By Clifford E. Kirsch, Wendell M. Faria and W. Thomas Conner*
The Business Lawyer
American Bar Association | May 1995

* Mr. Kirsch is Chief Counsel, Variable Products, The Prudential Insurance Company of America. Mr. Kirsch was formerly Assistant Director in the Securities and Exchange Commission’s Division of Investment Management, in charge of the Office of Insurance Products. Mr. Faria is an associate with the firm of Paul, Hastings, Janofsky & Walker. Mr. Faria was formerly Deputy Chief of the Office of Insurance Products. Mr. Conner is an associate with the firm of Sutherland, Asbill & Brennan. Mr. Conner was formerly a staff attorney in the Office of Insurance Products and the Division of Investment Management’s Office of Disclosure and Investment Adviser Regulation.

Parts of this Article were prepared while the authors were attorneys with the Securities and Exchange Commission. As a matter of policy, the Commission disclaims responsibility for any private publications by any of its employees, past or present. Thus, the views expressed in this Article are those of the authors and do not necessarily reflect the views of the Commission or of the authors’ former colleagues on the staff.
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INTRODUCTION
The investment company industry has grown dramatically in recent years. Since 1980, investment company assets have grown at an annual rate of 23.1%–doubling every four years–and now stand at $ 2.4 trillion. n1 Mutual funds, n2 the most popular form of investment company, account for 86% of this $ 2.4 trillion. n3 Mutual funds are now an investment choice for 27% of U.S. households. n4 In June 1994, there were 4901 separate mutual fund portfolios, an increase of 769% from the 564 that existed at the beginning of the 1980s. n5 During that time, mutual fund assets soared from $ 135 billion to over $ 2 trillion, an increase of more than 1445%. n6

Variable annuities and variable life insurance policies, which are other types of investment company securities, have also become very popular. n7 These products offer insurance protection but also permit policyholders to accumulate policy values by investing in underlying mutual funds rather than receiving the fixed income returns generally earned under more traditional insurance policies. The products have the added advantage of tax deferral. From March 1993 to March 1995, total net assets of variable annuities increased from $ 122 billion to $ 193 billion, with 1750 subaccounts. n8 During the same period, total net assets for variable life policies increased from $ 8 billion to almost $ 14 billion, with 834 subaccounts. n9

Advertising by mutual funds and variable insurance product issuers and their sponsors and underwriters has played a crucial role in the growth of these products. Advertising serves to educate prospective investors about the types of products available and the services offered in connection with those products.

Many fund groups, banks, and insurance companies, however, face a common problem: they offer similar types of products and services. Differentiation is key. Even a quick survey of advertisements and articles in the financial press shows that performance advertising is an essential tool to differentiate an issuer’s product. n10 Performance advertising answers what, for many investors, remains the most fundamental question–how has the investment performed?

The Securities and Exchange Commission (SEC or Commission) has permitted investment companies to advertise performance data since 1979. n11 Specifically, Rule 482 under the Securities Act of 1933 (the 1933 Act) permits any registered investment company to advertise any information the substance of which is contained in its statutory prospectus. n12 The Commission has twice amended the rule to require standardized computations of performance data for money market funds, mutual funds, and variable annuity separate accounts. n13

Rule 482 permits investment companies to present yield and total return–the current income and overall appreciation (including income), respectively–that an investor would have received by investing in the fund for specified periods. n14 Overall, the rule appears to have been effective in regulating historical performance data. The rule arguably has been less effective, however, in situations when competitive pressures have caused funds to engage in structural changes. When a structural change has occurred, it may be difficult to determine whether the use of historical performance data is appropriate, and, if so, how to recalculate that data. In response, the staff of the Commission has had to develop a significant body of interpretive positions to augment the black letter of Rule 482. n15 In addition, the long-term nature and structural and product complexity of variable insurance products require specialized, and often forward-looking, quantitative information to be presented to investors. The staff also has had to develop positions to cover these presentations.

This Article presents a detailed analysis of the regulation of mutual fund and variable insurance products advertising, with an emphasis on the regulation of performance advertising. The Article is divided into four sections.

The first section describes generally the three types of sales literature that mutual funds and variable insurance product issuers use to market their products. Mutual funds and insurance products are marketed through prospectuses that must be provided to investors, through advertisements, and through supplemental sales literature given to investors at the same time, or after, they are given prospectuses. n16

The second section gives an overall view of the regulatory framework governing investment company sales literature. Investment company advertising is regulated primarily under the 1933 Act, n17 but the Investment Company Act of 1940 (the 1940 Act) regulates some aspects as well. n18 This section provides a “black letter” analysis of the provisions of these statutes governing investment company communications with the public, discusses how the three types of sales literature are regulated under the Commission’s rules, and concludes with a discussion of several provisions of the NASD’s Rules of Fair Practice that have been developed recently. n19

