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Ads May Mislead Investors, Official Says


Some mutual fund companies appear to be unfairly manipulating the investment performance figures they use in their advertisements, according to a top SEC official.

It appears some funds are "gerrymandering" one-year investment performance figures in print advertisements to display the best possible investment results, said Lori Richards, director of the Office of Compliance, Inspections and Examinations at the SEC. The ads may be unfair and misleading to investors, Richards said.

Richards was to make her comments in a speech to mutual fund lawyers and compliance executives at the Investment Company Institute's Mutual Fund Compliance Conference in Washington last Thursday. The conference was closed to the press. A text of Richards' speech was obtained by Mutual Fund Market News. Richards was not available for comment to elaborate on her remarks.

Richards did not say how many fund companies or which fund companies had used the advertising practices she described. SEC examiners investigated the advertising practices during examinations of fund companies, Richards said. It was unclear if any of the instances Richards described had been referred to the SEC's enforcement division for possible action.

Federal securities laws prohibit funds from using ads which are false and misleading, including those which do not reveal important facts which an investor should know before buying a fund. Fund advertisements which use performance figures must include a fund's one-, five- and 10-year return, current to the last quarter.

In some instances, funds used one-year returns which ended on an odd date such as April 13 or May 3 rather than using performance derived from a 12-month period ending with the most recent quarter, Richards said. The SEC found that the one-year periods coincided with dates on which the funds' net asset values reached new highs, Richards said.

The returns during the odd one-year periods were significantly higher than the one-year performance ending in the most recent quarter, she said. Funds did not disclose in advertisements the reason for selecting the odd dates for the one-year performance, Richards said.

Funds using this odd-date performance often had volatile returns which were significantly lower than their advertised performance by the time the fund advertisements appeared in print, Richards said.

Fund performance ads were one of several compliance weaknesses which Richards described in her speech. Others included how funds allocate hot initial public offerings and how compliance officials monitor personal trading by key executives such as portfolio managers.

The manner in which some fund companies allocate initial public offerings in high demand among funds in their complex is a cause of concern for the SEC, Richards said. Fund companies usually establish a policy to insure that hot IPOs are distributed fairly. But exceptions to those policies must be examined closely, Richards said. Executives should review the allocations periodically to make sure that they are fair, she said. And, she urged executives to make sure that fund companies disclosed their allocation practices.

Several portfolio managers within a fund complex may seek to purchase the same IPO. In the case of IPOs which are hot, however, demand outstrips supply. In those cases, fund advisers must decide how to distribute the most sought after IPOs they receive among the funds they advise. The SEC successfully has sued investment advisers in instances where it has alleged allocation policies have been unfair to some investors.

Fund companies also continue to have compliance problems regarding personal trading by key executives, Richards said. One of the best controls on personal trading is to require that key officials who wish to trade do all of their personal transactions through a broker/dealer affiliated with the fund company, she said. The broker/dealer then can examine possible conflicts before a trade is executed, Richards said.