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Ad Charts Receive Regulatory Review

PALM DESERT, Calif. - Regulators are increasing their scrutiny of mutual fund advertising in light of fund companies' heavy promotion of their 1999 mutual funds' performances.

In particular, NASD Regulation has increased its scrutiny of how mutual funds depict performance using charts due to an increase in recent months of questionable chart advertisements, said Thomas Selman, vice president of NASDR. That is one of several steps NASDR and the SEC are taking to respond to the proliferation of mutual fund advertisements that promote the unprecedented investment performance that some funds enjoyed in 1999, regulators said. More than 150 funds had returns in excess of 100 percent last year.

Some of the performance ads have been in the form of so-called mountain charts, charts that display the growth of an investment over time plotted on a graph. While those ads have long generated special attention at NASDR, in recent months the association has noticed an increase in ads that raise questions about whether the graphic presentations in the charts are misleading, Selman said.

"We have seen some gaming with the charts," Selman said. "We intend to focus on that quite a bit." He declined to identify particular firms that had attracted NASDR attention.

Selman spoke at the 2000 Mutual Funds and Investment Management Conference here last week.

Mutual fund advertising has been an issue since February, when Arthur Levitt, chairman of the SEC, called on mutual fund directors to help temper the tone of mutual fund advertisements. Levitt also announced the SEC would conduct special exams with respect to fund ads. The pressure on fund industry advertising is continuing, said regulators at the conference.

NASDR plans to issue a notice to its members warning them that fund advertisements must be fair and balanced, Selman said. The notice also will advise executives to include added explanations about fund performance when the performance was due to an unusual event such as a hot initial public offering or a concentrated holding in one or two securities, he said. It is unclear when NASDR will issue the notice, he said.

NASDR's efforts come at the same time that the SEC is in the midst of revising a key advertising rule. The SEC has proposed a change in its advertising rules such that funds will not have to limit the information they include in their advertising to information included in fund prospectuses. Currently, any information in ads must be included in prospectuses.

Also as part of the changes, the SEC intends to warn fund companies that failure to include "material facts" in an advertisement violates federal securities laws, said Cindy Fornelli, senior advisor to Paul Roye, director of the SEC's division of investment management.

For example, the SEC may revise and strengthen the language required in fund ads that says that past performance does not guarantee future results, Fornelli said. The SEC also expects to make it clear that even ads that satisfy certain minimum disclosure requirements may still violate SEC anti-fraud rules by omitting key facts, she said.

The SEC also is conducting special exams of mutual fund companies based on their advertising. One firm subject to a recent exam was the Strong Funds. An SEC examiner conducted what has become known as a "Van Kampen exam," said Stephen Shenkenberg, deputy general counsel at Strong Capital Management of Menomonee Falls, Wis. (The SEC sued Van Kampen Investment Management of Oakbrook, Ill. in September for failing to disclose the role that hot IPOs played in allegedly misleading fund performance marketing material.)

Shenkenberg, who appeared on the same panel with Selman and Fornelli at the conference, said he asked the examiner why he had come. The examiner then displayed a recent advertisement in which Strong promoted its funds' performance. The examiner then sought information about the role that IPOs played in Strong fund performance.

"It clearly was targeted," Shenkenberg said of the exam.

Strong executives provided the examiner with information which showed that IPOs were not a significant part of performance, Shenkenberg said.