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:
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:
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.
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.
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.
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.
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."