July 31, 2002
Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 5th Street, NW
Washington, DC 20549-0609
RE: Proposed Amendments to Investment Company Advertising Rules: File No. S7-17-02
Dear Mr. Katz:
The Vanguard Group1 appreciates the opportunity to comment on recent proposals by the Securities and Exchange Commission to amend the rules governing investment company advertising. The Proposing Release2 identifies many of the problems inherent in most mutual fund performance advertising, and outlines various proposals to address those problems. We strongly support the Commission's objectives and the proposals, with certain exceptions and modifications recommended below.
We applaud the Commission's objective to eradicate performance advertising that misleads investors, invites unrealistic investment expectations, and often results in ill-timed investment decisions. Vanguard believes the Commission's proposed disclosure requirements will greatly curtail misleading performance ads, especially in newspapers and magazines, where performance advertising abuses are most egregious. Vanguard recommends that the Commission also require performance ads to direct investors' attention beyond past performance to other factors that are essential to understanding performance data in its proper context, such as a fund's objectives, risks, sales charges, and annual expenses.
Our specific recommendations regarding balanced performance advertising are discussed in Part I of this letter. In Part II, we comment on other elements of the proposals.
I. Mutual Fund Advertising Rules Should Prohibit Performance "Hype"
A. Advertising that promotes past performance harms investors.
Vanguard shares the Commission's belief that advertising rules should encourage advertising that is fair and balanced, and not misleading. We strongly believe that much of the mutual fund performance advertising that appears in newspapers and magazines today falls well short of these goals. In the wake of the high-performing markets of the late 1990s that led to some unprecedented, and clearly anomalous, returns, millions of dollars were spent on advertisements in newspapers and magazines that explicitly touted past performance for selected mutual funds-the most egregious of which were ads for funds invested in the internet sector.
Our biggest concern with performance advertising is that it often fails to provide the proper context in which to evaluate the performance numbers presented. Currently, required disclosures that balance the return information are relegated to footnotes with minute type. These ads rarely include any additional information that may have influenced returns, such as the fund's investment objectives, sector returns in the market at large, special risks or investments, sales charges, or expense ratios. In our view, such communications do more than "advertise" performance, they "hype" performance. And the firms that hype fund performance do so purposefully because they know, as we do, that cash flow follows performance, and even greater cash flow follows performance advertising.3
Ads that tout performance, with their implicit promise of continued similar results, are at best disingenuous and at worst, misleading, considering the significant evidence that past performance is not indicative of future returns. We believe an investor should not be led to expect that future long-term returns will be higher than long-term historical returns for various asset classes and sub-classes.4 The resultant harm to investors is significant:
B. The proposed disclosure and presentation requirements for performance ads are well designed to provide investors with better information.
We commend the Commission's efforts to discourage mutual fund companies from emphasizing past performance. We believe the Commission's proposal for specific additional disclosure in the main body of the ad, with attendant font size, style, and placement requirements, will provide potential investors with a more balanced and informed perspective on a fund's performance. We wholeheartedly support this result.
The performance advertising rules also will apply to other types of sales literature, including a wide range of performance reporting materials that are provided to existing and prospective investors. We believe the Commission's proposed disclosure requirements (together with Vanguard's recommendations, described below) can be included effectively in most legitimate performance reporting materials without significant additional cost.6 Like other mutual fund complexes, Vanguard will have to modify the design of some of its materials to comply with the proposals;7 however, we do not believe the disclosure requirements are unduly burdensome or impose unreasonable additional costs.
C. Vanguard recommends additional language to put performance in its proper context.
The Commission's proposals are intended to "help investors understand the limitations of past performance data and enhance the ability of investors to obtain updated performance information."8 To achieve this goal, the Commission has proposed that funds include the following narrative disclosure in all advertisements that include performance figures:
Additionally, as part of the standard prospectus offer language, all ads -- whether or not they contain performance numbers -- would be required to state that information about charges and expenses is contained in the statutory prospectus.
