Mutual Fund Performance Advertising: Inherently and Materially Misleading?
Mutual fund companies routinely advertise the past returns of their strong-performing, actively-managed equity funds. These performance advertisements imply that the advertised high past returns are likely to continue. Indeed, investors flock to these funds despite high past returns being a poor predictor of high future returns. Thus, fund performance advertising is inherently and materially misleading and violates federal securities antifraud standards. In addition, the SEC-mandated warning in these advertisements that “past performance does not guarantee future results” fails to temper investors’ focus on past returns.
The SEC should do more to prevent investors from being misled by fund performance advertisements. It should at least require a stronger warning that makes clear that high returns by actively-managed mutual funds generally do not persist. The SEC should also seriously consider reinstating its prior prohibition of performance advertisements. Such a ban would help investors focus on more important fund characteristics, such a fund’s costs, risk, and the extent to which the fund’s investment objective matches that of the investor.
This article addresses a number of matters that the new Dodd-Frank Wall Street Reform and Consumer Protection Act requires the GAO to study. In particular, it examines the regulatory requirements for mutual fund advertisements, the industry's marketing practices and use of past performance data, the impact of performance advertising on investors, and it makes recommendations to improve investor protections in mutual fund advertising.
Ahmed E. Taha and Alan Palmiter. 2011. "Mutual Fund Performance Advertising: Inherently and Materially Misleading?" ExpressO
Available at: http://works.bepress.com/ahmed_taha/3