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IC Chapter 4.doc

  1. 1. 1 From Readings on the Investment Company Act and the Investment Advisers Act Larry D. Barnett School of Law Widener University Wilmington, Delaware Copyright © 2008 by Larry D. Barnett All rights reserved Additional materials © 2008 by C. Steven Bradford
  2. 2. 2 Chapter 4. Marketing Tactics and Practices The Registration Requirement of The Securities Act Of 1933 Unless an exemption is available, the Securities Act requires an investment company offering its securities to the public to file with the SEC a disclosure document known as a registration statement. Open-end investment companies usually file on Form N-1A and closed-end investment companies usually file on Form N-2. These two forms are integrated forms that can be used to fulfill the registration requirements of both the Investment Company Act and the Securities Act. These forms are fairly long and detailed, so I have not reproduced them. An investment company's registration statement consists of three parts: (1) the prospectus; (2) a Statement of Additional Information (SAI); and (3) other information, including exhibits. The prospectus is the primary disclosure document provided to purchasers of investment company securities. A prospectus must be made available to every investor at some point in the process of purchasing investment company shares. The Statement of Additional Information, which contains more expansive and detailed disclosure, is not routinely provided to investors, but must be furnished free of charge upon request. The third part of the registration statement is only required to be filed with the SEC. Open-end investment companies usually offer their shares to the public on a continuous basis. They are allowed to file a single registration statement to offer an unlimited amount of securities for an indefinite time in the future.1 However, they are obligated to update the prospectus provided to investors and sometimes to file amendments to the registration statement to keep the information provided current. 1Investment Company Act Rule 24f-2.
  3. 3. 3 The SEC’s Summary Prospectus Proposal The SEC recently adopted amendments to the registration requirements that would allow open-end investment companies to provide to investors a more limited “summary prospectus” that contains only certain key information from the full prospectus. A fund’s prospectus delivery requirements would be met by providing this summary prospectus and a link to a web site containing the full prospectus, unless a particular investor requested a copy of the full prospectus. See Enhanced Disclosure and New Prospectus Delivery Options for Registered Open-End Management Investment Companies, Securities Act Release No. 8998 (Jan. 13, 2009). This proposal was scheduled to become effective on March 31, 2009, but it is currently trapped in the Obama administration freeze on the effectiveness of rules adopted in the last days of the Bush administration. President Obama has ordered agencies not to publish in the Federal Register any rules not yet published when he became President, and rules such as this cannot become effective until they are published. At this point, it is unclear what the SEC with a new Democratic majority led by newly appointed chair Mary Schapiro will do about this proposal.
  4. 4. 4 Investment Company Advertising And Sales Literature Introduction Investment company advertising and sales practices are regulated by both the SEC and the National Association of Securities Dealers ("NASD"), a self-regulatory association of securities professionals. NASD enforces policies set by the SEC, but it also has adopted policies of its own which are in some cases more restrictive than the SEC policies. False Or Misleading Sales Material Investment company sales materials are subject to the usual securities law prohibitions on false or misleading statements or omissions. Rule 10b-5 under the Exchange Act, ' 12(a)(2) of the Securities Act, and ' 34(b) of the Investment Company Act all prohibit, in contexts relevant to solicitations by investment companies, untrue statements of material fact or omissions of material facts necessary to make the statements made not misleading. Securities Act Rule 156 is relevant to the question of whether investment company advertisements and sales literature are misleading. Rule 156 neither permits nor prohibits any specific disclosure. It merely provides general guidance as to ways investment company sales literature might be misleading. Rule 156 replaced the SEC's long-standing "Statement of Policy on Investment Company Sales Literature," which was much more detailed and specific. In withdrawing the "Statement of Policy," the SEC indicated that it continued to be a historical expression of the SEC's views, and it is still looked to as a source of guidance. Communications Prior To Filing The Securities Act Registration Statement Section 5(c) of the Securities Act broadly prohibits all solicitations of investment company investors before the Securities Act registration statement is filed (unless the offering is exempt from the registration requirement). This includes written, oral, electronic, and broadcast communications. Thus, an investment company may not attempt to sell its shares to the public until it files a registration statement with the SEC.
  5. 5. 5 Communications After Filing the Registration Statement But Prior to Delivery of the Statutory Prospectus 1. Introduction Once the investment company files a Securities Act registration statement, oral sales communications are allowed. However, many written, broadcast, and electronic communications are prohibited until after a copy of the final, statutory prospectus that is part of the registration statement has been made available to investors. Investment companies have available three exceptions to this general prohibition on written, electronic, and broadcast communications--Rules 135A, 134, and 482. You should read each of these rules. Rule 135A, 134, and 482 communications may be transmitted to investors after the investment company has filed a registration statement and before investors have been given the final, statutory prospectus. The communications allowed by these rules may be sent by mail, broadcast, included in a newspaper or magazine advertisement, or transmitted by other means. For convenience, I shall refer to them as "advertisements." The usual sales procedure is to solicit potential purchasers through Rule 134, 135A, or 482 communications. If an investor indicates interest, a prospectus is then sent. Once the statutory prospectus is sent to an investor, supplemental sales material that goes beyond the limits of the three rules may be sent.2 2. Rule 135A Securities Act Rule 135A allows generic advertising that does not specifically refer to a particular investment company or its securities. A Rule 135A advertisement might, for example, extol the benefit of investing in mutual funds generally, with a phone number to call for additional information. A Rule 135A ad must include the sponsor's name and address.3 3. Rule 134 Securities Act Rule 134 allows the use of what is known as a "tombstone ad." The communication may include any of the information specified in section (a) of the rule, but it does not have to include all of the information allowed by subsection (a). A Rule 134 communication may not contain any additional material not specifically allowed by the rule. Except as provided in subsection (c), a Rule 134 communication must include the information specified in subsection (b). 2The supplemental sales literature may be sent simultaneously with the prospectus. 3See Rule 135A(a)(2).
  6. 6. 6 4. Rule 482 Securities Act Rule 482 is the primary rule used for investment company advertising. Note that section 482(a) says the advertising “may include information the substance of which is not included in” the statutory, § 10(a) prospectus. Section (b) of Rule 482 tells us that a Rule 482 advertisement must include various legends warning potential investors. The most important limitations on investment company advertising in Rule 482 deal with fund performance data. Section 482(g) requires that any performance data provided be timely, and sections 482(d) and (e) limit the performance data that may be included. Section (e) applies to money market funds. Section (d) applies to open-end management investment companies that are not money market funds. If the fund's yield or return are specified in the Rule 482 ad, they must be calculated in a standardized manner. An open-end management company that is not a money market fund may also include other measures of performance, but only if the standardized measure is included.4 The purpose of requiring standardized performance data like this is to allow investors to compare the performances of different funds. Supplemental Sales Literature Any sales literature not covered by Rules 134, 135A, and 482 may be sent only after a statutory prospectus (the prospectus filed as part of the registration statement) is made available to the investor. Investment Company Act Rule 34b-1 provides that any supplemental sales literature must usually contain the standardized performance data specified in Rule 482. Other performance data may also be provided, but only if the Rule 482 standardized data is included. NASD Requirements The National Association of Securities Dealers ("NASD") has Rules of Fair Practice, including advertising rules, that apply to all of its members. These rules are important because almost all of the underwriters and distributors selling investment company shares are NASD members subject to the rules. Rule 2210, which appears immediately following this material, deals with advertising generally. Note particularly the restrictions in section (d). IM-2210-3, which 4Securities Act Rule 482(d)(5).
  7. 7. 7 appears in these materials immediately after Rule 2210, contains guidelines for advertising of fund rankings. You will need these materials to answer the problems. Filing Requirements Section 24(b) of the Investment Company Act requires registered open-end investment companies, unit investment trusts, and face-amount certificate companies to file with the SEC "any advertisement, pamphlet, circular, form letter, or other sales literature addressed to or intended for distribution to prospective investors." The SEC staff has interpreted ' 24(b) to cover virtually all sales material, including advertisements pursuant to Rule 134, but not including Rule 482 advertisements.5 Rule 482 advertisements must be filed pursuant to the Securities Act.6 NASD also requires all advertisements and sales material used by members to be filed with NASD. See NASD Rule 2210. To avoid duplication, materials filed with NASD are generally deemed to satisfy the SEC filing requirement.7 The SEC does not review the content of most of the filed sales material, but it does try to systematically spot-check some of the sales literature. NASD review is more thorough, and the NASD staff sometimes requests that sales material be revised or clarified. Record-Keeping Requirement Investment Company Act Rule 31a-2(a)(3) requires every registered investment company to preserve all sales literature for at least six years. 5It is unclear whether Rule 135A communications must be filed under ' 24(b). See 1 Thomas P. Lemke, et al, REGULATION OF INVESTMENT COMPANIES ' 20.03[1][d] (2006). 6Securities Act Rule 497. 7Investment Company Act Rule 24b-3; Securities Act Rule 497(i).
