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United States Government Accountability Office: 
GAO: 

Report to Congressional Committees: 

July 2011: 

Mutual Fund Advertising: 

Improving How Regulators Communicate New Rule Interpretations to 
Industry Would Further Protect Investors: 

GAO-11-697: 

GAO Highlights: 

Highlights of GAO-11-697, a report to congressional committees. 

Why GAO Did This Study: 

Mutual funds are one of the most widely held investment products by 
Americans and advertising is one method by which investors may obtain 
information on funds. The Dodd-Frank Wall Street Reform and Consumer 
Protection Act requires GAO to conduct a review of mutual fund 
advertising, focusing on the advertising of past performance 
information. This report examines (1) what is known about the impact 
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. To address these objectives, GAO reviewed 
existing and proposed Securities and Exchange Commission (SEC) and 
Financial Industry Regulatory Authority (FINRA) rules, conducted a 
literature review of studies related to mutual fund advertising’s 
impact 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. 

What GAO Found: 

While some academic studies and others have suggested that 
advertisements that emphasize a fund’s past performance can influence 
investors to make inappropriate investments, the evidence that 
investors are harmed by these advertisements is mixed. Some academics 
believe that because research has shown that past performance 
generally does not persist and is not predictive of future 
performance, performance advertisements are inherently misleading. 
However, some studies illustrate that investors who are influenced by 
performance advertising may still achieve returns that exceed market 
indexes or other funds. In addition, 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. Of the six different advertising methods we included in our 
review—brochures, press releases, print media, the Internet, radio, 
and television—we estimate that 9 percent emphasized a fund’s 
performance and 35 percent contained some type of performance 
information. For example, many of these included the standardized 
presentation of the fund’s performance over a 1-, 5-, and 10-year 
period, and others presented information on a fund’s performance 
ranking relative to other funds. Fund company staff noted that, 
although performance information is not the focus of most 
advertisements, investors can still seek it out from required 
disclosure documents or public Web sites. 

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. However, fund company 
representatives expressed concerns that FINRA does not always 
effectively communicate changes in advertising rule interpretations 
that arise when the regulatory staff identify concerns about new 
material being advertised by fund companies. 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. 

What GAO Recommends: 

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. Both SEC and FINRA agreed 
with the recommendation. 

View [hyperlink, http://www.gao.gov/products/GAO-11-697]. For more 
information, contact Alicia Puente Cackley at (202) 512-8678 or 
cackleya@gao.gov. 

[End of section] 

Contents: 

Letter: 

Background: 

Although Academics and Others Argue That Investors Could Be Harmed by 
Performance Advertisements, Evidence of Impact Is Mixed: 

Limited Use of Performance Information in Advertising also May Limit 
Its Influence on Investors: 

Although the Regulatory Review Process Limits Potential for Misleading 
Advertisements, Communication of Rule Interpretation Changes Has Been 
Uneven: 

Conclusions: 

Recommendation for Executive Action: 

Agency Comments and Our Evaluation: 

Appendix I: Objectives, Scope, and Methodology: 

Appendix II: Comments from the Financial Industry Regulatory Authority: 

Appendix III: Comments from the Securities and Exchange Commission: 

Appendix IV: GAO Contact and Staff Acknowledgments: 

Appendix V: Bibliography: 

Tables: 

Table 1: Ways in Which Performance Was Presented in Advertisements 
That Included Any Performance Information, 2006 through 2010: 

Table 2: Stratified Population of Advertisements Submitted to FINRA 
and Sample Sizes of GAO Review: 

Figures: 

Figure 1: The Prevalence of Types of Information Included in 
Advertisements with Performance Information, 2006 through 2010: 

Figure 2: The Prevalence of Types of Information Included in 
Advertisements without Performance Information, 2006 through 2010: 

Figure 3: Examples of Components of Advertisements That Would Not Be 
Found Compliant with Applicable Standards: 

Abbreviations: 

AREF: Advertising Regulation Electronic Files: 

DOL: Department of Labor: 

ETF: exchange-traded funds: 

FINRA: Financial Industry Regulatory Authority: 

NAV: net asset value: 

SEC: Securities and Exchange Commission: 

[End of section] 

United States Government Accountability Office: 
Washington, DC 20548: 

July 26, 2011: 

The Honorable Tim Johnson: 
Chairman: 
The Honorable Richard C. Shelby: 
Ranking Member: 
Committee on Banking, Housing, and Urban Affairs: 
United States Senate: 

The Honorable Spencer Bachus: 
Chairman: 
The Honorable Barney Frank: 
Ranking Member: 
Committee on Financial Services: 
House of Representatives: 

Mutual funds are companies that pool money from many investors and 
invest it in stocks, bonds, and other securities or assets. They are a 
popular investment product, with about 90 million Americans owning 
shares in them in 2010. For many, mutual funds play an important role 
in saving for retirement. Thus, ensuring that investors are 
knowledgeable about the factors to consider when purchasing mutual 
funds and clearly understand the risks associated with their 
investments is important. According to some academic studies, 
investors can be overly influenced by a fund's past performance and 
advertising that emphasizes superior past returns--that exceed those 
of similar funds or market indexes--which can lead them to make poor 
choices or experience lower returns later. 

Advertisements are one method by which investors can obtain 
information about mutual funds. While advertisements can include 
different kinds of information about mutual funds, including 
performance, some advertisements focus mainly on a fund's performance. 
Both the Securities and Exchange Commission (SEC) and the Financial 
Industry Regulatory Authority (FINRA)--a self-regulatory organization--
have specific rules that govern the content of mutual fund 
advertisements, including rules on the calculation and presentation of 
performance information.[Footnote 1] 

This report responds to Section 918 of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (Dodd-Frank Act), which requires 
GAO to conduct a study on mutual fund advertising.[Footnote 2] Our 
objectives are to examine (1) what is known about the impact of mutual 
fund advertisements on investors, (2) the extent to which performance 
information is included in mutual fund advertisements, and (3) the 
regulatory requirements that exist for mutual fund advertisements and 
how they are administered and enforced. 

In addition to mutual funds, we included exchange-traded funds (ETF) 
in our review. ETFs are similar to mutual funds in that they are most 
commonly structured as open-end investment companies and offer 
investors a proportionate share in a pool of stocks, bonds, and other 
assets.[Footnote 3] We included ETFs because of their increasing 
popularity as investment vehicles. Throughout this report, we use the 
term "fund advertisements" to refer to mutual fund and ETF 
advertisements. To examine what is known about the impact of fund 
advertisements on investors, we conducted a literature review of 
existing studies and reports that included explorations of investors' 
usage of past performance information in fund purchases; the 
persistence of fund past performance; the effectiveness of existing 
regulatory disclosures; and the importance of various information 
sources, including advertisements, in investors' selection of funds. 
We also met with academics, representatives of industry and investor 
protection groups, and fund companies to discuss the impact of 
performance advertising on investors. To determine the extent to which 
fund advertisements contain performance information, we selected and 
reviewed a random sample of 300 mutual fund and ETF advertising 
materials--including brochures, press releases, public Web site 
content pieces, print advertisements, radio, and television 
advertisements--out of the universe of about 71,000 individual pieces 
that were reviewed and deemed compliant with applicable standards by 
FINRA during calendar years 2006--2010, which was the period for which 
data was available. For each of these advertisements, we collected 
information on whether the advertisements contained performance 
information and, if so, what kind, as well as other types of 
information. We based the selection of the 6 delivery methods on our 
initial review of about 200 advertisements submitted for FINRA review 
in 2010 in which all 21 delivery methods were represented.[Footnote 4] 
For each delivery method, we reviewed the different types of 
information contained in the materials and selected the six methods 
that retail investors would be more likely to encounter in their daily 
activities--such as advertisements that appear in print media or on 
the Internet. All estimates from the sample in this report have a 
margin of error of plus or minus 10 percentage points or less. We 
performed a data reliability assessment for data used in our 
generalizable sample and determined that the data were sufficiently 
reliable to perform our review and project our results to the six 
delivery methods in our population of advertisements. Additionally, we 
selected and interviewed a nongeneralizable sample of 18 fund 
companies on the advertising practices they currently used. We 
included the 10 companies that had filed the most mutual fund 
advertisements for review with FINRA in 2009, as well as the 5 
companies that had filed the most ETF advertisements.[Footnote 5] We 
also selected three fund companies (two offering mutual funds and one 
that offered ETFs) that filed fewer numbers of advertisements in 2009. 
Finally, we also interviewed three companies from a list of five that 
the Investment Company Institute--the mutual fund industry's trade 
organization--had identified as likely to have relevant perspectives 
on this issue. To describe the regulatory requirements for fund 
advertisements and how they are administered and enforced, we reviewed 
the rules and requirements related to fund advertisements, including 
proposed SEC and FINRA rules and public comments received on those 
rules. We met with SEC and FINRA officials to discuss the methods used 
to enforce these requirements and the process FINRA uses to review 
fund advertisements. For a more detailed discussion of our scope and 
methodology, see appendix I. 

We conducted our work from September 2010 to July 2011 in accordance 
with generally accepted government auditing standards. These standards 
require that we plan and perform the audit to obtain sufficient, 
appropriate evidence to provide a reasonable basis for our findings 
and conclusions based on our audit objectives. We believe that the 
evidence obtained provides a reasonable basis for our findings and 
conclusions based on our audit objectives. 

Background: 

The percentage of U.S. households owning mutual funds has grown from 
about 6 percent in 1980 to about 44 percent in 2010 with about 90 
million individual investors owning mutual fund shares.[Footnote 6] 
Most mutual funds continuously offer new shares to investors, and 
investors purchase and redeem shares directly from the fund. The price 
per share is known as the net asset value (NAV), which represents the 
difference between the market value of the fund's assets and its 
accrued liabilities divided by the number of outstanding shares. NAVs 
are calculated at least once each trading day--usually at 4:00 p.m. 
Mutual funds are "forward priced," meaning, for example, that for a 
fund with a 4:00 p.m. cut off time, orders to sell or redeem mutual 
fund shares received prior to 4:00 p.m. receive the price determined 
that same day at 4:00 p.m. Investors pay mutual fund fees including, 
among others, operating expenses, which cover the day-to-day costs of 
running a fund. These expenses are accrued daily, and generally paid 
monthly, from overall fund assets rather than from individual investor 
accounts. Generally shown as a percentage of the fund's average net 
assets, the annual total operating fee amount is referred to as the 
fund's operating expense ratio. 

Over the past decade, demand for a new type of investment company 
product known as ETFs has grown significantly both as an institutional 
and retail product. An ETF is an investment company whose shares, 
unlike those of mutual funds, are traded throughout the day on stock 
exchanges at market-determined prices that constantly fluctuate. 
Investors may buy or sell ETF shares through a broker just as they 
would the shares of any publicly traded company. Many ETFs aim to 
achieve the same return as a particular market index, such as the S&P 
500 index, while others invest in a unique mix of assets to meet a 
particular investment objective. 

Mutual Funds Overseen by Securities Regulators and Various 
Requirements Apply to Fund Advertising: 

As the primary regulators of mutual fund advertising, SEC and FINRA 
have cooperated in carrying out their respective roles, with SEC 
generally setting the regulations for mutual fund advertising and 
FINRA generally enforcing those regulations, although FINRA also has 
adopted rules of its own. SEC regulates mutual funds under the 
Investment Company Act of 1940 (Investment Company Act), the 
Investment Advisers Act of 1940, the Securities Act of 1933, and the 
Securities Exchange Act of 1934. The Investment Company Act was passed 
specifically to regulate mutual funds and other types of investment 
companies.[Footnote 7] Under the Investment Company Act, mutual funds 
are required to register with SEC, subjecting their activities to SEC 
regulation. The Securities Act requires that investors receive 
adequate and accurate information about mutual funds. FINRA is a self 
regulatory organization that has primary responsibility, under the 
Securities Exchange Act, for regulating its member broker-dealers, 
including their mutual fund sales practices, subject to SEC oversight. 
[Footnote 8] Because virtually all firms that market and sell fund 
shares are FINRA members, FINRA is an important source of information 
and guidance on advertising for mutual funds. 

Key rules that apply to mutual fund and ETF advertisements include: 

* Securities Act, SEC Rule 482. Includes specific performance 
presentation and calculation standards, such as the requirement that 
performance information be presented as the average annual return for 
1-, 5-, and 10-year periods. This rule also contains disclosure 
requirements, including, among others, alerting investors to consider 
the investment objectives, risks, charges, and expenses of mutual 
funds and stating that past performance does not guarantee future 
results. Finally, the rule also contains presentation standards on the 
type size, type style, prominence, and proximity that must be used in 
materials. For example, among other things, disclosure statements must 
be presented in a type size at least as large as that used in the 
major portion of the advertisement and required disclosures must be 
presented in close proximity to the performance data contained in an 
advertisement. 

* Investment Company Act, SEC Rule 34b-1. Applies the standardized 
performance requirements of Rule 482 to advertising materials that are 
preceded or accompanied by the fund's prospectus. 

* Securities Act, SEC Rule 156. Provides general guidance on how fund 
advertising may be determined to be materially false or misleading. 
Advertising is materially misleading if it contains an untrue 
statement of a material fact or it omits a material fact that is 
necessary in order to make it not misleading. 

* NASD Rule 2210. Entitled "Communications with the Public," this rule 
provides content requirements and prohibits misleading advertisements 
by broker-dealers. It directs that, among other things, communications 
with the public must be fair and balanced; may not omit material 
facts; must not contain false or exaggerated statements; and may not 
predict or project performance or imply that the past performance will 
recur. In addition to these general standards, the rule has specific 
disclosure requirements in a number of areas, such as communications 
with the public that contain testimonials and comparative information 
such as rankings. 