We believe that the Commission's required disclosure, while helpful, does not fully address the Commission's concerns. For years, the Commission has urged shareholders to consider more than past performance when making investment decisions, and has specifically mentioned several additional factors that are important to any investment decision.10 Unfortunately, the Commission's proposed disclosure does not adequately direct investor attention to those other important factors. We strongly believe that performance information should be presented in its proper context. Investors should think about performance in the context of a fund's objectives and risks, sales charges, and annual expenses, because these factors, not past performance, will directly impact future returns.11
We believe this additional information is vitally important to creating a proper context to consider performance numbers and, as such, should not be relegated to a footnote. Accordingly, in lieu of requiring the phrase "including fees and expenses" in the prospectus offer language, we recommend the following language reside in the main portion of all ads that include performance figures, subject to the same font size and style requirements12 as the other narrative disclosures:
Before investing, you should carefully consider [the fund's] investment objectives, risks, sales charges, and annual expenses.
We also suggest that the Commission take this opportunity to formalize the NASD's recommendations that advertisements provide adequate disclosure of any "unusual circumstances" that have contributed to advertised performance.13 The "unusual circumstance" is the first concern identified by the Commission in the Release, yet we believe it is not directly addressed by the proposed disclosures. Nonetheless, it is an important piece of information that, when applicable, should be placed prominently in the body of an advertisement.
As noted in the Release, some advertisements currently supplement performance information with disclosure of unusual circumstances,14 but such disclosure is not required, and even when it is included, it generally is not prominent. We think this information is too important to be consigned to a footnote. We support the Commission's attempts to encourage advertisements to present fair and balanced information, and we believe requiring prominent disclosure regarding unusual circumstances would help investors understand performance numbers in their proper context.
II. Additional Comments on the Proposals
A. The Commission should adopt a practical application of the proposals to performance reporting documents.
As stated previously, we wholeheartedly support the Commission's efforts to effectively eliminate advertising that promotes past performance and encourages investors to chase returns. However, we request that the Commission clarify how the proposals would apply to certain types of materials.
Although Vanguard does not advertise fund performance in newspapers and magazines, we certainly understand and acknowledge the widespread interest by our shareholders and potential investors in fund performance results, and we provide investors with documents containing performance information.15 We believe that documents containing lists of performance numbers, possibly over several pages, should be permitted to include prominently, once (on the first page or inside front cover), the proposed required disclosures in the required font size and style. This would mean, for example, that the disclosures would not have to be repeated on each page of a 14-page list of fund returns. Without this proposed clarification, sales material containing performance information would include repetitive disclosures that would become boilerplate and would be ignored by investors. An immediate "call-out" at the beginning of the document would better capture the reader's attention and convey the appropriate message. We believe that presenting the disclosures once, prominently and at the beginning, should satisfy the proposed requirements.
B. The Commission should reaffirm the ability of mutual fund companies to use Rule 135a advertisements.
We do not oppose the proposal that would eliminate the ability of investment companies to advertise under Rule 134 as we generally agree that Rule 482 sufficiently may regulate most mutual fund advertisements. If funds can no longer rely on Rule 134, however, we urge the Commission to reaffirm the appropriate use of Rule 135a advertisements. We believe that some types of investment company advertisements, especially those that "brand" a fund complex, would be better regulated under Rule 135a, and therefore should be distinguished from Rule 482.
In our opinion, advertisements for a fund complex (e.g., "Vanguard" or "The Vanguard Group") are markedly different from those for specific funds (e.g., "The Vanguard Windsor II Fund") because complex-wide advertisements serve to brand and identify a fund complex generally. We believe that branding advertisements more closely reflect the original intention of Rule 135a to provide information about funds generally, describe the different types of funds and the services offered, and encourage more educational and informative advertisements.16
In our experience, Rule 135a has been interpreted to prohibit use of the fund complex name, and not just the name of a particular investment company. Vanguard believes that this interpretation is unnecessarily restrictive and unrealistically narrow, because it does not accurately reflect today's financial markets.17 We believe that advertisements mentioning the name of a fund complex, but not a particular fund, do not constitute "offers" to sell securities because, without the identification of a specific, available product, there is nothing for an investor to buy. For example, mention of "The Vanguard Group" in an ad should not be construed as an offer to sell securities of an investment company because one cannot purchase shares of "The Vanguard Group."
