Rule2022-23756
Tailored Shareholder Reports for Mutual Funds and Exchange-Traded Funds; Fee Information in Investment Company Advertisements
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
November 25, 2022
Effective
January 24, 2023
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("Commission") is adopting rule and form amendments that require open-end management investment companies to transmit concise and visually engaging annual and semi-annual reports to shareholders that highlight key information that is particularly important for retail investors to assess and monitor their fund investments. Certain information that may be more relevant to financial professionals and investors who desire more in- depth information will no longer appear in funds' shareholder reports but will be available online, delivered free of charge upon request, and filed on a semi-annual basis on Form N-CSR. The amendments exclude open-end management investment companies from the scope of the current rule that generally permits registered investment companies to satisfy shareholder report transmission requirements by making these reports and other materials available online and providing a notice of that availability. The amendments also require that funds tag their reports to shareholders using the Inline eXtensible Business Reporting Language ("Inline XBRL") structured data language to provide machine-readable data that retail investors and other market participants may use to more efficiently access and evaluate investments. Finally, the Commission is adopting amendments to the advertising rules for registered investment companies and business development companies to promote more transparent and balanced statements about investment costs.
Full Text
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[Federal Register Volume 87, Number 226 (Friday, November 25, 2022)]
[Rules and Regulations]
[Pages 72758-72858]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-23756]
[[Page 72757]]
Vol. 87
Friday,
No. 226
November 25, 2022
Part IV
Securities and Exchange Commission
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17 CFR Parts 200, 230, 232, et al.
Tailored Shareholder Reports for Mutual Funds and Exchange-Traded
Funds; Fee Information in Investment Company Advertisements; Final Rule
Federal Register / Vol. 87 , No. 226 / Friday, November 25, 2022 /
Rules and Regulations
[[Page 72758]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 200, 230, 232, 239, 249, 270, and 274
[Release Nos. 33-11125; 34-96158; IC-34731; File No. S7-09-20]
RIN 3235-AM52
Tailored Shareholder Reports for Mutual Funds and Exchange-Traded
Funds; Fee Information in Investment Company Advertisements
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting rule and form amendments that require open-end management
investment companies to transmit concise and visually engaging annual
and semi-annual reports to shareholders that highlight key information
that is particularly important for retail investors to assess and
monitor their fund investments. Certain information that may be more
relevant to financial professionals and investors who desire more in-
depth information will no longer appear in funds' shareholder reports
but will be available online, delivered free of charge upon request,
and filed on a semi-annual basis on Form N-CSR. The amendments exclude
open-end management investment companies from the scope of the current
rule that generally permits registered investment companies to satisfy
shareholder report transmission requirements by making these reports
and other materials available online and providing a notice of that
availability. The amendments also require that funds tag their reports
to shareholders using the Inline eXtensible Business Reporting Language
(``Inline XBRL'') structured data language to provide machine-readable
data that retail investors and other market participants may use to
more efficiently access and evaluate investments. Finally, the
Commission is adopting amendments to the advertising rules for
registered investment companies and business development companies to
promote more transparent and balanced statements about investment
costs.
DATES: Effective Date: This rule is effective January 24, 2023.
Compliance Date: The applicable compliance dates are discussion in
section II.J.
FOR FURTHER INFORMATION CONTACT: Mykaila DeLesDernier, Pamela K. Ellis,
Senior Counsels; Zeena Abdul-Rahman, Branch Chief; Amanda Hollander
Wagner, Senior Special Counsel; or Brian McLaughlin Johnson, Assistant
Director, at (202) 551-6792, Investment Company Regulation Office; Alex
Bradford, Assistant Chief Accountant; Michael Kosoff, Senior Special
Counsel, at (202) 551-6921, Disclosure Review and Accounting Office;
Division of Investment Management; U.S. Securities and Exchange
Commission, 100 F Street NE, Washington, DC 20549-1090.
SUPPLEMENTARY INFORMATION: The Commission is adopting amendments to the
following rules and forms:
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Commission reference CFR citation [17 CFR]
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Organization; Conduct and Ethics; And Sec. Sec. 200.1 through
Information and Requests. 200.800.
Section 800............................ Sec. 200.800.
Securities Act of 1933 (``Securities
Act''): \1\
Rule 156............................... Sec. 230.156.
Rule 433............................... Sec. 230.433.
Rule 482............................... Sec. 230.482.
Regulation S-T: \2\
Rule 405............................... Sec. 232.405.
Securities Act and Investment Company Act
of 1940 (``Investment Company Act,'' or
the ``Act''): \3\
Form N-1A.............................. Sec. Sec. 239.15A and
274.11A.
Securities Exchange Act of 1934 (``Exchange
Act'') \4\ and Investment Company Act:
Form N-CSR............................. Sec. Sec. 249.331 and
274.128.
Investment Company Act:
Rule 30a-2............................. Sec. 270.30a-2.
Rule 30e-1............................. Sec. 270.30e-1.
Rule 30e-3............................. Sec. 270.30e-3.
Rule 31a-2............................. Sec. 270.31a-2.
Rule 34b-1............................. Sec. 270.34b-1.
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\1\ 15 U.S.C. 77a et seq.
\2\ 17 CFR 232.10 through 232.903.
\3\ 15 U.S.C. 80a et seq.
\4\ 15 U.S.C. 78a et seq.
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Table of Contents
I. Introduction and Background
A. Regulatory Context, and Developments and Analysis Informing
Final Rules
1. Fund Shareholder Reports--Regulatory Context
2. Developments Supporting Layered Disclosure Approach to Fund
Shareholder Reports
3. Evidence of Investor Preferences Regarding Fund Disclosure
4. Investment Company Advertisements, and Developments Affecting
Fund Marketing Practices
B. Overview of the Final Rules
1. Final Rules' Principal Elements
2. Other Aspects of Proposal
II. Discussion
A. Annual Reports
1. Scope of Annual Report Disclosure, and Registrants Subject to
Amendments
2. Contents of the Annual Report
3. Format and Presentation of Annual Report
4. Electronic Annual Reports
B. Semi-Annual Report
1. Scope and Contents of the Semi-Annual Report
2. Format and Presentation of Semi-Annual Report
3. Electronic Semi-Annual Reports Instructions and Requirements
C. Form N-CSR and Website Availability Requirements
1. New Form N-CSR Filing Requirements
2. Website Availability Requirements
3. Delivery Upon Request Requirements
D. Disclosure Items Removed From Shareholder Report and Not
Filed on Form N-CSR
E. Transmission of Shareholder Reports
1. Amendments Narrowing Scope of Rule 30e-3
2. Alternative Transmission Methods for Shareholder Reports and
Other Regulatory Materials
3. Alternatives for Satisfying Transmission Requirements for
Semi-Annual Reports
F. Prospectuses and SAIs Transmitted Under Rule 30e-1(d)
G. Investment Company Advertising Rule Amendments
[[Page 72759]]
1. Requirements for Standardized Fee and Expense Figures
2. Materially Misleading Statements About Fees and Expenses in
Investment Company Sales Literature
3. Additional Suggested Amendments to Investment Company
Advertising Rules
H. Inline XBRL Data Tagging
I. Technical and Conforming Amendments
J. Compliance Date
III. Other Matters
IV. Economic Analysis
A. Introduction
B. Economic Baseline and Affected Parties
1. Descriptive Industry Statistics
2. Fund Shareholder Reports
3. Transmission of Shareholder Reports
4. Investor Use of Fund Disclosure
5. Fund Advertisements
C. Benefits and Costs
1. Broad Economic Considerations
2. New Approach for Funds' Shareholder Reports
3. Advertising Rule Amendments
D. Effects on Efficiency, Competition, and Capital Formation
E. Reasonable Alternatives
1. More or Less Frequent Disclosure
2. More or Less Information in Shareholder Reports
3. Retaining Rule 30e-3 Flexibility or Implementing Access
Equals Delivery for Open-End Funds Registered on Form N-1A
4. Limiting the Advertising Rule Amendments to ETFs and Mutual
Funds
5. Amending Shareholder Report Requirements To Include Variable
Insurance Contracts or Registered Closed-End Funds
6. Requiring All Form N-CSR Disclosures To Be Tagged in Inline
XBRL
V. Paperwork Reduction Act Analysis
A. Introduction
B. New Shareholder Report Requirements Under Rule 30e-1
C. Form N-CSR
D. Rule 482
E. Rule 34b-1
F. Rule 433
G. Rule 30e-3
H. Investment Company Interactive Data
VI. Final Regulatory Flexibility Act Analysis
A. Need for and Objectives of the Rule and Form Amendments
B. Significant Issues Raised by Public Comments
C. Small Entities Subject to the Rule
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
1. Annual and Semi-Annual Reports
2. New Form N-CSR and Website Availability Requirements
3. Amendments To Scope of Rule 30e-3
4. Investment Company Advertising Rules
5. Inline XBRL Data Tagging
E. Agency Action To Minimize Effect on Small Entities
VII. Statutory Authority
VIII. Text of Proposed Rules and Form Amendments
I. Introduction and Background
The Commission is adopting rule and form amendments that are
designed to require mutual funds and exchange-traded funds (``ETFs'')
to transmit concise and visually engaging annual and semi-annual
reports to shareholders.\5\ The updated approach to funds' shareholder
reports will highlight key information that is particularly important
for retail investors to assess and monitor their fund investments.\6\
Other, more detailed information that currently appears in funds'
shareholder reports will be made available on a website that the
shareholder report specifies, filed with the Commission on EDGAR, and
delivered to investors free of charge in paper or electronically upon
request. These final rules are designed to modernize funds' shareholder
reports so these reports will better serve the needs of fund
investors--particularly retail investors.\7\ The final rules will
require a disclosure approach that emphasizes clearly and concisely the
information that is particularly useful to a retail audience, will
encourage disclosure techniques that promote effective communication,
and will continue to make available information that historically has
appeared in shareholder reports but that may be more relevant to
financial professional and other investors who desire more in-depth
information.
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\5\ For purposes of this release, the term ``fund'' generally
refers to an open-end management investment company registered on
Form N-1A or a series thereof, unless otherwise specified. Mutual
funds and most ETFs are open-end management investment companies
registered on Form N-1A. An open-end management investment company
is an investment company, other than a unit investment trust or
face-amount certificate company, that offers for sale or has
outstanding any redeemable security of which it is the issuer. See
sections 4 and 5(a)(1) of the Investment Company Act [15 U.S.C. 80a-
4 and 80a-5(a)(1)].
\6\ This release refers to funds' annual and semi-annual
shareholder reports as ``annual reports'' and ``semi-annual
reports'' respectively, and collectively as ``shareholder reports.''
\7\ ``EDGAR'' is the Commission's Electronic Data, Gathering,
Analysis, and Retrieval system.
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This approach is designed to alleviate concerns that fund retail
investors currently may receive, and find difficult to use, shareholder
reports that are lengthy, complex, and not well-suited to their
needs.\8\ Investors' inability to understand or use shareholder report
disclosure efficiently may impede their ability to monitor their
investments and lead to investors maintaining investments in funds that
may not be aligned with their investment goals. The final rules'
approach for shareholder reports is a continuation of the Commission's
initiatives designed to promote clear and concise disclosure for fund
investors.\9\ It responds to the preferences investors have expressed,
over the years and in response to the proposed rules.\10\ This approach
also builds on a similar ``layered'' disclosure approach that most
funds use to provide prospectus information tailored to investors'
informational needs.\11\
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\8\ See 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, Investment Company
Act Release No. 33963 (Aug. 5, 2020) [85 FR 70716 (Nov. 5, 2020)]
(``Proposing Release'') at nn.30 and 32, and accompanying text.
\9\ See, e.g., Enhanced Disclosure and New Prospectus Delivery
Option for Registered Open-End Management Investment Companies,
Investment Company Act Release No. 28584 (Jan. 13, 2009) [74 FR 4545
(Jan. 26, 2009)] (``2009 Summary Prospectus Adopting Release'');
Investment Company Reporting Modernization, Investment Company Act
Release No. 32314 (Oct. 13, 2016) [81 FR 81870 (Nov. 18, 2016)]
(``Investment Company Reporting Modernization Final Rules''); Form
CRS Relationship Summary; Amendments to Form ADV, Investment
Advisers Act Release No. 5247 (June 5, 2019) [84 FR 33492 (July 12,
2019)]; Updated Disclosure Requirements and Summary Prospectus for
Variable Annuity and Variable Life Insurance Contracts, Investment
Company Act Release No. 33814 (Mar. 11, 2020) [85 FR 25964 (May 1,
2020)] (``Variable Contract Summary Prospectus Adopting Release'').
\10\ See, e.g., 2009 Summary Prospectus Adopting Release, supra
footnote 9; see also infra section I.A.3.
\11\ See infra section I.A.2.
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In August 2020, the Commission proposed rule and form amendments
that would require a layered disclosure framework for funds'
shareholder reports that is substantially similar to the framework we
are adopting under the final rules.\12\ The Commission also proposed to
address the means by which shareholder reports are transmitted to fund
investors. To ensure that all fund investors would experience the
anticipated benefits of the proposed new tailored disclosure framework,
the Commission proposed to amend the scope of rule 30e-3--the rule that
currently permits investment companies to use a ``notice and access''
approach to transmitting shareholder reports--to exclude open-end
funds. Instead, funds would have to provide the reports directly to
shareholders. In addition to addressing shareholder report contents and
transmission, the Commission also proposed amendments to the
Commission's investment company advertising rules that were designed to
promote more transparent and balanced statements about investment
costs. The proposal also included a proposed new alternative approach
to satisfy prospectus delivery requirements for existing fund investors
(proposed new rule 498B) and proposed amendments to funds' prospectus
fee and risk disclosure requirements.
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\12\ See Proposing Release, supra footnote 8.
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The Commission received comment letters on the proposal from a
variety of
[[Page 72760]]
commenters, including funds and investment advisers, law firms, other
fund service providers, investor advocacy groups, professional and
trade associations, and interested individuals.\13\ Many commenters
supported the proposed use of layered disclosure in funds' shareholder
reports.\14\ Some recommended enhancements and alternatives to certain
areas of the proposed shareholder reports, with respect to their
content as well as scope.\15\ While many commenters expressed concern
regarding the proposed amendments to rule 30e-3, others supported the
Commission's proposed approach.\16\ Comments on proposed rule 498B were
mixed, with some commenters expressly supporting the proposal, some
supporting it with modifications, and others directly opposing it.\17\
Comments on the proposed prospectus fee and risk disclosure amendments
were similarly mixed.\18\ Finally, while a number of the commenters
that addressed the proposed advertising rule amendments supported them,
some stated that the proposed amendments were not necessary in light of
Financial Industry Regulatory Authority (``FINRA'') rules addressing
fee and expense information in retail communications or suggested that
the Commission modify the scope of the proposed amendments.\19\
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\13\ The comment letters on the Proposing Release (File No. S7-
09-20) are available at <a href="https://www.sec.gov/comments/s7-09-20/s70920.htm">https://www.sec.gov/comments/s7-09-20/s70920.htm</a>.
