July 31, 2002

Via Electronic Filing

Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W., Mailstop 6-9
Washington, D.C. 20549

Re: Proposed Amendments to Investment Company Advertising Rules, Release Nos. 33-8101; 34-45953; IC-25575; File No. S7-17-02

Dear Mr. Katz:

The Investment Counsel Association of America1 appreciates the opportunity to submit comments regarding the Securities and Exchange Commission's proposed amendments to the investment company advertising rules,2 which are designed to enhance and improve mutual fund advertising materials. We are not submitting comments on the specifics of the mutual fund proposal. Rather, we write in response to the Commission's requests for comments regarding the framework of the fund advertising rules and its relationship with the investment adviser advertising regime.3 In particular, we urge the Commission to adopt the ICAA's previously proposed revisions to the advertising rules under the Investment Advisers Act ("Advisers Act"), which, among other enhancements, would amend the rules to function in a manner similar to Securities Act Rule 156 governing mutual funds.4


Section 206 of the Advisers Act contains the Act's anti-fraud provisions and provides the statutory basis for the adoption of the anti-fraud rule relating to adviser advertising. Section 206(4) specifically prohibits an investment adviser from engaging "in any act, practice or course of business which is fraudulent, deceptive or manipulative" and authorizes the SEC "by rules and regulations, [to] define, and prescribe means reasonably designed to prevent, such acts, practices and courses of business as are fraudulent, deceptive or manipulative."5

Pursuant to this authority, the SEC adopted Rule 206(4)-1 (the "Rule") in 1961.6 The Rule provides both a general anti-fraud prohibition7 and four specific advertising provisions that prohibit advisers from: (i) using any testimonial of any kind concerning the adviser or its advice, analysis, report or services; (ii) referring to any specific past recommendations of such investment adviser that were or would have been profitable to any person, unless all specific past recommendations of the adviser for the immediately preceding one year period are also furnished or offered; (iii) representing that any graph, chart, formula or other device being offered can, in and of itself, determine or assist the client in determining which securities to buy or sell or when to enter into any such transaction, unless accompanied by prominent disclosures with respect to the limitations in using such graph, chart, formula or other device; and (iv) making any statement to the effect that any report, analysis or other service will be furnished free or without charge, unless it is entirely free.

The Rule defines "advertisement" to include any written communication "addressed to more than one person, or any notice or other announcement in any publication or by radio or television" that offers any analysis, report, publication or investment advisory service related to securities. The Commission staff has interpreted this definition quite broadly.

Unlike the mutual fund advertising rules, the investment adviser rules do not specifically address advertising of performance results. The SEC permits advertisements that include adviser performance results under a facts-and-circumstances test that analyzes whether a reader of the advertisement would be materially misled in any way. The SEC positions regarding performance advertising are set forth in numerous no-action letters and enforcement proceedings.

With one exception, the Rule has not been amended since its adoption in 1961.8 In the intervening 40 years, both the investment advisory profession and the clients served by it have changed significantly. A significant percentage of today's advisory clients are highly sophisticated persons, including corporations, partnerships, investment companies, pension funds, business trusts, foundations, and endowments, as well as high net worth individuals. Although many of the Commission's regulations, no-action letters, and other pronouncements recognize that sophisticated clients should have greater latitude in their dealings with advisers, the Rule itself does not recognize such a distinction. In light of these and other significant developments, we believe the time is ripe for a re-examination of the Rule.


By letter dated August 21, 2001, the ICAA submitted a proposal to the Commission to significantly revise Rule 206(4)-1. The proposal included the following principal recommendations:

The ICAA's proposed changes would update and simplify the Rule. Like the Commission's Rule 482 proposal, the ICAA's proposal would substantially enhance investor protection by improving the quantity and quality of information provided to clients and prospective clients. Our proposal would also provide minimum standards governing composite performance results prepared for retail clients.


The Commission's Rule 482 proposal presents an excellent framework in which to discuss the interplay between the advertising rules for mutual funds and those for investment advisers managing separate accounts for individual and institutional clients. The Commission explains that its proposal is part of "an effort to modernize our rules and forms in many areas."9 The Commission's proposal would eliminate the requirement that Rule 482 advertisements include only information "the substance of which" is included in the statutory prospectus. The proposal would "require enhanced disclosure of information in fund advertisements and [is] designed to encourage advertisements that convey balanced information to prospective investors."10 Significantly, the proposal would permit and indeed encourage funds to provide more current and relevant information to clients and potential clients, subject to the anti-fraud rules and accompanying factors set forth in Rule 156. This is exactly the result the ICAA proposal is intended to achieve for investment adviser advertising.