The third section discusses the development by the Commission of the rules that govern mutual fund and variable insurance products advertising and pays particular attention to Rule 482, which governs performance advertising. The final section examines the interpretive positions developed by the staff of the Commission as mutual funds and variable product issuers have developed new products and services and as structural changes have occurred in the industry. This section analyzes the use by variable insurance product issuers of different types of hypothetical illustrations, which, although not generally permitted for mutual funds, have been permitted in the insurance products area because of the structural and product complexity and long-term nature of these products. This section also discusses various problematic issues relating to variable life insurance performance advertising.
…
Citation:
n99 Evaluations come in various forms. For example, Morningstar, Inc. assigns funds one, two, three or four stars, Value Line Investment Survey assigns numbers, and Lipper Analytical Services ranks funds by performance. See Charles A. Jaffe, Mutual Fund Ratings Can Be Misleading, BOSTON GLOBE, July 7, 1994, at 37. The term “rankings” is used hereinafter to refer to any type of ranking or rating system, since in many cases the terms seem to be used interchangeably. See Alyssa A. Lappen, “Who rates among the fund raters?,” INSTITUTIONAL INVESTOR, Feb. 1994, at 63 (rankers can’t all be No. 1). A distinction may be drawn, however, in certain contexts. For example, the term “rating” could be used to refer to the assessment of the credit quality of debt instruments issued by various companies. Such ratings are performed generally by companies such as Standard & Poors, Moody’s, and Duff & Phelps.

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Practical applications using Bloomberg
by Joseph Cilia, Financial Markets Unit
Federal Reserve Bank of Chicago | May 1995

Bibliography cites:
Michael Carroll, and Alyssa A. Lappen, “Mortgage-Backed Mayhem,” Institutional Investor, July 1994

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A functional approach to reform

Jane E. Willis*
Columbia Business Law Review, No. 221 |1995

* J.D., magna cum laude 1994, Harvard Law School; law clerk to Honorable Robert E. Keeton, U.S. District Court for the District of Massachusetts. I am grateful for the guidance of Professor Howell Jackson and members of the law firm of Ropes & Gray. The opinions expressed in this Article do not represent the views of Ropes & Gray or any of its members.

Text: 24,473 words

SUMMARY:
… The mutual fund industry grew rapidly during the 1980s. … For example, depository institution regulation is duplicative because different federal agencies govern differently-chartered institutions that perform the same basic functions of deposit taking and lending, as well as certain investor services. … This restriction decreases the efficiency of bank sales programs because a customer who is comparing certificates of deposit to mutual funds would have to speak to two different employees in two different locations. …Having discussed each of the hazards identified in Camp, it is clear that it is no more “hazardous” to a bank’s health or to its consumers for a bank affiliate to act as a mutual fund distributor than it is for a bank or bank affiliate to engage in investment advisory activities. … Because acting as a mutual fund distributor does not constitute firm-commitment underwriting, the agencies could conclude that the Glass-Steagall Act does not prohibit a bank or bank affiliate from distributing mutual funds. …Bank mutual fund activity is just one example of the need for functional regulation. …

Citations:
n160 If one does not think that banks can succeed in the mutual fund business in general, then allowing banks to distribute mutual funds is just a further step in the wrong direction. Whether bank mutual funds will be successful is an open question. See Alyssa A. Lappen, Funds Follies, Institutional Investor, Oct. 1993, at 39 (“A pressing concern is quite simply, whether the nation’s banks, as a group, have the financial — or intellectual — wherewithal to succeed in the ferociously competitive mutual fund business.”); id. at 40 (quoting David Rosen, Executive Vice President of Republic New York Corp. as saying, “There is too much bank mutual fund product out there, you have to ask whether they will all survive.”); Waggoner, supra note 6 (“Some banks may find themselves in a business that’s far tougher — and more expensive -than they imagined. ‘It’s a lemming phenomenon . . . a lot of banks just don’t know what they’re doing.'”).
n164 Id.; see also Lappen, supra note 160 (“You shouldn’t start a money market fund if you think that maximum assets will be $ 200 million, because it will never be profitable.”).
n166 About 13% of the assets of proprietary bank mutual funds have come from commingled trusts. See Lappen, supra note 160 (“When banks say that they have sold this many [dollars in their] funds, they are fibbing. . . . They have used Hamburger Helper.”).
n168 Lappen, supra note 160. Accord Telephone Interview with Mary McArty, Consultant, Cerulli Associates (Mar. 4, 1994).
n186 See Lappen, supra note 160 (noting trend towards fee based income); Jay G. Baris, Issues Arise on Naming of Mutuals, Nat’l L.J., Aug. 16, 1993, at 27 (“With traditional asset bases dwindling, banks must seek non-traditional alternatives to bolster regulatory net worth and sagging profits.”).
n190 See Lappen, supra note 160 (attributing the term to an unnamed consultant).

