WASHINGTON - Fund directors should watch and halt "overly aggressive" performance advertisements that fund advisory firms sometimes use to promote funds, according to Arthur Levitt, chairman of the SEC. Ads that suggest funds can produce unrealistic results, can contribute to unreasonable expectations among fund investors, a fact that ultimately spells trouble for investors, Levitt said.
"Fund directors today must... pay more attention to the types of advertisements and commercials that are being used to market their funds," Levitt said. "In far too many instances, these advertisements are offering quick returns or instant wealth but in reality, have performances that are not sustainable."
Levitt made his comments at a meeting of the Mutual Fund Directors Education Council here Feb. 17 and 18. Roughly 35 independent directors were among a group of about 150 lawyers, consultants, regulators, fund executives and others. Directors, fund executives and others formed the council last year to provide education for fund directors.
The SEC plans to do more than jawbone directors on the advertising issue. SEC examiners will conduct a special inspection program of mutual fund companies to check the accuracy of performance claims that funds make in their ads, on their websites and in marketing material, Levitt said.
"We want to be sure that funds today are telling the whole story in their marketing efforts to attract new customers," Levitt said.
At the same time it is conducting the exams, SEC mutual fund attorneys will analyze fund annual and semi-annual reports, said Paul Roye, director of the SEC's division of investment management, in an interview. SEC lawyers will match the securities a fund owns and the investment strategies it uses against the strategies a fund purports to follow in its prospectus and advertising, Roye said.
The SEC initially expects to target funds that have extraordinary performance that the funds market aggressively, Roye said. It is unclear how long the special advertising exam program will last and how many funds the SEC will review, Roye said.
Directors and some lawyers were cool to Levitt's suggestion about directors curbing ads that accurately promote performance. It is reasonable for funds to try to explain their performance, as long as the explanation conforms with SEC and NASD Regulation rules, some fund directors and lawyers said.
"Think about buying an automobile," said Ronald Gilson, an independent director for the American Century Funds of Kansas City, Mo. "You're selling performance."
The SEC, however, plans to press the advertising issue, possibly with changes in advertising rules. The SEC will work with NASDR to promote what Levitt described as more balance and responsibility in fund ads. The SEC will look for ways it can revise advertising rules so that investors have more context to help them better determine what accounts for outstanding performance, Roye said.
Roye said he was concerned that investors might not be fully aware of their risks when a fund obtains top performance that is virtually impossible to repeat. For example, a fund that earns top performance by investing virtually all of its assets in one or two stocks that have record growth might require additional advertising disclosure for investors, Roye said.
The SEC's attention to fund advertising performance in recent months has created uncertainty among some in the fund industry, said Barry Barbash, a lawyer in the Washington office of Shearman & Sterling of New York. Some fund executives and lawyers are uncertain about just when they must disclose additional information after a fund has had outstanding performance, he said.