\14\ See, e.g., Comment Letter of Mutual Fund Directors Forum
(Jan. 4, 2021) (``Mutual Fund Directors Forum Comment Letter'');
Comment Letter of SIFMA (Dec. 22, 2020) (``SIFMA Comment Letter'').
\15\ Comments on particular aspects of the proposed rules'
scope, as well as the proposed shareholder report contents, are
discussed in detail in sections II.A-B below.
\16\ See infra section II.E.1.
\17\ See infra footnotes 68-72 and accompanying text.
\18\ See infra footnotes 76-79 and 83-84 and accompanying text.
\19\ See infra sections II.G.1-2; footnote 534 (providing FINRA
rule 2210's definitions of retail communications and
correspondence).
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After considering the comments on the proposal and as discussed in
more detail below, we are adopting rule and form amendments that would
effectuate the proposed layered disclosure approach for funds'
shareholder reports, with modifications to the proposed reports'
contents and scope in response to comments and to enhance disclosure
effectiveness. We are also adopting--with targeted clarifying changes,
but otherwise substantially as proposed--the proposed amendments to
exclude open-end funds from the scope of rule 30e-3, as well as the
proposed amendments to the investment company advertising rules. As
discussed more fully below, we are not adopting proposed rule 498B or
the proposed amendments to funds' prospectus fee and risk disclosure
requirements.
A. Regulatory Context, and Developments and Analysis Informing Final
Rules
1. Fund Shareholder Reports--Regulatory Context
Fund shareholders receive shareholder reports on a semi-annual
basis.\20\ These reports include detailed information about a fund's
operations over a given half- or full-year period. The Investment
Company Act, as well as Commission rules, prescribe the content
requirements for funds' shareholder reports.\21\ Shareholder report
contents include, among other items: information about fund expenses
and performance, portfolio holdings, funds' financial statements and
financial highlights (which are audited in annual reports), information
about a fund's board of directors and management, results of
shareholder votes, and instructions on how to access additional
information, including information regarding the fund's proxy voting
record, code of ethics, and quarterly portfolio holdings.\22\ Certain
of this information, including fund performance information, is
required to appear only in annual reports. Some funds also supplement
this with information that is not required by Commission rules or
forms, such as a president's letter and general market commentary.\23\
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\20\ See section 30(e) of the Investment Company Act [15 U.S.C.
80a-29(e)]; current and amended rule 30e-1 under the Investment
Company Act [17 CFR 270.30e-1]. A fund or an intermediary may
transmit the shareholder report to an investor. Most fund investors
hold their fund investments as beneficial owners through accounts
with intermediaries. As a result, intermediaries commonly assume
responsibility for distributing fund shareholder reports to
beneficial owners. See Optional internet Availability of Investment
Company Shareholder Reports, Investment Company Act Release No.
33115 (June 5, 2018) [83 FR 29158 (June 22, 2018)] (``Rule 30e-3
Adopting Release''), at paragraph accompanying n.274.
\21\ See section 30(e) of the Investment Company Act; see also
current and amended rule 30e-1; Item 27 of current Form N-1A and
Item 27A of amended Form N-1A (addressing the contents of open-end
fund shareholder reports).
\22\ See Proposing Release, supra footnote 8, at nn.14-17 and
accompanying text.
\23\ See, e.g., id. at n.18 and accompanying text.
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Many mutual funds and ETFs are organized as single registrants with
several series (sometimes referred to as portfolios).\24\ From an
investor's perspective, investing in a series provides the same general
experience as investing in a fund that is not organized in this way--
each series has its own investment objectives, policies, and
restrictions, and the Federal securities laws and Commission rules
often treat each series as a separate fund.\25\ Series of a registrant
are often marketed separately, without reference to other series or to
the registrant's name.
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\24\ See sections 18(f)(1) and (2) of the Investment Company Act
[15 U.S.C. 80a-18(f)(1) AND (2)]; 17 CFR 270.18f-2 (rule 18f-2 under
the Investment Company Act).
\25\ See, e.g., 17 CFR 270.22c-2(c)(2); 17 CFR 270.22e-4(a)(5);
General Instruction A to Form N-1A (defining ``fund'' to mean a
registrant or a separate series of the registrant).
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In addition, a single fund or series can have multiple share
classes.\26\ Share classes typically differ based on fee structure,
with each class having a different sales load and distribution and/or
service fee. Currently, fund registrants may prepare a single
shareholder report that covers multiple series, as well as multiple
share classes of each series.
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\26\ See 17 CFR 270.18f-3 (rule 18f-3 under the Investment
Company Act).
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Fund shareholders currently receive shareholder reports in paper or
electronically, depending on their preferences.\27\ We understand that
shareholders electing electronic delivery of fund disclosure materials
typically receive an email that contains a link to where the materials
are available online.
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\27\ See Proposing Release, supra footnote 8, at nn.21-22 and
accompanying text; see also Use of Electronic Media for Delivery
Purposes, Investment Company Act Release No. 21399 (Oct. 6, 1995)
[60 FR 53458 (Oct. 13, 1995)] (``Electronic Media 1995 Release'')
(providing Commission views on the use of electronic media to
deliver information to investors, with a focus on electronic
delivery of prospectuses, annual reports, and proxy solicitation
materials); Use of Electronic Media by Broker-Dealers, Transfer
Agents, and Investment Advisers for Delivery of Information,
Investment Company Act Release No. 21945 (May 9, 1996) [61 FR 24644
(May 15, 1996)] (``Electronic Media 1996 Release''); Use of
Electronic Media, Investment Company Act Release No. 24426 (Apr. 28,
2000) [65 FR 25843 (May 4, 2000)] (``Electronic Media 2000
Release'').
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For those shareholders who have not elected to receive shareholder
reports electronically, funds currently may rely on rule 30e-3 to
satisfy shareholder report transmission requirements. If a fund chooses
to rely on this rule, a shareholder does not receive paper shareholder
reports directly, but instead receives paper notices that a shareholder
report is available at an identified website address.\28\ Nonetheless,
funds relying on rule 30e-3 are required to deliver a paper copy of a
shareholder report to any person requesting such a copy, and a fund may
no longer rely on rule 30e-3 with respect to any shareholder who has
notified the fund (or relevant financial
[[Page 72761]]
intermediary) that the shareholder wishes to receive paper copies of
shareholder reports.
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\28\ See current rule 30e-3 [17 CFR 270.30e-3]; Rule 30e-3
Adopting Release, supra footnote 20.
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The costs of delivering prospectuses and shareholder reports,
including printing and mailing costs and processing fees, are generally
fund expenses borne by shareholders.
2. Developments Supporting Layered Disclosure Approach to Fund
Shareholder Reports
The Commission's proposed layered disclosure approach to funds'
shareholder reports builds on decades of experience with layered fund
disclosure, as well as the confluence of two other disclosure-related
developments that we believe support further reliance on the use of
layered disclosure--the growing length and complexity of shareholder
reports over time, and the internet's increasingly important role in
maximizing investor access to information.
The Commission's rules permitting the use of summary prospectuses
both recognize investors' preferences for concise and engaging
disclosure of key information and ensure that additional information
that may be of interest to some investors is available through a
layered approach to disclosure.\29\ These rules generally permit funds
to provide summary prospectuses to investors that include ``streamlined
and user-friendly information that is key to an investment decision,''
with more-detailed information that may be of interest to some
investors available online.\30\ We believe that these initiatives have
benefitted investors, and we estimate that approximately 92% of funds
use summary prospectuses.\31\ The Commission has not previously taken
comprehensive steps to create a layered disclosure framework for funds'
shareholder reports.\32\
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\29\ See supra footnotes 10-11 and accompanying text; see also
Variable Contract Summary Prospectus Adopting Release, supra
footnote 9.
\30\ See 2009 Summary Prospectus Adopting Release, supra
footnote 9, at section I. The vast majority of funds provide: (1) a
summary prospectus to investors in connection with their initial
investment decision; and (2) more-detailed information that may be
of interest to some investors, which is available online in the form
of the ``statutory prospectus'' and Statement of Additional
Information (``SAI'').
\31\ See Proposing Release, supra footnote 8, at n.81 and
accompanying text. We estimate that as of December 31, 2021,
approximately 92% of mutual funds and ETFs use a summary prospectus.
This estimate is based on data on the number of mutual funds and
ETFs that filed a summary prospectus in 2021 in EDGAR (10,876) and
the staff's estimate of the total number open-end funds, including
ETFs, registered on Form N-1A (11,840).
\32\ See Proposing Release, supra footnote 8, at n.83 and
accompanying text (noting that the Commission has, however, adopted
rules that permit streamlined disclosure of portfolio holdings in
funds' shareholder reports).
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Funds' shareholder reports generally have become longer and more
complex over the years. This trend has several sources. The
Commission's rules have required funds to include additional
information over the past several decades, and funds commonly
voluntarily provide additional information beyond that which is
required, including information about general economic conditions, fund
performance, and services provided to shareholders.\33\ The ability to
include multiple series, and multiple share classes of each series, in
a single report also increases these reports' length and complexity.
Based on staff analysis, the average annual report is approximately 134
pages long, and the average semi-annual report is 116 pages long.\34\
The length can vary substantially, however. Staff has observed annual
reports ranging in length from 16 pages to more than 1,000 pages. Most
reports that are between 22 and 45 pages long tend to cover a single
series.\35\
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\33\ See id. at nn.84-86 and accompanying text.
\34\ These figures are based on a 2020 staff review that
included a sample of reports from large, mid-sized, and small funds
that were available on fund websites.
\35\ See id.
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These trends have been accompanied by internet technology that has
continued to evolve, investors' increased access to the internet, and
the Commission continuing to recognize the role of the internet in
providing disclosure materials and other information to investors.\36\
For example, in 2021, approximately 95% of households owning mutual
funds had internet access, while only 68% of these households had
internet access in 2000.\37\ Further advances in technology, including
increasing use of mobile devices to access information, can make it
even easier for funds and intermediaries to communicate with investors
and to provide interactive or customizable information. We understand
that funds continue to explore additional ways to use technology to
communicate with investors.\38\ Against this backdrop, the Commission
has recognized that modernizing the manner in which funds and others
make information available to investors allows them to leverage the
benefits of technology and reduce fund costs while considering the
needs and preferences of investors.\39\ Continued improvements in
presenting information electronically, as well as investors'
continually growing comfort with the internet and electronic media as a
means of accessing fund information, have been integral in making the
use of layered disclosure in the summary prospectus context a success,
and we believe these factors will similarly make layered disclosure an
effective tool in the context of funds' shareholder reports.
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\36\ See Proposing Release, supra footnote 8, at nn.75-78 and
accompanying text.
\37\ See Investment Company Institute, 2022 Investment Company
Fact Book: A Review of Trends and Activities in the Investment
Company Industry (2022) (``2022 ICI Fact Book''), available at
<a href="https://www.ici.org/system/files/2022-05/2022_factbook.pdf">https://www.ici.org/system/files/2022-05/2022_factbook.pdf</a>, at
Figure 7.16.
\38\ See, e.g., infra footnotes 356-358 and accompanying
paragraph.
\39\ See Proposing Release, supra footnote 8, at n.79 and
accompanying text.
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3. Evidence of Investor Preferences Regarding Fund Disclosure
The Proposing Release discussed evidence that was available to the
Commission at the time of the proposal showing that investors generally
prefer concise, layered disclosure. The proposal considered feedback
that the Commission received in response to a June 2018 request for
comment seeking feedback on retail investors' experience with fund
disclosure and on ways to improve fund disclosure (the ``Fund Investor
Experience RFC'').\40\ In the proposal, the Commission stated that the
Fund Investor Experience RFC commenters' overall preference for summary
disclosure is generally consistent with other information the
Commission has received--through investor testing conducted prior to
the proposal, surveys, and other information-gathering--that similarly
indicates that investors strongly prefer concise, layered
disclosure.\41\ The Commission also discussed feedback from investors
responding to the Fund Investor Experience RFC, as well as investors
participating in certain past quantitative and qualitative investor
testing initiatives on the Commission's behalf, expressing preferences
for the inclusion of more tables, charts, and graphs in fund disclosure
and supporting the conclusion that investors
[[Page 72762]]
view funds' existing shareholder reports as too lengthy and
complicated.\42\
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\40\ See Request for Comment on Fund Retail Investor Experience
and Disclosure, Investment Company Act Release No. 33113 (June 5,
2018) [83 FR 26891 (June 11, 2018)] (``Investor Experience RFC'').
The comment letters on the Investor Experience RFC (File No. S7-12-
18) are available at <a href="https://www.sec.gov/comments/s7-12-18/s71218.htm">https://www.sec.gov/comments/s7-12-18/s71218.htm</a>. This feedback generally showed that retail investors
prefer concise, layered disclosure and feel overwhelmed by the
volume of information they currently receive, with some individual
investors specifically addressing and supporting a more concise,
summary shareholder report. See Proposing Release, supra footnote 8,
at nn.28-30 and accompanying text.
\41\ See id. at n.31 and accompanying text.
\42\ See id. at n.32-37 and accompanying text.
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Feedback on investors' preferences that the Commission received in
response to the Proposing Release was consistent with the Commission's
understanding of investors' preferences that the Proposing Release
described, with the vast majority of individuals who commented on the
proposal expressing support for the length, format, and content of the
proposed streamlined annual report.\43\ Industry commenters expressed
support for the proposed layered disclosure approach.\44\ Industry
commenters similarly supported the use of streamlined shareholder
documents and reducing the length and complexity of information
shareholders receive, ultimately leading to an improved overall
investor experience.\45\
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\43\ See infra footnotes 47-51 and accompanying text.
\44\ See, e.g., Comment Letter of CFA Institute (Dec. 30, 2020)
(``CFA Institute Comment Letter''); Comment Letter of Fidelity (Jan.
4, 2021) (``Fidelity Comment Letter''); Mutual Fund Directors Forum
Comment Letter.
\45\ See SIFMA Comment Letter; see also Comment Letter of
Teachers Insurance and Annuity Association of America (Jan. 4, 2021)
(``TIAA Comment Letter''); Comment Letter of FS Investments (Jan. 4,
2021) (``FS Investments Comment Letter'').
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Comments from individual investors similarly suggested that the
proposed shareholder report approach was in line with their preferences
in terms of the length of material and content areas that investors
find to be useful to monitor fund investments. To help market
participants understand the proposed shareholder report, the Commission
published a hypothetical annual report to illustrate what a more
concise, tailored shareholder report could look like, as well as a
feedback flier that investors could use to provide their views on the
hypothetical report.\46\ The Commission received feedback flier
responses from individual investors as well as academics. Of the
respondents who answered the feedback flier question, ``Overall, would
the sample shareholder report be useful in monitoring your fund
investments?'' the vast majority responded positively.\47\ The vast
majority of respondents who answered a question in the feedback flier
about the length of the hypothetical report responded that the length
was ``about right.''
