As required by Section 918 of the Dodd-Frank Act, the U.S. Government Accountability Office (“GAO”) has issued a report on its review of mutual fund advertising, focusing on the advertising of past performance information. The report examined: (i) what is known about the impact of fund advertisements on investors; (ii) the extent to which performance information is included in advertisements; and (iii) the regulatory requirements for fund advertisements and how they are administered and enforced. In preparing its report, the GAO reviewed existing and proposed SEC and FINRA rules, conducted a literature review of studies related to the impact of mutual fund advertising on investors and reviewed a random sample of 300 fund advertisements. The GAO’s report can be found here.

The GAO noted that some academic studies and representatives of investor protection organizations have expressed concerns that investors could be influenced to make inappropriate investment decisions by advertisements that emphasize past performance, but found that the evidence that investors are harmed by these advertisements is mixed. Among its observations, the GAO noted that surveys show that investors are increasingly relying on information from financial advisors and other sources and use a variety of information other than performance information when making their investment decisions. The GAO also noted that the potential for investor harm may be limited because advertising materials for mutual funds largely focus on information other than performance. The GAO estimated that from 2006 through 2010, only 9 percent of mutual fund advertisements intended to be seen by the public primarily focused on fund performance and only 35 percent of all advertisements submitted to FINRA contained some performance information.

The GAO also indicated that the regulatory review process for fund advertising appears to limit the potential for misleading advertisements, but noted that there are concerns about the consistency of FINRA’s comments on advertising materials. The GAO also indicated that FINRA’s mechanisms for communicating new rule interpretations to the industry could be improved.

With respect to inconsistency of FINRA comments, the GAO noted that one key factor may be that the standards in FINRA’s advertising rules are subjective and different FINRA analysts may interpret these standards differently from one another. The GAO noted, however, that FINRA maintains several processes that are designed to improve the consistency of comments provided on advertising materials.

The GAO also noted that FINRA lacks sufficient mechanisms for ensuring that new interpretations of existing rules are communicated evenly to all mutual fund complexes when they are provided in comment letters. For example, the GAO gave the example of FINRA changing its position on the use of hypothetical back-tested data in fund advertisements. When FINRA changed its interpretation of its advertising rules as applied to this practice, FINRA did not publicly disseminate any written guidance. Instead, FINRA alerted fund complexes of its new position through individual comment letters on advertising materials submitted for review. The GAO noted that disseminating changes in interpretive positions through this method leads to the uneven application of FINRA’s interpretations where one firm continues to use previously approved advertisements while other firms that are submitting advertisements for review are told not to use advertisements that follow the same practice. To address this specific concern, the GAO recommended that the SEC take steps to ensure that FINRA develops sufficient mechanisms to notify all fund companies about changes in rule interpretations for fund advertising. Both the SEC and FINRA agreed with the recommendation.