  8. 8. 8 Selected NASD Rules Concerning Advertising and Sales Material Rule 2210. Communications with the Public (a) Definitions For purposes of this Rule and any interpretation thereof, "communications with the public" consist of: (1) "Advertisement." Any material, other than an independently prepared reprint and institutional sales material, that is published, or used in any electronic or other public media, including any Web site, newspaper, magazine or other periodical, radio, television, telephone or tape recording, videotape display, signs or billboards, motion pictures, or telephone directories (other than routine listings). (2) "Sales Literature." Any written or electronic communication, other than an advertisement, independently prepared reprint, institutional sales material and correspondence, that is generally distributed or made generally available to customers or the public, including circulars, research reports, market letters, performance reports or summaries, form letters, telemarketing scripts, seminar texts, reprints (that are not independently prepared reprints) or excerpts of any other advertisement, sales literature or published article, and press releases concerning a member's products or services. (3) "Correspondence" as defined in Rule 2211(a)(1). (4) "Institutional Sales Material" as defined in Rule 2211(a)(2). (5) "Public Appearance." Participation in a seminar, forum (including an interactive electronic forum), radio or television interview, or other public appearance or public speaking activity. (6) "Independently Prepared Reprint." (A) Any reprint or excerpt of any article issued by a publisher, provided that: (i) the publisher is not an affiliate of the member using the reprint or any underwriter or issuer of a security mentioned in the reprint or excerpt and that the member is promoting; (ii) neither the member using the reprint or excerpt nor any underwriter or issuer of a security mentioned in the reprint or excerpt has commissioned the reprinted or excerpted article; and
  9. 9. 9 (iii) the member using the reprint or excerpt has not materially altered its contents except as necessary to make the reprint or excerpt consistent with applicable regulatory standards or to correct factual errors; (B) Any report concerning an investment company registered under the Investment Company Act of 1940, provided that: (i) the report is prepared by an entity that is independent of the investment company, its affiliates, and the member using the report (the "research firm"); (ii) the report's contents have not been materially altered by the member using the report except as necessary to make the report consistent with applicable regulatory standards or to correct factual errors; (iii) the research firm prepares and distributes reports based on similar research with respect to a substantial number of investment companies; (iv) the research firm updates and distributes reports based on its research of the investment company with reasonable regularity in the normal course of the research firm's business; (v) neither the investment company, its affiliates nor the member using the research report has commissioned the research used by the research firm in preparing the report; and (vi) if a customized report was prepared at the request of the investment company, its affiliate or a member, then the report includes only information that the research firm has already compiled and published in another report, and does not omit information in that report necessary to make the customized report fair and balanced. (b) Approval and Recordkeeping (1) Registered Principal Approval for Advertisements, Sales Literature and Independently Prepared Reprints (A) A registered principal of the member must approve by signature or initial and date each advertisement, item of sales literature and independently prepared reprint before the earlier of its use or filing with NASD's Advertising Regulation Department ("Department"). (B) With respect to debt and equity securities that are the subject of
  10. 10. 10 research reports as that term is defined in Rule 472 of the New York Stock Exchange, the requirements of paragraph (A) may be met by the signature or initial of a supervisory analyst approved pursuant to Rule 344 of the New York Stock Exchange. (C) A registered principal qualified to supervise security futures activities must approve by signature or initial and date each advertisement or item of sales literature concerning security futures. (D) The requirements of paragraph (A) shall not apply with regard to any advertisement, item of sales literature, or independently prepared reprint if, at the time that a member intends to publish or distribute it: (i) another member has filed it with the Department and has received a letter from the Department stating that it appears to be consistent with applicable standards; and (ii) the member using it in reliance upon this paragraph has not materially altered it and will not use it in a manner that is inconsistent with the conditions of the Department's letter. (2) Record-keeping (A) Members must maintain all advertisements, sales literature, and independently prepared reprints in a separate file for a period beginning on the date of first use and ending three years from the date of last use. The file must include: (i) a copy of the advertisement, item of sales literature or independently prepared reprint, and the dates of first and (if applicable) last use of such material; (ii) the name of the registered principal who approved each advertisement, item of sales literature, and independently prepared reprint and the date that approval was given, unless such approval is not required pursuant to paragraph (b)(1)(D); and (iii) for any advertisement, item of sales literature or independently prepared reprint for which principal approval is not required pursuant to paragraph (b)(1)(D), the name of the member that filed the advertisement, sales literature or independently prepared reprint with the Department, and a copy of the corresponding review letter from the Department. (B) Members must maintain in a file information concerning the source of any statistical table, chart, graph or other illustration used by the member in communications with the public.
  11. 11. 11 (c) Filing Requirements and Review Procedures (1) Date of First Use and Approval Information The member must provide with each filing under this paragraph the actual or anticipated date of first use, the name and title of the registered principal who approved the advertisement or sales literature, and the date that the approval was given. (2) Requirement to File Certain Material Within 10 business days of first use or publication, a member must file the following communications with the Department: (A) Advertisements and sales literature concerning registered investment companies (including mutual funds, variable contracts, continuously offered closed-end funds, and unit investment trusts) not included within the requirements of paragraph (c)(3). The filing of any advertisement or sales literature that includes or incorporates a performance ranking or performance comparison of the investment company with other investment companies must include a copy of the ranking or comparison used in the advertisement or sales literature. (B) Advertisements and sales literature concerning public direct participation programs (as defined in Rule 2810). (C) Advertisements concerning government securities (as defined in Section 3(a)(42) of the Act). (D) any template for written reports produced by, or advertisements and sales literature concerning, an investment analysis tool, as such term is defined in Rule IM-2210-6. (3) Sales Literature Containing Bond Fund Volatility Ratings Sales literature concerning bond mutual funds that include or incorporate bond mutual fund volatility ratings, as defined in Rule IM-2210-5, shall be filed with the Department for review at least 10 business days prior to use (or such shorter period as the Department may allow in particular circumstances) for approval and, if changed by NASD, shall be withheld from publication or circulation until any changes specified by NASD have been made or, if expressly disapproved, until the sales literature has been refiled for, and has received, NASD approval. Members are not required to file advertising and sales literature which have previously been filed and which are used without change. The member must
  12. 12. 12 provide with each filing the actual or anticipated date of first use. Any member filing sales literature pursuant to this paragraph shall provide any supplemental information requested by the Department pertaining to the rating that is possessed by the member. (4) Requirement to File Certain Material Prior to Use At least 10 business days prior to first use or publication (or such shorter period as the Department may allow), a member must file the following communications with the Department and withhold them from publication or circulation until any changes specified by the Department have been made: (A) Advertisements and sales literature concerning registered investment companies (including mutual funds, variable contracts, continuously offered closed-end funds and unit investment trusts) that include or incorporate performance rankings or performance comparisons of the investment company with other investment companies when the ranking or comparison category is not generally published or is the creation, either directly or indirectly, of the investment company, its underwriter or an affiliate. Such filings must include a copy of the data on which the ranking or comparison is based. (B) Advertisements concerning collateralized mortgage obligations. (C) Advertisements concerning security futures. (5) Requirement for Certain Members to File Material Prior to Use (A) Each member that has not previously filed advertisements with the Department (or with a registered securities exchange having standards comparable to those contained in this Rule) must file its initial advertisement with the Department at least 10 business days prior to use and shall continue to file its advertisements at least 10 business days prior to use for a period of one year. (B) Notwithstanding the foregoing provisions, the Department, upon review of a member's advertising and/or sales literature, and after determining that the member has departed from the standards of this Rule, may require that such member file all advertising and/or sales literature, or the portion of such member's material which is related to any specific types or classes of securities or services, with the Department, at least 10 business days prior to use. The Department will notify the member in writing of the types of material to be filed and the length of time such requirement is to be in effect. Any filing requirement imposed under this