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\46\ See Proposing Release, supra footnote 8, Appendix A
(``Hypothetical Streamlined Shareholder Report'') available at
<a href="https://www.sec.gov/files/final_2020_im_annual-shareholder%20report.pdf">https://www.sec.gov/files/final_2020_im_annual-shareholder%20report.pdf</a> and Appendix B (``Shareholder Report
Feedback Flier''), available at <a href="https://www.sec.gov/rules/proposed/2020/im-shareholder-report-ff.html">https://www.sec.gov/rules/proposed/2020/im-shareholder-report-ff.html</a>.
\47\ Commenters also expressed views about the relative
usefulness of the different proposed content areas as illustrated in
the hypothetical report, and these comments are described in more
detail in section II.A.2 infra.
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One comment letter also included data that this commenter had
compiled about individual investors' preferences as expressed in
response to the hypothetical report and feedback flier that the
Commission published.\48\ This commenter engaged a market research firm
to provide the feedback flier to 2,000+ mutual fund and/or ETF
investors and to collate responses from these investors. The commenter
reported that, based on this analysis, 91% of respondents said that the
hypothetical streamlined annual and semi-annual reports would be useful
in monitoring their fund investments.\49\ This analysis found that 78%
of respondents said that the length was ``about right,'' with 16%
saying that the length was ``too long'' and 6% saying that the length
was ``too short.''
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\48\ Comment Letter of Broadridge Financial Solutions, Inc.
(Jan. 4, 2021) (``Broadridge Comment Letter'').
\49\ The Broadridge Comment Letter stated, ``Half of the
participants were randomly assigned to view the SEC's hypothetical
streamlined annual shareholder report, and the other half viewed a
streamlined semi-annual report.'' The Commission only published a
hypothetical streamlined annual report and did not also publish a
hypothetical semi-annual report. The hypothetical semi-annual report
prototype that Broadridge included in its comment letter appears to
have been created by Broadridge, based on the hypothetical annual
report that the Commission published.
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In addition to feedback flier responses, the Commission also
received traditional comment letters from individuals, who similarly
expressed broad support for the proposed approach to fund shareholder
reports. One remarked that the hypothetical report was ``much better
than what we have now.'' \50\ Several likewise stated that they
supported the proposed streamlined shareholder report, with one
commenting, ``I think it contains the relevant information and would be
more useful to investors than the current annual report.'' \51\ One
individual, however, expressed that ``more should be done to push
transparency, plain English and brevity of disclosure.'' \52\
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\50\ Comment Letter of James J. Angel (Jan. 6, 2021) (``Angel
Comment Letter'').
\51\ Comment Letter of Lisa Barker (Jan. 3, 2021) (``Barker
Comment Letter''); see also Comment Letter of Ryan O'Malley (Dec.
29, 2021) (``O'Malley Comment Letter'') (``I generally like the idea
of a brief shareholder report.''); Comment Letter of Tom Riker (June
2, 2021) (``Riker Comment Letter'') (``I support the streamlined
shareholder report proposal.''); see also Comment Letter of Mo
Abdullah (Oct. 7, 2022) (``Abdullah Comment Letter'') (``The
proposed shareholder report seems like the right mix of
information.'').
\52\ Comment Letter of David Marlboro (Dec. 20, 2020)
(``Marlboro Comment Letter'').
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The Commission also received feedback on individuals' preferences
and views through qualitative investor interviews and a study on
performance benchmarks that the Commission's Office of the Investor
Advocate (``OIAD'') designed (the ``OIAD Benchmark Study'').\53\ The
qualitative interviews aimed to generate hypotheses about certain
content areas in a fund shareholder report that may cause confusion and
lead to impediments to investor understanding of key information. These
interviews focused in particular on investors' understanding of fund
performance disclosure, as displayed in connection with broad-based and
narrow performance benchmark indexes. The objective of the qualitative
interviews was to provide background for a more extensive quantitative
experimental study. In addition, OIAD recommended additional research
devoted to certain other issues that arose during the qualitative
interviews, including exploring ways of explaining share classes to
investors, to the extent that share classes are a necessary component
of fund disclosures.\54\
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\53\ See Alycia Chin, Jonathan Cook, Jay Dhar, Steven Nash, and
Brian Scholl, How Do Consumers Understand Investment Quality? The
Role of Performance Benchmarks, Office of the Investor Advocate
Working Paper 2022-01 (``Chin, et al.''), available at <a href="https://www.sec.gov/files/performance-benchmarks-2022-01.pdf">https://www.sec.gov/files/performance-benchmarks-2022-01.pdf</a>.
\54\ See id. at Appendix B; see also discussion on fund share
classes as section II.A.1.b infra.
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Following the qualitative interviews, OIAD conducted a study on the
impact of fund performance benchmarks on investor decision-making. This
research examined market data, and the results of a large behavioral
experiment sampling a general population, to understand how fund
companies employ benchmarks and how individuals respond to the
presentation of benchmarks. The OIAD Benchmark Study, which is
discussed in more detail below, analyzes individuals' responses to
benchmarks, including how individuals respond to benchmarks that
outperform and underperform the fund, and examines whether there is a
differential impact in performance graphs' use of broad versus narrow
benchmarks on a fund's attractiveness.
Each of these avenues offering evidence of investor preferences and
behaviors in response to fund disclosure has provided important context
and support for the final rules' approach to fund shareholder reports.
Staff will evaluate investor preferences and
[[Page 72763]]
behaviors as they evolve in the future, including through mechanisms
such as investor testing and investor surveys where appropriate, taking
into account relevant developments in connection with fund practices,
investors' preferences, the fund industry, and financial markets in
connection with any future regulatory initiatives.
4. Investment Company Advertisements, and Developments Affecting Fund
Marketing Practices
Many registered investment companies and business development
companies (``BDCs'') prepare advertising materials, which can include
materials in newspapers, magazines, radio, television, direct mail
advertisements, fact sheets, newsletters, and on various web-based
platforms. These advertising materials are subject to certain
requirements under Commission rules. The primary Commission rules
addressing investment company advertising include rules 482 and 433
under the Securities Act, rule 34b-1 under the Investment Company Act,
and rule 156 under the Securities Act (the term ``investment company
advertising rules'' in this release refers to this set of rules).
Rule 482 establishes certain content, legend, and filing
requirements for investment company advertisements.\55\ Many of the
rule's content requirements focus on advertisements that include
performance data of certain types of funds, including mutual funds,
ETFs, insurance company separate accounts registered as unit investment
trusts (``UITs''), and money market funds.\56\
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\55\ Investment company advertisements typically are
prospectuses for purposes of the Securities Act. Rule 482 provides a
framework in which investment company advertisements are deemed to
be ``omitting prospectuses'' that may include information the
substance of which is not included in a fund's statutory or summary
prospectus. See Proposing Release, supra footnote 8, at n.653-654
and accompanying text. Instead of relying on rule 482, registered
closed-end funds and BDCs may use free writing prospectuses in
accordance with rule 433 and certain other Commission rules for
advertising purposes. See id. at nn.656-676 and accompanying text.
\56\ See id. at nn.655-666.
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Rule 34b-1 applies to supplemental sales literature (i.e., sales
literature that is preceded or accompanied by a prospectus) by any
registered open-end company, UIT, or registered face-amount certificate
company. Rule 34b-1 includes many of the same requirements as rule 482,
including the same performance-related requirements.\57\
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\57\ See id. at nn.659-661 and accompanying text. The Commission
adopted rule 34b-1 to help prevent performance claims in
supplemental sales literature from being misleading and to promote
comparability and uniformity among supplemental sales literature and
rule 482 advertisements.
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Rule 156 states that whether or not a particular description,
representation, illustration, or other statement involving a material
fact is misleading depends on evaluation of the context in which it is
made. The rule discusses several pertinent factors that should be
weighed in considering whether a particular statement involving a
material fact is or might be misleading in investment company sales
literature, including rule 482 advertisements and supplemental sales
literature.\58\ Rule 156 applies to sales literature used by any person
to offer to sell or induce the sale of securities of any investment
company, including registered investment companies and BDCs.
---------------------------------------------------------------------------
\58\ See id. at n.662-663 and accompanying text.
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Separately, rules issued by FINRA regulating members'
communications with the public provide an important source of
advertising requirements and guidance for investment companies, as
underwriters and/or distributors of investment company shares are
commonly FINRA members.\59\ FINRA rule 2210, ``Communications with the
Public,'' includes both general and specific standards for
communications with the public.\60\
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\59\ FINRA is a self-regulatory organization composed of brokers
and dealers registered under the Exchange Act.
\60\ Non-money market fund open-end funds' retail communications
and correspondence (as defined in FINRA rule 2210, see infra
footnote 515) that include performance information also must include
fee and expense information that includes: (1) the fund's maximum
sales charge; and (2) the total annual fund operating expense ratio,
gross of any fee waivers or expense reimbursements (i.e., ongoing
annual fees). These funds' standardized performance information,
sales charge, and total annual fund operating expense ratio also
must be set forth prominently. FINRA rule 2210(d)(5). In addition,
FINRA rule 2210 applies to the retail communications of BDCs. See
FINRA Rule 2210 Interpretative Guidance at C.1, available at <a href="https://www.finra.org/rules-guidance/guidance/faqs/advertising-regulation#b2">https://www.finra.org/rules-guidance/guidance/faqs/advertising-regulation#b2</a> (responding, in part, that firms must file with FINRA
retail communications concerning BDCs that are registered under the
Securities Act).
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In recent years, investment companies increasingly have been
marketing themselves on the basis of cost in an effort to attract
investors. For instance, we have observed some funds calling themselves
``no-expense'' or ``zero-expense'' funds, or emphasizing their low
expense ratios, despite the fact that investors may incur other
investment costs.\61\ Comments that the Commission received on the
Proposing Release similarly recognized ``the trend for some funds to
market their investment products based on claims of low or no fees.''
\62\ Investors may incur certain costs and fees that, despite providing
revenue to the fund's adviser and its affiliates (or other parties),
are not direct costs of investing in a fund and so are not reflected in
a fund's expense ratio, and therefore may be less transparent or clear
to certain investors.\63\ Additionally, a fund may appear to be a
``zero expense'' fund because its adviser is waiving fees or
reimbursing expenses for a period of time, but the fund will incur fees
and expenses once that arrangement expires. In these and other cases,
we are concerned that, absent appropriate explanations or limitations,
investors may believe incorrectly that there are no expenses associated
with investing in the fund.
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\61\ A fund's expense ratio is the figure in its prospectus fee
table that represents the fund's total annual operating expenses,
expressed as a percent of the fund's average net assets. See also
Proposing Release, supra footnote 8, at section II.H.1.c (discussing
costs that the expense ratio does not reflect).
\62\ See CFA Institute Comment Letter; see also Comment Letter
of the Consumer Federation of America (Jan. 4, 2021) (``Consumer
Federation of America II Comment Letter'') (discussing concerns that
accompany funds being ``increasingly marketed on the basis of
costs'').
\63\ For example, an investor may incur intermediary costs, such
as wrap fees that an investor pays to the sponsor of a wrap fee
program (which may be the fund's adviser or its affiliates) for
investment advice, brokerage services, administrative expenses, or
other fees and expenses. See SEC Division of Examinations,
Observations from Examinations of Investment Advisers Managing
Client Accounts That Participate in Wrap Fee Programs (July 21,
2021), available at <a href="https://www.sec.gov/files/wrap-fee-programs-risk-alert_0.pdf">https://www.sec.gov/files/wrap-fee-programs-risk-alert_0.pdf</a>. All staff statements represent the views of the
staff. They are not a rule, regulation, or statement of the
Commission. The Commission has neither approved nor disapproved
their content. These staff statements, like all staff statements,
have no legal force or effect: they do not alter or amend applicable
law, and they create no new or additional obligations for any
person. As another example, investment company advertisements that
advertise low investment costs, based solely on a fund's prospectus
fee table, might not reflect or recognize other categories of costs
that may be supplementing a traditional management fee and/or may
affect the returns an investor experiences (e.g., intermediary
costs). See Proposing Release, supra footnote 8, at paragraph
accompanying n.685.
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While investment company advertising rules currently place limits
on how a fund may present its performance to promote comparability and
prevent potentially misleading advertisements, these rules generally do
not prescribe the presentations of fees and expenses in advertisements
to address similar concerns about comparability or potentially
misleading information.\64\ Addressing fee comparability in fund
advertisements is critical both in light of current trends in
[[Page 72764]]
fund marketing and because of the significant long-term effects that
fund fees and expenses can have on investment returns.
---------------------------------------------------------------------------
\64\ Commission rules require a fund to disclose maximum sales
loads in some advertisements, and FINRA rules also limit how a fund
advertisement may describe investment costs in some respects, but
these limitations currently apply only to a subset of fund
advertisements. See Proposing Release, supra footnote 8, at section
II.H.2.
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B. Overview of the Final Rules
1. Final Rules' Principal Elements
The final rules consist of the following principal elements:
<bullet> Shareholder Reports Tailored to the Needs of Retail
Shareholders: Under the new framework, shareholders will receive
concise and visually engaging annual and semi-annual reports designed
to highlight information that we believe is particularly important for
retail shareholders to assess and monitor their fund investments on an
ongoing basis. This information will include--among other things--fund
expenses, performance, and portfolio holdings. Funds will have the
flexibility to make electronic versions of their shareholder reports
more user-friendly and interactive. In addition, funds will be required
to tag the information in their shareholder reports using Inline XBRL
structured data language.
<bullet> Availability of Additional Information on Form N-CSR and
Online: Information that may be more relevant to financial
professionals and other investors who desire more in-depth information
will be made available online and delivered free of charge in paper or
electronically upon request. This information also will be filed on a
semi-annual basis with the Commission on Form N-CSR. This information
includes, for example, the schedule of investments and other financial
statement elements. Shareholder reports will contain cover page legends
directing investors to websites containing this information.
Accessibility-related requirements that we are adopting will help
ensure that investors can easily reach and navigate the information
that appears online.
<bullet> Amendments to Scope of Rule 30e-3 to Exclude Funds
Registered on Form N-1A: To ensure that all fund investors will
experience the anticipated benefits of the new tailored shareholder
reports, we are amending the scope of rule 30e-3 to exclude open-end
funds. This amendment ensures shareholders in open-end funds will
directly receive the new tailored annual and semi-annual reports,
either in paper or (if the shareholder has so elected)
electronically.\65\ This change reflects the Commission's continuing
efforts to improve the ways investors receive fund disclosure. We
believe that this approach represents a more effective means of
improving investors' ability to access and use fund information, and of
reducing expenses associated with printing and mailing, than continuing
to permit open-end funds to rely on rule 30e-3.
---------------------------------------------------------------------------
\65\ See infra footnote 618 and accompanying text (discussing
increase in e-delivery requests since the beginning of the COVID-19
pandemic).