SEC, the Department of Labor (DOL), and FINRA also have proposed new 
rules concerning the advertising materials of funds: 

* SEC Target-Date Fund Rule. In June 2010, SEC issued proposed 
regulations that addressed the advertising and naming of target-date 
funds (also known as life-cycle funds).[Footnote 9] Target-date funds 
take into account an individual's age or retirement date and its 
investments generally are designed to become more conservative as an 
investor approaches retirement. The proposed rule would, among other 
things, require a target date fund that includes the target date in 
its name to disclose the fund's asset allocation at the target date 
immediately adjacent to the first use of the fund's name in 
advertising materials and require advertising materials to include a 
table, chart, or graph depicting the fund's asset allocation over 
time, together with a statement that would highlight the fund's final 
asset allocation. The public comment period for the rule closed in 
August 2010, but as of July 2011, the rule has not yet been finalized. 

* DOL Target Date Disclosure Rule. In November 2010, DOL also released 
proposed regulations on target-date fund disclosures.[Footnote 10] DOL 
has designated target date funds as one of the types of qualified 
default investment alternatives, which are investments into which 
retirement plans can automatically place participants and obtain 
limited fiduciary relief if the participants do not choose their own 
investments. The proposed rule would require specific disclosures to 
be made for target date funds that are used as qualified default 
investment alternatives. For example, target date fund disclosures 
would require, among other things, an explanation of how the fund's 
asset allocation will change over time, and the point in time when it 
will reach its most conservative position; a table, chart, or graph 
that illustrates how the fund's asset allocation will change over 
time; and for a target date fund that refers to a particular date (for 
example, "Retirement 2050 Fund"), an explanation of the relevance of 
the date. Both SEC and DOL proposed rules contain some similar 
provisions that, if finalized, would help ensure that investors 
generally obtain more accurate information about target date funds, 
but differences do exist in the two agencies' proposed regulations. 
The public comment period for the rule ended in January 2011, but as 
of July 2011, the rule has not yet been finalized. 

* FINRA Communications with the Public. In September 2009, FINRA 
issued a regulatory notice proposing new rules governing broker-dealer 
communications with the public.[Footnote 11] The rules would employ 
new communications categories and require filing for certain types of 
communications currently not covered by existing filing requirements; 
for example, communications regarding ETFs that are not registered 
investment companies. Communications that currently qualify as 
advertisements under FINRA rules generally could fall under the new 
communications category, "retail communications," which would include 
any written (including electronic) communication that is distributed 
or made available to more than 25 retail investors. FINRA officials 
stated that they have submitted a draft of the proposed rule to SEC, 
but did not know when the final rule would be issued. 

Although Academics and Others Argue That Investors Could Be Harmed by 
Performance Advertisements, Evidence of Impact Is Mixed: 

Some academics and representatives of investor protection 
organizations expressed concerns that mutual funds that advertise 
superior performance--exceeding those of similar funds or market 
indexes--can adversely affect investors. Academics and regulators 
consider a mutual fund's past performance not to be a reliable 
indicator of future performance because any superior performance by 
funds generally does not persist for long periods of time. As part of 
conducting a search for literature relating to mutual funds' 
performance, we identified various papers that examined whether mutual 
funds can consistently exhibit superior performance. We also reviewed 
studies that these papers frequently cited as also addressing this 
topic. Many of these studies generally concluded that funds that 
exhibited superior performance were not able to persistently sustain 
their performance over long periods.[Footnote 12] For example, one 
study examined the performance records of about 1,900 equity mutual 
funds during 1962 through 1993. The author of this study compiled the 
gross investment returns--those that include expense ratios--of these 
funds and ranked the funds by their return for 1 year and then 
compared each funds' ranking in the year following the initial 
ranking. The author concluded from this analysis that funds that have 
superior returns (winners) are somewhat more likely to continue to 
perform well in the following year and funds that have poor returns 
(losers) are more likely to continue such performance or cease 
operations. However, the funds in the top 10 percent of returns differ 
substantially each year, with these top-performing funds frequently 
becoming the next year's worst performers and vice versa. 
Additionally, the study also examined 2-to 5-year returns and found 
that funds with superior returns in 1 year generally did not continue 
to experience these returns over the longer period.[Footnote 13] 
Academic research also generally reports that funds are unable to 
continue superior performance because their returns are likely the 
result of chance rather than the skill of the fund manager. For 
example, because there are a large number of mutual funds, by chance 
alone, some will outperform market indexes regardless of the fund 
manager's asset-selection ability. Three papers we reviewed found that 
chance accounted for almost all of the funds that had superior 
returns.[Footnote 14] For example, the authors of one of these studies 
used monthly returns of 2,076 actively managed U.S. domestic equity 
mutual funds that existed at any time between 1975 and 2006. The 
authors explained that, by chance alone, a certain expected percentage 
of these funds will achieve levels of returns significant enough to 
cover their trading costs and expenses (including fees). They applied 
a statistical technique designed to determine if the returns observed 
for the 2,076 funds were significantly different from those that would 
be expected from chance. After conducting their analysis, the authors 
estimated that the majority--about 75 percent of the 2,076 funds they 
examined--had managers with stock-picking skills such that their 
incremental returns were just sufficient to cover their trading costs 
and other expenses, and more than 24 percent exhibited no skill and 
thus were unable to produce additional returns sufficient to overcome 
their trading costs and expenses. Although the authors found that 
about 0.6 percent of managers of all funds overall appeared to exhibit 
skill in investment selection sufficient to produce returns beyond the 
level needed to cover their expenses, this proportion was not 
significantly different than zero.[Footnote 15] 

Because of the inability of most mutual funds to continually maintain 
superior returns, some academics told us that allowing mutual funds to 
advertise past performance information is inherently misleading to 
investors because if they invest in funds with superior past 
performance, they are not likely to experience similar results. Some 
academics note that mutual fund firms are likely to advertise those 
funds that do have superior performance to attract investor fund flows 
and studies done on this issue confirmed that mutual fund firms choose 
their highest-performing funds to advertise. For example, these 
studies found that advertised mutual funds are typically some of the 
highest-performing funds for fund families and also have significantly 
superior performance compared with other mutual funds.[Footnote 16] 
One study that we reviewed found that the 1-year performance records 
before funds are advertised were much higher than nonadvertised funds. 
For example, the study found that advertised funds' 1-year returns 
averaged about 26 percent, compared with about 6 percent for funds 
that were similar, but not advertised. Additionally, it found that 1 
year after the advertisement, the funds did not exhibit superior 
performance relative to various benchmarks.[Footnote 17] Therefore, 
investors influenced by advertisements that tout superior past 
performance and that base their purchase decisions on these 
advertisements are unlikely to experience similar levels of returns. 
One consumer advocate with whom we spoke stated that she hears 
complaints from investors when they lose money after purchasing funds 
based on their superior performance levels and the performance levels 
are not sustained. Representatives of some mutual fund firms with whom 
we spoke confirmed that they choose which funds to advertise based on 
the fund's performance level or rankings by industry research 
organizations such as Lipper and Morningstar, Inc., which periodically 
issue comparative ratings and rankings of funds' performance over 
different time periods.[Footnote 18] For example, one service has 
developed a rating system that categorizes funds by "stars." A fund 
that receives a "5 star" rating is a fund that achieved returns that 
fell within the top 10 percent of its peers for a set period of time. 

While much of the literature we reviewed finds that past performance 
does not persist over the long-term and superior returns are the 
result of chance, some literature contradicts these findings and other 
literature provides mixed evidence of the actual harm to investors 
from performance advertising. For example, we reviewed studies that 
found that some funds did exhibit some superior performance 
persistence over various short-term periods.[Footnote 19] For example, 
one study that reviewed no-load growth-oriented mutual funds during 
1975-1988, found that those that had superior performance in the most 
recent year continued to be superior performers in the following 1 to 
8 quarters.[Footnote 20] Another study found superior performance 
persistence over 1-and 2-year intervals from 1976 to 1994 and another 
found it over 5-year periods from 1974 to 1984.[Footnote 21] 

Additionally, other studies illustrate that investors who are 
influenced by funds advertising superior performance may not always be 
harmed as a result of such reliance. For example, even if a fund's 
advertised superior performance is not replicated in subsequent 
periods, such funds still may continue to have positive returns, 
including those that exceed the returns on market indexes, similar 
funds, or other alternative investments. Research by one mutual fund 
company showed that persistent superior performance by a fund is 
difficult to achieve, with only 21 percent of funds that were in the 
highest quintile of performance over the 5-year period ending December 
1997 achieving performance that ranked them in the highest quintile in 
the following 5-year period.[Footnote 22] However, although this same 
research showed that about 34 percent of the top performing funds in 
the first 5-year period ended up in the lowest 2 quintiles in the next 
5-year period, 41 percent of the top performing funds were at least in 
the top 2 quintiles in that subsequent 5-year period. Although this is 
about the proportion that would be expected to perform that way if 
returns are completely the result of chance, nevertheless, investors 
who bought in the first period as a result of any advertised 
performance by those funds and held their investment throughout the 
second period would still have been in a fund that performed better 
relative to a majority of other funds. 

Finally, some academics expressed concerns about the advertising of 
performance information for "incubated" funds.[Footnote 23] Mutual 
fund incubation is a strategy that some fund families use to develop 
new funds and involves a fund company creating a number of start-up 
funds, seeded with the company's or other private money, which are not 
marketed to the public.[Footnote 24] Academics argue that incubated 
funds generate investor protection concerns because any superior 
performance returns likely would not be continued. One study that 
analyzed returns from about 1,000 new U.S. domestic equity funds from 
1996 to 2005 found that the new funds that were incubated outperformed 
the nonincubated funds annually by 3.5 percent on a risk-adjusted 
basis. However, in the post-incubation period, the funds that had been 
incubated did not exhibit superior performance relative to 
nonincubated funds.[Footnote 25] The superior performance of an 
incubated fund may not be sustainable for several reasons. First, some 
academics have noted that fund companies may provide various 
advantages to the fund that will not be available later, such as 
granting the fund large portions of shares from "hot" initial public 
offerings that are more likely to rise quickly in price.[Footnote 26] 
Because incubator funds generally are small, even a small allocation 
of hot IPO shares can significantly boost returns. However, during the 
post-incubation phase when the fund is marketed to the public and more 
investors purchase it, the fund's larger size makes it more difficult 
for the fund manager to achieve the same level of returns because 
identifying sufficient numbers of assets with good return prospects 
becomes more challenging. Second, these academics believe that 
incubated funds are misleading to investors if companies publicly 
registered and marketed only the most successful ones without 
disclosing the number of incubated funds that did not produce superior 
returns. This would make the fund manager appear to have had special 
asset-picking abilities when, instead, the fund's returns were more a 
matter of chance. 

Performance Advertising May Lead Investors to Purchase Funds at 
Inopportune Times: 

Investors who purchase shares of funds that advertise superior past 
performance also may be harmed by buying at disadvantageous times 
compared with other investors. Many academics warn that most investors 
lack the ability to recognize the most appropriate time to make 
investments, and thus they discourage investors from attempting to 
"time the markets" with their purchases. These academics find that 
many investors invest when markets have risen and sell when they have 
declined and thus too often miss the best returns compared with 
investors who practice a strategy known as "buy and hold," in which 
investors purchase funds, hold them for extended periods, and are not 
influenced by short-term movements in price. To avoid adverse 
investment returns that can result from poor market timing, others 
advocate dollar-cost averaging, in which investors regularly 
contribute the same amount of money to their investment accounts. This 
strategy helps to smooth out the effects of market fluctuations 
because investors are able to purchase more shares when the price is 
low and fewer shares when the price is high and lessens the risk of 
making a larger lump-sum purchase when the price is high. 

Academics and others noted that investors who continually purchase 
shares of funds that advertise superior performance are more likely to 
experience lower returns as a result of poor market timing of such 
investments. Some studies have found that this strategy results in 
underperformance by investors relative to investors who use a buy-and- 
hold strategy.[Footnote 27] For example, one study found that between 
1991 and 2004 equity fund investors' timing decisions reduced their 
average returns by about 1.6 percent annually.[Footnote 28] 
Furthermore, agency officials and representatives of mutual fund 
companies with whom we spoke, as well as some researchers, said that 
more advertisements showing superior past returns for mutual funds 
appear after the market has performed well. However, investors who are 
influenced by these advertisements generally are purchasing the funds 
as their performance is beginning to decline and will be more 
adversely affected than if they had used dollar-cost averaging to 
invest. 