  13. 13. 13 paragraph will take effect 21 calendar days after service of the written notice, during which time the member may request a hearing under Rules 9551 and 9559. (6) Filing of Television or Video Advertisements If a member has filed a draft version or "story board" of a television or video advertisement pursuant to a filing requirement, then the member also must file the final filmed version within 10 business days of first use or broadcast. (7) Spot-Check Procedures In addition to the foregoing requirements, each member's written and electronic communications with the public may be subject to a spot-check procedure. Upon written request from the Department, each member must submit the material requested in a spot-check procedure within the time frame specified by the Department. (8) Exclusions from Filing Requirements The following types of material are excluded from the filing requirements and (except for the material in paragraphs (G) through (J)) the foregoing spot-check procedures: (A) Advertisements and sales literature that previously have been filed and that are to be used without material change. (B) Advertisements and sales literature solely related to recruitment or changes in a member's name, personnel, electronic or postal address, ownership, offices, business structure, officers or partners, telephone or teletype numbers, or concerning a merger with, or acquisition by, another member. (C) Advertisements and sales literature that do no more than identify a national securities exchange symbol of the member or identify a security for which the member is a registered market maker. (D) Advertisements and sales literature that do no more than identify the member or offer a specific security at a stated price. (E) Prospectuses, preliminary prospectuses, fund profiles, offering circulars and similar documents that have been filed with the Securities and Exchange Commission (the "SEC") or any state, or that is exempt from such registration, except that an investment company prospectus published pursuant to SEC Rule 482 under the Securities Act of 1933 will
  14. 14. 14 not be considered a prospectus for purposes of this exclusion. (F) Advertisements prepared in accordance with Section 2(10)(b) of the Securities Act of 1933, as amended, or any rule thereunder, such as SEC Rule 134, and announcements as a matter of record that a member has participated in a private placement, unless the advertisements are related to direct participation programs or securities issued by registered investment companies. (G) Press releases that are made available only to members of the media. (H) Independently prepared reprints. (I) Correspondence. (J) Institutional sales material. Although the material described in paragraphs (c)(8)(G) through (J) is excluded from the foregoing filing requirements, investment company communications described in those paragraphs shall be deemed filed with NASD for purposes of Section 24(b) of the Investment Company Act of 1940 and Rule 24b-3 thereunder. (9) Material that refers to investment company securities, direct participation programs, or exempted securities (as defined in Section 3(a)(12) of the Act) solely as part of a listing of products or services offered by the member, is excluded from the requirements of paragraphs (c)(2) and (c)(4). (10) Pursuant to the Rule 9600 Series, NASD may exempt a member or person associated with a member from the pre-filing requirements of this paragraph (c) for good cause shown. (d) Content Standards (1) Standards Applicable to All Communications with the Public (A) All member communications with the public shall be based on principles of fair dealing and good faith, must be fair and balanced, and must provide a sound basis for evaluating the facts in regard to any particular security or type of security, industry, or service. No member may omit any material fact or qualification if the omission, in the light of the context of the material presented, would cause the communications to be misleading. (B) No member may make any false, exaggerated, unwarranted or misleading statement or claim in any communication with the public. No member may publish, circulate or distribute any public communication
  15. 15. 15 that the member knows or has reason to know contains any untrue statement of a material fact or is otherwise false or misleading. (C) Information may be placed in a legend or footnote only in the event that such placement would not inhibit an investor's understanding of the communication. (D) Communications with the public may not predict or project performance, imply that past performance will recur or make any exaggerated or unwarranted claim, opinion or forecast. A hypothetical illustration of mathematical principles is permitted, provided that it does not predict or project the performance of an investment or investment strategy. (E) If any testimonial in a communication with the public concerns a technical aspect of investing, the person making the testimonial must have the knowledge and experience to form a valid opinion. (2) Standards Applicable to Advertisements and Sales Literature (A) Advertisements or sales literature providing any testimonial concerning the investment advice or investment performance of a member or its products must prominently disclose the following: (i) The fact that the testimonial may not be representative of the experience of other clients. (ii) The fact that the testimonial is no guarantee of future performance or success. (iii) If more than a nominal sum is paid, the fact that it is a paid testimonial. (B) Any comparison in advertisements or sales literature between investments or services must disclose all material differences between them, including (as applicable) investment objectives, costs and expenses, liquidity, safety, guarantees or insurance, fluctuation of principal or return, and tax features. (C) All advertisements and sales literature must: (i) prominently disclose the name of the member and may also include a fictional name by which the member is commonly recognized or which is required by any state or jurisdiction; (ii) reflect any relationship between the member and any non- member or individual who is also named; and (iii) if it includes other names, reflect which products or services are being offered by the member.
  16. 16. 16 This paragraph (C) does not apply to so-called "blind" advertisements used to recruit personnel. (3) Disclosure of Fees, Expenses and Standardized Performance (A) Communications with the public, other than institutional sales material and public appearances, that present non-money market fund open-end management investment company performance data as permitted by Rule 482 under the Securities Act of 1933 and Rule 34b-1 under the Investment Company Act of 1940 must disclose: (i) the standardized performance information mandated by Rule 482 and Rule 34b-1; and (ii) to the extent applicable: a. the maximum sales charge imposed on purchases or the maximum deferred sales charge, as stated in the investment company's prospectus current as of the date of submission of an advertisement for publication, or as of the date of distribution of other communications with the public; and b. the total annual fund operating expense ratio, gross of any fee waivers or expense reimbursements, as stated in the fee table of the investment company's prospectus described in paragraph (a). (B) All of the information required by paragraph (A) must be set forth prominently, and in any print advertisement, in a prominent text box that contains only the required information and, at the member's option, comparative performance and fee data and disclosures required by Rule 482 and Rule 34b-1. (e) Violation of Other Rules Any violation by a member of any rule of the SEC, the Securities Investor Protection Corporation or the Municipal Securities Rulemaking Board applicable to member communications with the public will be deemed a violation of this Rule 2210.
  17. 17. 17 NASD IM-2210-3. Use of Rankings in Investment Companies Advertisements and Sales Literature (a) Definition of "Ranking Entity" For purposes of the following guidelines, the term "Ranking Entity" refers to any entity that provides general information about investment companies to the public, that is independent of the investment company and its affiliates, and whose services are not procured by the investment company or any of its affiliates to assign the investment company a ranking. (b) General Prohibition Members may not use investment company rankings in any advertisement or item of sales literature other than (1) rankings created and published by Ranking Entities or (2) rankings created by an investment company or an investment company affiliate but based on the performance measurements of a Ranking Entity. Rankings in advertisements and sales literature also must conform to the following requirements. (c) Required Disclosures (1) Headlines/Prominent Statements A headline or other prominent statement must not state or imply that an investment company or investment company family is the best performer in a category unless it is actually ranked first in the category. (2) Required Prominent Disclosure All advertisements and sales literature containing an investment company ranking must disclose prominently: (A) the name of the category (e.g., growth); (B) the number of investment companies or, if applicable, investment company families, in the category; (C) the name of the Ranking Entity and, if applicable, the fact that the investment company or an affiliate created the category or subcategory; (D) the length of the period (or the first day of the period) and its ending date; and (E) criteria on which the ranking is based (e.g., total return, risk-adjusted performance). (3) Other Required Disclosure
  18. 18. 18 All advertisements and sales literature containing an investment company ranking also must disclose: (A) the fact that past performance is no guarantee of future results; (B) for investment companies that assess front-end sales loads, whether the ranking takes those loads into account; (C) if the ranking is based on total return or the current SEC standardized yield, and fees have been waived or expenses advanced during the period on which the ranking is based, and the waiver or advancement had a material effect on the total return or yield for that period, a statement to that effect; (D) the publisher of the ranking data (e.g., "ABC Magazine, June 2003"); and (E) if the ranking consists of a symbol (e.g., a star system) rather than a number, the meaning of the symbol (e.g., a four-star ranking indicates that the fund is in the top 30% of all investment companies). (d) Time Periods (1) Current Rankings Any investment company ranking included in an item of sales literature must be, at a minimum, current to the most recent calendar quarter ended prior to use. Any investment company ranking included in an advertisement must be, at minimum, current to the most recent calendar quarter ended prior to the submission for publication. If no ranking that meets this requirement is available from the Ranking Entity, then a member may only use the most current ranking available from the Ranking Entity unless use of the most current ranking would be misleading, in which case no ranking from the Ranking Entity may be used. (2) Rankings Time Periods; Use of Yield Rankings Except for money market mutual funds: (A) advertisements and sales literature may not present any ranking that covers a period of less than one year, unless the ranking is based on yield; (B) an investment company ranking based on total return must be accompanied by rankings based on total return for a one year period for investment companies in existence for at least one year; one and five year periods for investment companies in existence for at least five years; and one, five and ten year periods for investment companies in existence for at least ten years supplied by the same Ranking Entity, relating to the same