---------------------------------------------------------------------------
<bullet> Fee and Expense Information in Investment Company
Advertisements: Finally, we are adopting amendments that are designed
to respond to developments that we have observed in investment company
advertising. These amendments require that presentations of investment
company fees and expenses in advertisements and sales literature be
consistent with relevant prospectus fee table presentations and be
reasonably current. These advertising rule amendments affect all
registered investment company and BDC advertisements that include fee
and expense figures, and where the investment company presents total
annual expense figures in their prospectuses. The amendments therefore
are not limited to open-end fund advertisements. The amendments also
address representations of fees and expenses that could be materially
misleading.
2. Other Aspects of Proposal
After considering comments, we are not taking final action on
several aspects of the proposal at this time: (1) proposed new rule
498B, which would have provided a new alternative approach to satisfy
prospectus delivery requirements for existing fund investors; and (2)
proposed amendments to funds' prospectus fee and risk disclosure.
Proposed Rule 498B
In lieu of providing annual prospectus updates to existing fund
investors, proposed rule 498B would have provided an alternative
approach to keep these investors informed about their fund investments
and updates to their funds that occur year over year.\66\ Under this
proposed rule, new investors would have received a fund prospectus in
connection with their initial investment in a fund, as they currently
do, but funds could have opted into an alternative approach under which
they would not deliver annual prospectus updates to investors
thereafter.\67\ The proposed layered disclosure framework would instead
have relied on the shareholder report and timely notifications to
shareholders to keep investors informed about their fund investments.
---------------------------------------------------------------------------
\66\ See Proposing Release, supra footnote 8, at section II.F.
\67\ See section 5(b)(2) of the Securities Act [15 U.S.C.
77e(b)(2)] (generally requiring that a fund or financial
intermediary deliver a prospectus to an investor in connection with
a purchase of the fund's securities). Because section 5(b)(2)
requires funds to deliver a prospectus to an investor purchasing
shares, including existing shareholders who purchase additional
shares, funds generally provide annual updates of prospectuses to
all shareholders.
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While some commenters generally supported proposed rule 498B, most
commenters, even those who supported the proposed rule, suggested
fairly significant modifications.\68\ A number of commenters directly
opposed the proposed rule.\69\ Some of these commenters expressed
concern that existing investors would not continue to receive an
updated prospectus annually.\70\ Many other opposing commenters also
expressed concern about the proposed requirement to deliver notices of
material fund changes.\71\ Other commenters suggested that the proposed
new approach to satisfying prospectus delivery obligations could
increase the possibility of shareholder litigation (for example, if
failing to send a material change notice or not correctly tracking
existing investors could result in prospectus delivery obligations not
being satisfied).\72\
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\68\ See, e.g., Comment Letter of T. Rowe Price Associates, Inc.
(Jan. 5, 2021) (``T. Rowe Price Comment Letter''); Comment Letter of
Better Markets, Inc. (Jan. 4, 2021) (``Better Markets Comment
Letter'') (each commenter expressing support for adopting the rule
as proposed); see also, e.g., Comment Letter of the Investment
Company Institute (Dec. 21, 2020) (``ICI Comment Letter''); Fidelity
Comment Letter; Comment Letter of Tom and Mary (Aug. 12, 2020)
(``Tom and Mary Comment Letter'') (each commenter suggesting
modifications to the proposed rule).
\69\ See, e.g., Comment Letter of Charles Schwab Investment
Management, Inc. (Jan. 4, 2021) (``Charles Schwab Comment Letter'');
TIAA Comment Letter.
\70\ See, e.g., TIAA Comment Letter; Consumer Federation of
America II Comment Letter; Broadridge Comment Letter (discussing
data this commenter compiled about individual investors' preferences
showing that 88% of surveyed investors ``prefer the status quo of
annual prospectus delivery'').
\71\ See, e.g., Comment Letter of Dechert LLP (Jan. 4, 2021)
(``Dechert Comment Letter''); ICI Comment Letter; Comment Letter of
Stradley Ronon Stevens & Young, LLP (Jan. 15, 2021) (``Stradley
Ronon Comment Letter''); Comment Letter of The Vanguard Group, Inc.
(Dec. 22, 2020) (``Vanguard Comment Letter''); SIFMA Comment Letter;
Fidelity Comment Letter.
\72\ See, e.g., Dechert Comment Letter; Comment Letter of Sidley
Austin LLP (Dec. 29, 2020) (``Sidley Austin Comment Letter'');
Comment Letter of the Center for Capital Markets Competitiveness
(Jan. 4, 2021) (``Center for Capital Markets Competitiveness Comment
Letter'').
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Improving the fund disclosure framework and investors' experience
with fund disclosure continues to be an important priority for the
Commission, as does the consideration of how to best help investors
make informed investment decisions and monitor their fund investments.
In light of the
[[Page 72765]]
comments received, which we believe raise issues that merit further
consideration, we are not adopting rule 498B at this time.
Proposed Amendments to Funds' Prospectus Fee Disclosure
The Commission proposed amendments to funds' prospectus disclosure
requirements to provide greater clarity and more consistent information
regarding fund fees and expenses. The proposal would have replaced the
existing fee table in the summary section of funds' statutory
prospectuses with a simplified fee summary, and the Commission also
proposed to simplify the fee example that currently appears in funds'
prospectuses.\73\ The full, existing fee table would be moved to the
statutory prospectus under the proposal, for use by investors seeking
additional details about fund fees.\74\ Finally, the proposal would
have replaced certain terms in the current fee table with terms that
were designed to be easier to understand by most investors.\75\
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\73\ See Proposing Release, supra footnote 8, at sections
II.H.1.b-e.
\74\ See id. at sections II.H.1.b-c.
\75\ See id. at section II.H.1.f.
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Comments on the proposed fee summary, simplified example, and
proposed new fee terminology were mixed. Some agreed that investors
could benefit from simplified prospectus fee disclosures and generally
supported the proposed approach.\76\ Several commenters, however,
opposed the inclusion of the fee summary and noted that having multiple
different fee presentations could be confusing for investors and would
be burdensome for funds.\77\ A number of commenters opposed many of the
proposed new terms, stating that they would not further investor
comprehension and could be more confusing than the current terms.\78\
Some commenters also recommended that the Commission should verify the
benefits of the proposed approach through additional investor
testing.\79\
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\76\ Comment Letter of Morningstar Inc. (Jan. 4, 2020)
(``Morningstar Comment Letter''); Comment Letter of Consumer
Federation of America (Dec 15, 2020) (``Consumer Federation of
America I Comment Letter'').
\77\ See, e.g., SIFMA Comment Letter; Dechert Comment Letter; FS
Investments Comment Letter.
\78\ See, e.g., ICI Comment Letter; SIFMA Comment Letter; CFA
Institute Comment Letter; Charles Schwab Comment Letter; Comment
Letter of Dimensional Fund Advisors (Jan. 4, 2021) (``Dimensional
Comment Letter'').
\79\ See, e.g., Consumer Federation of America II Comment
Letter; ICI Comment Letter; Dechert Comment Letter.
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The proposal also included a new approach to disclosing acquired
fund fee and expenses (``AFFE'').\80\ Currently, all registered
investment companies that invest in other ``acquired funds,'' including
BDCs and private funds that would be investment companies but for
sections 3(c)(1) or 3(c)(7) of the Investment Company Act, disclose
AFFE in their prospectus fee tables.\81\ AFFE shows the investing
fund's pro rata share of the fees and expenses of any underlying funds.
Under the proposal, a fund that invests less than 10% of the value of
its total fund assets in other funds could disclose AFFE in a footnote
to the fee table, instead of including AFFE as a fee table line item
(which is included as a component of the fund's bottom-line ongoing
annual operating expenses). The proposed new approach to AFFE
disclosure was designed to maintain the benefits of transparent AFFE
disclosure and to provide more consistent disclosure of information
related to indirect costs.\82\
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\80\ See Proposing Release, supra footnote 8, at section
II.H.1.g.
\81\ See id. at nn.604-605 and accompanying text.
\82\ See id. at nn.608-614, and accompanying and following
paragraphs.
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Commenters expressed varying concerns about the proposed AFFE
approach. A number of commenters suggested that the proposed approach
to AFFE disclosure would decrease transparency of funds' AFFE.\83\
These commenters urged the Commission to retain the current approach to
provide investors full and clear information about funds' fees and
expenses. Some members of the fund industry generally supported the
changes, although some requested that the proposal be significantly
broadened, including suggestions to carve BDCs out from the definition
of ``acquired fund'' altogether.\84\
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\83\ See, e.g., Consumer Federation of America II Comment
Letter; Barker Comment Letter; Morningstar Comment Letter; Comment
Letter of Tom Williams (Aug. 6, 2020) (``Williams Comment Letter'').
\84\ See, e.g., Comment Letter of the Small Business Investor
Alliance (Dec. 4, 2020); Comment Letter of the Coalition for
Business Development (Jan. 4, 2021); ICI Comment Letter; see also,
e.g., Final Report on 2018 SEC Government-Business Forum on Small
Business Capital Formation (June 2019), available at <a href="https://www.sec.gov/info/smallbus/gbfor37.pdf">https://www.sec.gov/info/smallbus/gbfor37.pdf</a> (discussing, among other
things, forum recommendations on BDCs and AFFE. The SEC conducts the
Government-Business Forum on Small Business Capital Formation
annually. The recommendations contained in this report are solely
the responsibility of Forum participants from outside the SEC, who
were responsible for developing them. The recommendations are not
endorsed or modified by the SEC and do not necessarily reflect the
views of the SEC, its Commissioners or any of the SEC's staff
members.).
---------------------------------------------------------------------------
Helping investors more readily understand fund fees and expenses is
an important priority of the Commission. In light of the comments
received, which we believe raise issues that merit further
consideration, we are not adopting the proposed changes at this time.
Proposed Amendments to Funds' Prospectus Risk Disclosure
The Commission also proposed amendments to funds' prospectus
disclosure requirements that were designed to help investors more
readily understand funds' principal risks.\85\ These amendments would
have added specificity to the existing requirement that funds must
disclose principal risks in their prospectuses. The proposed amendments
clarified that a ``principal'' risk is one that would place more than
10% of the fund's assets at risk and is reasonably likely to occur in
the future. The proposal also would have required that funds'
description of risks be brief and organized in order of importance.
---------------------------------------------------------------------------
\85\ See Proposing Release, supra footnote 8, at section II.H.2.
---------------------------------------------------------------------------
While some commenters supported the proposed approach, most
generally opposed it.\86\ Commenters expressed concern about the
perceived difficulty and subjectivity of determining which risks
currently or in the future will place more than 10% of the fund's
assets at risk, as well as ordering risk disclosure, and the potential
of increased liability for funds associated with this.\87\
---------------------------------------------------------------------------
\86\ See, e.g., Consumer Federation of America II Comment
Letter; Comment Letter of NASAA (Jan. 4, 2021) (``NASAA Comment
Letter''); Comment Letter of the Americans for Financial Reform
Education Fund (Jan. 4, 2021) (``AFREF Comment Letter'') (each
expressing overall support for the changes); contra ICI Comment
Letter; Sidley Austin Comment Letter; Dechert Comment Letter;
Comment Letter of John Hancock (Jan. 4, 2021) (``John Hancock
Comment Letter'') (each expressing general opposition).
\87\ See, e.g., Sidley Austin Comment Letter; Comment Letter of
Federated Hermes (Jan. 4, 2021) (``Federated Hermes Comment
Letter'').
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Helping investors more readily understand funds' principal risks is
an important priority of the Commission. In light of the comments
received, which we believe raise issues that merit further
consideration, we are not adopting the proposed risk disclosure
amendments at this time.
II. Discussion
A. Annual Reports
In order to effectuate the new streamlined shareholder reports for
open-end funds, we are adopting substantially as proposed new Item 27A
to Form N-1A to specify the design and content of funds' annual and
semi-annual reports. We also are removing, as proposed, the provisions
in Item 27 of
[[Page 72766]]
current Form N-1A that relate to annual and semi-annual reports.\88\
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\88\ The final rules generally require funds to reorganize the
presentation of currently-required information. To the extent that
any of the amendments require funds to disclose new information
other than is required in section 30(e), such changes are
appropriate in the public interest for the reasons discussed more
fully in sections II.A.2 and II.B.1.
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The table below summarizes the contents that funds will include in
their annual reports--or, alternatively, that they will file on Form N-
CSR--in comparison to current shareholder report disclosure
requirements.\89\ While the new content requirements for shareholder
reports that are transmitted in paper will generally be the same as the
requirements for reports that are transmitted electronically (and that
appear online or are accessible through mobile electronic devices), we
are adopting, as proposed, instructions that address electronic
presentation and are designed to provide flexibility to enhance the
usability of reports that appear online or on mobile devices.\90\
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\89\ This release separately discusses the content requirements
for funds' semi-annual reports. See infra section II.B.
\90\ See infra section II.A.4.
\91\ ``Householding'' permits funds to deliver a single copy of
a prospectus, proxy materials, and a shareholder report to investors
who share the same address and meet certain other requirements in
order to avoid duplication of materials to investors who invest in
funds through a variety of individual and family accounts.
Table 1--Annual Report Contents
----------------------------------------------------------------------------------------------------------------
Current annual shareholder report New rule and form
disclosure (current Form provision) Description of amendments provisions Discussed below in
----------------------------------------------------------------------------------------------------------------
Add new identifying Item 27A(b) of Form N- Section
information to the 1A. II.A.2.II.A.2.a.
beginning of the annual
report.
Expense example (Form N-1A Item Retain in annual report in Item 27A(c) of Form N- Section
27(d)(1)). a more concise form. 1A. II.A.2.II.A.2.b.
Management's discussion of fund Retain in annual report in Item 27A(d) of Form N- Section
performance (``MDFP'') (Form N-1A a more concise form. 1A. II.A.2.II.A.2.c.
Item 27(b)(7)).
Add new fund statistics Item 27A(e) of Form N- Section
section to the annual 1A. II.A.2.II.A.2.d.
report.
Graphical representation of Retain in annual report.... Item 27A(f) of Form N- Section
holdings (Form N-1A Item 27(d)(2)). 1A. II.A.2.II.A.2.e.
Add new material fund Item 27A(g) of Form N- Section
changes section to the 1A. II.A.2.II.A.2.f.
annual report.
Changes in and disagreements with Retain in annual report in Item 27A(h) of Form N- Section
accountants (Form N-1A Item summary form. 1A. II.A.2.II.A.2.g.
27(b)(4)).
The entirety of the Item 8 of Form N-CSR.. Section
currently-required Rule 30e-1(b)(2) and II.C.2.II.C.1.c.
disclosure would move to (b)(3)..
Form N-CSR and would need
to be available online and
delivered (in paper or
electronic format) upon
request.
Statement regarding the Include a more general Item 27A(i) of Form N- Section
availability of quarterly reference to the 1A. II.A.2.II.A.2.h.
portfolio schedule, proxy voting availability of additional
policies and procedures, and proxy fund information in the
voting record (Form N-1A Item annual report.