Indeed, the Commission's cost-benefit analysis of simplification and clarification of fund advertising rules applies equally in the adviser arena:

The proposed amendments to rule 482 may aid funds and others in understanding and complying with the advertising rules, making it easier and cheaper for funds to advertise. This may, in turn, contribute to an increased flow of useful investment information to investors, which may lead to better-informed investment decisions and amplify the previously discussed benefits of efficient asset allocation. Although difficult to quantify, this easing of regulation may provide some reduction of burden to the funds that choose to advertise.11

As we discussed at greater length in our August 2001 letter, the investment adviser advertising rules are outdated and in need of modernization, perhaps even more so than the fund advertising rules. We therefore urge the Commission to commence a rulemaking to address the issues discussed below.

A. Eliminate the Four Specific Prohibitions in Rule 206(4)-1 and Substitute the Rule 156 Model

The four specific prohibitions contained in Rule 206(4)-1 no longer make sense in today's investing environment. Many advisory clients and prospective clients are more sophisticated than ever before. They choose to hire some advisers whose strategy is based on computerized quantitative analysis. They seek detailed information about the performance of their accounts and their peers' experience with their adviser or prospective adviser. They would like information enabling them to understand advisers' strategies and analysis. They would like to be able to review the portfolio holdings of a representative account. Advisory clients seek more current and relevant information than their advisers are permitted to provide to them today. Indeed, because of outmoded rules, clients of investment advisers may receive less information than clients of mutual funds, broker-dealers, and banks.

In particular, the rules prohibiting testimonials and past specific recommendations prevent current and prospective advisory clients from receiving timely and relevant information. For example, many institutional and high net worth clients or their consultants request performance attribution analysis. Such analysis necessarily involves discussion of past specific holdings or investment decisions, including which of those holdings were profitable or unprofitable. Advisers should be permitted to offer this important information to their clients.12

Similarly, advisers frequently use newsletters or similar publications to communicate regularly with their clients. In these publications, advisers often discuss their purchase and sale decisions for clients, and on an ongoing basis, seek to inform and educate clients about the adviser's investment style and decision-making processes. In the Franklin Management no-action letter (pub. avail. Dec. 10, 1998), the staff permitted advisers to discuss in their quarterly newsletters to clients specific securities that were bought, sold, or held for client accounts within a particular investment category and the reasons for the management decisions, provided that such advisers (1) use only objective, non-performance-based criteria to select securities for such purpose, and (2) do not describe how selected securities performed. We understand that, particularly in the current economic climate, many investment advisers believe they need to be able to discuss in their communications their best and worst performing security selections for clients, as well as an explanation of the reasons behind the performance of those securities. These presentations would - and should - be provided in a clear and balanced manner. We believe investors would benefit significantly from information about their advisers' decision-making process. Advisers should be permitted to - and indeed encouraged to - provide a balanced discussion of their security purchases, sales, or holdings and the reasons for their investment decisions.

Moreover, the four specific prohibitions in Rule 206(4)-1 should not be considered per se fraud. In fact, the SEC staff implicitly has recognized that these activities are not inherently fraudulent. We are not aware of any compelling reason why some advertising material is considered fraudulent if used by investment advisers, but permitted if used by mutual funds. Further, these four prohibitions are both under inclusive and over inclusive. They are under inclusive in that other activities may constitute fraudulent advertising. They are over inclusive in that the four specific prohibitions appear to be somewhat arbitrary and not based on evidence that these practices have resulted in particularly more problems than other practices.

The public would be better served by an advertising rule that reflects an adviser's duty to make accurate and adequate disclosure of relevant and meaningful information to current and prospective clients. Like Rule 156, Rule 206(4)-1 should set forth factors to consider in evaluating whether advertising material is misleading or deceptive. The ICAA's proposal includes a list of factors similar to Rule 156, drawn from SEC interpretations, no-action letters, speeches, and enforcement actions in this area. Indeed, in its current release, the Commission proposes to amend Rule 156 to emphasize that portrayals of performance may be misleading where they omit "explanations, qualifications, limitations, or other statements necessary or appropriate to make the portrayal not misleading." Similarly, the ICAA proposal includes the following factor in determining whether an advertisement is misleading: "the absence of explanations, qualifications, limitations or other statements necessary or appropriate to make such statement not misleading."13

B. The Difference Between Advisers and Funds with Respect to Performance Calculations Makes Sense

In its Rule 482 proposal, the Commission notes that "[c]urrently, our rules include standardized performance calculations for investment companies, but not for investment advisers. Does this difference make sense and, if not, what changes should we make?"14 We believe this difference does make sense for performance calculations. The performance calculation requirements for mutual funds are based on the notion of net asset value - a unitized figure derived from one pool of assets. A mutual fund has one custodian and controls its own pricing mechanisms and agents. In contrast, an investment adviser calculating performance is creating a composite of similarly managed accounts. Advisory clients choose their own custodians with their own systems and own reconciliation mechanisms. They may choose their own pricing agents. These clients have varying cash flows, account restrictions, fees, expenses, and performance objectives. It is not feasible to create a unitized calculation for advisers that would be similar to that of funds.