We believe there is an appropriate place for generic ads in the current advertising landscape, but that, as a practical matter, present interpretations have eliminated Rule 135a ads. We also believe that branding is an important component of mutual fund advertising that educates investors and promotes an understanding of mutual fund sponsors and their philosophies. Brokers and other financial service providers use generic advertisements regularly. We believe that mutual fund companies should not be treated differently and therefore request that the Commission confirm that funds may rely on Rule 135a and include the name of the fund sponsor in the advertisement.
C. The Commission should treat materials designed for institutional investors differently.
We recommend that the Commission not require the proposed additional narrative disclosures in sales literature, advertising, and other communications distributed solely to institutional investors.18 We note that such a distinction has been proposed by the NASD with respect to their amendments to rules governing member communications with the public.19 We believe this is an opportunity for the Commission to approve this important distinction under both Rule 482 and NASD Rule 2210, as proposed.
Investor protection concerns are greatest with retail advertising. Rule 482, however, extends well beyond performance advertisements in newspapers and magazines. The proposals also would affect all marketing, advertisements, and other materials distributed to institutional investors. Institutional investors are not swayed by performance advertising and are able to put such information in its proper context. They simply do not need heightened disclosure to interpret performance data.
In our experience, institutional investors expect a range of performance information to meet their investment needs. Most have the requisite degree of financial sophistication to understand that not only do returns change over time, but a fund's investment objectives, risks, sales charges, and annual expenses must be evaluated before making an investment decision. Institutional clients regularly invest significant sums and, in so doing, generally review a wide range of performance and other marketing materials. Adding significant amounts of additional disclosure relating to performance would not help these investors or improve these materials.
If the Commission adopts this approach, institutional sales materials would not include the proposed additional narrative disclosures, but would continue to present standardized performance information. These kinds of materials also would remain subject to the requirement that such materials be fair, balanced, and not misleading. They would be subject to internal compliance review processes and the NASD's spot check program. Finally, we believe the general antifraud standards, as well as the proposed application of enhanced prospectus liability to Rule 482 ads, would be sufficient to protect institutional investors. For this reason, we ask that the Commission distinguish the application of the proposals to institutional materials.
D. The proximity requirements should apply differently to Internet-based advertising.
Vanguard generally supports the application of the proposals to print, radio, and television advertisements. Vanguard believes, however, that there are important distinctions between paper-based advertising and Internet-based advertising.
We recommend the Commission affirm that, for Internet advertisements, performance information with a clearly marked "one-click" link to all of the required disclosure items, including recent month-end returns, prospectus offers, etc., would satisfy the proximity requirements of the Release.20
We believe that providing disclosure information that is "one-click" away from any discussion of performance is appropriate, given the inherent space limitations of web screen "pages" and the wealth of information, including fund prospectuses, that is readily available on the Internet. This is in sharp contrast to newspaper and magazine ads, which essentially stand alone.
We are concerned about current NASD interpretations that every web page constitutes a separate advertisement, requiring separate disclosure. As a practical matter, the NASD's approach requires lengthy disclosure to appear on every web page. However, in some instances, the NASD has agreed that the required disclosure statements may appear as pop-up boxes, or be connected through hyperlinks or rollovers if they are "one-click" away from the web page. We urge the Commission to formally adopt this approach by confirming that offering a hyperlink to required performance and disclosure information, on each applicable page of a web advertisement, would be appropriate for all Internet-based advertisements and would satisfy the proximity requirements of the Release.
