Reprint permission from the July 1, 2002 issue of Crain's Chicago Business.
The Securities and Exchange Commission (SEC) has now proposed that if a mutual fund advertises its performance results four days or more into a month, the ad must report the fund's returns through the last month and not just through the last quarter. The agency's goal is to keep investors' expectations realistic when they evaluate and buy mutual funds.
There is legitimate cause for the SEC's concern. When the stock market was chugging along, some mutual fund sponsors were caught gaming the system. In 1999, for example, two funds, one of them advertising a 61% one-year return and a No. 1 Lipper ranking, failed to flag the effect of "hot" initial public offerings on their performance results; results that simply could not be sustained long-term.
Some critics will argue that the SEC's proposal comes too late. After two years of steep stock market losses, most mutual funds have no reason to showcase their performance, so the proposal would have little immediate effect.
According to Competitrack Inc., a New York advertising research firm, mutual fund companies spent 70% less on TV and print ads in the first quarter of this year vs. the same period a year ago. And the few ads they ran offered reassurance and preached prudence, but tended to skirt any mention of performance. The current rules don't apply to ads devoid of numbers, and neither would the proposed rules.
But the SEC knows that markets go down and markets go up, and when the stock market regains its footing, the right to advertise mutual fund performance could easily be abused again.
Yet, the SEC's own rules seem to require mutual funds that advertise their past performance to present their short-term returns, however misleading they may be.
It's true that mutual fund ads are subject to the antifraud provisions of federal securities laws. But courts have been reluctant to side with regulators like the SEC, which haven't offered real guidance about just what constitutes fraud.
So, mutual fund families, faithful to the letter of the law, can brag about the results of their most successful one-year performers and reveal nothing at all about their laggards' investment returns.
The SEC's proposal would perpetuate the problem. And, more than ever, it would invite investors to make short-term decisions based on short-term results, a strategy no responsible financial adviser would endorse.
Worse still, the proposed rules would send a subtle, but unmistakable, signal that ads disclose everything a prospective investor needs to know about a mutual fund. The rules' very precision would set a standard and give the ads whose content they prescribe a stature they surely don't deserve.
Instead of calling for mutual fund ads to include more current performance figures, the SEC should deny mutual funds the right to hype their short-term results. Investors would no longer be seduced into chasing short-term performance. And, before long, they would start to rely on prospectuses and make the right investment decisions for the right reasons.
Marc J. Lane is a Chicago lawyer and financial planner and an adjunct professor of law at Northwestern University School of Law. He can be reached at [email protected]
Copyright © 2002 by Crain Communications Inc.