On the other hand, some advisers do follow an industry standard for performance calculations articulated by the Association of Investment Management and Research ("AIMR"). The AIMR standards permit clients to make apt comparisons of investment adviser composite performance, while providing flexibility to advisers to account for variations in client types, strategies, and sectors. Creating, interpreting, and enforcing similar performance calculation standards may not be an appropriate use of the Commission's limited resources.15

In contrast to performance calculations, there may be less reason to differentiate between funds and retail separate accounts with respect standardized performance presentations or formats. Institutional clients often demand customized performance reporting. Many institutions hire a number of different advisers and seek to obtain information in a standardized format in order to permit the creation of comparative materials to submit to their management. Similarly, consultants often require response to standardized questionnaires designed to facilitate adviser comparisons.

Retail clients, however, may find it more difficult to compare performance data presentations by various advisers. It may be advisable to establish standardized performance formats for marketing to retail clients. In our August 2001 letter, we proposed specific baseline standards for presentation of performance information to retail clients. These standards would require that performance advertising disclose: (1) the type of accounts or strategy represented; (2) a description of how the performance history was calculated; (3) the returns of an appropriate market index for comparison purposes; (4) the number of clients whose accounts are included in the composite; (5) the total client assets included in the composite; (6) the length of, and date of the last day in, the period used to compute performance. In addition, performance advertising to retail clients would have to be current to the most recent calendar quarter and for a period of not less than one year, or inception to date if less than one year, and provided for one-, five-, and ten-year periods.

In the interests of consistency, the proposed ICAA standards are drawn from various Commission positions and AIMR-PPS standards. These baseline standards would better enable retail investors to compare advertised performance of investment advisers.

C. The Commission Should Issue a New Advertising Interpretive Release

As discussed in our August 2001 letter as well as our letter dated June 18, 2002 to Chairman Pitt on the Commission's Special Study on Efficiency, the SEC has issued scores of no-action letters and other pronouncements related to investment adviser advertising during the past 40 years, resulting in a complex maze of interpretations and positions. Today, it is very difficult for compliance officers to sift through the nuances of all of these letters to determine their legal obligations under the Rule. The Commission's review of the structure of the advertising regime presents an appropriate opportunity for the Commission to consolidate its guidance in the advertising arena. We therefore urge the Commission to issue an interpretive release consolidating and modernizing its guidance on investment adviser advertising.

Thank you for considering our comments on this important issue. Please do not hesitate to contact the undersigned if we may provide any additional information.


General Counsel

cc: Harvey L. Pitt, Chairman
Cynthia A. Glassman, Commissioner
Roel C. Campos, Commissioner
Harvey J. Goldschmid, Commissioner
Paul S. Atkins, Commissioner
Paul F. Roye, Director, Division of Investment Management
Cynthia M. Fornelli, Deputy Director, Division of Investment Management
Robert E. Plaze, Associate Director, Division of Investment Management
Douglas J. Scheidt, Associate Director, Division of Investment Management

1 The ICAA is a not-for-profit association that exclusively represents the interests of SEC-registered investment advisers. Founded in 1937, the Association's membership today consists of approximately 300 investment advisory firms that collectively manage in excess of $3 trillion for a wide variety of institutional and individual clients. For additional information, please consult our web site at www.icaa.org.
2 Proposed Amendments to Investment Company Advertising Rules, Release Nos. 33-810l; 34-45953; IC-25575; File No. S7-17-02 (May 17, 2002) (hereafter "Release").
3 E.g., Release, Part IIIA (Request for Comments on the Framework for Regulation of Investment Company Advertisements).
4 Letter from Karen L. Barr, General Counsel, Investment Counsel Association of America to Paul F. Roye, Director, Division of Investment Management, Securities and Exchange Commission (Aug. 21, 2001) (proposing specific changes to Rule 206(4)-1 under the Advisers Act). The letter is incorporated by reference here.
5 Investment Advisers Act, Section 206(4).
6 Investment Adviser Release No. 121 (Nov. 2, 1961).
7 Rule 206(4)-1(a)(5).
8 In 1997, the Rule was amended to limit its applicability to advisers "registered or required to be registered under Section 203 of the Act." Investment Adviser Release No. 1633 (May 15, 1997).
9 Release at 19.
10 Release at 11.
11 Release at 26.
12 Advisers are permitted to provide customized information to one client, which is neither cost-efficient nor always warranted. Advisers should be permitted proactively to offer attribution analysis to a group of similarly situated clients.
13 See ICAA proposed rule 206(4)-1(b)(1).
14 Release at Section IIIA.
15 The ICAA does not, however, necessarily endorse the AIMR structure. We and a number of our member firms have experienced significant difficulty with AIMR's process in developing and interpreting its performance presentation standards.