RCA - Summer 2000 - Inaccurate Performance Graphs Result In Formal Action

NASD Regulation recently announced a settlement in which it censured and fined an NASD member firm $100,000 for running inaccurate mutual fund advertisements and for violating other NASD advertising-related rules. In particular, NASD Regulation found that the member firm:

  • published advertisements containing inaccurate graphs of mutual fund performance;

  • published an advertisement that did not convey the risks of fluctuating prices inherent in investing;

  • used advertisements and sales literature without first obtaining registered principal approval; and

  • failed to properly file items with NASD Regulation's Advertising/Investment Companies Regulation Department.
    In addition to the censure and fine, the firm has undertaken to file prior to use, for a period of six months, all advertisements depicting performance information through the use of graphs, bar charts, or pie charts.

The firm's use of inaccurate graphs in its advertisements violated NASD Conduct Rule 2210, which requires, in part, that members' communications provide a sound basis for evaluating the facts with respect to any product or service discussed. The firm's use of the graphs also violated NASD Conduct Rule 2110 which requires members in the conduct of their business to observe high standards of commercial honor and just and equitable principles of trade. The graphs depicted the performance of a hypothetical $10,000 investment in a specific mutual fund using a "mountain chart" format. NASD Regulation found several problems associated with the use of these graphs: 

  • Due to unequal distances between plot points on the graph lines, many of the advertisements failed to accurately portray increases and decreases in the investment.

  • Several of the graphs showed dollar values along the vertical axis that did not correspond to actual performance over time. For example, based on a $10,000 hypothetical investment at the fund's inception, the investment appeared to grow to be approximately $29,000 in the graph, when in fact it had grown to $22,000.

  • When the firm updated several of the advertisements, it continued to use the old graph lines, labeled with the numbers reflecting the fund's current performance, rather than re-drawing and re-plotting the graph lines to reflect the fund's actual performance over the period indicated.

  • In several of the graphs, dollar markings indicating "20K," "30K," and "40K" were placed along the vertical axis after the graph line was plotted, yet these markings did not correspond to the values portrayed by the graph line.

This case demonstrates member firms' responsibilities to ensure that their graphic presentations of performance are accurate and provide the reader with a sound basis to evaluate any service or product discussed as set forth in NASD Conduct Rule 2210.1

 

In its review of member filings of advertisements and sales literature, NASD Regulation has noted areas of concern in the use of graphic presentations of performance.


Labeling

Members must ensure that the axes and baselines of graphs are labeled clearly so that the reader can understand how the performance data relates to the graph. The increments on the axes must also aid the reader in understanding the significance of the data. NASD Regulation has cautioned members about using graphs with little or no indication of the increments on the axes.


Disclosure

The text accompanying a graph must clearly state its purpose and significance. Advertisements and sales literature that contain graphs illustrating the historic performance of a hypothetical investment in a product must disclose the relevant assumptions, such as: the initial investment amount; whether dividends and capital gains were reinvested; whether taxes have been reflected; and whether sales loads or other fees were deducted.


Starting Points or Baselines of Graphs

Members must ensure that the starting point of a graph fairly reflects the performance of the product without exaggeration. In certain bar graphs that compare performance data, members have used a baseline that is higher than zero. This higher value baseline may exaggerate the differences between the performance data illustrated. Similarly, in a mountain chart format, using a non-zero starting point may make poor performance appear more favorable. If a non-zero starting point is chosen, the member firm must have a reasonable basis for choosing such a point.


Scale

The NASD Conduct Rules do not require that members use a specific scale or format when depicting performance using graphs. Nevertheless, the prohibition of exaggerated or misleading statements or claims requires that members exercise care in choosing the appropriate scale for presentations of performance information.


Comparisons

Members may use graphs that compare an investment in a product with a hypothetical investment in a benchmark index over the same time period. In accordance with the NASD Conduct Rules, members must ensure that the comparative index is appropriate and provides the reader with a sound basis for evaluating the facts with respect to the product. For example, SEC rules require mutual fund annual reports or prospectuses to include hypothetical illustrations that compare the fund's performance to that of a benchmark index over a 10-year timeframe. If a member firm chooses to include a different comparative benchmark index in such a comparison in advertisements or sales literature for the fund, the member must ensure that the index chosen is appropriate.


Any questions regarding the use of charts and graphs in members' communications with the public may be directed to the Advertising/Investment Companies Regulation Department at (202) 728-8330.

 


1 Members should also be aware that the SEC has articulated certain principles with respect to graphics in the publication titled A Plain English Handbook, which is available on the SEC Web site. The Handbook indicates that graphic presentations must be truthful and states that, "any graphic should be proportionately correct or drawn to scale."