G December 2003 New Disclosure Rules Impose Additional Requirements on Mutual Fund Advertisements By William M. Uptegrove, Esq. he Securities and Exchange Commission information in “tombstone” ads. Both of these T (“SEC”) adopted new rules recently that changes take effect on March 31, 2004, so it is will change the way mutual funds disclose important for funds to prepare to implement information. In the wake of Canary Capital changes now. Partners’ $40 million settlement with the Attorney Mutual Fund Advertisement Rules Prior General of New York, Elliot Spitzer, the SEC has to the Amendments been under increasing pressure to halt the perceived abuses in the mutual fund industry. The The federal securities laws mandate what any SEC’s new requirements likely represent only the company must disclose during the registration first salvo in the battle to reform the industry, and process. To protect the investing public, Congress constitute important changes that will impact passed the Act, which has two basic objectives: (1) mutual fund managers and investors alike. to provide investors with accurate information regarding securities that are offered for sale and (2) . . . the SEC is stepping up its scrutiny to prohibit fraudulent practices during the offer or of mutual funds. sale of securities. With these goals in mind, section 5 of the Act places certain constraints on The amendments primarily modify two rules individuals engaged in the offer or sale of promulgated under the Securities Act of 1933 (the securities. Section 5 requires the filing of a “Act”). First, the SEC amended Rule 482, which registration statement with the SEC prior to any permits funds to advertise more freely than other public offering. Once the registration statement is issuers by allowing them to omit certain information filed, a statutory waiting period commences. contained in their statutory prospectuses. Rule 482 During the waiting period, section 5 of the Act has been amended to encourage more complete and prohibits the distribution of any written material timely disclosures and to make it easier for investors unless it complies w ith the prospectus requirements of to access and understand the information provided section 10 of the Act. To comply w ith section 10(a), by funds. Second, the SEC rescinded Rule 134 as it an issuer must comply with a lengthy list of disclosures. applies to mutual funds. Prior to its rescission, Rule These disclosure requirements make it difficult for 134 allowed funds to advertise a broad range of issuers to advertise at all during the “w aiting period,” This document is published by Lowenstein Sandler PC to keep clients and friends informed about current issues. It is intended to provide general information only. L Roseland, New Jersey Telephone 973.597.2500 65 Livingston Avenue www.lowenstein.com 07068-1791 Fax 973.597.2400
G because the Act defines “prospectus” broadly (to imposing new disclosure requirements on mutual include radio and television). funds. These changes are in recognition that, in many ways, investment companies -- mutual funds in While the Act defines “prospectus” broadly, particular -- differ from other entities regulated under section 2(a)(10)(b) provides some relief by the Act. Unlike other issuers, the offering process of excluding certain communications from that a mutual fund is continuous. The continuous nature definition. Rule 134 implements this exception, of the offering process effectively prohibits any providing a safe harbor for ads that conform to its dissemination of written material to investors. requirements. Rule 134 lists twelve categories of information that may be provided in a “tombstone” “Substance of Which” Requirement ad without contravening the mandates of the Act. New Rule 482 eliminates the “substance of which” These categories include, among other things, the requirement, permitting funds to include a wider issuer’s name, the issuer’s type of business, and the range of information in their advertisements. That is, price of the securities to be offered. Over the years, the new rule provides greater flexibility by permitting Rule 134 has been broadened and, prior to the funds to use a section 10(b) summary prospectus in SEC’s recent amendment, mutual funds were lieu of providing information the substance of which permitted to advertise a broad range of information is included in the section 10(a) statutory prospectus. under the Rule. Although this change provides flexibility, funds must Notwithstanding the broadening interpretation, remain cautious when advertising. The elimination significant restrictions remained. Rule 482, of the “substance of which” requirement does not promulgated under the Act, attempted to alleviate alter a fund’s liability for making false or misleading these restrictions by permitting specific investment statements. Funds remain subject to liability for fraud companies to advertise more freely, while still under section 12(a)(2) of the Act and to the general complying with the Act’s prospectus requirements. anti-fraud provisions of the federal securities laws. In Originally, Rule 482 restricted advertisement content addition, funds still must file their advertisements to information the “substance of which” was included with NASD Regulation, Inc. (NASDR) or the SEC, in the statutory prospectus. Congress later expanded and the NASDR rules regulating fund the scope of permissible advertising to include advertisements will continue to apply. Given the information not encompassed by the statutory current environment, and the SEC’s stress on using prospectus requirements, so long as that information the anti-fraud provisions to protect investors, funds would not be materially false or misleading. must prepare their advertisements with great caution or risk costly litigation. Requirements Under the Amended Rules Elimination of the Tombstone Safe The SEC’s recent rule changes implement Harbor Congress’s more flexible advertising standard, while The elimination of the “substance of which”
G requirement has, in the view of the SEC, made the its strong past performance, without disclosing “tombstone advertisement” safe harbor superfluous, more recent poor performance. The amended Rule as applied to mutual funds. Therefore, the SEC 482 addresses this concern by requiring funds that rescinded provisions of Rule 134 that had permitted advertise performance information to make investment companies to include a broad range of available total return quotations current to the information in tombstone advertisements. While most recent month-end. These additional Rule 134 will remain effective for other issuers, disclosures must be accessible to investors, via a investment companies may no longer rely on it. toll-free (or collect) telephone number or website, within three calendar days of the applicable month- Elimination of “Boilerplate” Disclosures end. The SEC hopes that by giving investors more The SEC intends to make fund disclosures more current information, it will enhance investor intelligible by eliminating the requirement that protection and prevent unrealistic expectations funds provide certain information in their about future performance. advertisements. The SEC expects the elimination Specific Required Disclosures of certain prospectus information, such as boilerplate disclosures about how performance is In addition to making funds’ advertisements calculated, to improve investors’ understanding of more understandable and timely, the SEC amended the information they do receive. Rule 482 to require specific disclosures when funds advertise performance figures. Presently, Rule 482 Availability of Up-to-Date Information requires funds that advertise to disclose: The SEC plans to eliminate the “selective use” of · a source from which an investor may obtain a information by making more current information prospectus containing more complete available to investors. Previously, mutual fund information about the fund; advertisements could indicate a fund’s performance · that the performance data quoted represents for a certain period, and therefore, according to the only past performance; and SEC, suggest to potential investors that such past · performance was reasonable prediction of future for a non-money market fund, that the performance. Rule 482 allowed a mutual fund to investment return and principal value will advertise its performance for any period as long as it fluctuate so that an investor’s shares, when provided the fund’s performance for 1-, 5-, and 10- redeemed, may be worth more or less than year periods (or, if shorter, for the life of the fund) their original value. current to the most recent quarter. That quarterly Amended Rule 482 requires that funds provide data, however, could be as much as three months old. additional, and more conspicuous, information This three month gap concerned the SEC. when using advertisements containing performance During that gap, a fund’s advertisements could tout figures. The new rule requires:
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