27(d)(3) through (5)).
Add provision allowing Item 27A(j) of Form N- Section
funds to optionally 1A. II.A.2.II.A.2.i.
disclose in their annual
reports how shareholders
may revoke their consent
to householding \91\.
Financial statements, including Move to Form N-CSR......... Item 7(a) of Form N- Section
schedule of investments (Form N-1A Would need to be available CSR. II.C.1.II.C.1.a.
Item 27(b)(1)). online and delivered (in Rule 30e-1(b)(2) and
paper or electronic (b)(3)..
format) upon request.
Financial highlights (Form N-1A Retain certain data points, Item 7(b) of Form N- Section II.C.1.C.1.b.
Item 27(b)(2)). but generally move to Form CSR.
N-CSR.
Would need to be available Rule 30e-1(b)(2) and
online and delivered (in (b)(3).
paper or electronic
format) upon request.
Results of any shareholder votes Move to Form N-CSR......... Item 9 of Form N-CSR.. Section
during the period (Rule 30e-1(b)). Would need to be available Rule 30e-1(b)(2) and II.C.1II.C.1.d.
online and delivered (in (b)(3)..
paper or electronic
format) upon request.
Remuneration paid to directors, Move to Form N-CSR......... Item 10 of Form N-CSR. Section
officers, and others (Form N-1A Would need to be available Rule 30e-1(b)(2) and II.C.1.II.C.1.e.
Item 27(b)(3)). online and delivered (in (b)(3)..
paper or electronic
format) upon request.
Statement regarding the basis for Move to Form N-CSR......... Item 11 of Form N-CSR. Section
the board's approval of investment Would need to be available Rule 30e-1(b)(2) and II.C.1.II.C.1.f.
advisory contract (Form N-1A Item online and delivered (in (b)(3)..
27(d)(6)(i)). paper or electronic
format) upon request.
[[Page 72767]]
Management information and Remove from shareholder ...................... Section II.D.
statement regarding availability reports, but information
of additional information about would remain available in
fund directors (Form N-1A Item a fund's SAI, which is
27(b)(5) and (6)). available online or
delivered upon request.
Statement regarding liquidity risk Remove from shareholder ...................... Section II.D.
management program (Form N-1A Item reports.
27(d)(6)(ii)).
Rule 30e-3 disclosure, if Remove from shareholder ...................... Section II.E.
applicable (Form N-1A Item reports.
27(d)(7)).
Funds have discretion to provide Disclosures in the annual Instructions 1 and 12 Section II.A.1.c.
other information in their report are restricted to to Item 27A(a) of
shareholder reports (e.g., that which is required or Form N-1A.
president's letter). permitted under Item 27A
of Form N-1A (other
materials may accompany
the transmission of the
report, so long they meet
the prominence
requirements for materials
that accompany the report).
----------------------------------------------------------------------------------------------------------------
1. Scope of Annual Report Disclosure, and Registrants Subject to
Amendments
a. Series Scope
We are adopting, as proposed, the requirement that funds must
prepare separate annual reports for each series of a fund. As a result,
under the final rules, a fund shareholder will receive an annual report
that addresses only the series in which that shareholder is invested.
Many mutual funds and ETFs are organized as single registrants with
several series (sometimes referred to as portfolios).\92\ Currently,
fund registrants may prepare a single shareholder report that covers
multiple series. As the Commission stated in the Proposing Release, we
believe this approach contributes to the length and complexity of
shareholder reports.\93\ Because the length and complexity associated
with multi-series shareholder reports are inconsistent with our goal of
creating concise shareholder report disclosure that shareholders can
more easily use to assess and monitor their ongoing fund investments,
the final rules will require fund registrants to prepare separate
annual reports for each series of the fund.\94\ We believe a
shareholder is more likely to read a shareholder report targeted to
that shareholder's fund as opposed to a multi-series report that may
also cover a number of other funds.
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\92\ See Proposing Release, supra footnote 8, at nn.108-110 and
accompanying text (noting that each series has its own investment
objectives, policies and restrictions and that the Federal
securities laws and Commission rules often treat each series as a
separate fund).
\93\ See Proposing Release, supra footnote 8, at text
accompanying n.111 (providing examples of how the current
presentation of multiple series within a single shareholder report
may confuse shareholders); see also supra at text accompanying
footnotes 8 and 29.
\94\ See Instruction 4 to Item 27A(a) of amended Form N-1A. As
proposed, fund registrants could continue to include multiple
shareholder reports that cover different series in a single Form N-
CSR report filed on EDGAR under the final rules.
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Most commenters supported this proposed requirement, stating that
it would significantly reduce the length of the report and make it
easier for shareholders to navigate.\95\ Some commenters, however,
urged the Commission to continue to allow fund complexes to bundle the
shareholder reports of certain types of funds together in one report,
in selected circumstances.\96\ For example, these commenters urged the
Commission to allow funds with similar investment strategies to be
bundled in the same report, such as target date funds, target risk
funds, state tax exempt funds, and money market funds. These commenters
argued that shareholders would benefit from seeing other investment
options that are available to them within the complex. Additionally,
some of these commenters stated that, because disclosures related to
funds with similar strategies and risk profiles likely would be
similar, allowing these funds to be bundled together in a single report
would allow fund complexes to organize their similarly-managed funds
efficiently into a single report.\97\ Some commenters likewise argued
that fund complexes should have further flexibility to bundle series as
they see fit to allow them to organize their reports efficiently and
reduce the costs associated with preparing shareholder reports.\98\
Finally, some commenters urged the Commission to allow insurance
companies providing shareholder reports to holders of variable
contracts to provide combined reports for those series available as
investment options for a particular variable contract.\99\ These
commenters stated that this practice would be consistent with rule 498
under the Securities Act and argued that contract holders would benefit
from receiving a single document that contains information regarding
all of the
[[Page 72768]]
investment options available under the variable contract.\100\
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\95\ See, e.g., CFA Institute Comment Letter; Morningstar
Comment Letter; NASAA Comment Letter; Comment Letter of Prof.
William A. Jacobson, Cornell Law School (Dec. 29, 2020) (``Cornell
Law School Comment Letter''); Barker Comment Letter; see also
Comment Letter of Donnelley Financial Solutions (Dec. 30, 2020)
(``DFIN Comment Letter'') (supporting this requirement and stating
that, if the Commission were to allow certain series to be bundled
into a single shareholder report, the Commission should at a minimum
require all information for each series appear together to eliminate
the need for a shareholder to navigate the entire report to review
all the information on a single series).
\96\ See, e.g., ICI Comment Letter; SIFMA Comment Letter;
Fidelity Comment Letter; T. Rowe Price Comment Letter; Vanguard
Comment Letter; Comment Letter of Capital Research and Management
Company (Jan. 4, 2021) (``Capital Group Comment Letter''); John
Hancock Comment Letter.
\97\ See, e.g., T. Rowe Price Comment Letter; SIFMA Comment
Letter; John Hancock Comment Letter.
\98\ See, e.g., Vanguard Comment Letter; Capital Group Comment
Letter; John Hancock Comment Letter.
\99\ See, e.g., ICI Comment Letter; SIFMA Comment Letter;
Fidelity Comment Letter; John Hancock Comment Letter.
\100\ See ICI Comment Letter (stating that, while rule 498
prohibits the bundling of summary prospectuses for different funds
together, it provides an exception from this prohibition for funds
that are all available as investment options for a particular
variable contract); see also John Hancock Comment Letter (also
stating that insurance companies that offer funds as investment
options sometimes request that certain reports be combined rather
than separated into multiple reports).
---------------------------------------------------------------------------
After considering these comments, we continue to believe a multi-
series report is inconsistent with our goal of creating concise
shareholder report disclosure that shareholders can more easily use to
assess and monitor their ongoing fund investments. For example, if the
report were to include information about multiple series, a shareholder
that is invested in one series of the registrant would need to spend
more time searching through the report to find disclosure related to
that shareholder's investment. Additionally, even if there may be some
efficiencies gained for fund complexes in bundling the reports of funds
with similar investment strategies, we believe those benefits are not
justified by the resulting inconsistency in which some funds'
shareholder report content would be bundled together in a single report
while others would have individual shareholder reports.\101\
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\101\ See, e.g. Morningstar Comment Letter (also stating that
the costs associated with creating separate shareholder reports for
each fund would not be significant because fund complexes would
simply be required to divide what is currently reported in one
document into several smaller documents); see also infra section
IV.C.2.
---------------------------------------------------------------------------
Furthermore, we believe that bundling funds with similar strategies
could present an increased risk of shareholder confusion. For instance,
if two series included in the same shareholder report were to have
similar names, such as two tax-exempt funds or two target date funds
where only the target date in the name differs (e.g., ``XYZ Target
Retirement 2040 Fund'' versus ``XYZ Target Retirement 2045 Fund''),
there could be a greater risk that a shareholder would mistakenly
review information that does not relate to that person's
investment.\102\ Because the shareholder report is designed to assist
existing shareholders in monitoring their investments on an ongoing
basis, rather than serving as a mechanism for funds to provide
shareholders information about other products, we disagree with
commenters who suggested that bundling funds with similar strategies
together in a single report, such as target date funds, would be useful
to investors.\103\
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\102\ See Morningstar Comment Letter.
\103\ See DFIN Comment Letter (noting that the cost of requiring
only one series to be included in a shareholder report is mitigated
by the cost savings derived from the proposal's exclusion of
financial statements from the shareholder report); see also infra
section IV.C.2.
---------------------------------------------------------------------------
Furthermore, we have similar concerns about commenters' suggestions
to permit bundling shareholder reports of those funds that are
available as investment options underlying variable contracts, although
this is permitted for summary prospectuses. In the context of reports
to existing shareholders who use these reports to monitor their
investments on an ongoing basis (as opposed to prospective investors
making an initial investment decision and who are a key audience for
summary prospectuses), we see little benefit to such contract holders
from allowing insurance companies to bundle together all the underlying
series, many of which the shareholders are not invested in.\104\
Contract holders seeking to shift their investments to other available
investment options may consult the contract's annual prospectus update,
or for variable contract registrants that use a summary prospectus, the
appendix of investment options/portfolio companies that an updating
summary prospectus is required to include.\105\
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\104\ See Variable Contract Summary Prospectus Adopting Release,
supra footnote 9 at n. 16 (noting that investment options offered by
variable annuity contracts can be numerous, with some contracts
offering more than 250 investment options).
\105\ See Item 18 of Form N-3 [17 CFR 239.17a and 274.11b]; Item
17 of Form N-4 [17 CFR 239.17b and 274.11c]; Item 18 of Form N-6 [17
CFR 239.17c and 274.11d].
---------------------------------------------------------------------------
b. Class Scope
To reduce the complexity of disclosure as well as to provide more
tailored information that is specific to a shareholder's investment in
the fund, the final rules, in a change from the from the proposal, will
require that a 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.\106\ We requested comment on
whether a shareholder report should be limited to a single class. After
considering the comments received in response to this request, among
other factors, we believe that this requirement will make it easier for
shareholders to navigate the shareholder report disclosure and
understand how it applies to their own interests in the fund, as
shareholders only will receive reports applicable to their share
class.\107\ Although different share classes of a fund represent
interests in the same investment portfolio, and certain shareholder
report disclosure will be the same for all classes, the final rules
recognize that there is significant disclosure that varies among share
classes, such as expenses and performance data.
---------------------------------------------------------------------------
\106\ See Instruction 4 to Item 27A(a) of amended Form N-1A. To
effectuate the requirement to prepare separate shareholder reports
for each share class, we are also adopting changes to: proposed Item
27A(b)(1) and (b)(2) (to identify on the cover page the class and
exchange ticker symbol of the class to which the shareholder report
relates); proposed Item 27A(c), Instruction 1.(e) (to delete the
requirement that a fund provide a separate line in the expense table
for each class); proposed Item 27A(d), Instruction 13 (to clarify
the requirements for management's discussion of fund performance in
the context of multiple class funds); and proposed Item 27A(e) (to
add an instruction providing that if a fund includes a statistic
that is calculated based on the fund's performance or fees, the fund
must show the statistic for the class of the fund to which the
report relates, and to clarify that a fund may include performance-
based statistics only if the relevant class has at least one year of
performance). See infra section II.A.2.
\107\ See Proposing Release, supra footnote 7, at section
II.B.1.
---------------------------------------------------------------------------
Commenters' support for the proposal to include all of a fund's
share classes in a single shareholder report was mixed. Certain
commenters generally supported the proposed approach and stated that
shareholders monitoring their investments may benefit from seeing other
cheaper classes that may be available.\108\ One of those commenters,
nevertheless, suggested that it would be beneficial if a fund were to
provide a brief description of share class availability and investor
eligibility requirements for each share class.\109\ Other commenters,
however, suggested that including all share classes in the tailored
shareholder report could result in lengthy and complex disclosure,
particularly with the class-specific information regarding fees and
performance data that would be required under the proposal.\110\ One
commenter suggested that the Commission require that a fund show class-
specific information, such as information regarding expenses and
performance data, for only the ``primary'' share class.\111\ Another
commenter observed that some funds have many classes, many of which
that are not available to most investors, and suggested that the
Commission limit the number of classes a fund may show in the annual
report.\112\
---------------------------------------------------------------------------
\108\ See, e.g., CFA Institute Comment Letter; ICI Comment
Letter; Morningstar Comment Letter.
\109\ See Morningstar Comment Letter.
\110\ See Capital Group Comment Letter; see also Tom and Mary
Comment Letter.
\111\ See Capital Group Comment Letter.
\112\ See Tom and Mary Comment Letter.
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[[Page 72769]]
After considering the statements of support as well as the concerns
raised by commenters, we have determined to require that a shareholder
report cover a single class of a multiple-class fund. We agree with
commenters that including all share classes of a multiple class fund
could result in lengthy and complex disclosure, particularly when a
fund has a large number of share classes.\113\ The length and
complexity that would result by including all classes of multiple class
fund would make it more difficult for a shareholder to identify
information, such as fees and performance, that may differ based on the
share class in which the shareholder invested. Further, such lengthy
and complex shareholder reports would be inconsistent with our goal of
creating concise shareholder report disclosure so shareholders can more
easily use the reports to assess and monitor their ongoing fund
investments.
---------------------------------------------------------------------------
\113\ According to staff review of filings received by the
Commission on Form N-CEN [17 CFR 274.101] through March 14, 2022,
the largest number of share classes reported by multiple class fund
was 23 share classes.
---------------------------------------------------------------------------
Instead of this approach, we considered adopting the approach a
commenter suggested, in which all share classes could be included in a
shareholder report if the fund were to provide additional disclosure
about share class availability and eligibility to assist with a
shareholder's understanding of share classes.\114\ However, this
approach would not address the concern that the inclusion of
information about multiple share classes could result in lengthy and
complex shareholder report disclosure that would run counter to our
goal of creating concise shareholder report disclosure.\115\ Further,
we believe that investors may benefit from having class-specific
shareholder reports, as it may be difficult for some investors to
identify or recall the share class in which they had invested.
