SEC Adopts New Rules and Form Amendments Relating to Tailored Shareholder Reports and Fee Information in Registered Investment Company Advertisements
October 28, 2022
The Securities and Exchange Commission on October 26, 2022 unanimously adopted rule and form amendments for mutual funds and exchange-traded funds registered on Form N-1A (collectively, funds) that will substantially impact the content and scope of disclosure for shareholder reports, as well as amendments that will require fee comparability in fund advertising.1 These amendments reflect the SEC’s goal of requiring funds to present key information to shareholders clearly and concisely. The amendments were proposed by the SEC in August 2020.2
These rule and form amendments, as adopted, reflect several modifications from the proposal. Notably, the SEC did not adopt proposed Rule 498B, which would have provided an alternative approach to delivering annual prospectus updates. Although a number of the changes discussed below will likely be supported by the fund industry, some industry participants are likely to be disappointed that the SEC declined to make a number of enhancements from the proposal.
This Dechert Newsflash provides a brief overview of the SEC’s final rulemaking package. A more detailed discussion of the amendments will be covered in an upcoming Dechert OnPoint.
Tailored Shareholder Reports
The amendments introduce a layered approach to shareholder report disclosure and require funds to transmit concise and visually engaging annual and semi-annual shareholder reports.3 These shareholder reports will reflect substantial changes from the current presentation and content requirements, and will highlight key information that the SEC believes will allow retail shareholders to assess and monitor their fund investments on an ongoing basis. Information that is more relevant to financial professionals and investors who desire more in-depth information will be required to be available online and filed with the SEC on a semi-annual basis on Form N-CSR with Inline XBRL tags.
In particular, shareholder reports must contain the following information4 (certain information which may be included is indicated as optional below):
• Fund/Class Name. A fund will be required to prepare a streamlined shareholder report relating to each class of the fund and will need to disclose the applicable name of the fund and class on the cover page or beginning of the report. Currently, fund registrants may prepare a single shareholder report that covers multiple series, as well as multiple share classes of each series. As adopted, this no longer would be permitted, and the amendments will require that each fund prepare and transmit to the shareholder a shareholder report that covers the single class of a multiple-class fund in which the shareholder invested.
• Ticker Symbol. Similar to the proposal, a fund will be required to disclose the exchange ticker symbol of the fund’s shares, or the ticker symbol of the class, adjacent to the class name.
• Principal U.S. Market(s) (for ETFs only). As proposed, if the fund is an ETF, the ETF must disclose the principal U.S. market(s) on which the ETF’s shares are traded.
• Statement Identifying the Report as Either an “Annual Shareholder Report” or “Semi-Annual Shareholder Report.” The cover page (or beginning of the shareholder report) must include a statement identifying the report as an “Annual Shareholder Report” or “Semi-Annual Shareholder Report.”
• Legend. As applicable, a fund will be required to disclose a standardized legend identifying the period of the report, as well as a website address where an investor can find additional information about the fund and phone number and any email address where that information can be requested.
• Statement on Material Changes (Optional for Semi-Annual Shareholder Report). If a shareholder report describes material fund changes (as discussed in more detail below), a fund will be required to include a prominent statement on the cover page or beginning of the shareholder report noting that the report describes changes that occurred during the reporting period.
• Expense Example. A fund will be required to provide a table showing the expenses associated with a hypothetical $10,000 investment in the fund during the preceding reporting period in two formats: (1) as a percent of a shareholder’s investment in the fund (i.e., expense ratio), and (2) as a dollar amount.
• Management’s Discussion of Fund Performance (Optional for Semi-Annual Shareholder Report).
o Narrative MDFP Disclosure (Not required for Money Market Funds). Although the amendments retain the current requirement for a fund’s annual report to include a narrative discussion of factors that materially affected the fund’s performance during the most recent fiscal year, the amendments modify the current requirements to encourage concise disclosure by specifying that the disclosure must “briefly summarize” the “key” factors that materially affected the fund’s performance during the last fiscal year, including the relevant market conditions and the investment strategies and techniques used by the fund’s investment adviser. In addition, there is an instruction to not include lengthy, generic or overly broad discussions of these factors, and the instruction directs funds to use graphics or text features (e.g., bullet lists or tables) to present the key factors.
