Investment Company and Mutual Fund Communications

The SEC's investment company advertising framework is built from several interlocking rules. Each rule carves out a specific path that lets a fund advertise without violating the registration requirements of the Securities Act (which prohibits selling unregistered securities). The Series 6 exam tests which rule does what.

Why does Securities Act registration matter for fund advertising?

Before diving into the advertising rules, understand the two Securities Act foundations they exist to satisfy:

• Registration requirement: The Securities Act prohibits offers or sales of securities unless registered (or exempt). Advertisements for registered funds could technically violate the registration requirement unless a rule carves out an exception.
• Civil liability: The Securities Act creates civil liability for misleading communications:
  • Strict liability for offering or selling a security in violation of the registration and prospectus-delivery requirements
  • Material misstatement and omission liability for false or misleading statements in a prospectus or oral communication

The open-end-fund-advertising rule, the summary-prospectus rule, and the generic-advertising and FINRA-filed safe harbors each describe a compliant path that keeps fund advertising out of registration trouble.

What does the SEC investment-company sales-material rule prohibit?

The SEC investment-company sales-material rule is the antifraud rule specific to investment company sales literature. It applies on top of the open-end-fund-advertising rule and the fund supplemental-sales-literature rule.

Sales literature is materially misleading if it:

• Contains an untrue statement of a material fact, OR
• Omits a material fact necessary to make a statement not misleading

Four specific areas the SEC flags as common problem zones:

What does the open-end-fund-advertising rule require?

The open-end-fund-advertising rule permits investment company advertisements to be deemed a prospectus under the Securities Act's omitting-prospectus provision, so they can contain information beyond what the statutory prospectus includes (performance data, for example).

Standardized performance requirements when performance data is included:

• Must show SEC-standardized total return:
  • 1-year average annual total return
  • 1-year and 5-year (if fund has existed at least 5 years)
  • 1-year, 5-year, and 10-year (if fund has existed at least 10 years, or life-of-fund if shorter)
• Returns must be current to the most recent calendar quarter ended prior to submission
• All three standardized periods must be presented with equal prominence

Required disclosures in an open-end-fund-advertising-rule ad:

• Disclosure advising investors to consider the fund's objectives, risks, charges, and expenses before investing
• Statement that the prospectus and summary prospectus contain this information and that investors should read them carefully
• A standardized legend:
  • Past performance does not guarantee future results
  • Current performance may be lower or higher
  • Investment return and principal value fluctuate
  • Shares may be worth more or less than cost when redeemed
• Maximum sales load and any other non-recurring fees
• Fee and expense presentations consistent with the prospectus fee table

Exam Tip: Gotchas

The open-end-fund-advertising rule's standardized total return requires 1-year / 5-year / 10-year average annual total returns (or life-of-fund if shorter). A fund cannot show only a 3-year return or YTD-only performance without also including the standardized periods. This is one of the most heavily tested facts in fund advertising.

What does the summary-prospectus rule allow funds to deliver?

The summary-prospectus rule lets funds satisfy prospectus delivery obligations by using a summary prospectus (a short, plain-English document) instead of the full statutory prospectus, provided:

• The summary prospectus is sent or given to investors covering 9 key items:
  1. Investment objectives
  2. Fees and expenses
  3. Principal investment strategies
  4. Principal risks
  5. Past performance
  6. Management (investment adviser and portfolio manager)
  7. Purchase and sale of fund shares
  8. Tax information
  9. Financial intermediary compensation
• The full statutory prospectus, Statement of Additional Information (SAI), and most recent shareholder reports are posted online at a publicly accessible website and made available free of charge
• The full statutory prospectus is sent to the investor upon request (generally treated as within 3 business days)

When is investment company sales literature deemed misleading under the fund supplemental-sales-literature rule?

The fund supplemental-sales-literature rule (issued under the Investment Company Act) is a companion to the open-end-fund-advertising rule. It addresses fund sales literature (as opposed to advertising) that accompanies or follows a statutory prospectus.

Such sales literature is deemed materially misleading if it contains performance data without:

• The uniformly computed (standardized) performance data required by the open-end-fund-advertising rule, AND
• The required standardized legend (past performance does not guarantee future results, etc.)

Compliance with the fund supplemental-sales-literature rule does NOT relieve the fund, underwriter, or dealer from liability under the antifraud provisions.

What does the SEC's generic fund-advertising safe harbor permit?

The SEC's generic fund-advertising safe harbor permits generic investment company advertisements that do NOT name a specific fund. Because no specific security is offered, a generic-advertising-safe-harbor ad is NOT a prospectus.

Allowed content:

• Investment company securities in general (e.g., how mutual funds work)
• Types of investment companies (open-end, closed-end, unit investment trusts (UITs)) and their characteristics
• Services offered in connection with investment companies
• Name and address of the sponsor (broker-dealer, underwriter, or adviser)

If the ad solicits inquiries and promises to send prospectuses in response, the ad must state:

• The number of investment companies covered
• Whether the sponsor is the principal underwriter or adviser

How does the SEC's FINRA-filed safe harbor treat fund communications?

The SEC's FINRA-filed safe harbor provides that FINRA-filed communications that comply with the FINRA communications rule's filing requirements (and relate to registered investment company securities) are NOT deemed a "prospectus" or "offer" under the Securities Act's definitional and offering-during-registration provisions.

This lets member firms use ads about specific funds without triggering registration violations during the registration period.

Which investment company advertising rules produce a prospectus?

This is the exam's favorite question in this area.

Exam Tip: Gotchas

An open-end-fund-advertising-rule advertisement IS treated as a prospectus (an "omitting prospectus"). A generic ad is NOT a prospectus because it does not name a specific fund. The exam tests which one qualifies as a prospectus for Securities Act registration compliance.