Including additional information about share class eligibility would
not necessarily help to address these concerns. In addition, providing
concise, plain-English disclosure about share class eligibility could
be particularly challenging. Based on staff experience, including
multiple share classes in a shareholder report may make it more
difficult for some retail shareholders to efficiently review
information relevant to their share classes, even those with
specialized knowledge about investing in funds.\116\
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\114\ See Morningstar Comment Letter.
\115\ See Proposing Release, supra footnote 8, at 19; see also
Comment Letter of Frank Dalton (Jan. 3, 2021) (``Frank Dalton
Comment Letter'') (suggesting that there be one report per fund).
\116\ See, e.g., Updated Investor Bulletin: Mutual Fund Classes,
SEC Office of Investor Education and Advocacy (updated Feb. 24,
2021) available at <a href="https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins-61">https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins-61</a>
(addressing common questions about fund share classes). See also
supra footnote 54 and accompanying text (describing recommendations
for future research exploring ways of explaining share classes to
investors).
---------------------------------------------------------------------------
We recognize, however, that shareholders and other market
participants could benefit from information about the other share
classes offered by a multiple class fund. To assist with shareholders'
and other market participants' analysis of those share classes, our
final rules will require website posting of fund documents that will
enable these parties to obtain information about those other share
classes easily.\117\ Further, in a change from the proposal, we are
adopting requirements for funds to tag the shareholder report contents
in a structured, machine-readable data language, which will make
shareholder report disclosure, including class-specific disclosure,
more readily available and easily accessible for aggregation,
comparison, filtering, and other analysis.\118\ Accordingly, we believe
it is appropriate to limit a shareholder report to one class of a
multiple class fund so shareholders can more easily use the reports to
assess and monitor their ongoing fund investments.
---------------------------------------------------------------------------
\117\ See amended rule 30e-1; see also infra section II.C.2
regarding the posting of information that funds will file as Items
7-11 of amended Form N-CSR, such as fund financial statements and
information about changes in and disagreements with accountants.
\118\ See infra section II.H.
---------------------------------------------------------------------------
c. Scope of Content
As proposed, the final rules will generally allow a fund to include
in its annual report only the information that Item 27A of Form N-1A
specifically permits or requires.\119\ We also are adopting, as
proposed, three additional provisions related to the content of a
fund's annual report. First, if a fund's particular circumstances may
cause the required disclosures to be misleading, the final rules will
allow a fund to add information to the report that is necessary to make
the required disclosure items not misleading.\120\ Disclosure in
response to this provision generally should be brief. Second, as
proposed, if a required disclosure is inapplicable, the final rules
will permit the fund to omit the disclosure, and a fund similarly may
modify a required legend or narrative information if the modified
language contains comparable information to what is otherwise
required.\121\ Finally, as proposed, the final rules will not permit a
fund to incorporate by reference any information into its annual
report.\122\ That is, a fund could not refer to information that is
located in other disclosure documents in order to satisfy the content
requirements for an annual report.
---------------------------------------------------------------------------
\119\ See Instruction 3 to Item 27A(a) of amended Form N-1A; see
also Proposing Release, supra footnote 8, at n.115 (noting that
funds would have flexibility with respect to the use of online tools
to assist shareholders in understanding the contents of an annual
report that appears online or otherwise is provided electronically).
\120\ See Instruction 2 to Item 27A of amended Form N-1A
(permitting a fund to include disclosure that is required under 17
CFR 270.8b-20 (rule 8b-20 under the Investment Company Act)); rule
8b-20 under the Investment Company Act (providing, ``[i]n addition
to the information expressly required to be included in a
registration statement or report, there shall be added such further
information, if any, as may be necessary to make the required
statements, in the light of the circumstances under which they are
made, not misleading''); see also Proposing Release, supra footnote
8, at paragraph accompanying n.117 (discussing, for example, that if
a fund changed its investment policies or structure during or since
the period shown, the expense, performance, or holdings information
that a fund must include in its annual report may require additional
disclosure to render those presentations not misleading).
\121\ See Instruction 7 to Item 27A(a) of amended Form N-1A; see
also Proposing Release, supra footnote 8, at n.119 (discussing that
a goal of this instruction was to promote better-tailored
disclosure).
\122\ See Instruction 5 to Item 27A(a) of amended Form N-1A; see
also Proposing Release, supra footnote 8, at n.120.
---------------------------------------------------------------------------
Commenters generally supported the proposed requirement to limit
the information included in the shareholder report, and they agreed
that this limitation would help focus shareholder reports on the most
salient issues to shareholders.\123\ One commenter expressly supported
the proposal to allow funds to omit information from the required items
that is inapplicable to the fund, and to modify required legends or
narratives so long as the modification contains comparable information
to what is required.\124\ To provide funds with additional flexibility,
one commenter suggested allowing funds to include supplemental
information reasonably related to the required content or including an
``unrestricted'' section of the report
[[Page 72770]]
where funds can provide discretionary content.\125\
---------------------------------------------------------------------------
\123\ See, e.g., ICI Comment Letter; Consumer Federation of
America II Comment Letter; Morningstar Comment Letter; NASAA Comment
Letter.
\124\ See ICI Comment Letter. But see Morningstar Comment Letter
and Consumer Federation of America II Comment Letter (expressing
concern that allowing funds to modify legends may lead to obscuring
important information and stressing the importance of maintaining
consistency where possible in section headers so that investors can
more readily consume reports since they may receive multiple
reports).
\125\ See Sidley Austin Comment Letter.
---------------------------------------------------------------------------
Comments on the proposed prohibition on incorporation by reference
in the shareholder report were mixed. Some commenters supported the
proposed prohibition, for example noting it would make it easier for
shareholders to understand the report without consulting additional
sources.\126\ By contrast, others opposed this prohibition based on
concerns that it may lead in increased litigation risk.\127\ Commenters
sought reassurance that information that will now be submitted online
on Form N-CSR will still be considered part of the ``total mix of
information'' assessed by courts in instances of shareholder
litigation.\128\ The final rules are not intended to change courts'
assessment of the total mix of information.
---------------------------------------------------------------------------
\126\ See, e.g., ICI Comment Letter; Morningstar Comment Letter;
Consumer Federation of America II Comment Letter; NASAA Comment
Letter.
\127\ See, e.g., Capital Group Comment Letter; Stradley Ronon
Comment Letter; Vanguard Comment Letter; Dechert Comment Letter.
\128\ See, e.g., ICI Comment Letter; Dechert Comment Letter,
---------------------------------------------------------------------------
We continue to believe that allowing only the required or permitted
information to appear in a fund's annual report will promote
consistency of information presented to shareholders and allow retail
shareholders to focus on information particularly helpful in monitoring
their investment in a fund.\129\ As discussed above, the final rules
provide funds with some flexibility to tailor the required information
to their unique characteristics.\130\ Additionally, in the limited
circumstances in which it may be appropriate for a fund to provide less
or more information than what Item 27A requires or permits, the final
rules allow the fund to omit information that is inapplicable to the
fund and/or add additional information to make the required disclosure
items not misleading. We believe that expanding the shareholder report
to include supplemental information, for example in an ``unrestricted''
section of the report, could lead to significant increases in the
length of the document and would be inconsistent with our goal of
focusing the report on the most salient information for shareholders.
---------------------------------------------------------------------------
\129\ See Proposing Release, supra footnote 8, at text following
n.116 (noting that this approach would also encourage more impartial
information by preventing funds from adding information commonly
used in marketing materials).
\130\ See id. at n.116 (noting that many of the instructions to
each requirement in the shareholder report provide some flexibility
so that a fund can tailor its presentation of information to match
how the fund invests. For instance, a fund has the ability to select
the categories that are reasonably designed to depict clearly the
types of a fund's investments when preparing its graphical
representation of holdings).
---------------------------------------------------------------------------
Although the final rules will only permit the inclusion of certain
information in the annual report and prohibit incorporation by
reference, funds will be required to refer shareholders to the
availability of certain additional website information near the end of
the report.\131\ The final rules, however, will--as proposed-- permit
funds to provide additional information to shareholders in the same
transmission as the shareholder report, so long as the shareholder
report is given greater prominence than any other materials included in
the same transmission, except for certain specified disclosure
materials.\132\ The disclosure materials that are exceptions to this
``greater prominence'' requirement include summary prospectuses,
statutory prospectuses, notices of the online availability of proxy
materials, and other shareholder reports. Therefore, we believe that
the final rules appropriately balance providing funds with the
flexibility to provide shareholders with information relevant to the
fund's unique characteristics, while maintaining a concise shareholder
report that highlights the most relevant information for shareholders
and promotes comparability across funds.
---------------------------------------------------------------------------
\131\ See Item 27A(i) of amended Form N-1A.
\132\ See Instruction 12 to Item 27A(a) of amended Form N-1A;
see also Proposing Release, supra footnote 8, at text accompanying
n.125 (explaining that the Commission would consider a fund to
satisfy the ``greater prominence'' requirement if, for example, the
shareholder report is on top of a group of paper documents that are
provided together or, in the case of an electronic transmission, the
email or other message includes a direct link to the report or
provides the report in full in the body of the message).
---------------------------------------------------------------------------
Some commenters suggested adding content areas to the shareholder
report, which they suggested would be useful for investors in
monitoring their investments.\133\ First, two commenters requested that
funds be allowed to continue to include information related to the tax
character of distributions in the shareholder report to comply with
certain IRS requirements.\134\ These commenters asserted that, absent
relief from the IRS, funds would have to make a separate mailing to
shareholders disclosing this tax-related information.\135\ Several
commenters also suggested that funds should be required to provide
additional risk-related information.\136\ Finally, one commenter
suggested that funds should be required to disclose how much the fund
manager invests in the fund.\137\
---------------------------------------------------------------------------
\133\ See, e.g., ICI Comment Letter; Federated Hermes Comment
Letter; Comment Letter of the Independent Trustees of the
Morningstar Funds Trust (Oct. 20, 2020) (``Morningstar Trustees
Comment Letter''); CFA Institute Comment Letter; Morningstar Comment
Letter.
\134\ ICI Comment Letter; Federated Hermes Comment Letter.
\135\ ICI Comment Letter (explaining that the Internal Revenue
Code requires regulated investment companies, including funds, to
report the tax character of certain distributions paid in written
statements delivered to shareholders. Although this requirement is
satisfied through delivery of the Form 1099-DIV, certain
shareholders do not receive this form. Therefore, funds frequently
choose to include this disclosure in the shareholder report as a
means of ensuring compliance with the reporting requirement).
\136\ Morningstar Comment Letter; Morningstar Trustees Comment
Letter (urging the Commission to shorten liquidity risk discussion
and require additional discussion of other risks if relevant, such
as derivatives risks and concentration risk); Angel Comment Letter
(suggesting that a fund be required to disclose its historical
standard deviation of returns compared to its benchmark's standard
deviation of returns as a uniform quantitative risk measure).
\137\ Morningstar Comment Letter.
---------------------------------------------------------------------------
After considering commenter suggestions, we do not believe it is
necessary to permit or require any additional content areas in the
shareholder report under the final rules. First, we believe that this
disclosure, unlike the other required content areas of the streamlined
shareholder report, would not as directly contribute to retail
investors' understanding of the fund's operations and performance over
the relevant performance period, and would add length and complexity to
the shareholder report. Additionally, we do not believe it is necessary
to permit funds to describe the tax character of distributions in the
shareholder report, because a fund could distill such tax-related
disclosure in a manner that would meet the final rules' requirements
for a fund statistic, or if a fund determines that such information is
relevant to the MDFP, the fund could consider including the relevant
disclosure in the fund statistics or MDFP sections of the shareholder
report under the final rules.\138\ Also, as the final rules do not
alter the requirements for delivering annual prospectus updates, which
include information about the fund's principal risks, we do not believe
it is also necessary to require funds to include additional risk-
related information in their shareholder reports.\139\ Similarly, we do
not believe it is necessary to require funds to include information
regarding how much the fund manager invests in the
[[Page 72771]]
fund in the shareholder report because such information is already
disclosed in the fund's SAI and may be available on fund websites, and
we believe that this disclosure would not be particularly salient to
retail investors monitoring their investments.\140\
---------------------------------------------------------------------------
\138\ See infra section II.A.2.c.i (discussing the narrative
MDFP disclosure requirements) and text accompanying infra footnote
263 (discussing the requirements for the disclosing additional fund
statistics).
\139\ See supra footnote 67.
\140\ See Item 20(c) of current and amended Form N-1A; see also
rule 498(e) (requirements to make certain materials--including a
fund's SAI--available on a website, for funds that use summary
prospectuses in reliance on rule 498).
---------------------------------------------------------------------------
d. Scope With Respect to Other Registrants
As proposed, the final annual report disclosure rules will apply
only to shareholder reports for investment companies registered on Form
N-1A.\141\ The amendments do not extend to other investment companies
such as closed-end funds, 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).
---------------------------------------------------------------------------
\141\ These funds represent the vast majority of investment
company assets under management. See infra section IV.B.1.
---------------------------------------------------------------------------
Several commenters suggested that the Commission should reevaluate
consistency of disclosure across all different fund types (e.g.,
closed-end funds and UITs, as well as open-end funds) because the
shareholders across fund types have similar informational needs and
would likely all benefit from a similar layered approach to
disclosure.\142\
---------------------------------------------------------------------------
\142\ Tom and Mary Comment Letter; Dechert Comment Letter; CFA
Institute Comment Letter; Comment Letter from Donald (Attorney)
(Oct. 12, 2020) (``Donald Comment Letter'').
---------------------------------------------------------------------------
We agree that disclosure consistency, and continuing to consider
consistency in informational needs among shareholders in different
types of investment companies, are important policy matters, and topics
that the Commission and staff will continue to evaluate. In the past
several years, the Commission adopted changes to the disclosure
framework for closed-end funds and variable contracts tailored to these
investment companies' characteristics.\143\ Before considering any
additional or different disclosure amendments for closed-end funds and
variable contracts, we believe it is necessary to understand funds' and
investors' experience with these new disclosure frameworks for closed-
end funds and variable contracts and assess their impact.
---------------------------------------------------------------------------
\143\ See Variable Contract Summary Prospectus Adopting Release,
supra footnote 9; Securities Offering Reform for Closed-End
Investment Companies, Investment Company Act Release No. 33836 (Apr.
8, 2020) [85 FR 33290 (June 1, 2020)] (``Closed-End Fund Offering
Reform Adopting Release'').
---------------------------------------------------------------------------
Some commenters also suggested that funds offered exclusively to
other funds or offered only to institutional investors be exempt from
the obligation to prepare shareholder reports.\144\ These commenters
argued that, because the shareholder report is oriented towards retail
shareholders, there is little benefit in requiring funds that are sold
exclusively to these investors to prepare, transmit, and file these
reports. These commenters suggested that such funds instead could rely
on the financial statements and other Form N-CSR requirements filed
with the Commission to keep institutional investors informed about
their fund investments.
