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Section 206 of the
Investment Advisers Act prohibits fraud, deception or manipulation,
regardless of whether the fund manager is registered. Once registered, Rule 206(4)-1
imposes additional restrictions on advertising that the SEC has determined
would be fraudulent, deceptive or manipulative.
The first item on the list of fraudulent, deceptive or
manipulative practices is testimonials,
which I wrote about earlier. The second item in the advertising rule is a prohibition
on using past performance in an advertisement, subject to some limitations.
I also wrote about that last week.
One of the controversial standards when using performance
results is that they must be shown net of fees.
In a 1986
No Action Letter to Clover Management the SEC said it was their view that
"Rule 206(4)-1(a)(5) prohibits an advertisement that: ... (2) Includes model or
actual results that do not reflect the deduction of advisory fees, brokerage or
other commissions, and any other expenses that a client would have paid or
actually paid; "
Can you just include a description of your fees? No.
[B]ecause advertisements typically present adviser
performance results over a number of
years, narrative disclosure of the existence and range of advisory fees, in our
not be an adequate substitute for deducting advisory fees because of the
effect on performance figures that occurs if advisory fees are not deducted. In
our view it is
inappropriate to require a reader to calculate the compounding effect of the
expenses on the advertised performance figures. Investment Company Institute No
Action Letter (1987)
But you can include gross returns, as long as they are
side-by-side with net of fees results. See Association of Investment
Management and Research (1996). Both the net and gross performance figures need
to be presented in an equally prominent manner. The "advertisement" must contain
sufficient disclosure to ensure that the performance figures are not
misleading. For example, when showing a performance figure gross of fees there
should be a disclaimer that the figures do not reflect the payment of
investment advisory fees and other expenses.
additional commentary on developments in compliance and ethics, visit Compliance Building,
a blog hosted by Doug Cornelius.
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