SEC Proposes Improved Fund Disclosure Regime
By: Daniel Holtzer*
On August 5, 2020, the Securities and Exchange Commission (“SEC”) proposed major disclosure reforms (collectively, the “Proposal”) designed to provide more streamlined information to retail investors of mutual funds and ETFs. The Proposal represents an overhaul of the current disclosure and delivery framework, and provides that a new summary shareholder report, rather than prospectuses, would serve as the primary disclosure document for fund shareholders.
The goal of the Proposal is to increase the usefulness of disclosures to retail investors, while keeping currently disclosed information available from other sources. The Proposal’s approach is to layer the disclosure. The information needed by common retail investors, more sophisticated retail investors, and private financial professionals all differ, and this Proposal recognizes that fact. Information retail investors need, such as fund performance and fee summaries will remain in the disclosures. Denser information, such as schedules of investments, results of shareholder votes, and director compensations will be moved to other fund filings such as Form N-CSR. This information would then be available on request, with clear instructions for accessing the information included in the shareholder reports.
Under the Proposal, delivery of annual and semi-annual reports to current shareholders would be eliminated and replaced by the delivery of a new, streamlined annual report that includes concise expense, performance, and holdings information. Funds would still be required to prepare annual and semi-annual reports, which would be filed and available upon request. The Proposal also includes prospectus disclosure changes relating to fees and risks, as well as proposed changes to fund advertisements to make them comparable with standardized fee and performance information.
A key driver behind the Proposal were surveys and studies suggesting that investors did not understand or did not use reports. Firstly, retail investors often disregarded or were confused by the information in annual and semi-annual reports and prospectuses. Investors did not understand the material, wanted something more summary, or could not make effective use of large portions of the information. Secondly, more simplified disclosures would likely result in better outcomes for retail investors. Several studies suggested that a more focused disclosure with only the important information would increase retention and lead to better outcomes in examples such as disclosure of credit card fees. These comments were echoed in recent recommendations from the Investment Advisory Committee, a committee instituted by the Dodd-Frank act to advise the SEC.
The SEC expects that, if adopted, the Proposal will lead to more knowledgeable consumers and reduce the delivery burden on firms. Its key objectives are to increase the focus on online accessibility, ensure that shareholder reports are more clear and engaging, and reduce emphasis on the annual prospectus.
New Summary Shareholder Report
The new summary shareholder report set forth in the Proposal is designed to focus on disclosure that is particularly important to retail investors, including fund expenses, performance, illustrations of holdings, and material fund changes. The SEC would encourage funds to make these reports more visually engaging with graphics, text features, and/or charts. The SEC has issued this hypothetical summary shareholder report to provide a sample to registrants. Information formerly in shareholder reports, such as financial highlights and a full investment schedule, would be included in new sections of Form N-CSR and available online or by mail. The shareholder report would include a brief header informing investors where they can access this information.
Further, the SEC has included a “plain English” requirement in its proposal. Funds would be required to avoid legalese, business jargon without explanations, boilerplate language, and other language that would make the information inaccessible to retail audiences. They would be further encouraged to use short, simple sentences and active voice where possible. The SEC has suggested layout and design features such as Q&A’s and ample white space. In addition, firms may be able to utilize definition popups for industry terms, expense calculators, and dynamic charts.
Elimination of Annual Update Delivery
The SEC’s proposal includes a new rule 498B under the Securities Act of 1933. This change allows funds to provide timely notification of material changes to certain prospectus disclosure items rather than deliver an updated prospectus annually to current investors who increase their investment. The 498B disclosures, combined with the new summary of material changes in annual reports, would effectively replace prospectus delivery, though it would still be provided to new fund shareholders. Annually updated prospectuses would still be available online.
Updated Fee Rules for Advertisements
The SEC has noted that fund advertisements often include fee schedules that are inconsistent with or are confusing compared to the information in prospectus fee tables. Accordingly, the SEC included proposed amendments to advertising rules to require that fee schedules in advertisements be consistent with prospectus fee tables. These changes would apply to registered open and closed-investment companies and BDC advertisements.
Better for Registrants
The burgeoning array of interactive tools and visual elements currently available gives firms many options when it comes to presenting their disclosures. Funds would be able to use interactive tools and charts, including expense calculators and popup definitions of financial terms to help retail investors through more dense text. Firms should consider how they can use these elements to make their reports more “user friendly” to the average investor.
Firms may be able to take strategic advantage of the Proposal if is adopted. For example, firms would have ample opportunity to use of dynamic elements to focus attention on favorable portions of their disclosure. If a fund has particularly low fees, they may choose to use a fee calculator over a simple table. If a fund’s performance was particularly good, they may choose to use a dynamic graph or chart over a static one. It remains to be seen how large of an effect these choices could have, but firms should nonetheless consider their options. Given that several surveys cited by the SEC found that more than half of investors spend 15 minutes or less reading these reports, monopolizing that time with dynamic elements could have significant effects.
In general, these changes are clearly a positive development. The proposals streamline the disclosure process for registrants, while facilitating more meaningful sharing of information from retail investors to funds, and hopefully will result in more active investors who are more knowledgeable about their investments. More simplified language, reduction in volume without a reduction in available information, and more electronic integration will make the information more accessible.
Comments are to be received within a 60 day period beginning August 5th. Already submitted comments can be found at this address.
*Daniel is a member of our compliance group, whose primary responsibilities include the day-to-day management of our clients’ compliance programs. His duties range from the coordination of annual review on-site visits to the management of client communications to ultimately keeping the compliance calendar on track. Daniel is graduate of Pomona College where he majored in Economics and minored in Mathematics.