Here at Nottingham, many of our clients are experienced money managers with successful proprietary strategies. Their SMAs are flourishing; perhaps they manage a private fund; or maybe they even sub-advise a sleeve in a mutual fund – and now they want to expand on that winning formula with their own dedicated mutual fund.
From the clients’ perspective, the legal and regulatory structure of their mutual fund is just a different cloth draped around the same underlying form. Whether it’s an SMA, a private fund, a sub-advised sleeve, or their new mutual fund, at the core it’s still their strategy. Thinking about it that way, it seems only obvious that a new Fund’s advertising would focus on the historical performance of the strategy. This data, the performance of products sharing the same strategy as the Fund, is what is referred to as “related performance.”
One would think that it’s perfectly normal and reasonable to provide prospective investors with this related performance. In fact, to a great extent, the SEC agrees. As outlined in various no-action letters, the SEC has long permitted a mutual fund’s prospectus to include related performance. As long as certain conditions are met, you’re free to show – in the prospectus – how your strategy has historically performed in order to give investors an idea of how the mutual fund might perform.
However, the next bit is where our clients often find themselves frustrated. What you’re allowed to show in the prospectus and what you’re allowed to advertise outside of the prospectus are two entirely different things. The SEC controls what is permissible in a mutual fund’s prospectus, but the SEC delegates some of its authority to FINRA when it comes to broader advertisements, and, until very recently, FINRA had taken the stance that related performance was completely prohibited.
If that dichotomy sounds like an absurd regulatory contradiction, you’re not alone in that thought. Due to these divergent interpretations, you were allowed to publish related performance in the most important public document related to the Fund – its prospectus – but you weren’t allowed to copy that same performance data in marketing material. Nor were you allowed to communicate in such a way as to reference or direct prospective investors to the specific part of the prospectus containing the related performance.
The confusing nature of this did not escape FINRA, and to their credit they did at one point submit proposed amendments to the SEC in order to bring their two rules in line with one another. The SEC chose not to act on those rules, and they were eventually withdrawn in 2004.
However, all was not lost. In May, 2015, FINRA issued a new interpretive letter. This time, FINRA finally allowed mutual funds to advertise using related performance in certain circumstances. The most important of these circumstances is that the marketing materials must be for institutional parties only. As defined by FINRA Rule 2210(a)(4), this encompasses a variety of persons both natural and corporate, but generally it refers to registered investment advisers, government entities, banks, and/or entities with over $50 million in assets. Unfortunately, as of the publication of this article, FINRA still prohibits the use of related performance in fund advertisements aimed at the general public or retail investors.
Beyond restricting this type of marketing to institutional recipients, there are also a number of other strings attached to its use. There are more beyond this summary, but the most significant requirements are these:
- First, the presentation must include performance for all related accounts – meaning that a portfolio manager cannot pick and choose which of their related accounts to include as related performance. Every portfolio that shares substantially the same strategy must be included;
- Second, the related performance must be presented net of fees and expenses of each specific account (as must the data for the mutual fund itself);
- Third, the related performance must be for a period of at least one year and be current to the most recent calendar quarter end;
- Lastly, any material differences between the mutual fund and the related accounts must be disclosed and explained.
To summarize, if you are a portfolio manager with a strategy being duplicated from your other products, you may be allowed to do the following when it comes to your mutual fund:
- Include the performance of those products in the prospectus of the mutual fund; and/or
- Include the performance of all of those products in advertisements sent only to institutional parties.
However, under the current regulatory framework, what you still cannot do is:
- Publish related performance in advertisements to retail parties (i.e. the general public); or
- Republish the related performance from your prospectus in peripheral advertisements to retail parties; or
- Reference or direct retail parties directly to the section of the prospectus which contains that related performance.
As always, advertising compliance can be a subjective affair, and there are an endless number of restrictions and considerations beyond those contained in this brief snapshot. Whether you are a current Nottingham client, or a prospective advisor with a successful strategy that you want to leverage, please feel free to reach out for a consultation. Regulatory compliance is a maze, but we’ll help you through it every step of the way.