o Performance Line Graph. The amendments retain the requirements for the performance line graph currently included in annual reports, but with certain changes designed to improve the current presentation.
o Use of Market Indexes in Performance Disclosure. The SEC amended the definition of “appropriate broad-based securities market index” to “an index that represents the overall applicable domestic or international equity or debt markets, as appropriate.”5 This will have the effect of requiring all funds to compare their performance to the overall applicable securities market, for purposes of both fund annual reports and prospectuses. The SEC noted that, for a fund that invests primarily in the equity securities of a non-U.S. country, an index representing the overall equity market of the non-U.S. country would satisfy the final rule’s requirements. However, the SEC explained that, alternatively, “an appropriate benchmark for a fund that invests primarily in the equity securities of a subset of the U.S. market, such as healthcare companies, should show its performance against the overall U.S. equities market, rather than a benchmark consisting of only healthcare companies.” The SEC also stated that it does not believe that “indexes that include characteristics such as ‘growth,’ ‘value,’ ‘ESG,’ or ‘small- or mid-cap’ represent the overall market, and therefore these indexes would not be appropriate broad-based securities market indexes under the final rules.” The SEC noted that, in addition to an appropriate broad-based securities market index, a fund also may show its performance against additional, more narrowly tailored indexes.
o Performance Table. Similar to the proposal, the amendments will retain the current requirement that funds’ shareholder reports include a table presenting average annual total returns for the past 1-, 5-, and 10-year periods, as applicable.
• Fund Statistics. Each fund will be required to disclose the fund’s: (1) net assets; (2) total number of portfolio holdings; (3) for funds other than money market funds, portfolio turnover rate; and (4) the total advisory fees paid by the fund during the reporting period. A fund also may include any additional statistics that the fund believes would help shareholders better understand the fund’s activities and operations during the reporting period.
• Graphical Representation of Holdings. Similar to the current requirements, each fund will be required to disclose one or more tables, charts or graphs depicting the fund’s portfolio holdings by category, as of the end of the reporting period.
• Material Fund Changes (Optional for Semi-Annual Shareholder Report). Each fund will be required to describe material changes since the beginning of the reporting period briefly with respect to changes to any of the following items:
o The fund’s name (as described in Item 1(a)(1) of Form N-1A);
o The fund’s investment objectives or goals (as described in Item 2 of Form N-1A);
o The fund’s annual operating expenses, shareholder fees, or maximum account fee (as described in Item 3 of Form N-1A), including the termination or introduction of an expense reimbursement or fee waiver arrangements;
o The fund’s principal investment strategies (as described in Item 4(a) of Form N-1A);
o The principal risks of investing in the fund (as described in Item 4(b) of Form N-1A); and
o The fund’s investment adviser(s), including sub-adviser(s) (as described in Item 5(a) of Form N-1A).
In addition to the list above, a fund will be permitted to describe other material fund changes that it would like to disclose to its shareholders, as well as other changes that may be helpful for investors to understand the fund’s operations and/or performance over the reporting period.
The SEC explained that a fund should make its determination of whether a change is material based on the facts and circumstances of the fund. The SEC noted that, in deciding whether a change to a fund is “material,” the fund may consider, among other potential factors: “the nature of the change, whether it reflects a material change in the way the fund is currently being managed, whether it reflects a material change in the fund’s risk profile, which section(s) of the prospectus the change affects, and how likely the change would be to influence a shareholder’s decision to continue to invest in the fund.”
• Changes in or Disagreements with Accountants. Each fund will be required to include in its annual report: (1) a statement of whether the former accountant resigned, declined to stand for re-election, or was dismissed and the date thereof; and (2) a brief, plain English description of disagreement(s) with the former accountant during the fund’s two most recent fiscal years and any subsequent interim period that the fund discloses on Form N-CSR.
• Availability of Additional Information. Each fund will be required to include a brief, plain English statement in the shareholder report that informs investors about certain additional information that is available on the fund’s website.
• Householding Disclosure. (Optional for Annual Shareholder Report and Not Required for Semi-Annual Shareholder Reports). The amendments retain the current provision that permits a fund to explain in its annual report how to revoke consent to the householding of the annual report.