  19. 19. 19 investment category, and based on the same time period; provided that, if rankings for such one, five and ten year time periods are not published by the Ranking Entity, then rankings representing short, medium and long term performance must be provided in place of rankings for the required time periods; and (C) an investment company ranking based on yield may be based only on the current SEC standardized yield and must be accompanied by total return rankings for the time periods specified in paragraph (d)(2)(B). (e) Categories (1) The choice of category (including a subcategory of a broader category) on which the investment company ranking is based must be one that provides a sound basis for evaluating the performance of the investment company. (2) An investment company ranking must be based only on (A) a published category or subcategory created by a Ranking Entity or (B) a category or subcategory created by an investment company or an investment company affiliate, but based on the performance measurements of a Ranking Entity. (3) An advertisement or sales literature must not use any category or subcategory that is based upon the asset size of an investment company or investment company family, whether or not it has been created by a Ranking Entity. (f) Multiple Class/Two-Tier Funds Investment company rankings for more than one class of investment company with the same portfolio must be accompanied by prominent disclosure of the fact that the investment companies or classes have a common portfolio. (g) Investment Company Families Advertisements and sales literature may contain rankings of investment company families, provided that these rankings comply with the guidelines above, and further provided that no advertisement or sales literature for an individual investment company may provide a ranking of an investment company family unless it also prominently discloses the various rankings for the individual investment company supplied by the same Ranking Entity, as described in paragraph (d)(2)(B). For purposes of this IM-2210-3, the term "investment company family" means any two or more registered investment companies or series thereof that hold themselves out to investors as related companies for purposes of investment and investor services. In the Matter of Competitive Capital Corporation Securities Exchange Act Release No. 9184
  20. 20. 20 Securities and Exchange Commission May 25, 1971 1971 SEC LEXIS 927 This was a private proceeding . . . with respect to Competitive Capital Corporation ('registrant'), a registered broker-dealer and a member of the National Association of Securities Dealers, Inc., and Richard E. Boesel, Jr. and Robert L. Sprinkel, III, who at the times relevant here were registrant's principal executive officers and together owned over 90 percent of its outstanding voting stock. ... On February 20, 1969, Fund [Competitive Associates, Inc.], a management, open-end diversified investment company, filed with us a registration statement under the Securities Act with respect to its initial public offering of 5,000,000 shares of common stock at $20 per share. Registrant was Fund's investment adviser and principal underwriter, and also at that time was acting as investment adviser and principal underwriter for another registered open-end management investment company, Competitive Capital Fund ('CCF'). Registrant, Fund and CCF were then managed by a common group of officers headed by Boesel and Sprinkel. Upon the filing of the registration statement, including Fund's preliminary prospectus, registrant and a public relations firm which it had previously retained in January 1968 to provide continuing financial public relations services for registrant and the investment companies it was managing and advising, sent copies of that prospectus, together with an accompanying press release announcing the proposed initial public offering, to approximately 120 business and financial editors throughout the country. That mailing was the start of a publicity campaign designed to attract attention to the Fund, through emphasizing, among other matters, the Fund's investment policies and the fact that separate portions of the Fund's assets would be managed by independent portfolio managers who would compete with each other. The public relations firm also mailed biographical sketches of Boesel and Sprinkel and during the period February 20 through March 4, 1969, arranged a schedule of approximately 19 interviews with members of the business and financial press for Boesel, Sprinkel and two other officers of registrant while such officers were in various cities to discuss the proposed public offering with prospective members of the selling group. At least 11 of the financial reporters participating in those interviews wrote articles concerning the prospective Fund offering which appeared in various newspapers and magazines throughout the country. Some of the articles were written under the by- line of nationally syndicated columnists and were printed in more than one publication. After each interview the public relations consultant communicated with the reporter to determine if he could supply the reporter with additional information. All of these activities took place prior to the effective date of the public offering. On or about March 4, 1969, the publication of articles concerning the proposed public offering came to the attention of counsel involved in the filing of the registration statement and of members of our staff. As a result, further interviews which had been
  21. 21. 21 scheduled were cancelled, and steps were taken to terminate any further publicity or public relations activities by the Fund and respondents, and efforts were made to have articles prepared for publication in various cities withdrawn. Despite such efforts, however, a number of such stories did appear thereafter. The registration statement was not declared effective until April 10, 1969. A basic purpose of the Securities Act [of 1933] is to require the dissemination of adequate and accurate information concerning issuers and their securities in connection with the offer and sale of securities to the public. To this end, Section 5 of the Act contains various restrictions on offers and sales prior to the filing or the effective date of a registration statement covering a public offering of securities. Thus Section 5(c) prohibits offers to sell securities prior to the filing of a registration statement. Section 5(b), insofar as here pertinent, prohibits any such written offers during the period between the filing of a registration statement and the date it becomes effective, the so- called waiting period, except an offer which is made by means of a prospectus which meets the informational requirements specified in Section 10 and the rules adopted thereunder. Accordingly, during such waiting period written communications concerning the securities must be restricted to the preliminary or 'red herring' prospectus filed as a part of the registration statement, a summary prospectus as authorized by Section 10(b), or the so-called 'tombstone' announcements permitted under Section 2(10) or Rule 134 thereunder. In order to implement the statutory objective, the term 'offer to sell' is broadly defined in Section 2(3) to include 'every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value,' and it has been liberally construed both by us and the courts. We have repeatedly pointed out that publicity or public relations activities under certain circumstances may constitute offers to sell securities within the statutory definition and thus involve violations of the Act. We have specifically noted that the publication of information and statements and publicity efforts generally about an issuer, its securities or a proposed offering, made prior to the filing of a registration statement, may constitute an illegal offer to sell even though not couched in terms of an express offer, where such activities are in effect a sales campaign which conditions the public mind or arouses the public interest in the particular securities. And we have stated that the release of publicity and the publication of information between the filing date and the effective date of a registration statement may similarly raise a question whether the publicity is not in fact a selling effort by an illegal means; i.e., other than by means of a statutory prospectus. Courts have also ruled that press releases announcing that securities would be sold at some time in the future and containing an attractive description of the securities or of the issuer constituted illegal offers to sell. It is necessary that the managers, investment advisers and underwriters of investment companies, as well as retained public relations firms, recognize that the Securities Act imposes certain responsibilities and limitations upon them as well as upon other persons engaged in the public sale of securities, and that failure to exercise proper control at any time over public relations activities respecting the distribution of securities may result in violations of law and adverse consequences to the investment companies
  22. 22. 22 and their underwriters in connection with the distribution of the securities.8 Insofar as this case is concerned, Congress has specified an exclusive procedure by which information concerning a proposed offering may be disseminated during the waiting period. Persons undertaking to employ public media of communication to give publicity to a forthcoming issue in ways not specified in the Act must carefully consider the possi- bility that such publicity oversteps the statutory limitations and constitutes a type of sales activity prohibited during the waiting period by Section 5(b). Even if we recognize that the limited advertising that an issuer which has a registration statement pending can employ may pose special problems for an investment company engaged in a continuous offering of its shares to the public, here the issuer was not at the time engaged in a continuous public offering. As has been seen, respondents, solely in connection with a pending registration statement for an essentially new investment vehicle, participated in an organized campaign utilizing a wide distribution of publicity material which was designed to and had the effect of conditioning the public for the forthcoming offering of Fund shares. Such activities constituted an offer to sell, and the publicity material constituted a prospectus which did not meet the requirements of Section 10 of the Securities Act. Its transmittal through various means of interstate commerce and the mails therefore constituted a willful violation of Section 5(b) of the Act by the respondents. In addition, Boesel and Sprinkel, as principal owners and executive officers of registrant, failed reasonably to supervise other officers of registrant who were engaged in similar publicity activities in order to prevent violations of Section 5(b). . . . [R]espondents stated in mitigation that the press release was used only after consultation with counsel; that the granting of interviews by the individual respondents was considered by them to be in accordance with practice in the industry; that the appropriate sanction of delay in the effectiveness of the Fund's registration statement has already imposed substantial adverse economic consequences to the Fund and registrant; and that respondents otherwise have an unblemished record in the securities business. We have considered these and other factors . . . . With respect to registrant, which is only being censured, we note that Boesel and Sprinkel are no longer officers, that subsequent to the events involved herein another unrelated corporation purchased a controlling interest, and that thereafter registrant filed a notice of withdrawal of its registration as a broker and dealer. In imposing a suspension for ten business days upon Boesel and Sprinkel, we note that each of them is experienced in the securities business and should have been familiar with the requirements of the Securities Act respecting the use of publicity in connection with a public offering. By the Commission . . . . 8 Violations of the Securities Act subject the persons involved not only to the risk of penal sanctions under the law but also to the possibility of civil liabilities to purchasers of securities, to the denial of acceleration of the effective date of a registration statement, or to elimination of a broker-dealer from participation as an underwriter or as a member of the selling group in a distribution.
