ICPMs misleading clients: OSC

Don’t believe everything you read, especially when it comes to marketing materials from investment counsel/portfolio managers (ICPM). A new OSC staff notice reveals that ICPMs’ marketing practices have “increasingly become an area of concern” with an “increasing number of deficiencies.”

“The information is lacking clarity, so it can be perceived that it is something that it’s not,” says Christina Forster Pazienza, assistant manager of compliance at the OSC.

She says the marketing materials of ICPMs are “misleading” and that the staff notice has been issued in the hopes that ICPMs will alter their marketing materials to reflect returns and claims more “honestly.”

The OSC takes issue with a number of ways ICPMs market their pooled funds and hedge funds, from using hypothetical performance data instead of actual numbers or using back-tested data as proof that a new fund can perform well.

One of the issues the OSC has identified in respect to hypothetical performance data — including back-testing and model performance data — is that these numbers may “mislead clients to believe that it is the actual performance returns of their investment fund or investment strategy,” says the notice.

The notice reveals that model performance data for a particular strategy are often based on funds that no clients are following, and that there are no caveats stating that the performance data are hypothetical or how they are calculated.

The OSC says there are a variety of problems with using hypothetical marketing data. For one, the notice states, “any outcome can be achieved. The returns are generally always positive; otherwise, ICPMs would not present them to prospective clients.” They also say that hypothetical data is “often combined with, or confused with, actual performance.”

Why are ICPMs putting misleading information in their marketing materials? Forster Pazienza says these companies just want to promote themselves. “If you think of marketing materials as a way to promote their firm, then they’re using that material in a way that they feel is promoting themselves,” she says. “Perhaps it’s also about competition.”

“It’s very competitive market place,” adds Jonathan Boersma, executive director of global investment performance standards at the CFA Institute. “Quite often managers are competing for client dollars and the fees that are generated from that. So some people with not maybe the greatest set of morals or ethical integrity tend to start stretching things.

Another reason for the less-than-accurate marketing materials, says Forster Pazienza is that there haven’t been clear rules surrounding what ICPMs can or cannot say in their materials. “Sometimes you have to spell things out for people so they can truly understand what they’re doing may not be appropriate.”

Katie Walmsley, president of the Investment Counsel Association of Canada, welcomes the notice, adding that direction around marketing rules for ICPMs has been lacking from securities regulators, but she takes some issue with the OSC characterization that there are problems occurring right now.

“I think the notice is a bit misleading in that regard,” she says. “The industry and ICPMs are at the highest standards and are acting in fair, honest, good faith dealing with clients. I think what is more complex is areas where you do have newer products on the market. I think the OSC is providing guidelines for the future, as opposed to identifying current problem situations.”

Walmsley is referring to practices such as back-testing data, which is most often used to create historical returns for a newly created fund. The OSC says back-testing has the “benefit of hindsight and [does] not have to manage in real market conditions.” As well, the notice says that the ICPMs can change their strategy to fit historical data.

“Any results can arise because so much is based on assumptions,” says Forster Pazienza. “Assumptions can change and fit with a scenario and can get any outcome.”

The OSC says ICPMs should present only actual performance and not use back-tested data because “it is subject to manipulation and has many limitations.”

However, there are some circumstances where back-tested data can be used. The notice explains that this method of reporting can be implemented if a newly created fund follows the same investment strategy of an existing fund, or if a new fund is based on the same investment strategy of more than one existing fund.

As well, marketing materials must disclose that the returns are based on existing funds, not the performance of the new fund, and that any difference between the funds must be explained.

“What we’re saying is that we want ICPMs to present actual performance,” says Forster Pazienza. “Some of the issues here is that they haven’t been operating for that long, but they want to create a track record.”

Regulators have other concerns around ICPMs — benchmarks aren’t being followed correctly, marketing brochures include “exaggerated and unsubstantiated claims” — but now that the notice is out, the OSC hopes firms will alter their materials to reflect performance more accurately.

However, this might be wishful thinking. The CFA Institute has had non-binding rules related to this issue for the last 20 years, and clearly, they still have a lot of work to do to make sure ICPMs are disclosing the right information. “We see more progress than the developed markets, but there’s certainly a long ways to go,” says Boersma. “If your clients doesn’t know about standards, and doesn’t know what to ask a manager, some might say, ‘my clients aren’t asking me about this so I’m not going to undertake the cost or effort to comply.’ That does raise questions as to how firm is run and their ethical intentions.”

Unlike the CFA Instiute, the OSC can punish rule breakers. To make sure things are changing, the OSC will continue to perform ongoing field reviews, and if the issues aren’t resolved, enforcement action could be taken. Forster Pazienza is optimistic that things will change.

“There hasn’t been guidance out there or legislation,” she says. “Registrants have been doing what they feel makes sense, but now we have pointed out areas for improvement.”