Form N-CSR and Website Availability Requirements
Consistent with a layered disclosure framework, the SEC is requiring funds to file on Form N-CSR information that currently is included in fund shareholder reports (with certain information to be tagged in iXBRL format) and deliver such information upon request to shareholders free of charge. The same information also must be provided on the fund’s website. Unlike the shareholder reports discussed above, the information provided on Form N-CSR and on the website may include information for multiple funds and classes. Form N-CSR will continue to require the following information: (i) financial statements; (ii) financial highlights; (iii) remuneration paid to directors, officers and others; (iv) changes in and disagreements with accountants; (v) matters submitted to fund shareholders for a vote; (vi) a statement regarding the basis for the board’s approval of investment advisory contract; and (vii) complete portfolio holdings as of the close of the most recent first and third fiscal quarters.
Additionally, the SEC eliminated the following two items currently included in shareholder reports: (i) the fund directors and officers table; and (ii) liquidity risk management program disclosures. Consistent with current requirements, the fund’s annual financial statements (but not semi-annual financial statements) must be audited and accompanied by any associated accountant’s report.
Amendments to the Scope of Rule 30e-3 to Exclude Open-End Funds
The amendments exclude open-end funds from the scope of Rule 30e-3.6 Currently, Rule 30e-3 generally permits certain registered investment companies 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. Open-end funds will need to mail the shareholder reports to investors, unless the investor has consented to electronic delivery.7
Fee and Expense Information in Investment Company Advertisements
The SEC also adopted amendments to the advertising rules for all registered investment companies and business development companies (BDCs) whose advertisements include fee and expense information, as part of the SEC’s efforts to promote more transparent and balanced statements about investment costs. The rule amendments require that presentations of investment company fees and expenses in advertisements and sales literature must be consistent with relevant prospectus fee table presentations, and must be reasonably current.
Compliance Period
The amendments will become effective 60 days after publication in the Federal Register. The Commission is providing an 18-month compliance period after the effective date for most of the amendments. There is no compliance period, however, for rule amendments addressing fee and expense information in advertisements that might be materially misleading. Although there is an 18-month transition period for this rulemaking, implementation will likely require substantial coordination with key internal stakeholders and outside service providers, among other steps.
A comprehensive Dechert OnPoint will follow to provide further analysis of amended shareholder report requirements and guidance for funds navigating this new disclosure regime.
*The authors would like to thank Yanyu Mao, Rachael Minassian and Brendan Powell for their contributions to the Newsflash.
Footnotes
1) Tailored Shareholder Reports for Mutual Funds and Exchange-Traded Funds; Fee Information in Investment Company Advertisements, Release No. IC-34731 (Oct. 26, 2022) (Adopting Release). At times, this Dechert Newsflash tracks the Adopting Release without the use of quotation marks. Terms not defined in this Dechert Newsflash have the meaning assigned to them in the Adopting Release.
2) Tailored Shareholder Reports, Treatment of Annual Prospectus Updates for Existing Investors, and Improved Fee and Risk Disclosure for Mutual Funds and Exchange-Traded Funds; Fee Information in Investment Company Advertisements, Release No. IC-33963 (Aug. 5, 2020). For additional information on the proposal, please see SEC Proposes to Modernize Disclosure Framework for Mutual Funds and Exchange-Traded Funds, Modify Fee Information in Investment Company and Business Development Company Advertisements, Dechert OnPoint (Sept. 1, 2020).
3) The amendments do not extend to other investment companies, such as closed-end funds, unit investment trusts (UITs) or open-end managed investment companies not registered on Form N-1A (i.e., issuers of variable annuity contracts registered on Form N-3).
4) The amendments will generally allow a fund to include in its shareholder report only the information that new Item 27A of Form N-1A specifically permits or requires.
5) Similar to current requirements, an “appropriate broad-based securities market index” must continue to be “administered by an organization that is not an affiliated person of the fund, its investment adviser or principal underwriter, unless the index is widely recognized and used.”
6) In addition, variable contract UITs will no longer be permitted to rely on Rule 30e-3 to satisfy their shareholder report transmission requirements with respect to underlying funds registered on Form N-1A.
7) The final amendments will not affect the availability of Rule 30e-3 for closed-end funds and management companies that offer variable annuity contracts.
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