July 31, 2002
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: Proposed Amendments to Investment Company Advertising Rules (Release No. 33-8101; File No. S7-17-02)
Dear Mr. Katz:
Fidelity Investments1 ("Fidelity") appreciates the opportunity to comment on the SEC's proposed amendments to the rules governing investment company advertising. Fidelity generally agrees with the views expressed by the Investment Company Institute ("ICI") in its letter to the Commission dated July 31, 2002 (the "ICI Letter"). We submit this letter to supplement the ICI Letter on specific issues.
Fidelity supports most of the proposed rule changes, and we believe that many of them will further our common goal of providing investors with useful and timely information. Specifically, Fidelity supports the following proposals for the reasons stated in the ICI Letter:
However, we urge the Commission not to adopt the following proposed changes, for the reasons discussed in this letter:
I. Month-end Performance Information Provided Through a Toll-Free Phone Number
A. The proposed amendment is unnecessary and does not promote investors' interests.
While we support the Commission's efforts to ensure that performance advertisements convey balanced information to investors, we have significant concerns with the Commission's proposal to require that fund advertisements containing quarter-end performance provide month-end total returns information via a toll-free (or collect) telephone number, and a website, within three calendar days of the month-end.
We understand that recent market volatility focused the Commission's attention on the timeliness of performance information in mutual fund advertising. We do not agree, however, that emphasizing short-term performance resolves that concern. To the contrary, we believe the Commission's proposal is not likely to benefit investors. Short-term performance is just one minor factor on which to base an investment decision concerning a mutual fund and should not be given greater emphasis than other important information such as a fund's investment objective, risks, and fee structure.
More importantly, to the extent that the Commission is concerned specifically with fund companies advertising stale performance data which no longer reflect current market conditions, the existing regulatory framework already provides sufficient investor protections to discourage that practice.3 Indeed, the Commission has specifically proposed to clarify that general antifraud principles apply to investment company advertisements even where they may on their face appear to comply with the securities laws. That principle compels the conclusion that an investment company is already prohibited from advertising quarter-end performance when it has available to it more recent data that would render the advertisement misleading.
B. The three-day time limit is unworkable.
In any event, the Commission's proposal to require that month-end performance be made available within three days of month-end is unworkable. If Rule 482 is amended to require month-end performance information, the Commission should require fund companies to provide updated month-end performance data as soon as reasonably practicable after month-end.
The Commission should look to the current text of Rule 482 as the model. Rule 482 requires that all performance information in an advertisement be "as of the most recent practicable date."4 This flexible standard has worked well for fund companies and investors for decades.
A rigid standard would be particularly inappropriate for fund companies such as Fidelity that sponsor mutual fund supermarkets with thousands of funds, or that make third-party funds available through retirement plans which they administer or for which they provide recordkeeping services. Fidelity cannot independently calculate performance information on all of those funds, and must rely on the third-party fund companies themselves or on third-party service providers such as Morningstar or Lipper for performance information.5 As a practical matter, it would be extraordinarily difficult in those contexts to obtain, process and disseminate accurate performance information on thousands of funds, from a variety of sources, in three days.
C. Fund companies should be able to choose to provide short-term performance data on the Internet.
If the Commission requires investment companies to provide month-end performance information, we believe that fund companies should have flexibility in determining how to make the data available, as recommended by the ICI in its July 18, 2001 letter to the Commission.6
In particular, the SEC should permit fund companies to provide month-end performance information by electronic means instead of by phone.
The Internet, unlike an automated phone system, provides a clear and flexible medium for communication of any kind of information, including complex information, on demand. In addition, the Internet has now become ubiquitous. An ICI study conducted in 2001 demonstrated what was already intuitively obvious -- the vast majority of mutual fund shareholders had already accessed the Internet, and that number is rapidly increasing.77 As a result, the Internet is now, in many cases, the best means for communicating information quickly and efficiently. At a minimum, it is at least equal in convenience and clarity to an automated voice-response system.
The SEC should also consider its role in furthering the development of electronic commerce in the securities industry. In 2000 Congress passed the Electronic Signatures in Global and National Commerce Act ("E-Sign").8 Congress intended E-Sign to foster the development and adoption of electronic commerce by, among other things, encouraging federal regulators to enact rules that permit the delivery of information electronically as an alternative to other media. The current rule proposals are an opportunity for the SEC to do precisely that.