Evidence on the Impact of Advertising Is Mixed: 

The extent to which investors are influenced to make investments by 
mutual fund performance advertising is mixed. Various academic studies 
have been published that find that performance advertising does 
influence investors' decisions. First, multiple studies have found 
that investors place more attention on a fund's past performance than 
on other fund characteristics.[Footnote 29] For example, one study 
that tested investors' reactions to the inclusion of fund expense 
ratios in performance advertisements found that, despite the prominent 
presence of fund expense information, investors overwhelmingly 
continued to use past performance information when forming preferences 
for mutual funds.[Footnote 30] Additionally, a survey of mutual fund 
investors conducted by an industry trade group found that about 70 
percent considered past performance before their most recent fund 
purchase.[Footnote 31] 

Multiple studies also have found that funds with superior performance 
tend to attract larger investment inflows.[Footnote 32] Studies we 
reviewed examined fund performance between 1969 and 2001 and found 
that new investments into funds are related to funds' performance 
levels, with funds that have superior performance levels receiving 
more new investments. For example, one study found that investor 
inflows depend both on a fund's industry rank within its market 
segment and its performance compared with funds offered by the same 
fund company.[Footnote 33] The study reviewed U.S. equity funds 
between 1993 and 2001 and found that funds in the top quintile of 
their industry segment received larger inflows than funds in lower 
quintiles. Additionally, only funds with the highest returns within a 
particular fund companies' offerings received large additional 
inflows. Because past performance drives new fund investments, one 
study we reviewed found that fund companies that utilize performance 
advertising receive the highest levels of new investments in 
advertised funds, showing that performance advertising does have some 
impact on investors' mutual fund purchase decisions. For example, it 
found that inflows to advertised funds were about 20 percent larger 
than those for nonadvertised funds with similar characteristics. 
[Footnote 34] Another study found that Morningstar ratings--which are 
based on a fund's performance record--also have a significant impact 
on mutual fund flows. Funds that moved from a 4-star to a 5-star 
rating (the highest rating) often experienced the largest increase in 
investor fund flows in the 6 months following the upgrade, with these 
funds receiving about 35 percent above normal expected flow.[Footnote 
35] 

However, other evidence indicates that fund advertising may not overly 
influence investors' fund investment decisions. Some studies have 
found that investors do not use fund advertisements as an important 
information source in their fund purchase decision. One investor 
survey that surveyed a representative sample of about 2,000 Americans--
both those that invest in mutual funds and those that do not--in 
September 2005 found that the vast majority regarded advertisements as 
either "not very" or "not at all" influential. The survey included 
mutual fund investors who purchase most of their mutual funds directly 
from the fund company or through a discount broker or fund 
supermarket; purchase most of their funds through a financial services 
professional, such as a broker or financial planner; and purchase most 
of their funds through a workplace-based retirement plan.[Footnote 36] 
Some studies have shown that although investors use performance 
information when making mutual fund purchase decisions, they also 
utilize a variety of other information. For example, one study found 
that before purchasing a mutual fund, investors review, on average, 
nine pieces of fund information including fees and expenses, risks, 
and price per share.[Footnote 37] 

Further, investors have access to a great deal of information 
regarding mutual funds beyond the information contained in 
advertisements. Numerous mutual fund information sources exist 
including required disclosure documents--fund prospectuses and 
statements of additional information--that contain information on 
funds' investment objectives, risks, fees and expenses, and past 
performance; Web sites provided by industry research organizations; 
investment periodicals; and financial advisers. Additionally, 
investors' usage of the Internet also has grown over time, which has 
made access to performance and other fund information easier. A survey 
by an industry trade group of 4,200 U.S. households--both those that 
own and do not own mutual funds--found that 9 of 10 households that 
own mutual funds have Internet access in 2010 and that almost 60 
percent use it to obtain investment information.[Footnote 38] Many 
mutual fund investors also use advice from financial advisers as an 
important source of information when considering which mutual funds to 
purchase. An industry survey showed that in 2006, 73 percent of recent 
mutual fund investors consulted a financial adviser before purchasing 
a fund. Another survey revealed that in 2010, about half of all mutual 
fund-owning households had used or had an ongoing relationship with, a 
financial adviser.[Footnote 39] 

Information from regulators also provides another indication that 
investors are not encountering misleading advertisements. We asked SEC 
and FINRA staff to review the complaints or inquiries each 
organization had received between November 2009 and April 29, 2011, to 
identify complaints or inquiries from investors or others on fund 
advertisements. Although these regulators had received over 50,000 
complaints or inquiries during this 17-month period, they identified 
just 25 complaints or inquiries as possibly relating to misleading 
mutual fund or ETF advertisements during the period we reviewed, and 
after discussing the details of these complaints or inquiries with 
regulators, we determined that only 3 complaints appeared to involve 
misleading fund advertisements.[Footnote 40] 

Regulators Have Taken Steps to Address Some Critics' Concerns Related 
to Performance Advertising: 

Because of the concerns that have surrounded mutual fund performance 
advertising over time, SEC and FINRA have issued various mutual fund 
performance advertising rules and have amended them as new concerns 
have arisen. For example, SEC requires that all fund companies that 
use performance advertising use a standardized process for calculating 
performance and that, if a fund company chooses to advertise a fund's 
standardized performance, it must include the fund's 1-, 5-, and 10- 
year returns calculated as of the most recently ended calendar 
quarter. This rule facilitates the ability of investors to have 
consistent information for comparing returns among funds. In the late 
1990s and early 2000s, the stock market experienced extraordinary 
returns but then dropped significantly. After seeing funds advertising 
returns reflecting only the period during which the market had risen, 
SEC staff became concerned that such advertising was misleading 
because it was using older performance data that did not always take 
into account recent market changes. To address this concern, SEC 
amended Rule 482 in 2003 to require that, among other things, fund 
companies provide investors access to more current information (the 
most recent month-end returns) through a toll-free number or a Web 
site. It also requires additional disclosures in advertisements that 
alert investors that a fund's past performance does not guarantee 
future results and that its current performance may be higher or lower 
than the performance being advertised. SEC also required that fund 
advertisements include a disclosure directing investors' attention to 
a fund's investment objectives, risks, and charges and expenses to 
address concerns that other fund information was being overshadowed by 
past performance information. In 2006, SEC approved amendments to NASD 
Rule 2210 to require that advertisements by broker-dealers containing 
performance information also include the fund's sales charges and 
annual operating expense ratio to help ensure that investors most 
interested in past performance information receive other important 
fund information. FINRA staff noted that helping to ensure that 
investors were aware of the funds' expense ratio was important because 
a fund's total annual operating expenses would affect its performance 
for as long as an investor held shares in the fund. 

In addition to having detailed requirements about the content of fund 
advertisements, SEC and FINRA undertake investor education initiatives 
to help ensure that investors consider other factors besides past 
performance as part of their investment decisions. Both agencies 
maintain Web sites and issue publications aimed at educating investors 
about mutual funds.[Footnote 41] Officials from both agencies stated 
that these materials include information about how past performance is 
not predictive of future performance. Both agencies also issue 
investor alerts on topics that arise for which particular concerns may 
exist. Moreover, they also noted that they participate in numerous 
speaking engagements in which they reinforce the message that past 
performance is not predictive of future performance and that investors 
should consider other fund characteristics before purchasing a fund. 

Limited Use of Performance Information in Advertising also May Limit 
Its Influence on Investors: 

The potential for investor harm also may be limited because 
advertising materials for mutual fund companies largely focus on 
issues other than performance. To determine the extent to which mutual 
funds were advertising performance, we selected and reviewed a random 
sample of 300 mutual fund and ETF advertising materials--including 
brochures, press releases, public Web site content pieces, print 
advertisements, radio, and television advertisements--out of the 
universe of about 71,000 individual pieces of such materials that 
FINRA determined to be compliant with applicable standards from 
calendar years 2006 through 2010. Because market conditions fluctuate, 
the results of our review of advertisements are not generalizable to 
periods other than 2006 through 2010. Based on this review, we 
estimate that 9 percent of the advertisements intended to be seen by 
the public had a primary focus on fund performance.[Footnote 42] The 
advertisements that focused on performance used one or more types of 
performance-related information to try to persuade investors to 
purchase the product. For example, some highlighted the fund's 
positive performance by presenting the SEC standardized performance 
information for the past 1-, 5-, and 10-year periods. Other 
advertisements compared fund performance data with an industry 
benchmark. For example, one of these advertisements compared a fund's 
returns to the S&P 500 index and used language describing a fund as 
"ahead of the pack" while another advertisement stated that it "out- 
performed its primary benchmark" to focus attention on the fund's 
superior performance. Some advertisements also used ratings or 
rankings compiled by industry third-party data providers to illustrate 
the funds' superior performance compared with competitors. For 
example, such advertisements used language such as "our growth fund 
received a 4 out of 5-star Morningstar rating" or "our small cap fund 
was ranked number 1 by Lipper." Representatives from 7 of the 18 fund 
companies we interviewed explained that they were increasingly using 
fund rankings and ratings rather than presenting a fund's SEC 
standardized return to emphasize performance. Some of them explained 
that they believe investors want this type of information. In 
addition, the fund company representatives noted that presenting 
rankings allows them to illustrate the superior performance of a fund 
or group of funds relative to competitors' funds even during periods 
with declining market conditions. 

Representatives from many of the fund companies we interviewed 
indicated that most of their advertising has not focused on 
performance information. Representatives from many of these companies 
explained that rather than focusing their advertisements on 
performance information, they instead are using advertisements more 
generally to educate investors about the types of products available. 
For example, rather than using advertisements with fund-specific 
content, their advertisements would explain how ETFs worked or 
describe the advantages and disadvantages of different products. 
Although performance may not be the primary focus of most fund company 
advertisements, fund company representatives stated that performance 
information is available to investors through a variety of materials, 
such as required disclosure documents and the Internet. 

Based on our review, we estimate that 35 percent of all advertisements 
submitted to FINRA during 2006 through 2010 contained at least some 
performance information (for example, SEC standardized performance 
information, a rating or ranking, or a general description of a fund's 
performance).[Footnote 43] Table 1 shows that the various ways in 
which performance was presented in these advertisements varied. For 
example, we estimated that of the 35 percent, 76 percent of these 
materials compared performance information with an industry benchmark 
and 70 percent contained SEC standardized performance information. 
Additionally, 31 percent presented rankings or ratings from third-
party analysis services, and 27 percent used a graphic to display the 
performance information. For example, many used graphs depicting a 
line or bar showing a fund's returns over time as compared to a line 
or bar depicting the return of a benchmark over that same period. 
Finally, 20 percent of the advertisements provided the information 
related to performance in more than one way. For example, an 
advertisement could include a rating, a ranking, and SEC standardized 
performance information. 

Table 1: Ways in Which Performance Was Presented in Advertisements 
That Included Any Performance Information, 2006 through 2010: 

How performance was presented or illustrated in advertisements: 
Performance benchmark; 
Estimated percentage: 76; 
Confidence intervals (percentage): (66, 84). 

How performance was presented or illustrated in advertisements: SEC 
standardized performance information; 
Estimated percentage: 70; 
Confidence intervals (percentage): (60, 79). 

How performance was presented or illustrated in advertisements: 
Ranking or rating; 
Estimated percentage: 31; 
Confidence intervals (percentage): (22, 41). 

How performance was presented or illustrated in advertisements: 
Performance graphic; 
Estimated percentage: 27; 
Confidence intervals (percentage): (19, 37). 

Source: GAO analysis. 

Note: These estimates are based upon a random sample. The percentages 
represent point estimates and the two-sided, 95 percent confidence 
interval. 

[End of table] 

Advertisements in our review that included performance information 
often also contained information on other fund attributes. For 
example, based on our review an estimated 71 percent of advertisements 
that included performance information also included information on the 
strategy of the fund. About two-thirds of the advertisements that 
included performance information also contained information on the 
fund's fees and expenses such as the fund's expense ratio. 
Advertisements that contained performance information also often 
explained factors that contributed to the fund's returns (52 percent) 
and sometimes provided information on the fund's portfolio holdings 
(36 percent). Figure 1 summarizes the other fund attributes found in 
advertisements that contain performance information. 

Figure 1: The Prevalence of Types of Information Included in 
Advertisements with Performance Information, 2006 through 2010: 

[Refer to PDF for image: horizontal bar graph] 

Information presented: Strategy; 
Estimated percentage: 71; 
Confidence intervals: 62, 79. 

Information presented: Fund fees and expenses; 
Estimated percentage: 64; 
Confidence intervals: 55, 74. 

Information presented: Fund analysis; 
Estimated percentage: 52; 
Confidence intervals: 42, 62. 

Information presented: Fund holdings information; 
Estimated percentage: 36; 
Confidence intervals: 26, 45. 

Information presented: Quality of management; 
Estimated percentage: 35; 
Confidence intervals: 24, 45. 

Information presented: General economic analysis; 
Estimated percentage: 32; 
Confidence intervals: 22, 41. 

Information presented: Other attribute; 
Estimated percentage: 13; 
Confidence intervals: 7, 21. 

Information presented: Educational information; 
Estimated percentage: 5; 
Confidence intervals: 2, 12. 

Information presented: Tax savings information; 
Estimated percentage: 5; 
Confidence intervals: 2, 11. 

Information presented: Service quality; 
Estimated percentage: 5; 
Confidence intervals: 2, 11. 

Information presented: General branding; 
Estimated percentage: 1; 
Confidence intervals: 0, 5. 

Source: GAO analysis. 

Note: These estimates are based upon a random sample. The percentages 
represent point estimates and the two-sided, 95 percent confidence 
interval. 

[End of figure] 

The remaining 65 percent of advertisements that we reviewed that did 
not contain performance information often emphasized other attributes 
related to the fund or the fund company. For example, about 35 percent 
focused on explaining the investment strategy for the fund. An 
estimated 31 percent provided general educational information, such as 
explaining recommended investment strategies and options for 
retirement saving. About 27 percent promoted the quality of the fund's 
managers. An estimated 19 percent emphasized fund company 
characteristics such as the quality of service or the wide variety of 
products offered. In addition, advertisements that did not include 
performance information sometimes provided general economic analysis 
(15 percent), such as the factors that influence the direction of the 
stock market or interest rates. Figure 2 summarizes the attributes of 
advertisements that do not include performance information. 

Figure 2: The Prevalence of Types of Information Included in 
Advertisements without Performance Information, 2006 through 2010: 

[Refer to PDF for image: horizontal bar graph] 

Information presented: Strategy; 
Estimated percentage: 35; 
Confidence intervals: 28, 42. 

Information presented: Educational information; 
Estimated percentage: 31; 
Confidence intervals: 25, 38. 

Information presented: Quality of management; 
Estimated percentage: 27; 
Confidence intervals: 21, 34. 

Information presented: Service quality; 
Estimated percentage: 19; 
Confidence intervals: 14, 26. 

Information presented: Other attribute; 
Estimated percentage: 17; 
Confidence intervals: 2, 23. 

