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SEC Keeps Eye on IPO Allocation Disclosure

BOSTON -The Securities and Exchange Commission is most likely to investigate fund companies about their allocation of 'hot IPOs' when a firm fails to provide adequate information about their allocations, according to Victoria Hulick, director of

compliance with Nicholas-Applegate Capital Management of San Diego. Hulick spoke at the annual Mutual Fund Compliance Conference of the National Investment Company Service Association of Wellesley, Mass. late last month.

"IPO allocation has become a major topic of SEC investigations," said Hulick. "The frequency of misallocation has increased and the SEC cases are being widely talked about."

If there is an infraction regarding IPO allocation, it is more than likely one that deals with disclosure issues, said Hulick.

"Companies have an affirmative obligation to disclose all material facts to clients," said Hulick. "You must disclose any facts that could cause advice to be deemed 'not disinterested,' in other words, when there are conflicts of interest. And the disclosure must be timely, accurate and complete. It doesn't do you any good to have a policy that you had five years ago but doesn't apply today. That will just get you into trouble."

The importance of disclosure holds not only for current clients, but for potential ones as well, in the form of advertising and filings.

"The phenomenon of 'hot IPOs' has not been lost on mutual funds," said Richard Walker, director of the division of enforcement of the SEC, at the conference. "Many have enjoyed highly-profitable runs due to IPO investments. In boasting of their returns, some of these mutual funds have neglected to disclose that their eye-catching performance was, in fact, highly dependent on IPOs and, more importantly, that as the fund grew, the impact of such hot IPOs on the fund's overall performance would diminish."

This was what caused the SEC to bring suit against Van Kampen Advisory of Houston last year, according to Walker. The Van Kampen Growth Fund operated as an incubator fund for its first 13 months. The fund invested in 31 hot IPOs, which accounted for more than half of the fund's 61.9 percent return, said Walker. When the fund was opened to the public in its second year, Van Kampen promoted the fund using the first year's performance data without disclosing the impact of the IPO investments, according to Walker.

Hulick cited this case as well as others including one from this May against Dreyfus of Uniondale, N.Y., in which an adviser to a mutual fund and its portfolio manager failed to disclose in the fund's prospectus and advertising the impact the allocation practices of hot IPOs had on the fund's performance.

The 1996 case against McKenzie Walker Investment Management of Larkspur, Calif. is another example of how a failure to disclose information is the biggest target for the SEC.

"The adviser used profitable trades and hot IPOs to boost its client accounts' performance which resulted in a disparate allocation of profitable equity trades and hot IPOs to accounts that paid the adviser a performance fee," said Hulick. "This might have been okay if the clients were given the opportunity to say, 'We're okay with that.'

In all three instances, the cases were settled, with the firms neither admitting or denying the allegations.

"All of these cases point in the same direction," said Hulick. "They all hinged on the disclosure aspects of the allocation as opposed to doing something wrong with the allocation itself. If you're going to take anything away from this, you should know that almost anything might be allowable if it's fair and equitable in your situation, adequately justified, and, most importantly, disclosed."