As a practical matter, moreover, we believe that virtually all fund companies already have Internet sites which could be updated to provide the required performance information. If a phone-based system were required, most fund companies would be forced to build automated telephone systems at great expense specifically for that limited purpose, or they would have to devote a portion of their live representatives' limited resources to answering questions about short-term fund performance instead of providing service to existing fund shareholders.
We therefore strongly recommend that the Commission permit fund companies to choose whether to provide performance data by phone or on an Internet site.9
II. Rule 134 should not be rescinded for investment companies.
We strongly support amending Rule 482 to eliminate the "substance of which" requirement pursuant to NSMIA. However, we do not believe that expanding the scope of Rule 482 eliminates the need for Rule 134, and we urge the Commission not to rescind Rule 134 for investment companies.
Because a Rule 482 advertisement is deemed a "prospectus" under the securities laws, a fund company choosing to advertise under that rule subjects itself to a heightened standard of liability for the contents of that advertisement under Section 12(a)(2) of the Securities Act of 1933. A Rule 134 "tombstone" advertisement, in contrast, is not a prospectus under the securities laws and is accordingly much more narrowly circumscribed in the subjects it may address.10 Because they are strictly limited to a predefined set of factual statements that do not constitute "selling arguments,"11 Rule 134 advertisements have never been -- and should not be -- subject to the heightened liability imposed under Rule 482.
This distinction is important. The basic common law principle of liability for a claim of misrepresentation is that a plaintiff must prove the elements of its case in order to prevail. For a claim of misrepresentation, therefore, a plaintiff traditionally is required to establish that the defendant not only made an inaccurate statement, but that it was done with scienter, that the plaintiff reasonably relied on the misrepresentation, and so on. The plaintiff similarly bears the burden of proof in virtually all securities law contexts; for example, section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder place the burden of proof on the plaintiff to prove both scienter and loss causation, among other things, on a claim of misrepresentation or omission.
In a very few contexts, policy considerations have caused Congress to invert the normal approach and place some part of the burden of proof on the defendant. Liability for misrepresentations in a prospectus is one such context. Under section 12(a)(2) of the '34 Act, if a plaintiff proves that there was a material misrepresentation or omission in a prospectus, both scienter and loss causation are presumed, and the issuer bears the burden of disproving them.
That extraordinary inversion of the burden of proof may be warranted for prospectuses as a matter of policy because they are the fund's primary selling document. By extension, that standard applies to Rule 482 advertisements, which are effectively excerpts of the prospectus and can address certain fund-specific topics -- specifically, performance -- which might similarly constitute a "selling argument."
For decades, Rule 134 has reflected the corollary principle that certain subjects relating to a fund may be presented in an advertisement without incurring anything more than ordinary liability.12 Rule 134 has reasonably permitted fund companies to address general matters largely tangential to a specific fund - like current economic conditions or non-fund-related products and services - or relatively innocuous fund-specific information, subject to conventional standards of care and liability.
Although the proposed amendments would permit Rule 482 advertisements also to address those tangential or innocuous subjects, the nature of the information conveyed has not changed in any way that that would justify imposing extraordinary liability with respect to it. There is no sound policy reason or statutory basis for imposing section 12(a)(2)'s extraordinary standard of liability on investment companies when they properly limit their speech to the narrow range of factual information permitted under Rule 134. If a fund company complies with Rule 134 and does not stray into subjects like fund performance, then ordinary standards of liability should apply as they do in virtually every other legal context both within and beyond the securities laws, and as they have applied to that same information under Rule 134 for decades.
With the adoption of Rule 482, fund companies were given a choice to advertise performance and other complex fund-specific information and thereby accept a correspondingly heightened standard of liability. As the ICI Letter points out, in the adopting release for Rule 482 the SEC assuaged investment company concerns over the heightened liability of Rule 482 by expressly acknowledging that fund companies would not be subject to those standards unless they chose to advertise under the more expansive Rule 482.13 The SEC struck the proper balance at that time between subject matter and standard of liability by presenting Rule 482 as an alternative to Rule 134.14 We do not believe that the current proposal to eliminate Rule 134 for mutual funds was intended by the SEC as a reconsideration of that existing balance or a conscious determination to extend the liability of fund companies.15
In short, the proposed amendments to Rule 482 do not eliminate the need for Rule 134. Rule 134 should remain available to fund companies in its present form.
