"Advertising Fund Performance: Public Policy Considerations" Remarks By Isaac C. Hunt, Jr., Commissioner, U.S. Securities and Exchange Commission 1997 Investment Adviser Conference Investment Company Institute Washington, DC June 6, 1997 Good afternoon. It's my pleasure to be with you today. For the most part, all appears to be going well in the investment management industry. Assets under management continue to set new records, and we seem to be adjusting smoothly to our new regulatory responsibility under the National Securities Markets Improvement Act of 1996. I also understand that the ICI's Annual Meeting, held a couple of weeks ago, was a tremendous success -- with over 1,800 participants and more than 100 journalists. Matt Fink, in his keynote address, commented that ever since the enactment of the Investment Company Act, mutual fund organizations have earned a high degree of public trust and acceptance. He said you should keep up the good work. Educate shareholders about the risks, as well as the rewards, of mutual funds. Comply with the spirit, as well as the letter, of the law. And, above all, keep putting fund shareholders first. The ICI and the SEC don't always see eye to eye; but I think Matt's comments at your Annual Meeting hit the mark. Professional integrity has been the cornerstone of the fund business. We -- at the SEC -- are vigilant in doing what we can to help maintain these high standards. After all, in the final analysis, this business is not about money management. It's about American families saving money to buy homes and to send their kids to college. It's about preparing for a comfortable retirement. It's about businesses having sufficient capital to prosper and provide well-paying jobs. Today, I thought I'd focus my remarks on one aspect of the fund industry that has received a lot of press recently and goes to the core of professional integrity -- how mutual funds advertise their past performance. The staff of the SEC has considered this subject in a series of recent no-action letters, and I expect that the Commission will consider its policy in this area in the near future. The Improvement Act added Section 24(g) to the Investment Company Act. That Section authorizes the Commission to adopt rules to permit a fund to include information in its advertisements "the substance of which is not in the prospectus." For those of you who only speak English, this means that funds will no longer have to cram the prospectus with a bunch of formulas that no one reads in order to use performance information in their ads. It also means that this is a good opportunity for the Commission to evaluate its policies in the advertising area. For the moment, let's not concern ourselves with the technical provisions of the securities laws -- but focus our attention on appropriate public policy. Doesn't that sound nice? At least during this lunch, we're not concerned with the various antifraud provisions under the Advisers Act, or whether a document is properly classified as a prospectus, supplemental sales literature, or a Rule 482 advertisement. After lunch, however, these provisions will be in full force, and the lawyers can go back to work. Let me stress that these are still early days as far as developing concrete policy. And -- as always -- the views I express today are my own and may not reflect the views of my colleagues at the Commission. Nevertheless, it's always a good idea to consider the coherence and direction of public policy. In this process, I want to solicit your views on this subject. So please put on your thinking caps, and imagine for the next couple of minutes that you are a public policy czar. In this mode, let's quickly review recent SEC staff positions with respect to advertising past performance. Recent SEC Staff Positions September 1995 will be our starting point with the MassMutual no-action letter. MassMutual addressed the case in which an unregistered investment account converted into a registered mutual fund with substantially similar investment objectives. The staff gave no-action assurances to the registered fund that sought to include, as part of its own performance information, the performance information of the unregistered account. Essentially this was the case of a mutual fund using its predecessor fund's performance information. Later, the SEC staff issued two well publicized no-action letters in August 1996: Bramwell Growth Fund, and Nicholas- Applegate Mutual Funds, which I'll refer to as Nicholas-Applegate I. In Nicholas Applegate I, an advisory firm asked to use performance information in a fund's prospectus from private accounts that were managed by the same advisory firm. It is important to note that the information would be in addition to the fund's own performance information. (Previously, the staff had permitted this information, but only for a fund's first year of operations.) The performance information included from the private accounts would be the composite of the accounts that were managed in a manner similar to the fund. The advisory firm represented that the information would be accompanied by disclosure that the private accounts' performance is not the fund's past performance -- nor should it be interpreted as indicative of the fund's future performance. The firm also argued that the inclusion of this information would provide investors with more complete and accurate information on which to base their investment decisions because they will have more information about the firm's long- term investment results. In giving no-action assurances, the SEC staff did not opine on any particular presentation of the private account information. The standard criteria would govern in that the presentation could not be misleading. The day after the Nicholas-Applegate I letter was issued, the staff issued the Bramwell letter. In this case, Elizabeth Bramwell had been the portfolio manager at the Gabelli Growth Fund where she racked up impressive returns. In February 1994, she left Gabelli to start her own fund, not surprisingly named the Bramwell Growth Fund. Ms. Bramwell asked the staff if she could include in her fund's prospectus the performance information of the Gabelli fund. She represented that the Gabelli performance information would appear separate from her new fund's performance information, and that the Gabelli data would only be for the time period that she managed the fund. She also represented that no other portfolio manager "played a significant part" in achieving the Gabelli fund's performance. When the staff issued its no- action letter for this arrangement, it was -- once again -- careful not to endorse any particular presentation. The Bramwell letter received quite a bit of attention in the press because it meant that, under certain circumstances, a portfolio manager's performance results were "portable." Star portfolio managers could now say to another fund complex "if you hire me you can advertise in your prospectus my great performance with the other fund group." The Nicholas-Applegate I and Bramwell letters were followed up with three letters that the staff issued in February of this year: another letter was issued to Nicholas-Applegate, which I'll refer to as Nicholas-Applegate