---------------------------------------------------------------------------
\144\ ICI Comment Letter; Fidelity Comment Letter; T. Rowe Price
Comment Letter.
---------------------------------------------------------------------------
We do not believe that such an exemption is necessary or
appropriate. Currently registered funds offered exclusively to other
funds, or only to institutional investors, transmit complete annual and
semi-annual reports to their shareholders. Under the final rules, these
funds will now be required to provide shareholders with a significantly
shorter document. While shareholder reports under the final rules
include content that is designed to be particularly salient to retail
investors, these reports include core fund information that all
investors can use to monitor fund investments, and that supplements
information that investors could glean from a fund's financial
statements. Additionally, to the extent a fund limits its investor base
to institutional investors and is able to qualify for the exclusions
from the investment company definition in sections 3(c)(1) or 3(c)(7)
of the Investment Company Act, the fund can operate as a private fund
under those exclusions and will not be subject to the shareholder
report requirements of section 30 of the Act.
2. Contents of the Annual Report
The following table outlines the information the final rule will
generally require funds to include in their annual reports.
Table 2--Outline of Annual Report
----------------------------------------------------------------------------------------------------------------
Item of current form N-
Description Item of amended form N- 1A containing similar
1A requirements
----------------------------------------------------------------------------------------------------------------
Cover Page or Beginning of Report.. Fund/Class Name............ Item 27A(b)...........
Ticker Symbol.............. Item 27A(b)...........
Principal U.S. Market(s) Item 27A(b)...........
for ETFs.
Statement Identifying as Item 27A(b)...........
``Annual Shareholder
Report''.
Legend..................... Item 27A(b)...........
Statement on Material Fund Item 27A(b)...........
Changes in the Report.
Content............................ Expense Example............ Item 27A(c)........... Item 27(d)(1).
Management's Discussion of Item 27A(d)........... Item 27(b)(7).
Fund Performance.
Fund Statistics............ Item 27A(e)...........
Graphical Representation of Item 27A(f)........... Item 27(d)(2)
Holdings.
Material Fund Changes...... Item 27A(g)...........
Changes in and Item 27A(h)........... Item 27(b)(4).
Disagreements with
Accountants.
Availability of Additional Item 27A(i)........... Item 27(d)(3) through
Information. (5).
Householding Disclosure Item 27A(j)........... (*)
(optional).
----------------------------------------------------------------------------------------------------------------
* Rule 30e-1(f)(3) currently requires a fund to explain, at least once a year, how shareholders may revoke their
consent to householding. This explanation is not currently required in funds' shareholder reports. As
proposed, we are not requiring it in the annual report.
[[Page 72772]]
As proposed, the annual report will not be subject to page or word
limits under the final rules. Commenters agreed with this approach and
one commenter stated that adopting a page limit may have the unintended
effect of producing dense, visually unappealing disclosures when funds
try to squeeze necessary information into a limited space.\145\ Another
commenter said that the Commission's proposed approach would provide
funds with the flexibility to provide explanatory or qualifying
information to the extent they believe it is necessary or
appropriate.\146\ We believe that the proposed restrictions on the
contents of these reports would naturally limit their length, which
would support our goal of concise, readable disclosure without the need
for further restrictions on page length or word count.\147\
---------------------------------------------------------------------------
\145\ Consumer Federation of America II Comment Letter.
\146\ NASAA Comment Letter.
\147\ See, e.g., infra at text following footnote 271 (stating
that, in the fund statistics section of the shareholder report,
funds have the flexibility to include additional statistics that the
fund believes would help shareholders better understand the fund's
activities and operation during the reporting period, but cautioning
that funds should carefully consider the inclusion of any statistic
that requires extensive narrative explanation).
---------------------------------------------------------------------------
a. Cover Page or Beginning of the Report
The final amendments to Form N-1A will require a fund to provide
the following information on the cover page or at the beginning of the
annual report:\148\
---------------------------------------------------------------------------
\148\ See Item 27A(b) of amended Form N-1A.
---------------------------------------------------------------------------
<bullet> As proposed, the name of the fund and the class to which
the annual report relates; \149\
---------------------------------------------------------------------------
\149\ In a change from the proposal, the final rules will
require that a shareholder report cover a single class of a
multiple-class fund. See Instruction 4 to Item 27A(a) of amended
Form N-1A; see also supra footnote 106 and accompanying text.
---------------------------------------------------------------------------
<bullet> As proposed, the exchange ticker symbol of the fund's
shares, or the ticker symbol of the class adjacent to the class name;
<bullet> As proposed, if the fund is an ETF, the principal U.S.
market(s) on which the fund's shares are traded;
<bullet> As proposed, a statement identifying the document as an
``annual shareholder report;''
<bullet> Substantially as proposed, the following legend: ``This
annual shareholder report contains important information about [the
Fund] for the period of [beginning date] to [end date]. You can find
additional information about the Fund at [Fund website address]. You
can also request this information by contacting us at [toll-free
telephone number and, as applicable, email address].'' \150\; and
---------------------------------------------------------------------------
\150\ In a change from the proposal, the legend under the final
rules does not contain the phrase ``[as well as certain changes to
the Fund].'' This phrase is duplicative of the requirement under the
final rules to include a separate legend highlighting that a
shareholder report describes material fund changes, if applicable.
See Item 27A(b)(4) of amended Form N-1A.
---------------------------------------------------------------------------
<bullet> In addition to the proposed cover page elements, we are
also adopting a requirement that if the shareholder report describes
material fund changes, a fund will have to include the following
prominent statement, or a similar clear and understandable statement,
in bold-face type: ``This report describes changes to the Fund that
occurred during the reporting period.'' \151\
---------------------------------------------------------------------------
\151\ See Item 27A(b) of amended Form N-1A. The reference to the
``beginning'' of an annual report is designed to address
circumstances in which there is not a physical page that would
precede the report, for example, when the report appears online or
on a mobile device. See infra section II.A.4.
---------------------------------------------------------------------------
Commenters generally supported the proposed cover page information,
and some recommended certain enhancements.\152\ One commenter suggested
that the Commission require funds to include a brief description of
investor eligibility requirements for each share class so that
shareholders understand if there is an opportunity to move to a more
appropriate class.\153\ Another commenter requested that funds disclose
their investment objectives on the cover page.\154\ One commenter also
requested that material fund changes should be disclosed on the cover
page.\155\ Finally, one commenter suggested that the Commission should
adopt an instruction to the required legend, similar to a current
instruction in Form N-1A related to prospectuses, to provide
flexibility for underlying funds used as investment options for
variable contracts to modify the legend in a manner that is consistent
with their structure.\156\
---------------------------------------------------------------------------
\152\ See, e.g., ICI Comment Letter; Capital Group Comment
Letter.
\153\ Morningstar Comment Letter.
\154\ Capital Group Comment Letter.
\155\ Comment Letter of Dominic Rosa (Sept. 16, 2020) (``Dominic
Rosa Comment Letter'').
\156\ See ICI Comment Letter (noting that the term ``us,'' as
used in the phrase ``contacting us'' in the required legend, could
be read to refer to the fund. However, for funds that serve as
investment options for variable contracts, shareholder reports are
delivered to contract holders. The record holders of underlying
funds are the insurance company separate accounts, and underlying
funds have no visibility or access to contract holders); see also
General Instruction C.3.(d) of current Form N-1A.
---------------------------------------------------------------------------
As discussed above, the final rules will require that a shareholder
report cover a single class of a multiple-class fund.\157\ Therefore,
we do not believe it is necessary to include additional information
regarding share class eligibility. Similarly, because shareholders will
continue to receive annual prospectus updates under the final rules, we
do not believe it is necessary to require or permit funds to include a
fund's investment objective (which also appears in the prospectus) in
the shareholder report. We believe that adding the fund's investment
objective would be duplicative and, in light of this, unnecessarily
increase the length of the shareholder report.
---------------------------------------------------------------------------
\157\ See Instruction 4 of Item 27A(b) of amended Form N-1A.
---------------------------------------------------------------------------
The final rules also will not require a fund to describe material
changes on the cover page of the shareholder report. Because the
shareholder report will be a relatively short document, we anticipate
investors would see this information within a few pages following the
cover page or beginning of the report. However, we agree with
commenters that it may be useful for shareholders to be alerted to
material changes that occurred during the reporting period. Therefore,
in a change from the proposal, if a shareholder report includes a
discussion of material fund changes, the final rules will require the
cover page of the report to include a prominent statement, in bold-face
type, explaining that the report describes certain changes to the fund
that occurred during the reporting period.\158\
---------------------------------------------------------------------------
\158\ Item 27A(b) of amended Form N-1A.
---------------------------------------------------------------------------
Finally, we do not believe it is necessary to adopt an instruction
to the required legend specifically allowing funds that serve as the
underlying investment options for variable contracts to modify the
legend in a manner that is consistent their structure. As discussed
above, Instruction 7 to Item 27A already allows funds to modify a
required legend or narrative information so long as the modified
language contains comparable information.\159\ A more specific
instruction for funds that serve as the underlying investment options
for variable contracts is unnecessary.
---------------------------------------------------------------------------
\159\ See supra text accompanying footnote 121.
---------------------------------------------------------------------------
b. Fund Expenses
The final rules will require a simplified expense presentation in
the annual report, modified from the proposed presentation to take into
account concerns raised by commenters. Under the final rules, 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
[[Page 72773]]
(i.e., expense ratio), and (2) as a dollar amount. In a change from the
proposal, the expense presentation under the final rules will not
require the table also to include information about the fund's total
return during the period.\160\ Additionally, the final rules do not
include the proposed requirement for a fund to include an explanation,
in a footnote to the expense example, that expense information does not
reflect shareholder transaction costs associated with purchasing or
selling fund shares.
---------------------------------------------------------------------------
\160\ See Proposing Release, supra footnote 8, at n.142. The
proposed expense presentation would have required a fund to show a
beginning account value of $10,000, costs paid during the period,
the fund's total return during the period before costs were paid,
and the ending account value based on the fund's net asset value
return. See id. at nn.154-155 and accompanying text. Under the
proposal, ETFs were required to include the ending value of the
account based on market value return. See id. at n.159 and
accompanying text.
---------------------------------------------------------------------------
Simplified Expense Table
The final rules include a simplified expense table that will
replace the current expense example in the shareholder report, which
consists of two different tables, along with the currently-required
narrative preamble.\161\ Commenters generally supported simplifying the
expense presentation in the shareholder report and eliminating the
narrative preamble to the table.\162\ In addition, the expense table
under the final rules is more simplified than the proposed presentation
and is designed to provide shareholders with a basis for comparing the
level of current period expenses of different funds (as percentages are
comparable), as well as to permit shareholders to estimate the costs,
in dollars, that they incurred over the reporting period. The expense
presentation will appear as follows, and the individual aspects of the
example are described in more detail below.
---------------------------------------------------------------------------
\161\ See Proposing Release, supra footnote 8, at text
accompanying nn.145-146 (explaining that the current expense
presentation requires funds present two tables: the first showing
the actual cost in dollars for a $1,000 investment in the fund over
the prior six-month period based on the actual return of the fund,
and the second showing the cost in dollars for a $1,000 investment
in the fund over the prior six-month period based on a hypothetical
5% annual return); see id. at n.162 and accompanying text
(discussing the currently-required narrative preamble).
\162\ See, e.g., ICI Comment Letter; AFREF Comment Letter; NASAA
Comment Letter; CFA Institute Comment Letter; Abdullah Comment
Letter. But see Consumer Federation of America II Comment Letter
(suggesting that the Commission conduct investor testing to
determine if investors would prefer the current presentation).
What Were the Fund Costs for the Last [Year/Six Months]?
[Based on a hypothetical $10,000 investment]
------------------------------------------------------------------------
Costs paid as a
Costs of a percentage of a
[Fund or class name] $10,000 $10,000
investment investment
------------------------------------------------------------------------
$ %
------------------------------------------------------------------------
As proposed, the final rules require a fund to provide the expenses
associated with a hypothetical $10,000 investment in the fund during
the preceding reporting period. Currently, funds are required to show
expenses associated with a $1,000 investment. The Commission proposed
an increased dollar value in order to present a more realistic
investment amount for an individual shareholder today.\163\ Commenters
supported the higher $10,000 assumed investment amount.\164\ One
commenter, however, stated that funds with a higher minimum investment
should be required to show that higher investment amount in the expense
presentation.\165\ As this would undermine comparing different funds,
we are not requiring funds with higher minimum investment amounts to
show that higher amount.
---------------------------------------------------------------------------
\163\ See Proposing Release, supra footnote 8, at n.151 and
accompanying text.
\164\ See, e.g., Consumer Federation of America II Comment
Letter; Morningstar Comment Letter.
\165\ ICI Comment Letter.
---------------------------------------------------------------------------
In addition to the cost in dollars of a $10,000 investment and the
expense ratio, the proposed expense table also would have required a
fund to show returns information, which was designed to facilitate
shareholders' understanding of how costs and performance affect their
ending account values. Some commenters, including retail investors,
requested that the expense example exclude returns information, and
provide only costs.\166\ These commenters stated that presenting
returns information in the expense table might be confusing for
shareholders and repetitive of the performance information that appears
later in the document. Additionally, one commenter supported an
approach that includes returns information in the expense table, but
stressed the importance of highlighting the costs paid in dollars and
expense ratio tables through text features, such as bold-face type, to
emphasize the importance of those two data points.\167\ After
considering commenters' concerns, the presentation of fund expenses
under the final rules will not include fund returns information because
we agree that presenting returns information in the expense example is
duplicative of the returns information that is presented in the MDFP
section of the report and could add unnecessary complexity and
confusion to the expense presentation. For example, because a fund's
reported return would relate to the fund's fiscal year, including
return information could result in different funds presenting
substantially different returns based primarily on whether a given
fund's fiscal year included a time period with aberrant market
performance. We also believe that the simplified presentation--
presenting just the costs in dollars and the expense ratio--would help
to focus investors on this key information.\168\
---------------------------------------------------------------------------
\166\ See, e.g., Comment Letter of Sandra Degan (Aug. 25, 2020)
(``Sandra Degan Comment Letter''); Comment Letter of Ubiquity (Sept.
14, 2020) (``Ubiquity Comment Letter''); Williams Comment Letter;
Tom and Mary Comment Letter; Barker Comment Letter. Additionally,
two commenters objected to the ETF-specific requirement to show the
ending account value based on both NAV and market value return, and
stated that ETFs should only be required to show NAV. See Ubiquity
Comment Letter, Tom and Mary Comment Letter.
\167\ CFA Institute Comment Letter.