The rapid expansion of technology is changing the landscape of the securities industry and is challenging traditional notions about investors' access to information. Increased availability of personal computers and Internet accessibility have provided to the mutual fund industry a cost-effective, timely, and reliable means to disseminate information to investors.21 According to one study, there are over 350 mutual fund websites available to the potential investor, a significant increase from prior years.22 Clearly, the investor who has access to the Internet has a tremendous wealth of information that is readily available and easily accessible.
Most mutual fund companies have embraced the Internet and maintain sophisticated websites that include interactive calculators, market updates, detailed fund information, and much more. Unlike paper-based advertisements, web-based advertising provides investors with quick, easy access to additional information, and we believe the Commission should recognize this accessibility by adopting a "one-click" approach.
E. The rule should require both telephone and website, if available, access to month-end returns.
We generally support the Commission's proposal to require fund groups to provide a toll-free telephone number, and, if available, a website, from which recent month-end returns are available.23 Although we support this part of the proposal, we have some reservations about the wisdom of requiring added emphasis on month-end performance figures. First, it may foster an inappropriate focus on short-term results. Second, the cost of updating materials is considerable. On balance, however, concern for investors who may otherwise be misled by performance advertising in a volatile market environment seems appropriate.
We do not believe that website postings alone would constitute sufficient access or availability, because investors' access to and use of computers varies significantly, depending upon their individual circumstances.24 We question, however, the utility of requiring a phone number in web advertisements containing the most recent month-end performance returns. As a practical matter, this may lead to redundancy and investor confusion. Because every page of a mutual fund company's website is considered to be a separate piece of sales literature, a fund that merely presents current month-end performance information on a web page would be required to provide, on that web page, a toll-free phone number ultimately directing investors to the exact same information contained on the web page. We believe this requirement would confuse investors, because it would imply that by calling the provided telephone number, an investor could receive more current performance information, when in fact it would be the same information. Directing investors from the website to the phone lines to receive the same information is redundant, expensive, and impractical.
We request that the Commission clarify that the required narrative disclosures would not have to be restated on the telephone calls or recordings that provide month-end returns. Restating the disclosure would serve no purpose since the investors would be sent to the phone lines after viewing an advertisement containing the required disclosures. Repeating such disclosures on the phone system would simply annoy our clients and add burdens without commensurate benefits to investors.
F. The 3-calendar day requirement is not workable for most fund companies.
Requiring firms to provide month-end performance numbers within three calendar days is impractical for a number of reasons. While we generally have Vanguard fund performance numbers within two business days, practical considerations make it unlikely that we would have performance numbers for non-Vanguard funds within less than ten business days.
Vanguard receives total return numbers from both internal sources and third-party sources. For the Vanguard funds, Vanguard's fund information department enters fund data into our systems, which are compiled and then forwarded to our various communication channels, such as the automated telephone account system and the website. It is possible for Vanguard to collect, compile, and elevate information for our own funds in two business days. However, Vanguard must rely on third-party sources for the performance and other data of third-party funds, such as those offered through Vanguard Brokerage Services' FundAccessTM program or 401(k) plans. These external sources provide streams of electronic data that Vanguard's systems must receive, analyze, and reformulate into a format usable by Vanguard's fund information department. Only at that point can Vanguard elevate the data to Vanguard telephone systems and websites. This process, from the receipt of the file to elevation, generally takes about ten to twelve business days.
Unfortunately, if we are required to offer information by the third calendar day, we face the risk that no performance advertisement, or even any document reporting basic fund performance information, could ever be used, since we would be unable to present month-end numbers in accordance with the proposed requirements. In addition, as a practical matter, the three-calendar day requirement raises other concerns. If the last day of a particular month occurs on a Friday, and the markets are closed the following Monday, for a national holiday, Vanguard's ability to generate information during those three days would be severely hampered both by the complexity of the process described above, and the fact that our fund information department and other third-party suppliers will have been closed for the entire three days. We recommend that the Commission adopt a "reasonable time" or "as soon as reasonably practicable" period that grants the industry the flexibility it needs to provide accurate information.