  23. 23. 23 Advertising Problems 1. The Royal Equity Fund (the "Fund") is a registered investment company. Almost all of the mutual fund ranking services rank the Fund in the middle of its category. However, StarSearch Rankings, Inc. ranks the Fund second out of a total of 40 funds in its category. StarSearch considers, in addition to total returns in the past, its evaluation of the quality of the people managing the fund, future market trends and their effect on the fund's portfolio, and the likely success of the fund in attracting new capital. May the Fund include the StarSearch ranking in its advertisements? May it do so even if it doesn't disclose the other rankings? Should it be able to? 2. Global Advisers, Inc. is the investment adviser of the Enterprise Fund, a registered investment adviser. Global Advisers is a wholly-owned subsidiary of Global Parent, Inc. Global Rankings, Inc., another wholly-owned subsidiary of Global Parent, Inc., is a leading, nationally recognized ranking entity for mutual funds. May the Enterprise Fund include its ranking by Global Rankings in its advertisements? Should it be able to? 3. Eveningstar, Inc. is a company that publishes mutual fund rankings. Its "Blue Chip Stock Fund" category includes funds that invest primarily in stable, well- established "blue chip" companies. However, funds in the category may have up to 20 percent of their assets invested in riskier, non-blue chip stocks. Eveningstar ranks the Quality Blue Chip Fund (the "Fund") sixth out of 50 Blue Chip Stock Funds. The Fund invests only in what Eveningstar would consider blue chip companies; it does not own any non-blue chip stocks. The managers of the Fund believe that Eveningstar's inclusion of companies with non-blue chip investments is unfair. Non-blue chip stocks, although they sometimes produce higher returns, are riskier and not what the Fund's managers think people are looking for when they seek a "blue chip" fund. If funds that invest part of their assets in non-blue chip stocks are excluded from the Eveningstar rankings, the Fund ranks first out of 30 funds. May the Fund include this revised ranking in its advertising? Should it be able to? 4. The Green International Fund (the "Fund) invests in the securities of foreign companies. It limits its investments to companies that are "socially responsible" as defined by a lengthy list of criteria it has developed. For example, it won't invest in companies that are involved with tobacco products, companies that do business with Yugoslavia, or companies that are heavy polluters. Most ranking services categorize funds as International or Socially Responsible, but do not have a separate category for socially responsible international funds. The Fund is ranked either with the international funds or with the social responsibility funds. The managers of the Fund believe this is unfair because the international fund
  24. 24. 24 rankings include funds that don't restrict their investments to socially responsible companies and the rankings of social responsibility funds include funds that invest in less risky domestic companies. The Fund's managers are aware of seven funds with investment restrictions similar to their own. The Fund's total return is better than any of the other socially responsible international funds. May they include this information in their advertisements? Should they be able to?
  25. 25. 25 Investment Company Act Release No. 25575 Securities and Exchange Commission May 24, 2002 67 Fed. Reg. 36712 Like most issuers of securities, when an investment company ("fund") offers its shares to the public, its promotional efforts become subject to the advertising restrictions of the Securities Act. Congress imposed these restrictions so that investors would base their investment decisions on the full disclosures contained in the "statutory prospectus," which Congress intended to be the primary selling document. 2 The advertising restrictions of the Securities Act cause special problems for many investment companies, particularly for open-end management investment companies ("mutual funds") and other investment companies that continuously offer and sell their shares.I For these funds, the advertising restrictions apply continuously because the offering process, in effect, is continuous. In recognition of these problems, the Commission has adopted special advertising rules for investment companies. The most important of these is rule 482 under the Securities Act, which permits investment companies to advertise investment performance data, as well as other information. Rule 482 advertisements are "prospectuses" under section 10(b) of the Securities Act (so-called "omitting prospectuses"), which means that, historically, they could only contain information the "substance of which" is included in the statutory prospectus. In the National Securities Markets Improvement Act of 1996, Congress amended the Investment Company Act to permit, subject to rules adopted by the Commission, the use of prospectuses under section 10(b) of the Securities Act that 2 2"Statutory prospectus" refers to the full prospectus required by Section 10(a) of the Securities Act. I I Editor=s note: Elsewhere in the Release, the Commission explained that Amutual funds typically offer and sell their shares continuously to provide an ongoing flow of capital into their portfolios and to enable them to meet redemption requests from outgoing shareholders. Unit investment trusts typically have active secondary markets in which the trusts' sponsors are continuously purchasing and selling the trusts' units.@
  26. 26. 26 include information the substance of which is not included in the statutory prospectus. II . .. ... Section 5 of the Securities Act contains prohibitions regarding the dissemination of written selling material to investors during the offering period. Section 5(b)(1) makes it unlawful to use interstate commerce to transmit any prospectus relating to a security with respect to which a registration statement has been filed unless the prospectus meets the requirements of section 10 of the Securities Act. "Prospectus" is broadly defined in section 2(a)(10) to include any advertisement or other communication, "written or by radio or television, which offers any security for sale or confirms the sale of any security." Thus, advertisements are considered prospectuses under the Securities Act if they offer a security for sale. Because the term "offer" is defined and interpreted broadly to encompass any attempt to procure orders for a security, written and radio or television advertisements relating to a security, or aiding in the selling effort with respect to a security, generally must be in the form of a section 10 prospectus. There is a limited exception to the general requirement that written and radio or television offers after the filing of a registration statement must be in the form of a section 10 prospectus. So-called "supplemental sales literature" may be used after the effective date of a registration statement if accompanied or preceded by the statutory prospectus.16 . . . ... Rule 482 The Commission adopted rule 482 under the authority of section 10(b) of the Securities Act, which permits the Commission to adopt rules that provide for a prospectus that "omits in part" or "summarizes" information contained in the statutory prospectus. . . . Significantly, rule 482 provides a means for mutual funds to advertise performance information according to standardized formulas.21 I IIEditor=s note: The National Securities Markets Improvement Act of 1996, Pub. L. No. 104-290, ' 204, 110 Stat. 3416, 3428, added paragraph (g) to section 24 of the Investment Company Act. Paragraph (g) authorizes the Commission to allow, Aby rules or regulations deemed necessary or appropriate in the public interest or for the protection of investors, the use of a prospectus for purposes of section 5(b)(1) of [the Securities Act] with respect to securities issued by a registered investment company. Such a prospectus, which may include information the substance of which is not included in the [statutory] prospectus . . . , shall be deemed to be permitted by section 10(b)@ of the Securities Act. 6 16Under section 2(a)(10)(a) of the Securities Act, supplemental sales literature is not considered to be a prospectus and, as a result, is not subject to section 5(b)(1) of the Securities Act.
  27. 27. 27 Because a rule 482 advertisement is a prospectus under section 10(b) of the Securities Act, a rule 482 advertisement is subject to section 12(a)(2) of the Securities Act, which imposes liability for materially false or misleading statements in a prospectus or oral communication, subject to a reasonable care defense. 22 Rule 482 advertisements are also subject to the antifraud provisions of the federal securities laws. Mere compliance with the terms of rule 482 is not a safe harbor against antifraud liability. ... Rule 34b-1 Rule 34b-1 under the Investment Company Act applies to supplemental sales literature, i.e., sales literature that is preceded or accompanied by the statutory prospectus.30 Under rule 34b-1, any performance data included in supplemental sales literature must be accompanied by performance data computed using the standardized formulas for advertising performance under rule 482. The Commission adopted rule 34b-1 to ensure that performance claims in supplemental sales literature would not be misleading and to promote comparability and uniformity among supplemental sales literature and rule 482 advertisements. Supplemental sales literature is subject to the antifraud provisions of the federal securities laws. Mere compliance with the terms of rule 34b-1 is not a safe harbor against antifraud liability. Rule 156 Rule 156 under the Securities Act provides guidance on the types of information that could be misleading in fund sales literature. It applies to all advertisements and supplemental sales literature. Under rule 156, whether a statement involving a material fact is misleading depends on an evaluation of the context in which it is made. Rule 156 indicates that representations about past performance could be misleading in situations where portrayals of past performance convey an impression of net investment results that would not be justified under the circumstances. 21 1 . . . The Commission adopted the use of standardized formulas in order to permit prospective investors to compare the performance claims of competing funds and to prevent misleading performance claims by funds. 22 2 An action under section 12(a)(2) does not require proof of scienter (i.e., an intent to defraud investors). . . . [H]owever, the plaintiff must establish that the misrepresentation or omission is material. 30 0 Under section 2(a)(10)(a) of the Securities Act, a communication sent or given after the effective date of the registration statement is not deemed a "prospectus" if it is proved that prior to or at the same time with such communication a written statutory prospectus was sent or given to the person to whom the communication was made.
