SEC tightening fund advertising rules

Mutual funds that advertise performance figures that skirt the recent market downturn could run afoul of anti-fraud laws – even if they technically follow federal regulations.

Paul Carey, a Securities and Exchange Commission member, delivered that message to a group of lawyers early this month at the Practising Law Institute’s “SEC Speaks” conference in Washington. The SEC, he said, is working on rules that would make its position clear.

The rules will be designed to “promote the use of current performance information, emphasize the use applicability of the anti-fraud rules and encourage responsible behavior by fund advertisers,” he said.

“Like it or not, many fund investors may make their investment decision based on information contained in fund ads,” Mr. Carey said.

“I believe this commission should continue its efforts to ensure that investors are not misled by overly aggressive but technically accurate fund advertisements.”

He also said the staff in the division of investment management has undertaken a review of fund marketing “in the hopes of identifying and curbing overly aggressive practices.”

A bulletin will soon be released reminding funds that their advertisements “should not mislead investors” and that ads must comply with general anti-fraud rules as well as specific advertising rules.

cases are mentioned

The commissioner referred to cases the SEC brought in the past two years against Van Kampen Investment Advisory Corp. and the Dreyfus Corp. The companies were accused of advertising big performance returns without disclosing that most of the gains were from initial public offerings of stocks making up so-called incubator funds.

He also said he had recently noticed another fund company advertising large returns through the end of 2000, without disclosing that returns had declined substantially this year.

He did not name the fund, but his comment emphasized that funds need to exercise more caution with the recent market downturn that followed years of unusually high returns.

On another issue, Robert Plaze, associate director of the SEC’s division of investment management, told the group that new rules to strengthen the oversight role of independent directors seem to be working.

Independent directors “are taking their role more seriously,” he said, “discussing things that perhaps weren’t discussed in the past, in particular conflicts, and otherwise more vigorously fulfilling their obligations.”

Rules adopted by the SEC this year require that independent directors make up a majority of fund governing boards, instead of 40% as required under the Investment Company Act of 1940.

In addition, independent directors must be nominated by other independent directors, and must be able to retain counsel that’s independent of the management company.

“More and more, the investors must rely on independent directors to protect their interests,” Mr. Plaze said. The role of directors is more important than it was in the past, when fewer people were investors, he added.

Further, fund companies increasingly are asking the SEC to grant exemptions from the Investment Advisers Act of 1940, he said, so that funds can make transactions with advisers that have affiliated business interests with the fund.

consolidation a factor

That issue has come to the forefront at the SEC more in recent years as fund groups have grown and many mergers have taken place within the industry. The law generally prohibits advisory businesses from conducting transactions that may create a conflict of interest between advisers and the funds they manage.

The SEC can grant exemptions in some circumstances. But, Mr. Plaze said, “the commission simply can’t do that unless we have confidence in the corporate governance system.”

Concerning mutual fund fees, many of the largest mutual funds appear to have enough assets to cut them, suggested Barry Miller, an associate director in the investment management division who worked on a study the SEC released last year on the topic.

The SEC staff looked at the management contracts of the 100 largest funds, he said. Fifty-three of the funds had “break points,” at which management fees fell once assets went beyond set levels.

Of those 53 funds, 39 had assets beyond the last break point, Mr. Miller said. “You can draw conclusions that since these were the largest funds, maybe there were some more savings and economies of scale. I don’t know if that’s right or not, but certainly I think if I were a director of those funds, that would be something I’d be looking at,” he said.