II, and letters were issued to GE Funds, and ITT Hartford Mutual Funds. Unlike the previous staff letters that addressed performance information that could be included in a fund's prospectus, this trio of letters concerned performance data that, in the staff's view, could be included in a fund's supplemental sales literature and advertisements. In Nicholas-Applegate II, the investment advisory firm requested no-action assurance to include in a fund's ads and sale literature composite performance information of certain private accounts and other mutual funds that the firm managed. In GE Funds, an investment adviser requested relief to include in a fund's ads and sales literature performance information of private accounts and other funds managed by the advisory firm or a sister advisory firm. Lastly, in ITT Hartford, a mutual fund sought assurances that it could include performance information of other funds, managed by its advisory firm, that served as funding vehicles for the firm's variable insurance products. The SEC staff, in providing no-action assurances in each of these matters, noted that the other funds and private accounts had substantially similar investment objectives. The staff also placed a significant degree of reliance on specific representations that the fund groups made. In particular, each fund stated that in the ads or supplemental sales literature it would: 1. prominently disclose that the other account performance is not the fund's own performance, and should not be considered indicative of the past or future performance of the fund; 2. prominently disclose that the other account performance should not be considered a substitute for the fund's performance; 3. present other account performance information in addition to, and no more prominently than, the fund's own performance information (provided the fund has a performance history); and 4. explain all material differences between the other accounts and the fund to ensure that the other account's information is not presented in a misleading manner. At the present time, the ramifications of this last trio of no-action letters will be fairly limited because the NASD does not allow this type of advertising and most fund groups are NASD members. Nevertheless, let's consider the broader policy implications. Public Policy Considerations I always like to start at the beginning, and I guess the first question is should a fund be allowed to advertise its own past performance in any context ? Presently, the SEC requires every document with performance information to include a legend, which states in effect that: Performance data represents past performance, and may not reflect future investment returns. Investment returns and the principal value of the fund will fluctuate, and fund shares may be worth more or less at redemption than at purchase. This type of legend appears to be an undeniable truth. But if this is the case, should a fund only be permitted to tell investors the stocks and bonds that it presently holds, and how its portfolio manager will make buy and sell decisions in the future? * * * Now let's assume that a fund's past performance is relevant to making an investment decision with respect to the fund. Is the past performance of other funds or private accounts relevant? If so, which ones? There are a couple of paths to take in this regard. One approach is to focus on the investment advisory firm -- as opposed to the individual portfolio managers. This approach makes sense at one level. If I'm considering a fund group's growth and income fund, I may find it useful to know the performance results of other similar investment vehicles managed by the firm. Maybe the firm has private accounts that are managed in a similar manner? Maybe a successful hedge fund? Perhaps the advisory firm has managed a growth fund for 10 years, and it's just starting up its growth and income fund. Maybe, I should know something about the similar fund that has been around for 10 years? After all, many advisory firms have strong corporate cultures and huge research departments, and there is often a firm method of stock picking that is not tied to any one individual. For example, a couple of Fidelity's portfolio managers left for other fund groups in the past couple of years. However, a Fidelity spokeswoman pointed out that, "portfolio managers make the investment decisions, but they're backed by a deep research team that stays." Moreover, a Wall Street Journal article reported a couple of weeks ago that more fund groups are moving to a team management approach; thereby downplaying the significance of any particular individual's contributions. Do you think focusing on the skills of the advisory firm is an appropriate approach? Does this raise any concerns? * * * Let's think about this for a minute. Isn't any organization made up of individuals? When the staff at the SEC recommends an enforcement action to the Commission and suggests that we sue only a firm -- there is a question that always arises: Where are the individual persons who supposedly did the bad deeds? Looking at the portfolio management business, typically more than 500 fund mangers switch fund groups every year. Clearly, these persons are important to a fund's success. This would suggest an approach other than allowing a fund to promote the performance of another fund or private account. This approach would be to focus on the individual portfolio managers -- rather than the investment advisory firm. This approach has some appeal. A financial planner recently was quoted in the Wall Street Journal as saying that in his experience a true team at a fund complex is very rare. He said, even if there is a team in place, somebody's calling the shots. You can't effectively buy stocks by committee. And how many times have we seen profiles of portfolio managers and the stocks they plan to buy or sell. In 1995, Money magazine had a typical article entitled, "10 Star Investors Name Their Top Pick Today." The article started off -- Imagine you're at a dinner party with 10 of the country's best investment minds. What would you ask them? `How's the weather?' We don't think so. "Seen any good movies lately?" Maybe not. . . . "You'd want to buttonhole each one and ask which investment they like most -- right now." Given the importance of portfolio managers, do you think a policy that focuses on these persons is the right approach? Does this raise any concerns? * * * For those of you who would favor a policy of allowing portfolio managers to advertise their track records with funds they managed while at other firms, do you think the old funds should be allowed to continue to advertise the former manager's results? Should the old fund have to start its performance history from scratch? Does it make sense to have two funds in different complexes advertising the same performance results? * * * As I said at the beginning of this discussion, these are early days as far as developing anything concrete, but it's always good to consider the coherence and direction of public policy. I thank you for your thoughts on this most complex subject. Please wish us well at the SEC in making the right choices as we journey down this road. Thank you. # # # # #