Information presented: General economic analysis; 
Estimated percentage: 15; 
Confidence intervals: 10, 21. 

Information presented: Retirement planning information; 
Estimated percentage: 13; 
Confidence intervals: 8, 18. 

Information presented: Tax savings information; 
Estimated percentage: 9; 
Confidence intervals: 5, 14. 

Information presented: Fund holdings information; 
Estimated percentage: 9; 
Confidence intervals: 6, 14. 

Information presented: Fund fees and expenses; 
Estimated percentage: 7; 
Confidence intervals: 4, 12. 

Information presented: Fund analysis; 
Estimated percentage: 5; 
Confidence intervals: 2, 9. 

Information presented: General branding; 
Estimated percentage: 5; 
Confidence intervals: 3, 10. 

Information presented: Distribution information; 
Estimated percentage: 4; 
Confidence intervals: 2, 8. 

Source: GAO analysis. 

Note: These estimates are based upon a random sample. The percentages 
represent point estimates and the two-sided, 95 percent confidence 
interval. 

[End of figure] 

Some Have Called for Changes in Required Disclosures in Advertisements 
and Others Expressed Concerns That Such Disclosures Have Become Too 
Complicated: 

Concerns exist among some academics that the current SEC-mandated 
disclosures, which are aimed at dissuading investors from focusing on 
past performance, are not effective. For example, one academic study 
tested the effectiveness of the disclosure that must be made in 
advertisements under Rule 482, which requires, among other things, 
firms to include in the text of the advertisement that: (1) "past 
performance does not guarantee future results; (2) the investment 
return and principal value of an investment will fluctuate so that an 
investor's shares, when redeemed, may be worth more or less than their 
original cost; and (3) current performance may be lower or higher than 
the performance data quoted."[Footnote 44] To determine whether 
potential investors were sufficiently influenced by this required 
disclosure or whether other versions of such information were more 
effective, the study tested about 550 participants by showing them 
different versions of mock performance advertisements in which the 
disclosure statements varied in content and prominence. After viewing 
different versions of the disclosure, participants were then asked 
about their beliefs about the fund's future performance and their 
willingness to invest in the fund. The results indicated that the 
current disclosure required by SEC neither reduced participants' 
expectations about the fund's future performance nor their willingness 
to invest in the fund. However, the study found that participants who 
viewed a more strongly worded disclosure--one that informs investors 
that high fund returns generally do not persist--were more likely to 
disregard the advertised performance data. An official from FINRA's 
Office of Investor Education explained that the office has been 
considering conducting research to determine if disclosures can be 
used to encourage investors not to overly rely on past performance 
information. He added that such research could help inform regulatory 
changes. 

Because of the concerns over the effectiveness of disclosures required 
to be made in advertisements containing performance information, some 
academics and others have called for various changes. To prevent 
investors from inappropriately investing in funds that advertise high 
performance that is not likely to be repeated, some academics with 
whom we spoke instead would prohibit fund companies from showing 
performance information in advertisements. According to these 
academics, the current disclosures that warn investors that past 
performance is no guarantee of future performance are not enough to 
fully ensure investors are adequately protected from timing 
investments poorly. While recognizing that performance information 
still would be available to investors through other sources such as 
fund prospectuses and third-party research providers, they argue that 
at least some investors who use performance advertisements no longer 
would be aware of a fund's high performance if performance advertising 
were prohibited. Additionally, they argue that, although SEC requires 
past performance in the prospectus, that document is different from a 
performance advertisement because, in addition to performance 
information, a prospectus contains various other fund details so that 
an investor can make an informed decision. They also argue that 
investors who read prospectuses are likely to be more sophisticated 
than those who might decide to invest in a particular fund based 
solely on a performance advertisement. Another researcher told us that 
SEC's standardized performance requirement--which requires that fund 
companies that choose to advertise specific returns for their funds 
show the 1-, 5-, and 10-year returns--should not include the 1-year 
return. He explained that the shorter the performance period, the 
higher the risk the returns are outliers and, therefore, not 
meaningful information for investors. He suggested replacing the 
currently mandated 1-year returns with 3-year returns. 

Representatives from some fund companies expressed concerns that 
adding different or more disclosures would not help investors. For 
example, some indicated that current disclosures already were 
voluminous. A representative from one fund company told us that as 
regulatory changes have occurred, additional disclosure requirements 
were added for advertisements. However, none were removed, resulting 
in advertisements with so much information that investors are 
distracted by the information provided. For example, based on our 
review, we estimate that performance advertisements contain an average 
of 31 sentences of disclosure. One performance advertisement we 
reviewed had 102 disclosure sentences. Representatives from some fund 
companies told us that keeping disclosure requirements simple was 
important for preventing investors from ignoring the information 
entirely. While performance advertisements are required to disclose 
key information about a fund, representatives from some firms argued 
that fund advertisements should not be considered the primary or only 
source of information available to investors for a fund and need not 
contain as much information as currently is required. Representatives 
from many firms also told us that the number of required disclosures 
affected their decisions on what types of advertisements to develop 
because of space restrictions or readability. One fund company 
representative told us that for certain performance advertisements, 
additional content might be appropriate; however, they were prevented 
from including it due to the amount of space required for the 
disclosures. 

Although the Regulatory Review Process Limits Potential for Misleading 
Advertisements, Communication of Rule Interpretation Changes Has Been 
Uneven: 

FINRA Reviews Fund Advertisements Intended for Public: 

As part of its investor protection responsibilities, FINRA reviews 
advertisements seen by the public or provided to potential investors 
by broker-dealers. Under NASD Rule 2210, broker-dealers--including 
those that distribute mutual fund shares--must generally submit fund 
advertisements to FINRA for review within 10 business days of first 
use. Although this allows such firms to provide fund advertisements 
after they have been seen by the public or broker-dealers' customers, 
many firms file such materials before using them as a business 
practice.[Footnote 45] Representatives from several firms with whom we 
spoke said that they pre-filed fund advertisements because the broker- 
dealers and financial advisors that sell their funds wanted 
documentation that FINRA reviewed their materials for compliance with 
applicable standards. Some mutual fund firm representatives whose 
firms did not always file all fund advertisements before first use 
told us that they instead pre-filed fund advertisements that were more 
costly to create, such as television commercials or new print ad 
campaigns. They did so to ensure that these materials would receive 
regulatory review before they were finalized and to avoid having to 
make costly changes later. 

To conduct the fund advertisement reviews, FINRA's Advertising 
Regulation Department has a centralized and standard process for 
reviewing all fund advertisements that are filed. In 2010, FINRA 
reviewed more than 77,000 fund advertisements and other materials 
relating to mutual funds and ETFs. As of June 2011, FINRA's 
Advertising Regulation Department consists of about 65 staff persons, 
with about 25 analysts and 11 supervisory staff dedicated to 
conducting reviews. On average, each analyst reviews between 250 and 
300 pieces per month. The majority of firms submit their materials 
electronically through FINRA's Web-based system, although FINRA also 
accepts hard copies of materials.[Footnote 46] FINRA analysts review 
materials filed to see if they comply with SEC and FINRA advertising 
regulations and to help prevent the use of misleading fund 
advertisements, including those that misuse performance information. 
For example, analysts review fund advertisements to ensure that all 
required disclosures are present and that prohibited features (such as 
language that promises positive returns) or images or charts that are 
misleading (such as a hypothetical illustration that projects positive 
performance of a fund) are not included. Because firms must submit 
filings that present the performance of a fund to SEC as part of other 
regulatory requirements, FINRA officials stated that they rely on the 
performance information provided by firms and that they do not 
recalculate performance figures. However, analysts do verify that any 
mutual fund rankings and ratings presented in the fund advertisements, 
such as those provided by industry third-party data providers, are 
accurate. Figure 3 illustrates the types of information FINRA examines 
when conducting its review. 

Figure 3: Examples of Components of Advertisements That Would Not Be 
Found Compliant with Applicable Standards: 

[Refer to PDF for image: illustration] 

Promissory language: 
Advertisements cannot include unwarranted or exaggerated statements 
that promise results such as positive returns or minimizing investment 
risk: 
“Guaranteed returns” 
or: 
“Invest with peace of mind” 
or: 
“If you’re ready to maximize your returns...” 

Misleading images: 
Similarly, advertisements cannot include images that suggest or 
promise results such as positive returns. 

Inappropriate presentation and proximity: 
Required performance disclosures cannot be placed away from the 
performance data and cannot be in smaller fonts than that used for the 
data. 

Problematic graphics: 
Graphics cannot predict or project performance and should not imply 
that past performance will recur. 

Source: GAO; Art Explosion. 

[End of figure] 

After completing a review of fund advertisements, FINRA analysts 
transmit a letter to the submitting firm generally indicating either 
that the material appears to be consistent with applicable standards 
or it needs revisions to be compliant.[Footnote 47] If a submission is 
found not to be compliant, the FINRA analyst will provide comments in 
the review letter identifying which rules the material violates and 
whether it can be revised or should not be used at all. According to 
FINRA data, from 2006 through 2010, only about 14 percent of materials 
required revisions and less than 1 percent were not approved for use. 
A FINRA official explained that the percentages of noncompliant 
materials were low because firms have been required to submit 
materials for many years and have gained experience in what is 
required and what should not be included in materials. In addition, 
firms are required to have internal approval on any material prior to 
use and submission to FINRA, which also serves to help ensure that 
most materials are compliant with applicable rules. This approval must 
be completed by a fund company's registered principal--generally an 
officer of the fund company who has passed examinations administered 
by FINRA demonstrating competence in federal securities laws, rules, 
and regulations. Additionally, representatives from many of the firms 
with whom we spoke told us that before they submit materials for 
official review they frequently call to discuss issues with FINRA 
staff, such as when they are uncertain if the information they want to 
use in an advertisement complies with rules and regulations. FINRA 
officials stated that firms and their representatives can face 
significant repercussions for not complying with FINRA comment letters 
that require revisions, including fines and being barred from the 
industry.[Footnote 48] 

Although FINRA Has Controls in Place for Advertising Reviews, Some 
Firms Expressed Concerns about the Consistency of Some Reviews: 

Although representatives of the mutual fund firms with whom we spoke 
were generally satisfied with their interactions with FINRA staff, 
some noted concerns related to the reviews of advertising materials by 
FINRA analysts. Over three-quarters of the 18 fund company 
representatives with whom we spoke generally were satisfied with their 
interactions with FINRA--with some fund companies stating that FINRA 
analysts were open to discussing their comments or willing to answer 
questions when firms were developing new materials. Three of the firms 
added that, when needed, they were able to discuss issues with higher-
level management in FINRA's Advertising Regulation Department. 
Furthermore, some fund company representatives specifically stated 
that they were pleased with the overall review process. 

Representatives from many firms told us that they sometimes received 
inconsistent comments from FINRA on materials. They explained that in 
some cases when they made minor updates to materials that had been 
previously filed and deemed compliant and re-filed it with FINRA, they 
subsequently received comments on portions of the material that had 
not been changed. In some cases, the representatives stated that this 
occurred when there had been a change in the FINRA analyst to whom 
they were assigned. Some firm representatives acknowledged that part 
of the inconsistency might result from the subjective nature of the 
advertising rules. For example, FINRA rules set general content 
standards that advertisements must be fair, balanced, and not 
misleading. However, because the rules do not prescribe what is 
considered fair, balanced, and not misleading, what one FINRA analyst 
interprets as meeting these standards may be different than what 
another analyst deems appropriate. For example, an industry 
representative stated that FINRA interprets what constitutes a fair 
and balanced advertisement on a case-by-case basis, which sometimes 
can lead to problems because one firm's material may be deemed 
compliant, while another firm's may not. 

FINRA acknowledges the challenge of consistency in its reviews and has 
developed quality control procedures to improve the level of 
consistency in the application of rules. Due to the volume of 
materials reviewed, FINRA supervisors reviewed the work of their 
analyst staff on an average of about 12 percent of materials in 2009 
and 2010. To compensate for this low level of supervisory review, 
FINRA has other quality controls in place, including supervisory 
review of all new analysts' work. Additionally, supervisors conduct 
monthly checks of each analyst's work to assess whether the analysts 
are appropriately and consistently applying the rules. FINRA also has 
developed a standard checklist that contains step-by-step instructions 
and lists all requirements and rules that analysts can use as they 
conduct their reviews. Moreover, FINRA also maintains and regularly 
updates a "watch list" of topics of industry concern that it is 
following. If an advertisement contains an item that is listed on the 
watch list, FINRA requires that analysts bring the material to their 
supervisor for additional review and approval before the review letter 
can be released to the firm. Nearly all staff have industry 
certifications and all new staff, regardless of their level of 
industry experience, go through a standard training course and receive 
ongoing training on emerging issues. Finally, FINRA's Advertising 
Regulation Department has regular staff meetings and issues memoranda 
and other communications that discuss consistency issues management 
has identified. 

In addition to the Advertising Regulation Department's quality control 
procedures, FINRA's Office of Internal Audit and SEC review the 
department's operations. For example, the Office of Internal Audit 
conducts a comprehensive review of the Advertising Regulation 
Department about every 3 years--most recently in 2005 and 2008--which 
includes a review of department processes and procedures, general 
operations, and its Web-based system and database. SEC also oversees 
FINRA's efforts by conducting periodic oversight examinations, the 
most recent in 2006. During these examinations, SEC reviews policies, 
procedures, and staffing resources and also reviews a sample of fund 
advertisements to help ensure that FINRA is appropriately and 
consistently enforcing advertising rules and regulations. 