G. We recommend an extension of the proposed compliance dates.
Vanguard recommends that the Commission provide a 180-day compliance period due to the complexity of conforming existing systems and materials with the Release's requirements.
As discussed above, Vanguard receives certain fund information from third-party sources. Because such information presently does not identify total return separately, in the format contemplated by the Release, our fund information department will need to re-design our systems' ability to accept new information. In addition, we must work with our third-party vendors to redesign the format in which they make certain fund information available. We would need to redesign our telephone system to accommodate new requirements. It has been our experience that the average time to redesign, test, implement, and elevate both the telephone and Internet systems is 5-6 months.
* * *
We commend the Commission for taking these important steps to improve mutual fund advertising and we appreciate the opportunity to comment. If you would like to discuss these comments further, or if you have any questions, please feel free to contact me at 610-503-4016, or Lisa L. B. Matson, Associate Counsel, at 610-669-5284.
cc: Paul F. Roye
Christopher P. Kaiser
David S. Schwartz
Division of Investment Management
John J. Brennan
R. Gregory Barton
The Vanguard Group, Inc.
|1||The Vanguard Group, Inc. ("Vanguard") headquartered in Valley Forge, Pennsylvania, is the nation's second largest mutual fund firm. Vanguard serves 17 million shareholder accounts, and manages more than $550 billion in U.S. mutual fund assets. Vanguard offers 109 funds to U.S. investors and 10 additional funds in foreign markets.|
|2||Proposed Amendments to Investment Company Advertising Rules, Investment Company Act Release No. 25,575 (May 17, 2002) (hereinafter "Release").|
|3||See generally, Prem C. Jain & Joanna Shuang Wu, Truth in Mutual Fund Advertising: Evidence on Future Performance and Fund Flows, Journal of Finance, vol. 55 no. 2, 937-58 (2000).|
|4||For the twenty-five year period ended June 30, 2002, the average annual return for the average general equity fund was 12.6%. Derived from data provided by Lipper, Inc.|
|5||See generally, Jain & Shuang Wu, supra note 3.|
|6||Internet-based advertising is an exception. See Part II.D. infra,"The proximity requirements should apply differently to Internet-based advertising," for a discussion of specific recommendations for applying the proposals to Internet-based advertising.|
|7||Many of Vanguard's performance reporting materials will be affected by the proposed rules. See infra note 15.|
|8||See Release at 15.|
|9||These three items would appear in addition to: (1) the currently required statement that the performance data quoted represents past performance, and that the investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than the original cost; and (2) the prospectus offer language.|
|10||See generally, Securities and Exchange Commission, Mutual Fund Investing: Look at More Than a Fund's Past Performance (last modified Jan. 24, 2000) (available at http://www.sec.gov/investor/pubs/mfperform.htm). These additional factors include: (1) the fund's fees and expenses; (2) the fund's age and size; (3) volatility of the fund; (4) the effect of taxes on the fund; (5) the fund's investment risks; (6) recent changes in the fund's operations; (7) the types of services offered by the fund; and (8) how investment in the fund may affect an investor's portfolio diversification.|
|11||See Mark M. Carhart, On Persistence in Mutual Fund Performance, The Journal of Finance vol. 52 no. 1 (March, 1997), 57-81. Carhart also notes that "[a]lthough the top-decile mutual funds earn back their investment costs, most funds underperform by about the magnitude of their investment expenses." Id. at 80.|
|12||As long as the substance of the disclosure is included, firms should have flexibility with regard to the order and composition of the disclosure, but not with respect to the proximity and prominence requirements.|
|13||See NASD Notice to Members 00-21, NASD Regulation Reminds Members of Their Responsibilities When Advertising Recent Mutual Fund Performance (2000) (available at http://www.nasdr.com/pdf-text/0021ntm.txt). The Notice stated "Members may not omit any material fact or qualification if the omission would cause the communication to be misleading." According to the NASD, members should include "prominent, cautionary language" in advertisements containing extraordinary performance information. Such disclosure should state that performance is attributable to unusually favorable conditions (and state what those conditions are), that such performance is unlikely to be sustained, and warn that the conditions might not continue and the performance likely will not be repeated.|
