Last week, the US Government Accountability Office released a report on mutual fund advertising documenting the results of a study mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Dodd-Frank legislation required the GAO to conduct a review of mutual fund advertising, focusing on the advertising of past performance information. This GAO's report examines (1) what is known about the effect of fund advertisements on investors, (2) the extent to which performance information is included in advertisements, and (3) the regulatory requirements for fund advertisements and how they are administered and enforced. In conducting its study, the GAO reviewed existing and proposed SEC and FINRA rules, conducted a literature review of studies related to mutual fund advertising's effect on investors, and reviewed a random sample of 300 fund advertisements. GAO also met with regulators, fund companies, academics, and industry and investor protection groups.
Among the report's key findings is that investors do not seem to be as influenced by mutual fund performance advertising as they may have been in the past. For the most part, this is due to the greater availability of other sources of information about retail mutual funds.
the extent to which investors rely on performance advertisements is unclear. Industry surveys show that investors are increasingly relying on information from financial advisors and other sources and use a variety of information—beyond performance information—when making investment decisions. GAO’s review of a random sample of mutual fund advertisements also revealed that advertising focusing on performance is generally not common.
The GAO also found that the policing efforts conducted by FINRA over investment company advertisements appears to be quite effective in curbing most, if not all, abuses:
Another factor that helps limit the potential for investors to be misled by fund advertising is an established regulatory review process of fund advertisements used by broker-dealers intended to be seen by the public at the time of first use. FINRA reviews all advertisements intended to be seen by the public and provides comment letters to fund companies that can require changes that must be made to advertisements or can prohibit advertisements from being used entirely. FINRA, which is overseen by SEC, also conducts special reviews on emerging industry issues at firms selling mutual funds that can help to identify potentially misleading advertisements.
The only issue identified by the GAO in its study was compliance errors in some fund advertising efforts, apparently as a result of changes to FINRA rule changes and interpretations that were not adequately communicated to funds creating the advertising pieces. This generated the GAO's only real recommendation is that FINRA better communicate interpretations and rule changes:
Because FINRA communicates some new interpretative positions initially by making comments on advertisements submitted for its review, only those firms that submit new advertisements learn of new interpretations of existing rules. As a result, they may be competitively disadvantaged if other firms attract additional investments by continuing to use previously approved advertisements that do not comply with the new position. In addition, this uneven method of communicating changes in rule interpretations can result in investors being exposed to advertising that does meet current standards and may be considered misleading.
To help ensure investors are better protected from misleading advertisements, SEC should take steps to ensure FINRA develops sufficient mechanisms to notify all fund companies about changes in rule interpretations for fund advertising.
The full text of the GAO's study is available at: http://www.gao.gov/new.items/d11697.pdf