business of predicting market shifts that could result in a climate where advertising that technically complies with the advertising rules could, nonetheless, be misleading. We are, however, charged with the duty to protect investors. Like it or not, many fund investors may make their investment decisions based on information contained in fund ads. I believe that the Commission should continue its efforts to ensure that investors are not misled by overly aggressive, but technically accurate, fund advertisements. In the event that ads are misleading, our examination and enforcement staff will take appropriate action. And, I hope that I won't be seeing another misleading ad in the paper, with no mention that the fund's current performance bears no resemblance to the spectacular standardized performance highlighted in the ad.