III. Narrative Disclosure Requirements
The Commission has proposed to impose specific placement and format requirements on certain narrative disclosures in Rule 482 advertisements.16 Fidelity believes that these requirements would be unduly cumbersome and counterproductive, and we urge the Commission not to adopt them. Fund complexes should continue to have the latitude to determine format and placement based upon the specific facts and circumstances surrounding a particular advertisement.
The proposed amendments would require that certain disclosures be in a type size at least as large as, but in a style different from, the major portion of a Rule 482 advertisement. In addition, to comply with the requirement that the new disclosure always appear in the body of the advertisement, a typical print advertisement would have to include multiple lines of full-sized disclosure in its body dedicated solely to performance.17 Designing clear and readable advertisements consistent with these requirements would be difficult at best.
These size and style requirements are reasonable under Rule 134 because they apply only to the legend informing investors how to obtain a prospectus. Given the typical physical constraints on most ads, the full range of information permitted in a Rule 482 ad should not reasonably be subject to the same strict size and placement requirements.
In addition, we agree with the ICI that the font and style requirements of the proposed rule change would lead many investors to dismiss most of the disclosure as boilerplate language, which would defeat the Commission's intent.18
We believe that some flexibility is warranted, and that the existing regulatory framework prohibiting misleading communications is sufficient to address the Commission's concerns.
IV. Compliance Date
The Commission's proposal to require compliance within 90 days after the effective date of the amendments is too short for most of the proposed changes. We support the proposal in the ICI Letter to require compliance with the proposed rules after the second full calendar quarter following the adoption of the amendments, except for the removal of the "substance of which" requirement under Rule 482, which should become effective immediately upon adoption.
V. The Current Regulatory Framework
Fidelity supports the Commission's efforts to revise the current regulatory framework in an effort to provide more meaningful and useful information to investors in mutual fund advertisements. As part of this effort, Fidelity recommends that the Commission work toward developing a framework that is consistent with the mutual fund advertising rules currently proposed by the NASD.19 Specifically, the Commission should recognize in its rules the distinction between materials intended for retail and institutional audiences and restructure the rules so that materials intended for an institutional audience are subject to reasonable general standards, instead of specific disclosure requirements. These changes would allow fund companies to create advertisements that match the specific needs and sophistication of their intended audience.
Finally, we believe that the current regulatory framework does not adequately address the increased role of the Internet in mutual fund advertising. Financial service companies such as Fidelity have developed Internet sites through which they offer a wide variety of products and services. Although most of the communications about these products and services are published under the name of one of Fidelity's broker-dealers and are subject to the federal securities laws and the NASD Conduct rules for members, many are not.20 As a result, we have had to adapt the rules governing mutual fund advertising to apply to Internet sites which are comprised of a wide range of content by, for example, applying the SEC's Newsletter Guidelines.21 While this approach has enabled us to develop a site that complies with the current mutual fund advertising rules, it has been a needlessly difficult and complex undertaking. Fidelity recommends that as the Commission looks for ways to improve the current regulatory framework that it consider the special challenges the mutual fund advertising rules present to financial service companies in today's electronic marketplace.
* * *
We appreciate the opportunity to comment on this important rule proposal. Please contact me, David Forman, at (617) 563-0128 should you have any questions concerning Fidelity's views.
David A. Forman
Senior Legal Counsel
cc: Paul F. Roye, Director
Susan Nash, Associate Director
Division of Investment Management
Thomas M. Selman, Vice President
Investment Companies/Corporate Financing
NASD Regulation, Inc.
