New legislation aimed at providing greater balance in advertisements containing fund performance may open the door for firms to create even more misleading ads, industry critics claim.

The crux of the new rule is that fund companies have to provide a source for more current performance data within their advertisements that tout that performance. The ads also are now required to emphasize the notion that past performance doesn't guarantee anything. However, regulators also eased restrictions in other areas, a fact that makes some wary.

"I have a sense that the fund industry will use this to make a whole new class of misleading ads," said Roy Weitz, industry critic and publisher of FundAlarm.com. Weitz was referring to a section of the new regulation where the Securities and Exchange Commission eliminated a requirement that advertisements contain only information "the substance of which is included in the statutory prospectus."

The amendment allows funds to include more timely information, including current economic conditions, that wouldn't normally be included in the fund's prospectus, the SEC said. It would also make this information subject to prospectus liability.

Economic Data

The use of economic data is what Weitz takes issue with, saying that fund companies could refer to general improvements in the economy, gauged in percentage growth, and measure those gains up against the performance of a particular fund, potentially implying that fund beat the market over a given period. "There's a lot of ways you can spin that stuff. The SEC seems to be inviting it, [although] I'm sure they didn't intend to," Weitz said. The SEC did not return calls seeking comment by press time.

Weitz also said the other parts of the rule are weak and will provide little if any benefit to the investor.

The SEC approved the rule requiring mutual fund companies to provide more balanced information in their advertisements when promoting fund performance late last month. The new rule will require that firms advertise a phone number or Web site where investors can go to get more timely information on performance. Most advertisements currently contain performance for the previous 10-, five- and one-year periods, as well as year-to-date numbers. However, those figures are often lagging by a few months, dating back to the end of the most recently completed quarter. The new requirements call for all the numbers available on the site or phone to be as current as the end of the most recent month.

The amendments will require ads containing performance to also include a disclosure reemphasizing that past performance is not an indication of future performance, a message that is supposed to have been beaten into investors' minds over the last few years.

Also, advertisements will now have to direct investor's attention to the fund's objectives, risks, charges and expenses, in an attempt to avoid letting performance data overshadow other important pieces of information. More prominent disclosure of the dates over which advertised performance is quoted, as well as other important information, is now necessary. Fund companies will have to come in line with the new rule beginning March 31, 2004.

Performance advertisements had all but disappeared during the market downturn, when returns were awful and fund firms couldn't bear to push very negative numbers. However, regulators began to notice performance ads popping up again following the market recovery that began in March.

Firms like Smith Barney and Fidelity Investments ran ads highlighting extraordinary year-to-date performance (see MME 8/18/03). Regulators had become increasingly worried that these lofty numbers would create unrealistic expectations for investors.

Fidelity, which earlier this year advertised its Fidelity Leveraged Company Stock Fund and its 44.9% year-to-date return at the time, said that it would not comment on the rule until its legal staff has had a chance to review the final version of it. However, a spokesman for the firm emphasized that Fidelity does support reform that improves fund advertising and that it "generally supported" the proposed rule last year in a comment letter to regulators.

Investors Counting Peanuts

Charlie Brown never learned his lesson no matter how many times Lucy pulled the football out from under him when he went to kick a field goal; mutual fund investors chasing short-term performance aren't going to smarten up either, Weitz said.

However, Weitz said regulators have only passed "superficial actions" that won't help average investors when dealing with ad information. He said it will take another bubble bursting and more flagrant Wall Street abuses for investors to get the message. The problem is the current regulations address short-term performance, asking for numbers only a few months more current, when that data is not supposed to be that important for long-term thinking investors. "In the background, the SEC has basically thrown in the towel and said people are going to be swayed by short-term numbers so we may as well make those numbers more accurate," Weitz said.

Others said some positives could be drawn from the legislation. "I think it is important for regulators to keep a close eye on fund advertisements," said Gregg Wolper, an analyst with Morningstar of Chicago. "There is only so much regulations can do. The responsibility is on the fund companies themselves, to make sure their ads are keeping in line with their pronouncements of responsible long-term investing."

Andrew Clark, a senior research analyst with Lipper of New York, said the move is a half step, not a full step. He said it missed the mark in terms of excluding expense and fee disclosure and also in the disclosure that often funds with higher returns come hand-in-hand with higher risks.

Copyright 2003 Thomson Media Inc. All Rights Reserved.

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