SEC Yields on Performance Advertising
November 20, 2000
Earlier this month, NASD Regulation proposed a rule change which would give mutual fund companies more flexibility with regard to related performance' information in fund advertisements, according to Cindy Fornelli, senior advisor to the director of the division of investment management of the Securities and Exchange Commission. While the SEC supports the proposed changes, it would still like to see changes in the rules regarding manager performance, Fornelli said. NASD Regulation is a subsidiary of the National Association of Securities Dealers of Washington, D.C.
Related manager performance - performance information not strictly about the fund in question - became an issue in 1996 when the SEC released what has become known as the "Bramwell" no-action letter. Elizabeth Bramwell was the portfolio manager of the Gabelli Growth Fund, which had yielded impressive returns. When Bramwell left that fund, she started her own fund and asked the SEC if she could include her previous performance in the new fund's prospectus. The commission effectively granted the request in releasing what is known as a "no-action letter" to Bramwell.
Since then, the SEC has permitted the use of manager performance and other related performance information in fund prospectuses, with conditions. However, the NASDR, which regulates the advertising of investment firms, has been much stricter, disallowing all related performance in advertisements.
The rule change proposal grants much of what the SEC has supported, but not the use of manager performance. The three types of related performance information the NASDR amendment allows are: 1) "Clone" performance which is "the total return of all registered open-end management investment companies...that have the same investment policies, investment objectives, investment strategies, investment adviser and sub-investment adviser as [the fund];" 2) "Predecessor" performance, which would allow a fund to advertise returns of a non-registered, insurance or hedge fund that is similar to the advertised fund; and 3) "Comparison portfolio" performance which is the total return of a composite of other portfolios, including other investment companies, managed by the same investment adviser.
The reasons related manager performance was left out are discussed in NASD statements in support of the proposal.
NASD did not allow manager performance because disclosing it could "mislead" investors about the effect of other factors on a fund's performance- such as "research analysts who recommend securities to the portfolio manager and traders who obtain best execution," NASD said. The resources of the investment adviser also have an important impact on a fund's performance, NASD said.
"Moreover, a relatively long period may elapse between the departure of a portfolio manager from the previous mutual fund and the advertisement of the new mutual fund's performance, thus rendering the manager performance information stale," NASD said.
The SEC believes however that manager performance is appropriate and not necessarily misleading, said Fornelli.
"It can be helpful and is something that potential shareholders want," she said. Nevertheless, the SEC will accept the NASD proposal, Fornelli said.
"Both sides are pleased with the result," said Fornelli. "There's been this difference with what's allowed in fund prospectuses and advertising and I think the SEC staff, the staff of the NASD, and people in the industry are happy with the two positions being more aligned...except for the manager performance area."
The SEC may finally be backing down to NASD regulation on the Bramwell issue for several reasons. For one, funds are less inclined to use past performance of a manager's fund to promote a new fund, in part because they want to avoid being pressured by managers boasting of past performance. Fund companies can and do avoid using managers' past fund performances by stating in a fund prospectus that performance is based on many people and factors, not solely the portfolio manager, as well as by addressing it in employment agreements.