Major Changes Coming to Mutual Fund Disclosure
On August 5, 2020, the SEC proposed comprehensive changes to the mutual fund and exchange-traded fund (ETF) disclosure framework. The proposal also would update advertising rules for registered investment companies (RIC) and business development companies (BDC) to include certain standardized figures and reasonably current information.
Many shareholders disregard existing fund reporting as being overly long and complex and, as a result, spend little or no time reviewing the documentation that is costly to mail. A recent SEC staff analysis indicates the average prospectus is 128 pages. Under the proposal, the amounts and types of fund information would remain largely unchanged; however, the detailed information more relevant to financial professionals and analysts would be available online and delivered upon request to fund shareholders who want that additional information. The changes are designed to provide investors with concise, simple, and easy-to-understand information about a fund’s fees, expenses, and principal risks.
The proposal would require a streamlined shareholder report including fund expenses, performance, illustrations of holdings, and material fund changes. Funds are encouraged to use graphic or text features—such as tables, bullet lists, and question-and-answer formats—to promote effective communication. The SEC included an example of the new shareholder report. The changes also provide flexibility for open-end funds to make electronic versions of shareholder reports more user friendly and interactive.
Money invested in mutual funds has surged dramatically, from $6 trillion in 1988 to $21 trillion in 2018. The SEC estimates there are 10,310 mutual funds and 2,100 ETFs that would be affected by these proposed changes. Comments are due within 60 days of publication in the Federal Register. If approved, the SEC proposed an 18-month transition period after the effective date for funds to come into compliance with the amendments.
Additional Information on Form N-CSR & Online
Certain information currently included in a fund’s annual and semiannual reports may be less relevant to retail shareholders and of more interest to financial professionals and those investors who desire more in-depth information. Under the proposal, this information would be available online, delivered free of charge upon request, and filed with the SEC on a semiannual basis on Form N-CSR. This information would include the schedule of investments and other financial statement elements. Audited annual and unaudited semiannual financial statements would be filed with Form N-CSR rather than the shareholder report.
Tailoring Required Disclosures to Needs of New & Ongoing Fund Investors
Currently, all open-end fund shareholders generally receive an updated prospectus each year. The proposal would create a new rule, 498B, whereby new investors would only receive a fund prospectus on initial investment. Funds would keep existing shareholders updated through the shareholder report (including a summary in the annual report of material changes over the prior year), as well as timely notifications of material fund changes as they occur. Current versions of the fund’s prospectus would remain available online and would be delivered upon request in paper or electronically, consistent with the shareholder’s delivery preference. The change would not apply to investors holding a fund through a separate account funding a variable annuity or a variable life insurance contract, which are covered under recently adopted Rule 498A.
Separate shareholder reports would be required for each series, rather than collectively; shareholders would receive reports that address only the series in which they are invested. This is a big deviation from common practice for fund families, which often file a single shareholder report for numerous funds in a family.
Amendments to Scope of Rule 30e-3 to Exclude Open-End Funds
Because the SEC expects open-end shareholders to benefit from the above changes, this proposal would exclude open-end funds from Rule 30e-3. Rule 30e-3 generally permits funds to satisfy shareholder report transmission requirements by making these reports and other materials available online and providing a notice of the reports’ online availability, instead of directly providing the reports to shareholders.
Investors who prefer to receive the full reports in paper may—at any time—choose that option free of charge. This rule begins on January 1, 2021. The proposal would not affect the availability of Rule 30e-3 for other registered management companies (such as registered closed-end funds) or registered unit investment trusts.
Improvements to Prospectus Disclosure of Fund Fees & Risks
Currently, the prospectus includes two separate presentations of fee information—in a table that shows shareholder transaction fees and annual fund operating expenses and in a hypothetical example that shows estimated expenses, in dollars, that an investor will pay for investing in a fund over different holding periods. The proposal would tailor disclosures of fund fees and risk for different types of investors’ informational needs as follows:
- Replace the existing fee table in the summary section of the statutory prospectus with a simplified fee summary
- Move the existing fee table to the statutory prospectus, for use by investors seeking additional details about fund fees
- Replace certain terms in the current fee table with terms that may be clearer to investors; for example, purchase charge instead of maximum sales charge and temporary discount instead of fee waiver
In addition, open-end funds that make limited investments in other funds could disclose the fees and expenses associated with those investments (“acquired fund fees and expenses”) in a footnote to the fee table and fee summary, rather than as a fee table line item.
The proposal would promote the disclosure of a fund’s principal risks, rather than additional, often overwhelming, disclosures about nonprincipal risks, and tailor principal risk disclosure by specifying how principal risks can be assessed. SEC staff analysis found the average number of principal risks disclosed in the prospectus is 13. Funds would be required to disclose principal risks in order of importance, rather than today’s common practice of alphabetical listing.
Fee & Expense Information in Investment Company Advertisements
The proposal would require that presentations of investment company fees and expenses in advertisements and sales literature are consistent with relevant prospectus fee table presentations and are reasonably current. The proposed amendments also address representations of fund fees and expenses that could be materially misleading. For example, some funds advertise zero expenses based on information included in their prospectus fee table, potentially misleading investors to believe these funds have no costs even though the adviser may be collecting fees, e.g., securities lending costs, from the investor’s fund investment. These amendments would affect all advertisements of RICs and BDCs.