SEC Amends Mutual Fund Advertising Rules, Proposes New Rules and Amendments for Fund of Funds Investments


Amendments to Investment Company Advertising Rules

Washington, D.C., Sept. 24, 2003 -- The Securities and Exchange Commission unanimously approved the following items at today's open meeting:

The Commission adopted rule amendments recommended by the Division of Investment Management that are designed to encourage mutual fund advertisements that convey more balanced information to prospective investors, particularly with respect to past performance.

The amendments address concerns that, especially in times of strong market performance, some funds may use advertising techniques focusing on past fund performance that may create unrealistic investor expectations or may mislead potential investors. These concerns arose during the period of extraordinary market returns in 1999-2000, when many funds experienced impressive performance and engaged in advertising campaigns focused on past performance. Recently, improvements in market performance have again generated an increase in fund advertising highlighting short-term performance.

The rule amendments are part of the Commission's continuing efforts to raise standards for mutual fund performance advertising, so that investors are informed, and not misled, by that advertising. The Commission has previously addressed this area through enforcement actions and investor education efforts (see, for example, Mutual Fund Investing: Look at More Than a Fund's Past Performance (Jan. 24, 2000).

Under existing rules, funds that advertise performance information typically include returns for 1-, 5-, and 10-year periods (or, if shorter, for the life of the fund) that are current to the end of the most recent calendar quarter. In order to ensure that investors will have ready access to more timely information, the new amendments require funds that advertise performance to make available returns that are current to the most recent month-end by a toll-free or collect telephone number or on a Web site. Fund advertisements will be required to identify this telephone number or Web site where an investor can obtain month-end performance information.

The amendments also will:

  • Require fund advertisements that contain performance information to include disclosure that past performance does not guarantee future results and that current performance may be lower or higher than the performance quoted;
  • Require fund advertisements to include disclosure that would direct investors' attention to a fund's investment objectives, risks, and charges and expenses, in order to address concerns that this important information about a fund may be overshadowed by fund advertising that is focused on past performance;
  • Require more prominent disclosure in fund advertisements of important information, such as the dates during which quoted performance occurred; and
  • Reemphasize that fund advertisements are subject to the antifraud provisions of the federal securities laws.

The Commission also implemented a provision of the Investment Company Act by:

  • Eliminating the requirement in rule 482 under the Securities Act that investment company advertisements under that rule contain only information the substance of which is included in the statutory prospectus;
  • Rescinding, as duplicative, the provisions of rule 134 under the Securities Act that permit investment companies to include in "tombstone" advertisements a broad range of information; and
  • Making conforming changes to investment company registration forms, including Form N-1A for mutual funds and Forms N-3, N-4, and N-6 for variable insurance products.

These amendments will provide funds with the ability to include more timely information in their advertisements under rule 482, such as information about current economic conditions, that normally would not be included in a fund's prospectus. It would also ensure that this information is subject to prospectus liability, which presently is not the case when this information is included in a "tombstone" advertisement under rule 134. The amendments will also improve prospectus disclosure by permitting funds to eliminate from their prospectuses boilerplate disclosure that clutters the prospectus and obscures other important information.

Mutual fund companies will have to comply with the new advertising rule amendments beginning March 31, 2004.

Fund of Fund Investments

The Commission proposed new rules 12d1-1, 12d1-2, and 12d1-3 under the Investment Company Act of 1940, and amendments to disclosure forms N-1A, N-2, N-3, N-4, and N-6.

Due to abuses associated with pyramiding schemes, the Investment Company Act limits the ability of a fund to acquire shares of another fund — a so-called "fund of funds" arrangement. The Act limits the amount one fund may acquire of another fund's shares, and limits the amount of assets one fund may invest in other funds. In the last decade, the Commission has issued exemptions for fund of funds arrangements that are unlikely to lead to the abuses that form the basis for the statutory limitations.

The proposed rules would codify exemptions relating to three types of fund of funds arrangements:

  1. "Cash sweep arrangements." The most common type of exemption permits "cash sweep arrangements," in which a stock or bond fund invests its cash in affiliated money market funds. Proposed rule 12d1-1 would permit a registered fund to acquire shares of a registered or unregistered money market fund without regard to the statutory limits. The rule also would permit unregistered funds to acquire any amount of shares of a registered money market fund.
  2. "Affiliated funds of funds." The Investment Company Act permits a fund to acquire any amount of shares of one or more funds in the same fund complex. A fund that relies on this statutory exception can invest only in: (i) funds in the same fund complex; (ii) government securities; and (iii) short-term paper. Proposed rule 12d1-2 would permit an affiliated fund of funds to: (i) make limited investments in funds outside the same fund complex; (ii) invest in securities not issued by a fund; and (iii) invest in money market funds in reliance on proposed rule 12d1-1.
  3. "Unaffiliated funds of funds." The Investment Company Act also permits a fund to take small positions in any number of other funds provided, among other conditions, that the acquiring fund charges a sales load no greater than 1½ percent. Proposed rule 12d1-3 would permit an unaffiliated fund of funds to charge a sales load greater than 1½ percent, provided that the aggregate sales loads and distribution-related fees of the acquiring and underlying funds are not excessive under the NASD rule regarding fund of funds fees. The NASD rule limits aggregate sales loads and overall fund distribution fees.

If adopted, these rules would give funds greater flexibility to invest in other funds without having to obtain an exemptive order from the Commission in circumstances that do not create risks for the fund or its investors.

The Commission also proposed amendments to disclosure forms that funds use to register under the Investment Company Act and the Securities Act of 1933. The proposed amendments would require any fund that invests in another fund to include in its prospectus fee table an additional line item that discloses the costs of investing in underlying funds. This disclosure would permit investors to better understand fund costs, and to compare the relative costs of different fund of funds arrangements.

The fund advertising amendments, as well as the proposed fund of funds rules and amendments are expected to be available on the Commission' Web site within the next few days. The Commission is soliciting comment on the fund of funds proposals until December 3, 2003.

Last modified: 9/24/2003