|1||Fidelity Investments is composed of a group of diversified financial services companies, including several NASD registered broker-dealers as well as the largest mutual fund complex in the United States. In 2001, Fidelity filed over 8,700 mutual fund and variable product advertisements with the NASD.|
|2||We also support the proposed amendments to Item 21 of Form N-1A, Item 25 of Form N-3, Item 21 of Form N-4, and Item 25 of Form N-6 which require certain disclosure about the methods used to calculate performance data in advertisements to reflect the proposed removal of the "substance of which" requirement in Rule 482.|
|3||Rule 156(b)(2) provides guidance on statements or omissions that could cause a fund advertisement to be misleading, including a number of specific factors which could cause portrayals of past performance information to be misleading.|
|4||See Rule 482(g).|
|5||On average, Fidelity receives performance data on third-party funds from sources such as Lipper or Morningstar on the fourth or fifth day following the month-end. For third-party fund performance information that is provided to us directly by the fund company, we receive this data as much as ten days following the month-end.|
|6||See ICI letter from Craig S. Tyle, General Counsel, Investment Company Institute, to Paul F. Roye, Director, Division of Investment Management, Securities and Exchange Commission (July 18, 2001).|
|7||A May 2001 survey by the ICI indicated that 82% of mutual fund shareholders had accessed the Internet. See 2001 Profile of Mutual Fund Shareholders, Investment Company Institute (Fall 2001) at p. 4. This percentage was up from 68% in April 2000, and 62% in 1988. See "Mutual Fund Shareholders' use of the Internet," Fundamentals, Vol. 9, No. 3 Investment Company Institute (July 2000).|
|8||See Electronic Signatures in Global and National Commerce Act, 15 U.S.C. §7001, et seq. (June 30, 2000).|
|9||We also agree with the ICI that there is no apparent benefit to requiring a phone number in advertisements that already contain month-end returns. See ICI Letter p. 8.|
|10||In a 1974 adopting release for amendments to Rule 134, the Commission stated that "there is a significant difference, which is crucial in terms of the legal requirements of Section 2(10)(b) and Rule 134, between selling a product from the face of an advertisement and attracting the reader's attention and stimulating his interest in obtaining the legally sanctioned selling document, the statutory prospectus." See SEC Release No. 33-5536 (November 4, 1974), 1974 SEC LEXIS 2372 at p. 3.|
|11||In a 1974 adopting release for Rule 134 amendments, the Commission stated "The amended rule  would not permit inclusion of any performance data, since such information might constitute a selling argument." See SEC Release No. 33-5536 (November 4, 1974), 1974 SEC LEXIS 2372 at pp. 2-3.|
|13||See ICI Letter at p.12.|
|14||Many financial service companies such as Fidelity offer a broad array of products and services necessitating an integrated approach to advertising. For example, our retail brokerage company often develops brochures that include descriptions of the various products and services available to brokerage account customers which include a list of funds available as brokerage core account options. Because of these fund descriptions, these types brochures are generally reviewed and filed pursuant to Rule 134. The proposal to eliminate Rule 134 would needlessly subject the entire brochure to heightened liability under Rule 482.|
|15||We also disagree with the SEC's suggestion that there would be a financial benefit to fund complexes as a result of having to comply with only one advertising rule. See SEC Release No. 33-8101; 34-45953, (May 17, 2002) at p. 22. In Fidelity's experience, there is no correlation between the number of advertising rules available and the cost of producing or reviewing advertising.|
|16||See proposed Rule 482(b).|
|17|| See proposed Rule 482(b)(3).|
|18||See ICI Letter at p.10.|
|19||See SEC Release No. 34-45181 (December 31, 2001). The changes as proposed by the NASD to its rules governing member communications with the public would, among other things, create a new category of sales material for advertisements directed at institutional investors. Under the proposed rule, these materials will be exempt from the NASD's filing requirements as well as many of the NASD's content standards. The NASD rule proposal recognizes that institutional investors have an in-depth understanding of investment concepts and of the products available to them, and therefore do not require the same level of explanation or detail on basic investment concepts as do less-sophisticated investors.|
|20||The Fidelity website comprises various types of communications relating to Fidelity's financial products and services, including brokerage services, investment adviser services, life insurance products and donor advised gift funds. Communications regarding Fidelity's life insurance companies or Fidelity's Charitable Gift Fund, for example, are not subject to the SEC's or the NASD's advertising rules because they are not published by a broker-dealer.|
|21||The Newsletter Guidelines (the "Guidelines") culminate a series of oral and written communications among the SEC, ICI and its counsel and members of the investment company industry that continued from 1987 to 1990. The Guidelines allow for the combined application of the SEC advertising rules (Rules 134,156, 482, and to a lesser extent, Rule 135a) and allow financial services companies to use newsletters within the parameters of the 1933 Act and allow for non-offering or "freewriting" material to appear in the same newsletter as offering material as long as certain conditions are met.|