  28. 28. 28 Note Rules 482 and 34b-1 resulted from a concern of the Securities and Exchange Commission Athat investors could not compare performance claims [of different funds] because no prescribed methods of calculating fund performance existed (except for money market funds), and because funds were being advertised on the basis of different types of performance data. In addition, the Commission [was concerned] that some of the methods being used distorted performance. The [Rules] were designed to prevent misleading performance claims by funds and to permit investors to make meaningful comparisons among fund performance claims in advertisements.@ Advertising by Investment Companies, Investment Company Act Release No. 16245, 53 Fed. Reg. 3868 (1988). The provisions of Rules 482 and 34b-1 that govern after-tax returns were added in 2001. Disclosure of Mutual Fund After-Tax Returns, Investment Company Act Release No. 24832, 66 Fed. Reg. 9002 (2001). In the Release, the Commission explained the need for the provisions as follows: ATaxes are one of the most significant costs of investing in mutual funds through taxable accounts. . . . Recent estimates suggest that more than two and one-half percentage points of the average stock fund's total return is lost each year to taxes. Moreover, it is estimated that, between 1994 and 1999, investors in diversified U.S. stock funds surrendered an average of 15 percent of their annual gains to taxes. Despite the tax dollars at stake, many investors lack a clear understanding of the impact of taxes on their mutual fund investments. Generally, a mutual fund shareholder is taxed when he or she receives income or capital gains distributions from the fund and when the shareholder redeems fund shares at a gain. The tax consequences of distributions are a particular source of surprise to many investors when they discover that they can owe substantial taxes on their mutual fund investments that appear to be unrelated to the performance of the fund. Even if the value of a fund has declined during the year, a shareholder can owe taxes on capital gains distributions if the portfolio manager sold some of the fund's underlying portfolio securities at a gain.8 The tax impact of mutual funds on investors can vary significantly from fund to fund. For example, the amount and character of a fund's 8 8 This is attributable, in part, to the fact that a mutual fund generally must distribute substantially all of its net investment income and realized capital gains to its shareholders in order to qualify for favorable tax treatment as a >regulated investment company= (>RIC=) [under the Internal Revenue Code]. As a RIC, a mutual fund is generally entitled to deduct dividends paid to shareholders, resulting in its shareholders being subject to only one level of taxation on the income and gains distributed to them. . . .
  29. 29. 29 taxable distributions are affected by its investment strategies, including the extent of a fund's investments in securities that generate dividend and other current income, the rate of portfolio turnover and the extent to which portfolio trading results in realized gains, and the degree to which portfolio losses are used to offset realized gains. . . . While the tax- efficiency of a mutual fund is of little consequence to investors in 401(k) plans or other tax-deferred vehicles, it can be very important to an investor in a taxable account, particularly a long-term investor whose tax position may be significantly enhanced by minimizing current distributions of income and capital gains. ... Today we adopt rule . . . amendments that require a fund to disclose its standardized after-tax returns for 1-, 5-, and 10-year periods. After-tax returns, which will accompany before-tax returns in fund prospectuses, will be presented in two ways: (i) After taxes on fund distributions only; and (ii) after taxes on fund distributions and a redemption of fund shares. Although after-tax returns will not generally be required in fund advertisements and sales literature, any fund that either includes after-tax returns in these materials or includes other performance information together with representations that the fund is managed to limit taxes will be required to include after-tax returns computed according to our standardized formulas. . . .@ The Commission has taken the position that an advertisement satisfying Rule 482 may nonetheless be materially misleading and violate Rule 156. Proposed Amendments to Investment Company Advertising Rules, Investment Company Act Release No. 25575, 67 Fed. Reg. 36712, 36717 (2002). In the Release, the Commission wrote: A[F]und advertisements are subject to the antifraud provisions of the federal securities laws. We understand that questions have been raised regarding whether compliance with the terms of rule 482 satisfies all of the obligations of a fund with respect to its advertisements. . . . [C]ompli- ance with the >four corners= of rule 482 does not alter the fact that funds, underwriters, and dealers are subject to the antifraud provisions of the federal securities laws with respect to fund advertisements.@
  30. 30. 30 Zweig Series Trust Securities and Exchange Commission No-Action Letter Publicly Available January 10, 1990 1990 SEC NOACT LEXIS 48 LETTER TO SEC We are counsel for Zweig Series Trust (the "Trust"), formerly Drexel Series Trust. Since September 1, 1989, the Trust has been advised by Zweig/Glaser Advisers ("ZGA") and its principal distributor has been Zweig Securities Corp. (the "Distributor"). Prior thereto, the Trust was managed by Drexel Management Corporation ("DMC") and its principal distributor was Drexel Burnham Lambert Incorporated ("DBLI"), both wholly-owned subsidiaries of The Drexel Burnham Lambert Group Inc. ("Group"). The Trust currently consists of nine series: Money Market Series; Government Securities Series; Bond-Debenture Series; Blue Chip Series ("Blue Chip"); Emerging Growth Series ("Emerging Growth"); Option Income Series ("Option Income"); Convertible Securities Series ("Convertible Securities"); Limited Term Government Series; and Priority Selection List Series ("Priority Selection"). A tenth series is presently in registration. Since the change in management, the investment management and portfolio supervisory service for Blue Chip, Emerging Growth, Option Income, Convertible Securities and Priority Selection Series have been provided by individuals and entities with no prior or present affiliation with Group or its subsidiaries, including DMC. On behalf of the Trust, ZGA and the Distributor, we respectfully request that the staff of the Securities and Exchange Commission (the "Staff") advise us that it will not recommend enforcement action if investment results for Blue Chip, Emerging Growth, Option Income, Convertible Securities, and Priority Selection Series prior to September 1, 1989 are not included in calculations of average annual total return in advertisements, sales literature or omitting prospectuses pertaining to the Trust or these series. I. Background The Trust is an open-end management investment company organized as a Massachusetts business trust. The Trust commenced operations on March 25, 1985 and was managed by DMC until September 1, 1989, at which time ZGA assumed management responsibilities. ZGA, registered with the Commission as an investment adviser since August 26, 1989, is a partnership comprised of two corporations, themselves controlled by Mr. Eugene J. Glaser and Dr. Martin E. Zweig. Glaser Corp. purchased the business and substantially all of the assets of the Trust's management company from Group, and contributed them to ZGA; Dr. Zweig acquired exclusivity rights and contributed them to ZGA. At meetings held in May, June and July 1989, the Board of Trustees of the Trust voted to approve a new management agreement with ZGA. At meetings held in June and
  31. 31. 31 July, the Board of Trustees approved a subadvisory agreement between ZGA and Davis, Weaver & Mendel, Inc. (the "Subadviser") with respect to Option Income and Priority Selection Series. On August 31, 1989, the shareholders of each Series of the Trust voted to approve the new management agreements between ZGA and the Trust and ZGA and the Subadviser. Within ZGA, Dr. Zweig's primary role is investment advisory while Mr. Glaser's is primarily administrative and marketing. Dr. Zweig is an investment adviser, president of two closed-end funds and publisher of five investment advisory newsletters. In keeping with Dr. Zweig's and his staff's securities selection processes, changes in the fundamental investment policies of six of the nine series of the Trust were approved by the shareholders in connection with the change of management so as to enable the series to utilize the investment techniques of Dr. Zweig and his staff. The new distributor is a corporation controlled by Dr. Zweig. Dr. Zweig is Chairman of ZGA and Mr. Glaser is President. Mr. Glaser is Chairman and Chief Executive Officer of the Trust and Dr. Zweig is President. Certain individuals who were employees of DMC have severed that relationship and are currently employed by ZGA. Portfolio supervisory responsibilities for Blue Chip and Emerging Growth and Convertible Securities reside with individuals at ZGA who have been associated with Dr. Zweig and have no prior or present affiliation with DMC, DBLI or Group. The Subadviser has responsibility for Option Income and Priority Selection and it, too, has no prior or present affiliations with DMC, DBLI or Group. Until September 1, 1989, Mr. Glaser was President and a director of DMC, President, Chief Executive Officer and a trustee of the Trust and Senior Vice President and a director of DBLI. As president of DMC, Mr. Glaser's responsibilities were primarily administrative and marketing. Although as President, the portfolio managers technically reported to him, Mr. Glaser had no day-to-day responsibilities for portfolio selection. Mr. Glaser would periodically meet with the portfolio managers to review the existing portfolio for informational purposes only. Since the new management company, ZGA, became adviser to the Trust, Dr. Zweig supervises and directs the portfolio managers and their selections. Mr. Glaser continues to be responsible for overall administrative and marketing activities. Currently, there are no affiliations, as defined in Section 2(a)(3) of the Investment Company Act of 1940, between DMC, DBLI and Group, and any of their officers, directors or employees, and the Trust, ZGA, the Distributor, the Subadviser, or any of their officers, directors, trustees or employees. Nor is there any continuity of portfolio management or supervision for Blue Chip, Emerging Growth, Option Income, Convertible Securities, or Priority Selection Series. II. Discussion In the Philadelphia Fund, Inc. no-action letter (pub. avail. October 17, 1989) ("Philadelphia Fund") and in the Investment Trust of Boston Funds' no-action letter (pub. avail. April 13, 1989) ("Boston Funds"), the Staff took no- action positions concerning mutual fund advertising of performance figures in situations where there was a change of
