Up Front News
October 28, 2002
Regulators Take Hard Look At Cherry-Picking in Ads
NEW YORK - Advertising regulations can be murky waters to navigate for asset managers.
The reason, said Jennifer Klass, an associate in the broker/dealer division of the Washington law offices Morgan Lewis, is that the SEC hasn't issued much guidance on advertising for asset managers, except for Section 206 of the Investment Advisers Act of 1940. This law gives the Securities and Exchange Commission rulemaking authority to prevent such fraud in advertising. Additional advertising regulation comes in the form of no-action letters issued by the SEC during the past three decades, she said.
As a result, the SEC said in 2000 that fraudulent advertising is the most common type of enforcement brought against investment advisors.
But Klass, speaking to a room of executives at a National Regulatory Services seminar on advertising performance regulations in New York last week, said that firms can clear up most confusion by knowing what sorts of advertising strategies send up red flags with regulators.
SEC examiners often look for quick changes in performance composites, which can be an indicator that advisors are "cherry picking," or choosing numbers to show optimum performance, Klass said. Regulators also look for delays in producing back-up performance records to substantiate advertising claims. "They'll assume you're in the back room preparing them," if firms don't have the records readily available, she said.
In addition, Klass said dropping the performance of terminated clients, which can often improve a firm's overall performance numbers, is also at the top of the SEC's list.
Regulators are also wary of using portable performance, or the practice of transferring an asset manager's performance record when he changes firms. And she said regulators regard the use of back-testing, or applying a quantitative model to historical financial data as "highly suspect" because it does not involve market risk and because if a manager finds the data unsatisfactory, he can "tweak and rerun" the scenario to produce better results.
False Advertising Claims
Klass also recommended a simple set of common-sense best practices. She said that firms should have written advertising policies. Advertisers should ensure that they can deliver on the promises they are making in their advertisements, and they should consider the sophistication of the audience to which they are advertising.
Executives who produce and approve advertising should all have separate and distinct functions during the process, such as number-crunching, design, and review and approval of the materials.
"It helps ensure that there is less room for abuse and manipulation," Klass said.
In addition, she said all advertising should be stamped with a date and kept on record with performance data that substantiates the claims of the advertising.
"Institutionalize the way the ad is created," she said.