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U.S. Participation in the Globalization Trend
by Michel V. Hurley *
Emory International Law Review | Fall 1994

* Candidate for J.D., Emory University, 1995; graduated from Vassar College, 1992, with a B.A. in Political Science. The author dedicates this Comment to her parents, Valerae and William Hurley, in appreciation of their heroic support and guidance.

INTRODUCTION
The word “Globalization” is used widely to summarize a complex worldwide development; it describes the growing number of interweaving dependencies–economic, political and cultural–among countries and the consequent blurring of international boundaries in those areas. 1 The globalization trend complicates the application of local laws to economic activity because the actors and their objects often are not contained within the borders of a single nation or even a single geographical region. One field that has received much recent attention, but few and scattered simplifying solutions, is that of securities regulation. While the General Agreement on Tariffs and Trade (GATT) has proven to be somewhat problematic, it still manages to provide some guidance for the international trade of manufactured goods; the securities field enjoys no such consensus. Thus, renowned securities regulation expert and Harvard Law School professor Louis Loss believes that globalization “very likely will be the central theme of securities regulation through the nineties.” 2

Securities issuers and investors are not waiting idly for governments to reach agreements on uniform rules. Wherever it has been possible to reach out for foreign capital or for new places to invest, people have found ways to skirt prohibitive local laws in order to
[*702] do so. 3 Unfortunately, as this comment will show, such unregulated investing has often led to great inefficiency and inequity, prompting legislators to search for new ways to handle the effects of globalization. Columbia Law Professor Michael Gruson wrote in 1987, “At this point, lawyers seem to be following the driving factor of market forces. Since the markets have so far developed in spite of the many remaining impediments and obstacles, lawyers are now called upon to help simplify and ease the natural flow. . . .” 4 Globalization thus calls either for more systematic planning and direction or at least for the removal of current inconsistent and ineffective regulatory barriers to international securities trading.

Barring some break in the trend–and with appropriate regulatory responses–full integration may result. Morgan Stanley International President Richard A. Debs described the future securities market as one which has no national boundaries, to which participants . . . from all over the world have access, in which price is established by supply and demand from around the world, not from a single domestic market, and in which transactions can be effected on a twenty-four hour basis or close to it. 5

However, the United States, historically the world leader in the field, is not prepared for the globalization of securities markets. In 1987, the Securities and Exchange Commission (SEC) noted that U.S. stock markets were failing to keep pace with others in at [*703] tracting foreign listings. 6 In 1989, the U.S. Senate conducted hearings to determine how to stop the decline in this area. 7 One senator remarked that he was “concerned about the continued ability of U.S. institutions and markets to remain atop the competitive roost. And in fact, by certain measures, we’ve already lost our leading edge in some areas.” 8 Since then, Congress, the SEC, and the various self-regulatory organizations (SROs) 9 have been pondering ways to improve the statistics. Underlying the attention, however, is a usually unexpressed reluctance to change which stems from feelings of U.S. supremacy–the notion that we should not bother to “fix what is already working.” 10

Part I of this comment explains the necessity for further internationalization of U.S. securities markets. Part II discusses efforts made to that end, as well as persisting problems. Finally, Part III attempts to provide a framework for change, taking into account a number of popular theories. It concludes with the suggestion that, in addition to current efforts, a combination of deference to foreign securities laws and limited deregulation in this country is necessary for safe and profitable American participation in the global market. In the words of Michael Gruson, “Lawyers who have a natural tendency to accept without question the regulatory sys [*704] tems of their country will have to keep an open mind.” 11

This comment is offered both as a primer on progress made in the area of internationalization of American securities markets and as a suggested focus for future development. In the interest of brevity, it does not discuss certain relevant issues: State (“blue sky”) laws are not examined in addition to federal regulation, because the states are tending toward deference to uniform laws for foreign issues anyway. 12 Jurisdiction over any trade in a U.S. market is assumed, because there is a “U.S. connection” to any such trade. 13 Finally, this comment examines problems with divergent foreign accounting and disclosure standards to the near exclusion of all other discrepancies, because the author believes these to be the two major obstacles to successful and expedient international securities trading.

Citation:
3 Total American investments in foreign securities amounted to $340 billion in July, 1993. Alyssa A. Lappen, “International Investing’s Hottest Hands,” INSTITUTIONAL INVESTOR, July 1993, at 63. Robert McCabe, chief market analyst at Merill Lynch in New York, notes that in recent months nearly 40 percent of American mutual fund money has been ploughed into overseas investments. Larry Black, After the Deluge of U.S. Cash; A Wall of American Money Has Hit World Share Markets This Year, INDEPENDENT, Dec. 30, 1993, at 27. Mutual funds are groupings of investments in many different stocks and/or bonds (depending on the fund for the purpose of lowering risk). See infra note 44.

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