FINRA Lacks Sufficient Mechanisms for Communicating New Rule 
Interpretations to Industry: 

Based on information we collected, FINRA lacks sufficient mechanisms 
for ensuring that new interpretations of existing rules are 
communicated evenly to all fund companies. The mutual fund firms we 
interviewed expressed concerns about the evenness of how FINRA 
communicates changes in interpretations of advertising rules. 
Currently FINRA communicates such changes to fund companies in a 
variety of ways. First, it can issue new rules, which are legal 
changes to existing requirements. New rules go through an official 
proposal and review process in which public comments are made and then 
considered as part of finalizing the rule. Second, FINRA publishes 
regulatory notices to provide guidance to firms. For example, notices 
have provided information on new advertising requirements or the usage 
of social media in advertising. Third, FINRA officials state that they 
orally alert the industry to new rules and requirements or changes in 
rule interpretations through various public speaking arrangements and 
annual FINRA conferences. For example, FINRA's Advertising Regulation 
Department holds an annual conference during which it dedicates one 
session to discuss regulatory developments that have occurred 
throughout the year. Representatives from some firms with whom we 
spoke said they thought that this conference was useful because it 
gave them an opportunity to learn about new issues, rules, and 
requirements. FINRA officials also told us that they offered a number 
of industry training events, including online learning courses, Web 
casts, and pod casts. 

Finally, a FINRA official and representatives from many firms with 
which we spoke told us that FINRA also uses individual firm comment 
letters from its advertising review process to communicate recent 
interpretive positions. For example, FINRA staff recently identified 
concerns about mutual fund firms that would start a new fund and then 
create hypothetical returns by comparing the fund's investment 
strategy with historical data to show how the fund would have 
performed had it been in existence. The FINRA staff decided that such 
information--known as hypothetical back-tested data--was misleading 
because investors might believe that the hypothetical returns 
represented actual fund performance and likely would recur. However, 
in this and other instances in which FINRA changed how it interpreted 
the advertising rules, it did not publicly disseminate any written 
guidance about these interpretive positions. Instead, FINRA began 
alerting firms and implementing the change through individual comment 
letters. 

However, relying on comment letters to communicate such new rule 
interpretations could increase the potential for investors to be 
exposed to misleading advertisements. FINRA is responsible for helping 
to ensure that its rules are designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, and to protect investors.[Footnote 49] The review 
of fund advertisements fulfills a part of this responsibility and is 
intended to assist in preventing misleading advertisements from 
becoming available in the marketplace. However, many firms expressed 
concern with the unevenness that results from FINRA communicating 
changes to rule interpretations using the comment letter process. For 
example, firms that submitted advertisements for FINRA review that 
contained unacceptable information, based on a new interpretation 
would receive a comment letter explaining the new interpretation and 
would have to revise their materials. However, firms that were using 
older, previously reviewed advertisements containing information in 
conflict with the new interpretation would not be aware of the change 
and could continue using it. This uneven method of communicating new 
rule interpretations can result in investors being exposed to 
advertising that does not meet current interpretations and may be 
considered misleading. 

In addition, this uneven mechanism for communicating new rule 
interpretations can also lead to competitive advantages or 
disadvantages for firms. Because only firms submitting materials after 
the FINRA staff develop their new rule interpretation may learn of it 
through comment letters, other firms that have submitted materials 
previously may be continuing to use advertisements with material that 
now would not be considered acceptable under the new interpretation. 
As a result, these firms might have a competitive advantage over firms 
required to comply with the new interpretation because investors might 
choose the funds being advertised using older content that other firms 
have been prohibited from using. Additionally, by not making all firms 
aware of new rule interpretations more broadly, some firms might incur 
additional expenses when they developed and submitted materials 
without knowledge of the new changes. The firms then would have to 
make revisions after finding out these materials no longer complied 
with the new interpretations. 

FINRA officials noted that rule interpretation changes arise because 
while the advertising rules were developed many years ago, the 
industry is constantly changing and developing new products and new 
ways to market them. They noted that when they see new concerns arise, 
they believe the most efficient way to address them is to alert the 
firm directly in the comment letter. However, by not taking steps to 
more fully ensure that all industry members are concurrently aware of 
new interpretative positions, other firms may be continuing to use 
advertisements with information that FINRA now considers as 
potentially misleading to investors. In fact, representatives from 
some firms with whom we spoke told us they were not aware of some new 
interpretative positions and learned of them, not through FINRA, but 
through other firms, industry connections, or the media. 

FINRA and SEC Conduct Additional Oversight and Enforcement of Fund 
Advertisements: 

FINRA and SEC also conduct additional oversight activities to help 
identify advertising concerns that may not be caught during FINRA's 
advertising review process. For example, the Advertising Regulation 
Department conducts sweeps, which are targeted examinations that focus 
on specific emerging issues. In June 2010, FINRA conducted a sweep on 
19 firms that sell products similar to ETFs, but unlike most ETFs, are 
not registered as investment companies. During this sweep, FINRA 
requested and reviewed advertising materials for these products and 
found that the advertisements did not adequately balance information 
about risks and potential benefits of these products under FINRA 
rules.[Footnote 50] For example, a commodity ETF that invests in gold 
must identify that precious metals are subject to volatile price 
changes. An advertisement that did not explain this risk and discussed 
only the potential benefits of gold would be considered misleading. 
FINRA addresses concerns found during sweeps by issuing new 
requirements or guidance, if necessary. 

Additionally, FINRA conducts routine risk-based examinations of broker-
dealers through the member regulation program to determine if firms 
are in compliance with federal securities laws, rules, and 
regulations. These examinations may include a review of a firm's 
advertising material, if deemed appropriate. FINRA also investigates 
allegations of wrongdoing by investigating customer complaints, tips, 
or other indications of rule violations. 

When necessary, FINRA undertakes disciplinary actions against firms 
and individuals for violations of FINRA rules; federal securities 
laws, rules, and regulations; and other related securities rules. 
According to FINRA officials, during 2006 through 2010, 34 formal 
disciplinary actions were taken against FINRA regulated member firms 
that advertised funds (32 concerning mutual funds and 2 concerning 
ETFs) for advertising materials. For example, one company that was 
alleged to have misleading and exaggerated advertising claims and to 
have omitted material information including rankings criteria in 
television and Web site advertisements agreed to a settlement without 
admitting or denying the allegations and, among other things, was 
fined $20,000. 

In addition to FINRA's oversight, SEC also conducts activities related 
to the review of fund advertisements. For example, SEC conducts risk- 
based examinations of mutual fund companies during which 
advertisements may be reviewed. SEC officials told us that if during 
the scoping of an examination they found that a mutual fund was 
advertising unusually high returns, they might include a review of 
advertising in the examination. SEC also may decide to review 
advertising during an examination if its staff notice unusual 
practices in a firm's advertisements, if concerns are raised during an 
examination of another fund company, or if it receives a referral from 
FINRA. If advertising violations are found during an examination, SEC 
can take enforcement actions. Officials told us that between 2000 and 
early 2011, they took five formal enforcement actions related to fund 
advertisements. 

Conclusions: 

Because tens of millions of Americans invest in the shares of mutual 
funds, ensuring that they receive fair and objective information and 
are not misled by the advertising for such funds is an important 
regulatory goal. Some academics have suggested that the use of 
performance information in fund advertisements could overly influence 
investor choices. However, evidence from existing academic research 
was mixed regarding the extent to which fund performance persisted and 
the extent to which investors relied on performance information. In 
addition, the potential for investors to be harmed by performance 
advertisements also appears reduced by other factors. First, 
relatively few advertisements tend to focus primarily on performance 
information. Second, as more fund information is available on the 
Internet and more investors access it, investors increasingly have 
other sources beyond advertisements to consider as part of making fund 
purchase decisions. Third, securities regulators have continued to 
refine rules to help ensure that advertisements do not include 
misleading information and employ an established review process for 
advertisements. 

Although mutual fund companies generally were satisfied with their 
interactions with FINRA review staff, FINRA has not, in all cases, 
effectively communicated its new interpretations of existing rules to 
the industry. Over time as new advertising practices or concerns arise 
in the marketplace, FINRA staff expectations of what content should be 
excluded or how it should be presented can change. However, when 
communicating these rule interpretation changes through formal comment 
letters only to the individual companies that submitted affected 
materials, awareness and compliance with new interpretations could be 
limited. By developing additional ways to better ensure that all fund 
companies are notified of new interpretative positions for advertising 
material, FINRA could help decrease the potential for some fund 
companies to have an unfair competitive advantage over others by using 
inappropriate advertisements. Moreover, the effective communication of 
such information across the industry also would decrease the potential 
for investors to be misled. 

Recommendation for Executive Action: 

To help ensure that investors are better protected from potentially 
misleading advertisements, the Chairman, SEC, should take steps to 
ensure FINRA develops sufficient mechanisms to notify all fund 
companies of new interpretations of existing rules that arise during 
the course of FINRA's regulatory reviews of advertisements. 

Agency Comments and Our Evaluation: 

We provided a draft of this report to DOL, FINRA, and SEC. DOL did not 
provide written comments. FINRA and SEC provided written responses, 
which are reprinted in appendixes II and III, respectively. DOL, 
FINRA, and SEC also provided technical comments, which we have 
incorporated where appropriate. In her letter, the SEC Chairman noted 
that because millions of Americans invest in mutual funds, an 
important regulatory goal is to ensure that investors receive fair and 
objective information and are not misled by fund advertisements. She 
stated that she remains committed to considering changes to SEC's 
advertising regulations, such as its target date retirement funds 
proposal, in order to reduce the potential for investors to be misled 
by fund advertisements and ensure that fund advertisements 
appropriately communicate information to potential investors. She also 
stated that she believes that uniform dissemination of regulatory 
positions tends to enhance compliance, thereby furthering investor 
protection. She plans to request that FINRA review its methods for 
disseminating new interpretations of its fund advertising rules and 
has asked SEC staff to work with FINRA, as needed, in developing 
mechanisms to enhance transparency in this area and to consider our 
findings as part of SEC's ongoing oversight of FINRA. 

The executive vice president of FINRA's Regulatory Policy department 
noted that FINRA has begun to take steps to address the points in our 
report. First, FINRA intends to publish, through a Notice or other 
means, any significant new interpretation of the advertising rules 
that affects a broad section of the industry. Next, FINRA will develop 
mechanisms to provide regular summaries of advertising issues and its 
interpretation of advertising rules to industry. His letter noted that 
these mechanisms may include regular letters or webinars to 
advertising compliance contacts at firms. Additionally, he stated that 
during regular Advertising Regulation Department manager meetings, 
FINRA managers will pay particular attention to whether interpretive 
issues affect a broad section of the industry and determine if a 
Notice or other industry guidance should be issued. He also stated 
that these steps will help to ensure that firms are aware of their 
compliance requirements, further investor protection, and reduce the 
possibility of competitive advantage to firms that continue to use 
inadvertently noncompliant materials. 

We are sending copies of this report to the Chairman, SEC; Chairman 
and Chief Executive Officer, FINRA; the Secretary of Labor; and 
interested congressional committees. The report also is available at 
no charge on the GAO Web site at [hyperlink, http://www.gao.gov]. 

If you or your staff have any questions about this report, please 
contact me at (202) 512-8678 or cackleya@gao.gov. Contact points for 
our Offices of Congressional Relations and Public Affairs may be found 
on the last page of this report. Key contributors to this report are 
listed in appendix IV. 

Signed by: 

Alicia Puente Cackley: 
Director, Financial Markets and Community Investment: 

[End of section] 

Appendix I: Objectives, Scope, and Methodology: 

Our objectives were to examine (1) what is known about the impact of 
mutual fund advertisements on investors, (2) the extent to which 
performance information is included in mutual fund advertisements, and 
(3) the regulatory requirements that exist for mutual fund advertising 
and how they are administered and enforced. Our review included mutual 
funds and exchanged-traded funds (ETF), which are investment companies 
whose shares, unlike those of mutual funds, are traded throughout the 
day on stock exchanges at market-determined prices that constantly 
fluctuate. We included ETFs in our review because of their increasing 
popularity as investment vehicles. 

To examine what is known about the impact of fund advertisements on 
investors, we conducted a literature review of existing studies and 
reports, including those related to: 

* investors' use of past performance information in fund purchases; 

* the persistence of fund performance; 

* the flow of funds into mutual funds with high returns; 

* the impact on investors' returns from purchasing recent high- 
performing mutual funds; 

* the effectiveness of existing regulatory disclosures; and: 

* the importance of various information sources, including 
advertisements, in investors' selection of funds. 

To identify existing studies and reports, we first conducted focused 
Internet searches. We also conducted searches of several databases of 
business and financial academic research, including Proquest, EconLit, 
Gale Group, BAMP, and SciSearch, using key words to link 
advertisements, mutual funds, performance data, regulations, impact, 
and investor protection concepts for studies generally between the 
1970s and 2010. We then reviewed the bibliographies of reports 
obtained to identify additional material. Furthermore, we asked for 
recommendations for studies, reports, and articles from academic 
experts and from representatives of organizations that address issues 
related to mutual fund advertising. We limited our review to only 
those studies that were conducted in the United States, to ensure that 
the funds were subject to the same mutual fund and advertising laws, 
rules, and regulations. Each of the documentary sources cited in our 
report was reviewed for methodological strength and reliability and we 
ultimately determined 50 studies were sufficiently reliable for our 
purposes. We performed our searches from October 2010 to May 2011. We 
also interviewed representatives and gathered documents from federal 
agencies, academics, representatives of industry investor protection 
groups, and fund companies about the impact of performance advertising 
on investors. 