|14||See Release at 7.|
|15||For example, Vanguard publishes "Facts on Funds," which contains, for all Vanguard funds, standardized performance, objectives, risk profiles, and expense ratios. Vanguard's periodic newsletter "In the Vanguard" contains a "Performance Profile" that lists, by asset class, all 109 Vanguard funds and identifies: (1) year-to-date returns, (2) standardized returns, (3) one-year income and capital gains distributions, if any, (4) one-year high and low share price, (5) risk measurements, and (6) next prospectus online availability dates. Vanguard also publishes the "Vanguard Total Return Chart." This chart presents, in list format (generally about 14 pages), standardized fund returns as well as month-end, year-to-date, and three-year returns, as applicable. These are only some of the many pieces that would be affected by the proposals.|
|16||See generally, Adoption of Rule Changes Relating to Investment Company Advertising, Securities Act of 1933 Release No. 5,248 (May 9, 1972), available at 1972 SEC LEXIS 70. Rule 135a ads are permitted to highlight the importance of a certain investment philosophy, or, for example, the benefits of investing for retirement. The Rule 135a adopting release states: "it is anticipated that an acceptable type of statement [in a Rule 135a ad] would be, for example: `If you would like to know more about three mutual funds advised and distributed by X & Co., write to: . .' " Id. at *12.|
|17||Today, many fund complexes have multiple registered investment companies with distinguishing investment objectives and risks. For example, The Vanguard Group of Investment Companies consists of 35 registered investment companies offering 109 separate funds.|
|18||As we stated in our Comment Letter to the NASD regarding proposed Rule 2210, we generally support the NASD's proposed definition of "institutional investor." However, we believe some clarification is necessary. The proposed definition of institutional investor in Rule 2210(a)(4) is based on the NASD Rule 3110(c)(4), which defines "institutional account" to include, among other things, a bank and "an investment adviser registered either with the Commission or any state." We recommend that the term "bank" include a trust company organized under state law. The investment management responsibilities of trust companies and banks are very similar. Also, in our experience, trust companies, like banks, possess a strong understanding of the securities markets and are not in need of the same level of investor protection as retail investors.|
|19||See NASD Notice to Members 99-79, NASD Regulation Requests Comment on Proposed Amendments to Provisions Governing Communications with the Public (1999) (available at: http://www.nasdr.com/pdf-text/9979ntm.txt).|
|20||Of course, we would agree with the Commission that performance dates should appear on the same screen as the performance numbers to which they relate.|
|21||The U.S. Department of Commerce reported that 174 million Americans, representing about 66 percent of the population, use computers and 143 million Americans use the Internet. A Nation Online: How Americans are Expanding Their Use of the Internet, U.S. Department of Commerce (February 2001).|
|22||See, Kasina Reports, E-Business Practices & Trends in the Mutual Fund Industry (available at http://www.kasina.com./top20sites/index.html).|
|23||We do, however, support an express exemption from the telephone number requirement for those funds that are sold exclusively through the Internet. In Internet-only offerings, investors agree to conduct all transactions and communications with the fund over the Internet; therefore, it would be appropriate to permit those funds to update performance information exclusively through a website.|
|24||According to a survey by the Investment Company Institute, about 82% of mutual fund shareholders have accessed the Internet. See, 2001 Profile of Mutual Fund Shareholders, Investment Company Institute (Fall 2001) at p. 4. However, Vanguard does not believe that most mutual fund shareholders rely exclusively on Internet access. Vanguard currently provides month-end return information on our website, and would continue to do so in addition to complying with the proposed telephone requirement. Approximately 30% of Vanguard's retail shareholders are registered users of our website, with approximately 35% of those registered users actively using Vanguard's electronic delivery services for receipt of prospectuses, reports, and other communications. We believe this number will continue to increase rapidly, but remain unconvinced that Internet access alone affords a sufficient degree of communication for all investors.|