  32. 32. 32 investment advisers. In both cases, the Staff advised that it would not recommend enforcement action if the performance data presented in advertisements, sales literature or omitting prospectuses covered only the period commencing with the new investment adviser because the new adviser had no prior affiliation with prior management. The Staff required that the advertisements or sales literature for those funds would clearly state: (1) the date of inception of the particular fund, and the fact that the fund was under different management; (2) that per share income and capital charges for the last 10 years were disclosed in the fund's statutory prospectus; and (3) that average annual total return figures for one, five and ten year periods were available on request. We believe that the facts set forth above, with respect to Blue Chip, Emerging Growth, Option Income, Convertible Securities and Priority Selection Series, and their total change in the management, are similar to those in the Philadelphia Fund and Boston Funds letters. We submit that here, as there, it is in the best interests of prospective shareholders that advertisements and sales literature reflect performance data commencing with September 1, 1989, the date of new management. We recognize that the Trust's situation is not totally on all fours with the situation in Boston Funds where there were no prior advisory personnel in common with new management. In Philadelphia Fund, however, the individual responsible for portfolio management, who is now sole shareholder of the new adviser, had joined the prior adviser approximately 18 months before. No-action assurance was requested for the advertised performance to commence with the date of this individual's assumption of management of the fund's portfolio, and not the date that the new adviser commenced management. We believe that this approach, which looks to the substance of the change, i.e., who had portfolio responsibility and when, is more important than the form, i.e., the mere fact of change in the corporate identity of the adviser. Therefore, in recognizing the continuity of certain of the portfolio managers themselves, even though they are now under Dr. Zweig's supervision, we are not seeking no-action relief for four of the series. We respectfully submit, however, that no-action relief for the other five series would be in the best interests of prospective shareholders. We believe that this request is consistent with the purposes underlying the amendments to Rule 482 of the Securities Act of 1933 and the adoption of new Rule 34b-1 under the Investment Company Act of 1940 . . . . As the Commission stated in proposing these changes, their primary purpose is to "enhance investors' ability to compare and evaluate investment company performance claims." In order for prospective shareholders to obtain a fair view of the series' performance, they must be able to evaluate the series' performance under current management. Otherwise, they will be making a comparison that has no validity. As required in Philadelphia Fund and Boston Funds, advertisements containing performance data from September 1, 1989 to the present will clearly indicate the date of inception of the series and the fact that the series previously operated under different management, state that the per share income and capital charges for the last ten years are disclosed in the Trust's statutory prospectus and indicate that average annual total return figures for one, five and ten year periods are available upon request.
  33. 33. 33 III. Conclusion In light of the reasons stated herein, and consistent with the Staff's positions in Philadelphia Fund and Boston Funds, and Commission intent in amending Rule 482 so as to enhance investors' ability to compare and evaluate fund performance, we respectfully request the Staff to advise us that it will not recommend enforcement action to the Commission if the Trust, ZGA and the Distributor do not include any period prior to September 1, 1989 for calculations of annual total return for Blue Chip, Emerging Growth, Option Income, Convertible Securities and Priority Selection Series of the Trust in omitting prospectuses, advertisements and sales literature of the Trust or any of the enumerated series. ... SEC REPLY Your letter . . . requests our assurance that we would not recommend that the Commission take any enforcement action against the Zweig Series Trust ("Trust"), or Zweig Securities Corp. (the "Distributor")[,] if investment results prior to September 1, 1989, for five series of the Trust are excluded from calculation of average annual total returns presented in advertisements under Rule 482[(d)](3) of the Securities Act of 1933 ("1933 Act") and sales literature under Rule 34b-1[b] of the Investment Company Act of 1940I ("1940 Act"). The Trust commenced operations on March 25, 1985, and was managed by Drexel Management Corporation ("DMC") until September 1, 1989. Since that time, Zweig/Glaser Advisers ("ZGA") has assumed management responsibilities for the Trust. ZGA is a partnership comprised of two corporations; one corporation is controlled by Mr. Eugene J. Glaser and the other is controlled by Dr. Martin E. Zweig. Mr. Glaser is President of ZGA, and Chairman and Chief Executive Officer of the Trust. Prior to September 1, 1989, Mr. Glaser was President and a director of DMC, and President, Chief Executive Officer and a Trustee of the Trust. You believe that the Trust's no-action request is similar to requests to which the staff has granted no-action relief. Your letter acknowledges that the [Investment Trust of Boston Funds] letter is generally not applicable to the Trust's situation[;] however[,] you believe that the Trust's request is similar to the Philadelphia Fund letter. We believe that the Philadelphia Fund letter is distinguishable from the circumstances outlined in your letter. In the [Boston Funds] letter, the staff granted no-action relief permitting a fund to present performance information under Rule 482[(d)](3) of the 1933 Act that reflected only the performance results of a new adviser, thus eliminating the performance results attained under a previous adviser. The staff response explicitly stated that it was based I I Editor's note: Rule 34b-1 was amended after the staff responded to the Zweig Series Trust request. The relevant portion of the Rule presently appears in subsection (b) (1)(iii).
  34. 34. 34 on the fact that all investment advisory and portfolio management services were provided and supervised exclusively by officers and employees of the new adviser who had no prior affiliation with the previous adviser or any of its affiliates. Similarly, in the Philadelphia Fund letter the staff permitted the funds to eliminate performance results achieved prior to the time that a new adviser provided investment advice to the funds. Because the new adviser was neither affiliated with, nor at any time under the control of, the adviser whose performance results the funds sought to omit, the staff permitted the Philadelphia Fund to present performance results that only reflected the results of the new adviser (and the prior adviser with which it was affiliated) rather than the one, five, and ten year periods required by Rule 482[(d)](3).4 We believe it important to emphasize that the Rule, by its terms, requires fund performance to be calculated for the one, five, and ten year time periods; the staff has carved a narrow exception to that requirement only when the performance results of the fund would include the performance results of an unrelated previous adviser. We believe that Mr. Glaser's positions (President and a director) with DMC, the Trust's previous adviser, as well as with affiliates of DMC, preclude the Series from eliminating their prior performance.5 Accordingly, we are unable to assure you that we would not recommend that the Commission take any enforcement action under Rule 482[(d)](3) of the 1933 Act or Rule 34b-1[b] under the 1940 Act, against the Trust or the Distributor if investment results prior to September 1, 1989, for the five series are excluded from calculations of average annual total return.6 4 4 In the Philadelphia Fund letter, three advisers had provided investment advice to the funds. The current adviser was affiliated with the prior adviser because a portfolio manager, Mr. Baxter, who had been solely responsible for providing investment advice to the investment companies when they were managed by the prior adviser, organized a corporate investment adviser, which is the current adviser to the funds, and became the President, Treasurer, sole director, and sole shareholder of that advisory firm. The funds sought to eliminate those performance results attained prior to Mr. Baxter's management of the funds. Because Mr. Baxter was affiliated with the prior adviser[,] only the perfor- mance results of the original adviser -- and not those of the prior adviser -- to the investment companies could be omitted from calculations of performance results. . . . 5 5You state that Mr. Glaser was also a Senior Vice President and a director of Drexel Burnham Lambert Incorporated, which wholly owned DMC. 6 6 Of course, Rule 482[(d)(5)] permits a fund to demonstrate its total return over different periods of time by means of aggregate, average, year-by-year, or other types of total return figures provided that, among other things, any nonstandardized return is accompanied by quotations of total return as required by Rule 482[(d)](3). Therefore, while the Trust may not omit the past performance results of the Series, under subparagraph [(d)(5)] of Rule 482 it may include average annual total return figures for the Series from September 1, 1989, in an advertisement that otherwise complies with the Rule. See The Fairmont Fund Trust (pub. avail. Dec. 9, 1988).