To assess the extent to which performance information is used in 
advertising, we first reviewed a nongeneralizable sample of 201 mutual 
fund and ETF advertisements submitted to the Financial Industry 
Regulatory Authority (FINRA) between January and November 2010 to 
understand the different types and formats of advertising material. 
Our sample consisted of a selection of five advertisements from each 
of the 21 FINRA-classified advertising delivery methods for both 
mutual funds and ETF advertisements.[Footnote 51] For each 
advertisement, we collected information on whether the advertising 
materials contained performance information and identified the other 
types of information they contained. From this review, we then 
identified 6 of the 21 delivery methods classified by FINRA--
brochures, press releases, public Web site content pieces, print 
advertisements, radio, and television advertisements--that generally 
contained performance information and that retail investors were more 
likely to encounter in their daily activities. Next, we selected a 
stratified random sample of 300 fund advertisements (out of a 
population of 71,087) that were deemed compliant with applicable 
standards by FINRA during calendar years 2006 through 2010, which was 
the period for which FINRA data was available. We stratified the 
population into five strata based on the year the advertisement was 
submitted to FINRA and selected a sample of 60 advertisements within 
each stratum. Because market conditions fluctuate, the results of our 
review of advertisements are not generalizable to periods other than 
2006 through 2010. Table 2 provides a description of the strata sample 
sizes and the distribution of the sample across the six chosen 
delivery methods. 

Table 2: Stratified Population of Advertisements Submitted to FINRA 
and Sample Sizes of GAO Review: 

Year: 2006; 
Population size: 10,551; 
Brochure: 23; 
Press release: 2; 
Print ad: 3; 
Radio: 0; 
Television: 0; 
Web site: 32; 
Sample size: 60. 

Year: 2007; 
Population size: 10,989; 
Brochure: 22; 
Press release: 4; 
Print ad: 4; 
Radio: 0; 
Television: 0; 
Web site: 30; 
Sample size: 60. 

Year: 2008; 
Population size: 14,660; 
Brochure: 17; 
Press release: 0; 
Print ad: 2; 
Radio: 0; 
Television: 0; 
Web site: 41; 
Sample size: 60. 

Year: 2009; 
Population size: 15,576; 
Brochure: 13; 
Press release: 1; 
Print ad: 2; 
Radio: 1; 
Television: 1; 
Web site: 42; 
Sample size: 60. 

Year: 2010; 
Population size: 19,311; 
Brochure: 12; 
Press release: 1; 
Print ad: 3; 
Radio: 0; 
Television: 0; 
Web site: 44; 
Sample size: 60. 

Year: Total; 
Population size: 71,087; 
Brochure: 87; 
Press release: 8; 
Print ad: 14; 
Radio: 1; 
Television: 1; 
Web site: 189; 
Sample size: 300. 

Source: GAO analysis of FINRA data. 

[End of table] 

For each of these advertisements, we determined whether the 
advertisements contained performance information, whether performance 
or some other characteristic was the primary information being 
emphasized in the advertisement, how performance information and 
disclosures were presented, and what other types of information were 
contained in fund advertisements. We considered an advertisement to 
have had any type of performance information if it included general 
statements about the fund's returns (such as if the fund had a 
positive performance in a quarter); standard performance data showing 
the fund's returns for 1-, 5-, and 10-year periods; and independent 
third-party data providers' ratings or rankings.[Footnote 52] We 
considered performance to be the emphasis of an advertisement if it 
was the predominant focus of the accompanying text and the graphics. 
For example, an advertisement containing information only on a fund's 
third-party rating or presenting its 1-, 5-, and 10-year Securities 
and Exchange Commission (SEC) standardized return. We do not report 
information on the type of mutual fund (for example, stock, bond, 
money market, or balanced) or ETF that was being advertised in the 
advertisements we reviewed because FINRA's Advertising Regulation 
Electronic Files (AREF) system does not maintain this level of detail 
on advertisements. Therefore, we would have been unable to determine a 
stratified random sample based on the type of fund being advertised. 
Had we been able to collect this type of information, we may have 
found that different patterns of performance information or other 
attributes existed by type of fund. 

The results of the sample are only generalizable to the 71,087 
advertisements for the six delivery methods we included in our 
universe. Because we treated our review as a stratified random sample, 
we assumed our sample was only one of a large number that could have 
been drawn. Because each sample could have provided different 
estimates, we expressed our confidence in the precision of our 
particular sample's results as a 95-percent confidence interval. This 
is the interval that would contain the actual population value for 95 
percent of the samples we could have drawn. As a result, we are 95 
percent confident that each of the confidence intervals based on the 
advertisement review includes the true values in the sample 
population. All estimates from the sample in this report have a margin 
of error of plus or minus 10 percentage points or less. 

We performed data reliability assessments for data used in our 
generalizable sample of the six advertising delivery methods. For 
example, we interviewed knowledgeable officials and conducted a "walk- 
through" of FINRA's AREF system, which maintains data on the 
advertisements reviewed by FINRA, to understand how data are entered 
and captured, what types of edit checks are included in the system, 
and the overall data reliability of the system. We also performed 
electronic testing and verified there were no duplicates in the full 
universe of advertisement data received for 2006 to 2010 on the six 
selected advertising delivery methods to ensure that the data were 
complete and consistent with previous summary data provided to us by 
FINRA. We discussed with FINRA officials reasons for any 
inconsistencies we found. To ensure that advertisements were properly 
classified by investment product and other advertisement attributes, 
we also compared FINRA's coding of data in its AREF system to the 
advertisements we reviewed in our nongeneralizable sample. We 
determined that the data were sufficiently reliable to perform our 
review and project our results to the six delivery methods in our 
population of advertisements. 

Additionally, we selected and interviewed a nongeneralizable sample of 
18 fund companies on the advertising practices they currently used, 
including performance advertising. Our selection of fund companies 
included the 10 companies that had filed the most mutual fund 
advertisements for review with FINRA in 2009, as well as the 5 
companies that had filed the most ETF advertisements.[Footnote 53] We 
also chose three fund companies (two offering mutual funds and one 
that offered ETFs) that filed lesser numbers of advertisements in 
2009. Finally, we selected and interviewed three of five fund 
companies that were provided to us by the Investment Company 
Institute--the mutual fund industry's trade organization--which it had 
identified as likely to have relevant perspectives on this issue. 

To address our third objective, we reviewed regulatory rules and 
requirements related to fund advertisements, including proposed 
Department of Labor, SEC, and FINRA rules and public comments received 
on those rules. We also interviewed SEC and FINRA officials to discuss 
the methods used to enforce advertising requirements and the process 
FINRA uses to review fund advertisements. We participated in a "walk- 
through" of FINRA's AREF system in which officials explained to us the 
processes in which advertisements are submitted to FINRA and how FINRA 
staff review and provide comments on advertisements to fund companies. 
We also attended the FINRA Advertising Regulation Conference in 
November 2010 to learn of new issues related to mutual fund 
advertising and observe how information is disseminated. Furthermore, 
we reviewed notices and other documents FINRA and SEC provided to fund 
companies and materials both agencies publish related to mutual funds 
and ETFs. Additionally, we interviewed fund companies to gather their 
opinions on existing regulatory requirements and experiences with 
FINRA's advertising review process. Finally, we spoke with SEC and 
FINRA officials on the types of enforcement actions taken and the 
number of complaints or inquiries they received related to mutual fund 
advertising. 

We conducted our work from September 2010 to July 2011 in accordance 
with generally accepted government auditing standards. These standards 
require that we plan and perform the audit to obtain sufficient, 
appropriate evidence to provide a reasonable basis for our findings 
and conclusions based on our audit objectives. We believe that the 
evidence obtained provides a reasonable basis for our findings and 
conclusions based on our audit objectives. 

[End of section] 

Appendix II: Comments from the Financial Industry Regulatory Authority: 

FINRA: 
Financial Industry Regulatory Authority: 
Thomas M. Selman: 
Executive Vice President: 
Regulatory Policy: 
1735 K Street, NW: 
Washington, DC 20006: 
T: 202 728 6977: 
Fax: 202 728 8935: 
[hyperlink, http://www.finra.org] 

July 11, 2011:  

Alicia Puente Cackley: 
Director: 
Financial Markets and Community Investment: 
United States Government Accountability Office: 
Washington, D.C. 20548: 

Dear Ms. Cackley: 

Thank you for the opportunity to comment on the Government 
Accountability Office's (GAO) draft report concerning mutual fund 
advertising and regulatory requirements that apply to such 
advertising. The report provides a comprehensive overview of the uses 
of fund advertising, the academic studies concerning performance 
advertising, the extent to which investors rely upon performance 
advertising and the regulatory oversight of mutual fund advertising, 
particularly FINRA's advertising review program. As the report states, 
FINRA's review of mutual fund advertisements has helped to limit the 
potential for investors to be misled by mutual fund advertising. 

The report identifies the SEC and FINRA as the primary regulators of 
mutual fund advertising and states that they have cooperated in 
carrying out their respective roles. The report noted the relatively 
small number of complaints received by both organizations related to 
mutual fund advertising. Additionally, the report indicates that the 
mutual fund firms contacted by GAO staff were generally satisfied with 
their interactions with FINRA staff. 

Based on discussions with those firms, the report recommends that the 
SEC take steps to ensure FINRA develops mechanisms to notify all fund 
companies about new interpretations of existing rules. The report also 
states that some firms have complained that FINRA analysts have
commented on portions of material that had been previously filed and 
deemed compliant. The report lists some of the quality controls that 
have enabled FINRA's Advertising Regulation Department to maintain an 
acceptable level of consistency in its review program. In addition to 
these quality controls, and in light of our conversations with GAO 
staff; FINRA has already taken the following steps to address these 
points: 

* FINRA intends to publish, through a Notice to firms or by other 
means, any significant new interpretation of the advertising rules 
that affects a broad section of the industry. This approach will help 
us achieve the objectives in your report, such as ensuring that firms 
are aware of their compliance requirements, furthering investor 
protection and reducing the possibility of a competitive advantage to 
firms that continue using inadvertently noncompliant material. Pending 
the development of this publication or Notice, FINRA will apply any 
significant new interpretations of the advertising rules in our 
regular filings program. 

* FINRA also will develop one or more mechanisms to provide a regular 
summary of advertising issues and its interpretation of the 
application of the advertising rules to these issues. For example, 
these mechanisms would include a regular letter to advertising 
compliance contacts in the industry and regularly scheduled webinars 
for these contacts. 

* As the report indicates, FINRA"s Advertising Regulation managers 
meet regularly to discuss important matters, including novel 
interpretive issues. Going forward, the managers will pay particular 
attention to the question of whether any of these issues affect a 
broad section of the industry and, if so, whether FINRA should issue a 
Notice or other guidance to the industry. We will also remind firms of 
their ability within the existing advertising filing system to alert 
their analyst about similar, previously filed material. This approach 
should help address the point raised by some firms about receiving 
comments on material that was previously deemed compliant. 

We appreciate the constructive comments in the report, and we believe 
these actions will help address the important concerns that GAO has 
raised. We appreciate your review of these issues and the 
recommendations for how we can strengthen our advertising review 
program. If you have any questions, please do not hesitate to contact 
me at (202) 728-6977. 

Sincerely, 

Signed by: 

Thomas M. Selman: 
Executive Vice President: 
Regulatory Policy: 

[End of section] 

Appendix III: Comments from the Securities and Exchange Commission: 

4.1
United States Securities And Exchange Commission: 
The Chairman: 
Washington, D.C. 20549 

July 15, 2011: 

Ms. Alicia Puente Cackley: 
Director: 
Financial Markets and Community Investment: 
U.S. Government Accountability Office: 
441 G Street, N.W. 
Washington, DC 20548: 

Dear Ms. Cackley: 

Thank you for the opportunity to comment on the draft report entitled 
Mutual Funds: Improving how Regulators Communicate New Rule 
Interpretations to Industry Would Further Protect Investors. The draft 
report responds to Section 918 of the Dodd-Frank Wall Street
Reform and Consumer Protection Act, which requires the Government 
Accountability Office to conduct a study on mutual fund advertising. 

The draft report examines what is known about the impact of fund 
advertisements on investors, the extent to which performance 
information is included in fund advertisements, and the regulatory 
requirements for fund advertisements and how they are administered and 
enforced. In preparing the draft report, GAO reviewed existing and 
proposed Commission and Financial Industry Regulatory Authority rules 
and requirements, conducted a literature review of existing studies 
and reports, and reviewed a random sample of 300 fund advertisements. 
GAO also met with regulators, fund companies, academics, and industry 
and investor protection groups. 

As GAO observes in the draft report, because millions of Americans 
invest in mutual funds, it is an important regulatory goal that 
investors receive fair and objective information and are not misled by 
fund advertisements. The GAO found that, while some academic studies 
and others have suggested that fund advertisements that emphasize past 
performance can influence investors to make inappropriate investments, 
the evidence that investors are harmed by these advertisements is 
mixed. GAO noted, as a factor that reduces the potential for investor 
harm, the fact that securities regulators have continued to refine 
their rules to help ensure that advertisements do not include 
misleading information and employ an established review process for 
advertisements. I remain committed to considering changes to the 
Commission's advertising regulations, such as the Commission's target 
date retirement funds proposal, in order to reduce the potential for 
investors to be misled by fund advertisements and assure that fund 
advertisements appropriately communicate information to potential 
investors. 

In its review. GAO also found that F1NRA sometimes communicates new 
interpretations of existing advertising rules through formal comment 
letters to individual fund companies and that this practice could 
limit awareness of, and compliance with, new interpretations. To address
this finding, the draft report recommends that the Chairman of the 
Commission take steps to ensure that FINRA develops mechanisms to 
notify the entire fund industry of new interpretations that arise 
during the course of regulatory reviews of fund advertisements. 

