Fund Execs Liable for Prospectus Inaccuracy; SEC Suggests Verification

Fund executives and boards of directors may not know if their firm faces liability related to prospectus accuracy. Key issues are very math-intensive and often beyond the normal domain of counsel and fund accounting firms. 

Prospectus accuracy was central to a recent U.S. Court of Appeals decision, SEC vs. Tambone. Executives were found personally liable for damages since they knew, or should have known, that prospectuses were inaccurate.

Prospectus errors are central to two lawsuits against MFS and Lord Abbett. Damage claims exceed $425 million. The suits allege that loaded A-share trades under $50,000 should be discouraged since B- or C-share account values always are higher. With respect to this issue, and related conflicts-of-interest, it is claimed that prospectuses are silent, misleading, or in error.

After careful analysis of the class action math issues, we agree that problems exist. For equity trades below $50,000 from the two firms, B- or C-share account values always are higher than A-share values. Advisors are paid 30% more to sell A-shares though, under $50,000, that share never is an investor’s best choice. As claimed, it appears that prospectuses are silent on these issues and contain errors.

Then we analyzed prospectuses from 20 load firms. We found that errors are common in sales limits, numeric tables, and textual rationales.

Prospectus Verification Services

If your counsel or auditors missed any issues, they will have a hard time identifying and fixing them. The math is very intense and not intuitive. Take our quick quiz and see for yourself.

Broker Village is in a unique position to help fund firms identify and fix issues before they manifest, protecting their profits and brand. Fixes are fast, easy, and inexpensive to implement. Our firm has provided these services for years. We provide analytics and consulting to fund firms, B/Ds, and regulators. We will determine if:

a) Conflicts of interest exist at the advisor, B/D, or fund firm levels;

b) Share class sales limits are suitable, particularly for typical trade sequences;

c) Fee and performance tables are accurate and consistent with SAI text; and if

d) Textual rationales are consistent with the math.

Click here to see exactly how we can help you.

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Support for the Need to Ensure Accuracy

a) Recent press and lawsuits concern prospectus accuracy. Since 2008 the press has covered the issue. Then class actions were filed against MFS and Lord Abbett. For both, alleged harm is $400+ million. Then came the recent decision by the U.S. Court of Appeals (SEC vs. Tambone). It found that fund executives have a duty to ensure the accuracy and completeness of fund prospectuses. If not, they can face personal liability.

MFS Lawsuit: Reuters, July 28, 2008
Lord Abbett Lawsuit: PR Newswire, September 18, 2008
SEC vs. Tambone Lawsuit: SEC Website, December 5, 2008
Unscrambling the Alphabet of Fund Fees: NY Times, January 20, 2008
It's Called Class A, But is it Best for You?: NY Times, April 6, 2008
That Prospectus May Need a Fine Tooth Comb: NY Times, July 13, 2008
Lawsuits Shed Light on Share Class Suitability: Financial Times, November 3, 2008
Share Class Suits Raise Questions About Prospectus Accuracy: BoardIQ.com, December 2, 2008

b) Excerpt of article about SEC’s claim against Columbia Funds executives (SEC vs. Tambone): www.sec.gov/litigation/litreleases/lr18590.htm

“The [SEC] alleges that the defendants had a duty to act at all times in the best interests of the Columbia mutual funds and to provide full and fair disclosure of all material facts to investors. [D]espite this duty, the defendants never disclosed to fund shareholders or to the independent trustees of the funds that particular investors were being allowed to make short-term trades in the funds, or that Columbia…had a conflict of interest.” 

c) Excerpt of legal article about the executive’s duty to ensure the accuracy of prospectuses: www.complianceweek.com/blog/carton/2008/12/05/the-sec-weighs-in-on-the-first-circuits-decision-in-tambone-case/

“The First Circuit explained that Tambone and Hussey, as executives of Columbia Distributor, had a legal duty to confirm the accuracy and completeness of the prospectuses and other fund material that they distributed.” 

d) Excerpts of 12/18/08 ignites.com article which was guest-written by a lawyer about an executive’s duty to ensure the accuracy of prospectuses: www.ignites.com/moneyvoices/20081218/legal_challenge_fund_execs

“The First Circuit ruled that the executives had a duty to confirm the accuracy and completeness of the prospectuses used to sell the funds. Now, employees of a distributor who “use” an issuer’s prospectus to sell shares can be personally liable if they either knew or should have known the prospectus contained misrepresentations. Industry professionals would be well-advised to conduct a comprehensive review of their prospectuses and annual reports.” 

e) Excerpts of 12/2/08 BoardIQ.com article about Board’s duty to ensure prospectus accuracy: www.brokervillage.com/BIQArticleAboutProspectuses12-08.pdf

"[B]oards should…ensure that investors receive accurate and meaningful disclosure in fund prospectuses. For chief compliance officers, observers suggest that annual compliance reviews include testing of calculations used in prospectuses. Howard Suskin, a partner with Jenner Block, says fund directors can, as a best business practice, confirm that the calculations in fund prospectuses are correct by hiring an independent firm to audit the prospectus. Gene Gohlke, an associate director [at] the SEC…notes that “[A]s part of the board’s review and approval of the compliance programs…it would seem prudent [to] pay attention to what controls exist regarding preparation of, review and vetting of disclosure materials, including fee tables, performance tables and whatever type of tabular [and] textual presentations are in disclosure documents.”