  35. 35. 35 North American Security Trust Securities and Exchange Commission No-Action Letter Publicly Available August 5, 1994 1994 SEC NOACT LEXIS 876 LETTER TO SEC We are writing on behalf of North American Security Trust ("NAST"), a registered management investment company, to request your assurance that you will not recommend to the Commission any action against NAST if, in advertising the performance of its Asset Allocation Trust ("New Trust") as permitted by Rule 482 under the Securities Act of 1933 ("1933 Act") and Rule 34b-1 under the Investment Company Act of 1940 ("1940 Act"), NAST uses, for periods prior to the establishment of the New Trust, the historical performance of a predecessor portfolio, the Moderate Asset Allocation Trust, the largest of three portfolios combined to form the New Trust. NAST is an open-end, management investment company . . . . It has a number of separate investment portfolios, each of which is represented by a separate series of shares of beneficial interest . . . . Prior to July 10, 1992, NAST had nine separate portfolios, three of which were designated the "Conservative Asset Allocation Trust," the "Moderate Asset Allocation Trust" and the "Aggressive Asset Allocation Trust." NASL Financial Services, Inc., a wholly-owned subsidiary of North American Security Life Insurance Company, . . . is NAST's investment adviser. Pursuant to its advisory agreement with NAST, it selects, contracts with and compensates subadvisers for each of NAST's portfolios. Prior to December 13, 1991, the subadviser for the Conservative, Moderate and Aggressive Asset Allocation Trusts and for three other NAST portfolios was M.D. Sass Investors Services, Inc. On that date, NAST's trustees accepted the resignation of that subadviser and retained as subadviser for certain of the portfolios, including the three Asset Allocation Trusts, Goldman Sachs Asset Management . . . . On January 31, 1992, the trustees of NAST approved a plan of reorganization providing for the combination of the Conservative, Moderate and Aggressive Asset Allocation Trusts into a newly-established portfolio, the New Trust. Following the approval of the plan of reorganization by shareholders of each of the affected portfolios, the combination of the three portfolios was implemented on July 10, 1992 by the transfer of all assets of each such portfolio to the New Trust, and the assumption of all liabilities of each such portfolio by the New Trust, in exchange for shares of the New Trust and the immediate distribution by each such portfolio, to its shareholders pro rata, of the New Trust shares it received from the New Trust. The three Asset Allocation Trusts were then abolished. Although effected by means of a newly-established portfolio, the reorganization was in substance a combination of the Conservative and Aggressive Asset Allocation Trusts with and into the Moderate Asset Allocation Trust, with the Moderate Asset Allocation Trust being the surviving entity. The investment objective, policies and
  36. 36. 36 restrictions of the Moderate Asset Allocation Trust were carried over without change to the New Trust. At the time of the reorganization, the net assets of the Moderate Asset Allocation Trust constituted 70% of the net assets of the New Trust, while the net assets of the Conservative and Aggressive Asset Allocation Trusts constituted 21% and 9%, respectively, of the net assets of the New Trust. In effect, shareholders of the Conservative and Aggressive Asset Allocation Trusts became shareholders of the Moderate Asset Allocation Trust. The reorganization had a limited effect on the individual securities held by the Moderate Asset Allocation Trust. At the time of the reorganization, all of the individual securities held by the Conservative and Aggressive Asset Allocation Trusts were also held by the Moderate Asset Allocation Trust. Moreover, sixty-two of the sixty-four securities then held by the Moderate Asset Allocation Trust were also held by each of the Conservative and Aggressive Asset Allocation Trusts. The principal difference in the three portfolios was the relative portion of assets held in three categories of securities -- equity, fixed income and money market. As here pertinent, Rule 482[(d)] under the 1933 Act requires, among other things, that any quotations of investment performance of NAST's non-money market portfolios used in advertisements permitted by the rule . . . include quotations of average annual total return for the one year period, and the period since inception, preceding the most recently completed calendar quarter. Rule 34b-1 under the 1940 Act would declare misleading any sales literature containing performance quotations for NAST's non- money market portfolios unless it contained, among other things, the total return information required by Rule 482[(d)]. For the one year period ending June 30, 1992, the total return . . . for the Conservative, Moderate and Aggressive Asset Allocation Trusts was 8.46%, 11.20% and 9.78%, respectively. For the period from inception (August 28, 1989) through June 30, 1992, the average annual total return so computed for such portfolios was 5.23%, 2.74%, and 2.51%, respectively. We believe that the requirements of the Commission's rules governing the advertising of investment company performance, in the context of the combination of the three Asset Allocation Trusts, are satisfied if the [N]ew Trust uses, for periods prior to the reorganization, the historical performance of the Moderate Asset Allocation Trust, provided the advertising material discloses that for the period prior to July 10, 1992 the performance used is that of the former Moderate Asset Allocation Trust. ... If the reorganization had been implemented by a combination of the Conservative and Aggressive Asset Allocation Trusts into the Moderate Asset Allocation Trust, there would be no basis for precluding the quotation of the Moderate Asset Allocation Trust's performance history prior to the date of the combination. In substance, such was the result of the reorganization. The two smaller portfolios were combined into a third, the investment adviser and investment objectives and policies of which were unchanged by the transaction. To preclude the quotation of the Moderate Asset Allocation Trust's historical performance because the combined assets were allocated to a new portfolio would seem to be nothing more than an elevation of form over substance.
  37. 37. 37 . . . A purpose of the Commission's performance quotation rules is to show investment experience for intermediate-term and long-term investors. Such purpose should be ignored only where a significant change, such as a change in manager or in investment objectives or policies, has occurred which makes use of performance data prior to the change potentially misleading. Where, as here, the only change in substance is a substantial increase in net assets, there is, in our view, no legitimate basis for depriving shareholders of the surviving portfolio, many of whom will have been shareholders of the predecessor portfolio, of information relating to the historical performance of the latter. In view of the foregoing, we request your concurrence in our view that historical performance quotations of the New Trust may, consistent with Rules 482 and 34b-1, reflect the performance of the Moderate Asset Allocation Trust for periods prior to the reorganization of the three Asset Allocation Trusts into the New Trust or, alternatively, your assurance that you will not recommend to the Commission any action against NAST if its advertisements of the historical performance of the New Trust include, for periods prior to the reorganization, the performance of the Moderate Asset Allocation Trust. NAST agrees that any performance of the Moderate Asset Allocation Trust will prominently disclose that fact. SEC REPLY Your letter . . . requests our assurance that we would not recommend that the Commission take any enforcement action if North American Security Trust ("NAST") advertises the performance of one of its portfolios, the Asset Allocation Trust ("New Trust"), as described in your letter. NAST . . . is an open-end management investment company. On January 31, 1992, NAST's trustees approved a plan to reorganize three of its portfolios -- the Conservative Asset Allocation Trust ("Conservative Trust"), the Moderate Asset Allocation Trust ("Moderate Trust"), and the Aggressive Asset Allocation Trust ("Aggressive Trust") (collectively, the "Asset Allocation Trusts") -- into a newly established portfolio, the New Trust. NAST implemented the reorganization on July 10, 1992.1 Rather than treating the New Trust as a new portfolio with no historical performance data prior to its establishment on July 10, 1992, you propose to advertise the historical performance of the New Trust using, for periods prior to July 10, 1992, the performance data for the Moderate Trust. You represent that any advertising material containing historical performance would prominently disclose that for the period prior to July 10, 1992, the performance used is that of the Moderate Trust. 1 1Each of the Asset Allocation Trusts transferred all of its assets and liabilities to the New Trust in exchange for shares of the New Trust, and immediately distributed New Trust shares pro rata to its shareholders. The three Asset Allocation Trusts were then dissolved.

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