Like GAO, I believe that the uniform dissemination of regulator), 
positions tends to enhance compliance, thereby furthering investor 
protection. The development by FINRA of additional mechanisms to 
notify the entire fund industry anew interpretations could decrease 
the potential for investors to be misled by advertisements. Therefore, 
I plan to request that FINRA review its methods for disseminating new 
interpretations of its fund advertising rules with a view to enhancing 
transparency of those interpretations. In addition, I have asked the
Commission staff to work with FINRA, as needed, in developing 
mechanisms to enhance transparency in this area and to consider the 
GAO's findings as part of the staff's ongoing oversight of FINRA. 

Thank you again for the opportunity to comment on this report. 

Sincerely, 

Signed by: 

Mary L. Schapiro: 
Chairman: 

[End of section] 

Appendix IV: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

Alicia Puente Cackley, (202) 512-8678, or cackleya@gao.gov: 

Staff Acknowledgments: 

In addition to the individual named above, Cody Goebel, Assistant 
Director; James Ashley; Tania Calhoun; Barbara Chapman; Christine 
Houle; Thomas McCool; Marc Molino; Barbara Roesmann; Kelly Rubin; 
Andrew Stavisky; Verginie Tarpinian; and Frank Todisco made key 
contributions to this report. 

[End of section] 

Appendix V Bibliography: 

We conducted a review of 50 research studies that analyzed factors 
associated with mutual fund investors, performance, and advertising. 
The studies are listed below: 

Ackermann, Carl and Tim Loughran. "Mutual Fund Incubation and the Role 
of the Securities and Exchange Commission." Journal of Business Ethics 
70, (2007): 33-37. 

Barber, Brad M., Terrance Odean, and Lu Zheng. "Out of Sight, Out of 
Mind: The Effects of Expenses on Mutual Fund Flows." Journal of 
Business 78, no. 6 (2005). 

Barras, Laurent, Olivier Scaillet, and Russ Wermers. "False 
Discoveries in Mutual Fund Performance: Measuring Luck in Estimated 
Alphas." The Journal of Finance LXV, no. 1 (February 2010). 

Berk, B. and Richard C. Green. "Mutual Fund Flows and Performance in 
Rational Markets." The Journal of Political Economy 112, no. 6 
(December 2004): 1269-1295. 

Blake, Christopher R. and Matthew R. Morey. "Morningstar Ratings and 
Mutual Fund Performance." The Journal of Financial and Quantitative 
Analysis 35, no. 3 (September 2000): 451-483. 

Blake, Christopher R., Edwin. J. Elton, and Martin J. Gruber. "The 
Performance of Bond Mutual Funds." The Journal of Business 66, no. 3 
(July 1993): 371-403. 

Bollen, Nicolas P. B. and Jeffrey A. Busse. "Short-Term Persistence in 
Mutual Fund Performance." The Review of Financial Studies 18, no. 2 
(Summer 2005): 569-597. 

Braverman, Oded, Shmuel Kandel, and Avi Wohl. "The (Bad?) Timing of 
Mutual Fund Investors." Working paper (August 2005). 

Bullard, Mercer, Geoff Friesen, and Travis Sapp. "Investor Timing and 
Fund Distribution Channels." Working paper (June 2008). 

Capon, Noel, Gavan J. Fitzsimons, and Russ Alan Prince. "An Individual 
Level Analysis of the Mutual Fund Investment Decision." Journal of 
Financial Services Research 10 (1996): 59-82. 

Carhart, Mark M. "On Persistence in Mutual Fund Performance." The 
Journal of Finance 52, no. 1 (March 1997): 57-82. 

Coates, John C. IV and R. Glenn Hubbard. "Competition in the Mutual 
Fund Industry: Evidence and Implications for Policy." The Journal of 
Corporation Law 33, no. 1 (Fall 2007). 

Consumer Federation of America, Mutual Fund Purchase Practices 
(Washington, D.C., 2006). 

Cox, James D. and John W. Payne. "Mutual Fund Expense Disclosures: A 
Behavior Perspective." Washington University Law Quarterly 83 (2005): 
907-938. 

Cuthbertson, Keith, Dirk Nitzsche, and Niall O'Sullivan. "Mutual Fund 
Performance." Working paper (December 2006). 

Del Guercio, Diane and Paula A. Tkac. "Star Power: The Effect of 
Morningstar Ratings on Mutual Fund Flows." Federal Reserve Bank of 
Atlanta, working paper 2001-15 (August 2001). 

Del Guercio, Diane and Paula A. Tkac. "The Determinants of the Flow of 
Funds of Managed Portfolios: Mutual Funds vs. Pension Funds." The 
Journal of Financial and Quantitative Analysis 37, no. 4 (December 
2002): 523-557. 

Dominitz, Jeff, Angela A. Hung, and Joanne K. Yoong. "How Do Mutual 
Fund Fees Affect Investor Choices? Evidence from Survey Experiments." 
RAND working paper (December 2008). 

Evans, Richard B. "Does Alpha Really Matter? Evidence from Mutual Fund 
Incubation, Termination and Manager Change." Working paper (June 2006). 

Evans, Richard B. "Mutual Fund Incubation." The Journal of Finance 
LXV, no. 4 (August 2010): 1581-1611. 

Fama, Eugene F. and Kenneth R. French. "Luck versus Skill in the Cross-
Section of Mutual Fund Returns." The Journal of Finance LXV, no. 5 
(October 2010). 

Friesen, Geoffrey C. and Travis R. A. Sapp. "Mutual Fund Flows and 
Investor Returns: An Empirical Examination of Fund Investor Timing 
Ability." Journal of Banking and Finance 31 (April 2007): 2796-2816. 

Gallaher, Steven, Ron Kaniel, and Laura Starks. "Madison Avenue Meets 
Wall Street: Mutual Fund Families, Competition and Advertising." 
Working paper (January 2006). 

Goetzmann, William N. and Roger G. Ibbotson. "Do Winners Repeat?" The 
Journal of Portfolio Management 20, no. 2 (1994): 9-18. 

Grinblatt, Mark and Sheridan Titman. "The Persistence of Mutual Fund 
Performance." The Journal of Finance 47, no. 5 (December 1992): 1977- 
1984. 

Hendricks, Darryll, Jayendu Patel, and Richard Zeckhauser. "Hot Hands 
in Mutual Funds: Short-Run Persistence of Relative Performance, 1974- 
1988." The Journal of Finance 48, no. 1 (March 1993): 93-130. 

Jain, Prem C. and Joanna Shuang Wu. "Truth in Mutual Fund Advertising: 
Evidence on Future Performance and Fund Flows." The Journal of Finance 
55, no. 2 (April 2000): 937-958. 

Jayaraman, Narayanan, Ajay Khorana, and Edward Nelling. "An Analysis 
of the Determinants and Shareholder Wealth Effects of Mutual Fund 
Mergers." Journal of Finance LVII, no. 3 (June 2002): 1521-1551. 

Jensen, Michael C. "The Performance of Mutual Funds in the Period 1945-
1964." The Journal of Finance 23, no. 2 (May 1968): 389-416. 

Jones, Michael A., Vance P. Lesseig, Thomas I. Smythe, and Valerie A. 
Taylor. "Mutual Fund Advertising: Should Investors Take Notice?" 
Journal of Financial Services Marketing 12, no. 3 (2007): 242-254. 

Jordan, Jenny and Klaus P. Kass. "Advertising In the Mutual Fund 
Business: The Role of Judgmental Heuristics In Private Investors' 
Evaluation of Risk and Return." Journal of Financial Services 
Marketing 7, no. 2 (November 2002): 129-140. 

Investment Company Institute, Ownership of Mutual Funds, Shareholder 
Sentiment, and Use of the Internet, 2010 (Washington, D.C., 2010). 

Investment Company Institute, Understanding Investor Preferences for 
Mutual Fund Information (Washington, D.C., 2006). 

Kempf, Alexander and Stefan Ruenzi. "Family Matters: Rankings within 
Fund Families and Fund Inflows." Journal of Business Finance & 
Accounting 35, nos. 1 and 2 (January/March 2008): 177-199. 

Koehler, Jonathan J. and Molly Mercer. "Selection Neglect in Mutual 
Fund Advertisements." Management Science 55, no. 7 (July 2009): 1107- 
1121. 

Kozup, John, Elizabeth Howlett, and Michael Pagano. "The Effects of 
Summary Information on Consumer Perceptions of Mutual Fund 
Characteristics." The Journal of Consumer Affairs 42, no. 1 (Spring 
2008): 37-59. 

Malkiel, Burton G. "Returns from Investing in Equity Mutual Funds 1971 
to 1991." The Journal of Finance 50, no. 2 (June 1995): 549-572. 

Mercer, Molly, Alan R. Palmiter, and Ahmed E. Taha. "Worthless 
Warnings? Testing the Effectiveness of Disclaimers in Mutual Fund 
Advertisements." Journal of Empirical Legal Studies 7, no. 3 
(September 2010): 429-459. 

Nesbitt, Stephen L. "Buy High, Sell Low: Timing Errors in Mutual Fund 
Allocations." The Journal of Portfolio Management 22 (1995): 57-60. 

Palmiter, Alan R. and Ahmed E. Taha. "Mutual Fund Investors: Divergent 
Profiles." Columbia Business Law Review no. 3 (2008): 934-1020. 

Palmiter, Alan R. and Ahmed E. Taha. "Mutual Fund Performance 
Advertising: 

Inherently and Materially Misleading?" Working paper (February 2011). 

Palmiter, Alan R. and Ahmed E. Taha. "Star Creation: The Incubation of 
Mutual Funds." Vanderbilt Law Review 62 (October 2009): 1485. 

Pontari, Beth A., Andre J. S. Stanaland, and Tom Smythe. "Regulating 
Information Disclosure in Mutual Fund Advertising in the United 
States: Will Consumers Utilize Cost Information?" Journal of Consumer 
Policy 32 (2009): 333-351. 

Porter, Gary E. and Jack W. Trifts. "Performance Persistence of 
Experienced Mutual Fund Managers." Financial Services Review 7, no. 1 
(1998): 57-68. 

Sirri, Erik R. and Peter Tufano. "Costly Search and Mutual Fund 
Flows." The Journal of Finance 53, no. 5 (October 1998): 1589-1622. 

The Vanguard Group, We Believe #4: Consistently Outperforming the 
Financial Markets Is Extremely Difficult (Valley Forge, Pa., 2006). 

Wermers, Russ. "Is Money Really 'Smart'? New Evidence on the Relation 
Between Mutual Fund Flows, Manager Behavior, and Performance 
Persistence." Working paper (November 2003). 

Wermers, Russ. "Mutual Fund Performance: An Empirical Decomposition 
into Stock-Picking Talent, Style, Transactions Costs, and Expenses." 
The Journal of Finance 55, no. 4 (August 2000): 1655-1695. 

Wilcox, Richard T. "Bargain Hunting or Star Gazing? Investors' 
Preferences for Stock Mutual Funds." The Journal of Business 76, no. 4 
(October 2003): 645-663. 

Zhang, Andrew. "Mutual Fund Expense Ratios in Market Equilibrium." 
Working paper (July 2007). 

[End of section] 

Footnotes: 

[1] FINRA was established in 2007 through the consolidation of NASD 
and the member firm regulation, enforcement and arbitration functions 
of the New York Stock Exchange. FINRA defines six different types of 
"communications with the public" by fund companies: advertisements, 
sales literature, correspondence, institutional sales material, public 
appearances, and independently prepared reprints. Throughout the 
report, we use "advertisement" to include advertisements and sales 
literature. The remaining four types of communications with the public 
were excluded from our review. 

[2] Pub. L. No. 111-203, Title IX, § 918, 124 Stat. 1376, 1837 (2010). 

[3] ETFs can be registered with SEC as investment companies under the 
Investment Company Act of 1940. According to industry data, about 90 
percent of ETF assets are in funds registered as investment companies 
under that act. The remaining 10 percent of ETF assets, which are 
generally commodity-based, are held in ETFs that are not registered 
with or regulated by SEC under the Investment Company Act of 1940. The 
Commodity Futures Trading Commission regulates commodity-based ETFs 
that invest in commodity futures, while SEC regulates those that 
invest solely in physical commodities under the Securities Act of 
1933. ETFs that are not registered as investment companies are 
currently not required to submit advertisements and sales materials to 
FINRA for review; therefore, we have excluded them from our review. 

[4] FINRA classifies advertisements and sales materials that they 
review into 21 delivery methods: account statement-related 
communications; articles and third-party reprints; material for broker-
dealer use only; brochure; audio/video tapes (CDs and DVDs); 
electronic messages (e-mail, instant messages, and text); fund fact 
sheets (fund-specific information sheets); handouts (flyers and other 
hand-delivered material); mailings; performance reports (periodic and 
other performance reports such as an annual report); telephone 
(telemarketing and other telephone scripts); press releases; print 
advertisements, posters and signs; radio advertisements and 
broadcasts; research reports (equity and debt research); seminar-
related communications; software output and tools; stationery; 
television advertisements and broadcasts; Web site information-
password protected; and Web site information-publicly accessible 
(Internet advertisements and materials posted to fund company Web 
sites). 

[5] Because some companies file both mutual fund and ETF 
advertisements, 12 companies represented both the 10 most frequent 
mutual fund filers and the 5 most frequent ETF filers. 

[6] In 2010, 62 percent of households that own mutual funds own them 
inside tax-deferred accounts--such as 401(k) and other defined 
contribution plans, individual retirement accounts, and variable 
annuities. Another 28 percent of households own mutual funds both 
inside and outside tax-deferred accounts, and only 9 percent of 
households own mutual funds only outside of tax-deferred accounts. 

