SEC Division of Investment Management staff letter: Dr. William Greene, Stern School of Business

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UNITED STATES riji~' ~i c';'
SECURITIES AND EXCH. ANGE COMMISSION ~ ll* ff...i ...~ ;!.jn WASHINGTON, D,C, 20549 ~ I~"::'.';; ¡;'..:/ ~~""_'-""..~...;. February 3, 1997

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Dr. Will iam Greene ACT )t iwc-~t'J n t., L-~13 Department Chair Stern School of Business SEC'IION-- _::-~ 44 West Fourth Street, Suite 7-88 RULE ~ß~

New York, N.Y. 10012-1126

Dear Dr. Greene:
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Commissioner Wallman has referred your inquiry regarding

mutual fund performnce to the Division of Investment Management,

which, as you may know, is responsible for the regulation of the

maj or participants in the investment management business. You

ask whether a mutual fund sponsor can establish a numer of

lightly capitalized private pools for the purpose of generating

performance track records. In the situation you describe, the

sponsor, after waiting for a period of time, would select the

pools with the best returns and take them public, touting their

excellent past performance. You note that one of your colleagues

suggested to you that the Commission staff recently took a

position permitting this practice.

The hypothetical you raise is one that the Division terms

the "incubator fund" problem. The Division has consistently, for

close to th~rty years, expressed severe reservations about these

funds. In particular, the Division has been concerned that a

mutual fund is likely to be managed differently than it was

during its "incubation period" and that it is potentially

misleading for a fund sponsor of a number of incubator funds

organized at the same time to select and cite the performance of a single incubator fund without disclosing the performnce of other similar, but less successful, incubator funds. These

• concerns underlie the Division's longstanding position that, to

be consistent with the antifraud provisions of the federal

securities laws, incubator fund performance should not be

included in a mutual fund's prospectus in the absence of

extremely clear disclosure explaining the sponsor's purpose in

establishing the incubator fund. In view of this position, the

Division is typically not even presented with the type of facts

set forth in your hypothetical.

We presume that the staff position to which your colleague

refers is a 1995 no-action letter to MassMutual Institutional

Funds. Unfortunately, this letter has been, in our judgment,

mischaracterized in a number of press accounts. In MassMutual,

the Division permitted seven newly registered mutual funds to

calculate past performance using performance data attributable to

'" -.

Dr. William Greene

February 3, 1997

their unregistered predecessor separate accounts. MassMutual,

however, presented facts significantly different from those in

your hypothetical. In particular, MassMutual represented that

each predecessor account was created for purposes entirely

unrelated to the establishment of a performnce record.

MassMutual noted, for example, that two of the separate accounts

had been in existence for more than twenty years, two had existed

for more than ten years, and the other three had each existed for

at least four years. MassMutual also represented that each

registered fund would be managed in substantially the same manner

as its corresponding predecessor account. These representations

were designed to ensure that a MassMutual fund's use of

performnce data attributable to an unregistered predecessor

account would not mislead investors.

We believe that, in light of the facts presented in

MassMutual, the relief granted in that letter in no way extends

to the type of practice that you describe. Rather, such a

practice would continue to raise serious concerns under the

antifraud provisions of the federal securities laws.

I hope that this informtion is helpful. If you have

additional questions, please call the undersigned, Barry A.

Mendelson or Daniel E. Burton at (202) 942-0660.

Sincerely, ~:

. LJ, VL~~

~ w. Murphy . I
Associate Director .
(Chief Counsel)

Enclosure