[7] The Investment Advisers Act requires mutual fund advisers to 
register with SEC, imposes reporting requirements on them, and 
prohibits them from engaging in fraudulent, deceptive, or manipulative 
practices. The Securities Act requires fund shares offered to the 
public to be registered with SEC and regulates mutual fund 
advertising. The Securities Exchange Act, among other things, 
regulates how funds are sold and requires persons distributing funds 
or executing fund transactions to be registered with SEC as broker-
dealers. 

[8] Self-regulatory organizations are private organizations with 
statutory responsibility to regulate their own members through the 
adoption and enforcement of rules of conduct. 

[9] Investment Company Advertising: Target Date Retirement Fund Names 
and Marketing, 75 Fed. Reg. 35,920 (June 23, 2010) (to be codified at 
17 C.F.R. parts 230 and 270). 

[10] Target Date Disclosure, 75 Fed. Reg. 73,987 (Nov. 30, 2010) (to 
be codified at 29 C.F.R. part 2550). The comment period for the 
proposed regulation closed on January 14, 2011. 

[11] FINRA Regulatory Notice 09-55, Communications with the Public 
(September 2009). 

[12] Michael C. Jensen, "The Performance of Mutual Funds in the Period 
1945-1964," The Journal of Finance Vol. 23, No. 2 (May 1968): 389-416; 
Christopher R. Blake, Edwin. J. Elton, and Martin J. Gruber, "The 
Performance of Bond Mutual Funds," The Journal of Business, Vol. 66, 
No. 3 (July 1993): 371-403; Jonathan B. Berk and Richard C. Green, 
"Mutual Fund Flows and Performance in Rational Markets," The Journal 
of Political Economy, Vol. 112, No. 6 (December 2004): 1269-1295; 
Burton G. Malkiel, "Returns from Investing in Equity Mutual Funds 1971 
to 1991," The Journal of Finance, Vol. 50, No. 2 (June 1995): 549-572; 
Mark M. Carhart, "On Persistence in Mutual Fund Performance," The 
Journal of Finance, Vol. 52, No. 1 (March 1997): 57-82; and Nicolas P. 
B. Bollen and Jeffrey A. Busse, "Short-Term Persistence in Mutual Fund 
Performance," The Review of Financial Studies, Vol. 18, No. 2 (Summer 
2005): 569-597. 

[13] Carhart (1997). 

[14] Laurent Barras, Olivier Scaillet, and Russ Wermers, "False 
Discoveries in Mutual Fund Performance: Measuring Luck in Estimated 
Alphas," The Journal of Finance, Vol. LXV, No. 1 (February 2010); 
Eugene F. Fama and Kenneth R. French, "Luck versus Skill in the Cross- 
Section of Mutual Fund Returns," The Journal of Finance, Vol. LXV, No. 
5 (October 2010); and Gary E. Porter and Jack W. Trifts, "Performance 
Persistence of Experienced Mutual Fund Managers," Financial Services 
Review, Vol. 7, No. 1 (1998): 57-68. 

[15] Barras, Scaillet, and Wermers (2010). 

[16] Jonathan J. Koehler and Molly Mercer, "Selection Neglect in 
Mutual Fund Advertisements," Management Science, Vol. 55, No. 7 (July 
2009): 1107-1121; and Prem C. Jain and Joanna Shuang Wu, "Truth in 
Mutual Fund Advertising: Evidence on Future Performance and Fund 
Flows," The Journal of Finance, Vol. 55, No. 2 (April 2000): 937-958. 

[17] Jain and Wu. 

[18] Morningstar, Inc., provides data on investment offerings 
including mutual funds and ETFs. Lipper supplies mutual fund 
information, analytical tools, and commentary. Both Morningstar and 
Lipper's benchmarking and classifications are widely recognized as 
industry standards. 

[19] For examples of these studies, see William N. Goetzmann and Roger 
G. Ibbotson, "Do Winners Repeat?" The Journal of Portfolio Management, 
Vol. 20, No. 2 (1994): 9-18; Mark Grinblatt and Sheridan Titman, "The 
Persistence of Mutual Fund Performance," The Journal of Finance Vol. 
47, No. 5 (December 1992): 1977-1984; and, Darryll Hendricks, Jayendu 
Patel, and Richard Zeckhauser, "Hot Hands in Mutual Funds: Short-Run 
Persistence of Relative Performance, 1974-1988," The Journal of 
Finance, Vol. 48, No. 1 (March 1993): 93-130; and Russ Wermers, "Is 
Money Really "Smart"? New Evidence on the Relation Between Mutual Fund 
Flows, Manager Behavior, and Performance Persistence," working paper 
(November 2003). 

[20] Hendricks, Patel, and Zeckhauser (1993). 

[21] Wermers (2003) and Grinblatt and Titman (1992), respectively. 

[22] The Vanguard Group, We Believe #4: Consistently Outperforming the 
Financial Markets Is Extremely Difficult (Valley Forge, Pa., 2006). 

[23] Some academics also expressed concerns over mergers between 
funds. According to one paper that analyzed fund mergers, the funds 
that fund companies merged into other funds within their fund family 
were more likely to be those that had exhibited significant 
underperformance. Although some concerns existed over whether 
investors might be misled if the newly merged fund advertises 
different performance than the previously separated funds, SEC staff 
generally expects that fund companies will determine whether a new 
fund resulting from a reorganization may use the historical 
performance of one of several predecessor funds by comparing the 
attributes of the new fund with the predecessor funds to determine 
which of the predecessor funds most closely resembles the new merged 
fund and is therefore considered to be the survivor fund. Although 
allowing the performance of the survivor fund to be presented as the 
performance of the merged fund implies that the merged fund's 
performance going forward should be similar, this study found that the 
merged funds often had reduced performance after merging, resulting in 
a transfer of wealth between the existing shareholders of the survivor 
fund and the shareholders of the fund that was merged. See N. 
Jayaraman, A. Khorana, and E. Nelling, "An Analysis of the 
Determinants and Shareholder Wealth Effects of Mutual Fund Mergers," 
Journal of Finance, Vol. LVII, No. 3 (June 2002): 1521-1551. 

[24] A fund company could register a new fund immediately but not 
actively market it (to build a performance record for a fund it may 
wish to advertise later). Some academics noted that indications that a 
fund company is incubating a registered fund include delays in 
obtaining a trading ticker symbol, which is a unique set of characters 
used to identify the shares of publicly traded companies and mutual 
funds, or the company's providing data on the new fund to the third- 
party investment monitoring firms. 

[25] Richard B. Evans, "Mutual Fund Incubation," The Journal of 
Finance, Vol. LXV, No. 4 (August 2010): 1581-1611. 

[26] Alan R. Palmiter and Ahmed E. Taha, "Star Creation: The 
Incubation of Mutual Funds," Vanderbilt Law Review Vol. 62 (October 
2009): 1485. 

[27] Stephen L. Nesbitt, "Buy High, Sell Low: Timing Errors in Mutual 
Fund Allocations," The Journal of Portfolio Management, Vol. 22 
(1995): 57-60; Geoffrey C. Friesen and Travis R. A. Sapp, "Mutual Fund 
Flows and Investor Returns: An Empirical Examination of Fund Investor 
Timing Ability," Journal of Banking and Finance, Vol. 31 (April 2007): 
2796-2816; Oded Braverman, Shmuel Kandel, and Avi Wohl, "The (Bad?) 
Timing of Mutual Fund Investors," working paper (August 2005); and 
Mercer Bullard, Geoff Friesen, and Travis Sapp, "Investor Timing and 
Fund Distribution Channels," working paper (June 2008). 

[28] Friesen and Sapp (2007). 

[29] Beth A. Pontari, Andre J. S. Stanaland, and Tom Smythe, 
"Regulating Information Disclosure in Mutual Fund Advertising in the 
United States: Will Consumers Utilize Cost Information?" Journal of 
Consumer Policy, Vol. 32 (2009): 333-351; Noel Capon, Gavan J. 
Fitzsimons, and Russ Alan Prince, "An Individual Level Analysis of the 
Mutual Fund Investment Decision," Journal of Financial Services 
Research, Vol. 10 (1996): 59-82; and Richard T. Wilcox, "Bargain 
Hunting or Star Gazing? Investors' Preferences for Stock Mutual 
Funds," The Journal of Business, Vol. 76, No. 4 (October 2003): 645-
663. 

[30] Pontari, Stanaland, and Smythe (2009). 

[31] Investment Company Institute, Understanding Investor Preferences 
for Mutual Fund Information (Washington, D.C., 2006). 

[32] Erik R. Sirri and Peter Tufano, "Costly Search and Mutual Fund 
Flows," The Journal of Finance, Vol. 53, No. 5 (October 1998): 1589- 
1622; Alexander Kempf and Stefan Ruenzi, "Family Matters: Rankings 
within Fund Families and Fund Inflows," Journal of Business Finance & 
Accounting, Vol. 35, Nos. 1 and 2 (January/March 2008): 177-199; Berk 
and Green (2004); and Diane Del Guercio and Paula A. Tkac, "The 
Determinants of the Flow of Funds of Managed Portfolios: Mutual Funds 
vs. Pension Funds," The Journal of Financial and Quantitative 
Analysis, Vol. 37, No. 4 (December 2002): 523-557. 

[33] Kempf and Ruenzi (2008). 

[34] Jain and Wu (2000). 

[35] Diane Del Guercio and Paula A. Tkac, "Star Power: The Effect of 
Morningstar Ratings on Mutual Fund Flows," Federal Reserve Bank of 
Atlanta, working paper 2001-15 (August 2001). 

[36] Consumer Federation of America, Mutual Fund Purchase Practices 
(Washington, D.C., 2006). 

[37] Investment Company Institute, Understanding Investor Preferences 
for Mutual Fund Information. 

[38] Investment Company Institute, Ownership of Mutual Funds, 
Shareholder Sentiment, and Use of the Internet, 2010 (Washington, 
D.C., 2010). 

[39] Investment Company Institute, Understanding Investor Preferences 
for Mutual Fund Information and Investment Company Institute, 
Ownership of Mutual Funds, Shareholder Sentiment, and Use of the 
Internet, 2010, respectively. 

[40] We reviewed complaints received by SEC between November 16, 2009, 
and April 29, 2011, and complaints received by FINRA between January 
1, 2010, and March 31, 2011. 

[41] See [hyperlink, http://www.investor.gov] and [hyperlink, 
http://www.finra.org/investors/index.htm]. 

[42] Because these estimates are based on a probability sample, they 
are subject to sampling error. All estimates from the sample in this 
report have a margin of error of plus or minus 10 percentage points or 
less. We selected the six delivery methods that investors might 
encounter without specifically seeking such information to include 
traditional methods of advertising. Appendix I contains a complete 
description of the methodology we used for the random sample. 

[43] This estimated 35 percent of advertisements that contains at 
least some performance information includes the estimated 9 percent of 
advertisements for which fund performance was the primary focus. 

[44] Molly Mercer, Alan R. Palmiter, and Ahmed E. Taha, "Worthless 
Warnings? Testing the Effectiveness of Disclaimers in Mutual Fund 
Advertisements," Journal of Empirical Legal Studies, Vol. 7, No. 3 
(September 2010): 429-459. 

[45] Among other types of materials, institutional sales materials--or 
materials intended to be used only with institutional investors, such 
as broker-dealers registered with FINRA or qualified employee benefit 
plans--are not required to be filed with FINRA for review. Firms that 
have been members of FINRA for less than 1 year must file all 
advertisements 10 days prior to first use. According to FINRA guidance 
to its members, a review takes about 3 weeks. 

[46] Firms must pay a $100 fee for filing advertisements (for up to 10 
pages) or $500 fee (for up to 10 pages) for an expedited review, in 
which FINRA generally will provide a review letter within 3 to 4 
business days. 

[47] Firms can currently receive four other types of determinations in 
review letters: (1) FINRA has a minor comment, but the advertisement 
does not require revisions; (2) FINRA does not have jurisdiction over 
the firm or product and therefore is not able to provide a review; (3) 
FINRA needs more information before it can provide its review; and (4) 
FINRA tells a firm to not use an advertisement--for pieces that 
contain significant problems-and requires the firm to respond in 
writing how they plan to address the situation. 

[48] Representatives of firms--including principals--are generally 
registered with SEC and FINRA. Representatives who are barred from the 
industry receive a permanent expulsion from associating with a FINRA 
member firm in any or all capacities. 

[49] Section 15A(b)(6) of the Securities Exchange Act. 

[50] The examination is now closed and the department made one 
referral to pursue disciplinary action. In September 2009, FINRA 
issued Regulatory Notice 09-55, which, among other things, proposes 
that communications on these types of products be filed with FINRA. 

[51] For some delivery methods, five advertisements were not available 
because fund companies had not submitted advertisements to FINRA for 
review for each of the 21 categories in 2010. FINRA classifies 
advertisements and sales materials that they review into 21 delivery 
methods: account statement-related communications; articles and third- 
party reprints; material for broker-dealer use only; brochure; audio/ 
video tapes (CDs and DVDs); electronic messages (e-mail, instant 
messages, and text); fund fact sheets (fund-specific information 
sheets); handouts (flyers and other hand-delivered material); 
mailings; performance reports (periodic and other performance reports 
such as an annual report); telephone (telemarketing and other 
telephone scripts); press releases; print advertisements, posters and 
signs; radio advertisements and broadcasts; research reports (equity 
and debt research); seminar-related communications; software output 
and tools; stationery; television advertisements and broadcasts; Web 
site information-password protected; and Web site information-publicly 
accessible (Internet advertisements and materials posted to fund 
company Web sites). 

[52] The Securities and Exchange Commission requires standard 
performance to be in the format of average annual total returns for 
1-, 5-, and 10-year periods. 

[53] Because some companies file both mutual fund and ETF 
advertisements, 12 companies represented both the 10 most frequent 
mutual fund filers and the 5 most frequent ETF filers. 

[End of section] 

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