\168\ Because the final rules will not include fund return
information in the expense example, the expense table will not
include the proposed ``ending value of the account'' column and
related instructions, including the proposed instructions requiring
the presentation of expense information as a mathematical expression
and the requirement to give more prominence to the ``cost paid'' and
``cost paid as a percentage of your investment' columns than the
other columns in the table. Similarly, commenter concerns regarding
the disclosure related to ETF-specific requirement to show the
ending account value based on both NAV and market value return are
moot.
---------------------------------------------------------------------------
Additional Aspects of the Shareholder Report's Presentation of Expenses
Some commenters suggested additional modifications to the proposed
expense presentation. First, we proposed an expense table title: ``What
were your Fund costs for the period? (based on a hypothetical $10,000
investment).'' Additionally, under the proposal, the column in the
table that would include the fund's expense ratio was entitled ``costs
paid as a percentage of your investment.'' One commenter requested we
modify these two headers to remove the references to ``your'' because
an investor might reasonably interpret these uses of the possessive
pronoun as actually reflecting that investor's own personal
experience.\169\ We agree, that the use of the term ``your'' in the
header to the table and the title of the expense ratio column could
confuse investors, and we have changed these two headers to clarify
that the expenses presented in
[[Page 72774]]
the table are a reflection of a hypothetical $10,000 investment.
---------------------------------------------------------------------------
\169\ NASAA Comment Letter.
---------------------------------------------------------------------------
Additionally, the final rules will replace the proposed header
reference to ``the period'' with a more specific reference to either
``the past year'' or ``the past six months,'' depending on whether the
report is an annual or semi-annual report. We believe this more
specific heading reference to the relevant period will help
shareholders better appreciate that the figures in the semi-annual
report expense table reflect a shorter period than the annual report
(and thus these figures will likely be smaller than the parallel
figures in the annual report).
The proposal also would have included a new footnote to the expense
presentation that would have required a fund to include a footnote
briefly explaining, in plain English, that the expense information does
not reflect shareholder transaction costs associated with purchasing or
selling fund shares.\170\ This was designed to inform investors that
there may be additional costs not reflected in the expense example, if
applicable. Some retail investors stated that the proposed footnote is
of limited value and recommended streamlining it.\171\ After
considering commenter concerns, we agree this footnote would provide
limited information to investors, particularly since it would not have
included quantitative information regarding these costs, and these
costs may vary based on distribution channel, making it difficult to
present this information concisely in the footnote or otherwise. By
merely alerting investors to the possibility of additional costs, the
proposed footnote could make the table less readable without providing
investors information they could use effectively in evaluating the
expense presentation. We therefore are not adopting that proposed
footnote.
---------------------------------------------------------------------------
\170\ The proposal would have also required a fund to include a
footnote to the proposed returns information that would be included
in the expense presentation, describing other costs that are
included in the fund's total return if material to the fund. Because
the final rules' expense presentation does not include returns-
related information, we are not adopting this footnote requirement.
See Proposing Release, supra footnote 7, at n.164.
\171\ Williams Comment Letter; Tom and Mary Comment Letter.
---------------------------------------------------------------------------
We are adopting, as proposed, an instruction that will direct funds
to calculate ``Costs of a $10,000 investment'' by multiplying the
figure in the ``Cost paid as a percentage of a $10,000 investment''
column by the average account value over the period based on an
investment of $10,000 at the beginning of the period.\172\ The figure
in the ``Cost paid as a percentage of your investment'' column, in
turn, will be the fund's expense ratio as it appears in the fund's most
recent audited financial statements or financial highlights.\173\
---------------------------------------------------------------------------
\172\ See Instruction 2(a) to Item 27A(c) of amended Form N-1A.
As proposed, the computation instructions will also require funds to
assume reinvestment of all dividends and distributions. See
Instruction 2(b) to Item 27A(c) of amended Form N-1A.
\173\ See Instruction 2(c) to Item 27A(c) of amended Form N-1A.
In the semi-annual report, the fund's expense ratio will be
calculated in the manner required by Instruction 4(b) to Item 13(a)
of current and amended Form N-1A, using the expenses for the fund's
most recent fiscal half-year. Id.
---------------------------------------------------------------------------
Additionally, as proposed, we are retaining three current
instructions that we believe continue to provide important information
to shareholders.\174\ First, if a fund incurred any ``extraordinary
expenses'' during the reporting period, the fund may briefly describe,
in a footnote to the expense table, what the actual expenses would have
been if these extraordinary expenses were not incurred.\175\ The
Commission received no comments on this instruction. Second, if a fund
is a feeder fund, the fund must reflect the aggregate expenses of the
feeder fund and the master fund in the expense table and include a
footnote stating that the expense table reflects the expenses of both
the feeder and master funds.\176\ One commenter supported continuing to
permit funds to report aggregated fees with the related footnote, and
noted that allowing reporting in this manner allows investors to more
easily understand the total expenses they are paying.\177\ No
commenters opposed the instruction. Finally, if a fund's shareholder
report covers a period of time that is less than a full reporting
period, the fund must include a footnote to the table noting this and
explaining that expenses for a full reporting period would be higher
than the figures shown.\178\ We received no comments on this
instruction.\179\
---------------------------------------------------------------------------
\174\ See Proposing Release, supra footnote 7, at paragraph
following n.171.
\175\ See Instruction 1(d) to Item 27A(c) of amended Form N-1A
(defining ``extraordinary expenses'' as ``expenses that are
distinguished by their unusual nature and by the infrequency of
their occurrence. Unusual nature means the expense has a high degree
of abnormality and is clearly unrelated to, or only incidentally
related to, the ordinary and typical activities of the Fund, taking
into account the environment in which the Fund operates. Infrequency
of occurrence means the expense is not reasonably expected to recur
in the foreseeable future, taking into consideration the environment
in which the Fund operates. The environment of a Fund includes such
factors as the characteristics of the industry or industries in
which it operates, the geographical location of its operations, and
the nature and extent of government regulation'').
\176\ See Instruction 1(b) to Item 27A(c) of amended Form N-1A.
\177\ Morningstar Comment Letter.
\178\ See Instruction 1(c) to Item 27A(c) of amended Form N-1A.
This would generally apply to newly-formed funds that are required
to file an annual or semi-annual report for a period shorter than
the reporting period.
\179\ While the proposal included an instruction that would have
required a separate expense table, or a separate line item in the
expense table, for each class of as multiple-class fund, this
instruction is moot in light of the final rules' requirement that a
shareholder report cover only a single class of a multiple-class
fund. See Instruction 4 to Item 27A(a) of amended Form N-1A; see
also footnote 106 and accompanying text; see also Proposing Release,
supra footnote 7, at n.174 and accompanying text.
---------------------------------------------------------------------------
Feedback on Including Additional or Different Information About Fund
Costs
Some commenters also responded to the Commission's request for
comment on differences in the expense presentations in the annual
report and prospectus.\180\ These presentations currently differ in
that the shareholder report expense example is derived from a fund's
audited financial statements and therefore reflects actual historical
expenses that a shareholder incurred over the past year (i.e.,
backwards-looking expenses). The prospectus fee table and expense
example, on the other hand, reflect hypothetical future expenses (i.e.,
forward-looking expenses).\181\ Some commenters argued that the expense
presentations of the prospectus and annual report should be
aligned.\182\ Similarly, one commenter suggested that the shareholder
report expense example should disclose the prospectus expense ratio and
explain any differences in a footnote.\183\ Furthermore, some
commenters suggested that the expense presentation in the shareholder
report should include additional transaction costs, beyond commissions,
including costs paid from fund assets for investment research and
payments made to affiliated securities lending agents.\184\ Conversely,
one commenter urged the Commission to exclude interest expenses and
dividends paid on short sales from the current expense ratio, on the
basis that these
[[Page 72775]]
adjustments would make expense information more comparable across
funds.\185\ Finally, other commenters also argued that the Commission
should require funds to disclose--on fund websites or in the
prospectus, as a complement to shareholder report disclosure--best
execution policies reflecting ``efforts to ensure that fund transaction
costs, including commission dollars generated by the fund,'' directly
benefit shareholders.\186\
---------------------------------------------------------------------------
\180\ See Proposing Release, supra footnote 8, at text following
n.600; see also, e.g., Dominic Rosa Comment Letter; Barker Comment
Letter; Tom and Mary Comment Letter; Capital Group Comment Letter;
Morningstar Comment Letter.
\181\ Currently, the prospectus fee table also reflects sales
loads that an investor would pay and AFFE, whereas the shareholder
report expense presentation does not, because these elements are not
reflected in the fund's financial statements. See Proposing Release,
supra footnote 8, at n.148 and accompanying text.
\182\ Dominic Rosa Comment Letter; Barker Comment Letter; Tom
and Mary Comment Letter; Capital Group Comment Letter.
\183\ Morningstar Comment Letter.
\184\ Dimensional Comment Letter; AFREF Comment Letter.
\185\ See Morningstar Comment Letter (arguing that removing
interest and dividend expenses from the expense ratio gives
investors a better sense for what a fund company is charging them
for the cost of running the fund and allows funds with different
types of investments to present their expenses in a comparable way.
Morningstar has adjusted its methodology for calculating fund
expense ratios in their data to exclude interest and dividend
expenses).
\186\ Comment Letter of Healthy Markets Association (Nov. 6,
2020) (``Healthy Markets Association Comment Letter''); see also CFA
Institute Comment Letter.
---------------------------------------------------------------------------
Because the prospectus and shareholder report differ in the time
periods that they reflect (i.e., the prospectus is ``forward looking''
while the shareholder report is ``backward looking''), aligning the
expense presentations in these documents presents significant
challenges. Additionally, we believe that it would be confusing to
investors to be given two expense ratios in the shareholder report (one
backwards-looking, derived from the audited financial statements, and
the other from the forward-looking prospectus). Furthermore, because
the shareholder report is designed to provide shareholders with a
summary of the key information provided in the fund's audited financial
statements, we continue to believe that the types of costs reflected in
the shareholder report expense example should be derived from those
that are included in the fund's audited financial statements. As
discussed above, however, helping investors more readily understand
fund fees and expenses is an important priority of the Commission and
we believe that the general topic of fund fee disclosure effectiveness,
in light of comments received, merits further consideration.\187\
---------------------------------------------------------------------------
\187\ See supra text following footnote 84.
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c. Management's Discussion of Fund Performance
Substantially as proposed, the final rules will largely maintain
the current requirements for the MDFP section of the annual report,
with several targeted changes.\188\ In particular, we are adopting
amendments to the current MDFP requirements to make the disclosure more
concise. Additionally, the final rules include additional performance-
related information that is available in fund prospectuses, including
certain performance information and comparative information showing the
average annual total returns of one or more relevant benchmarks,
modified from the proposal to take into account the final rule's
requirement for the shareholder report to cover a single class of a
multiple-class fund. We also are amending, as proposed, the definition
of an appropriate broad-based securities market index to require that
all funds compare their performance to the overall applicable
securities market, for purposes of both fund annual reports and
prospectuses.
---------------------------------------------------------------------------
\188\ See Proposing Release, supra footnote 7, at text following
n.176 (explaining that the current MDFP disclosure generally
includes: a narrative discussion of the factors that materially
affected the fund's performance; a performance line graph; a table
showing the fund's average annual total returns; a discussion of the
effect of any policy or practice of maintaining a specified level of
distributions to shareholders on the fund's investment strategies
and per share net asset value, as well as the extent to which the
fund's distribution policy resulted in distributions of capital; and
for ETFs that do not provide certain premium or discount information
on their websites, a table showing the number of days the fund
shares traded at a premium or discount to net asset value).
---------------------------------------------------------------------------
i. Narrative MDFP Disclosure
As proposed, the final rules retain the current requirement for
funds' annual reports to include a narrative discussion of factors that
materially affected a fund's performance during the most recent fiscal
year, with minor modifications from the current requirements to
encourage concise disclosure.\189\ In particular, the final rules amend
the current requirement to specify 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. As proposed, the final rules instruct funds
not to include lengthy, generic, or overly broad discussions of these
factors.\190\ The instruction, as proposed, also directs funds to use
graphics or text features--such as bullet lists or tables--to present
the key factors, as appropriate. Finally, as proposed, the final rules
will not allow funds to include any additional information--such as a
fund president's letter to shareholders, interviews with portfolio
managers, general market commentary, and other similar information--in
the shareholder report.\191\
---------------------------------------------------------------------------
\189\ See Item 27A(d)(1) of amended Form N-1A.
\190\ See Instruction 1 to Item 27A(d)(1) of amended Form N-1A.
\191\ See supra text accompanying footnote 131. Additional
information could, however, accompany the shareholder report
provided that it meets the prominence requirements for materials
that accompany the report. See Instruction 12 to Item 27A(a) of
amended Form N-1A.
---------------------------------------------------------------------------
Commenters supported the proposed amendments to the narrative MDFP
section and stated that the proposed approach appropriately maintains a
fund's flexibility in presenting information that is most salient to
investors, while requiring such information to be presented in a
visually engaging and accessible format.\192\ In addition, survey data
submitted by a commenter indicated that retail investors, and older
investors in particular, expressed that the new presentation would help
them better understand fund performance.\193\
---------------------------------------------------------------------------
\192\ See, e.g., Consumer Federation of America II Comment
Letter; ICI Comment Letter; Fidelity Comment Letter.
\193\ Broadridge Comment Letter.
---------------------------------------------------------------------------
We are adopting the narrative MDFP section as proposed because we
continue to believe providing shareholders with a more streamlined and
visually engaging presentation of the key factors affecting fund
performance will allow shareholders to focus on the most salient fund
information.\194\ Our approach balances the need for funds to have
flexibility in determining what information is salient given a fund's
unique strategy and risk profile, while encouraging funds to present
that information in a manner that is most effective for shareholders.
Therefore, we do not believe it is necessary to further limit the
narrative MDFP disclosure.
---------------------------------------------------------------------------
\194\ See Proposing Release, supra footnote 7, at text following
n.180.
---------------------------------------------------------------------------
ii. Performance Line Graph and Guidance on Use of Market Indexes in
Performance Disclosure
Substantially as proposed, the final rules will retain the
requirements for the performance line graph currently included in
annual reports, with certain amendments designed to improve the current
presentation and to reflect that a shareholder report will cover a
single class of a multiple-class fund.\195\ The shareholder report must
include a performance line graph that shows the performance of a
$10,000 investment in the fund and in an appropriate broad-based
securities market index over a 10-year period.\196\ In addition, a fund
has
[[Page 72776]]
the option to compare its performance to other indexes, including more
narrowly based indexes that reflect the market sectors in which the
fund invests. We continue to believe the line graph presentation helps
shareholders understand how the fund has performed over a 10-year time
horizon compared to an appropriate broad-based securities market index
and other relevant indexes, as applicable.\197\
---------------------------------------------------------------------------
\195\ See Item 27A(d)(2) of amended Form N-1A and related
instructions.
\196\ An ``appropriate broad-based securities market index'' is
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. See Instruction 6 to Item
27A(d)(2) of amended Form N-1A.
\197\ See Proposing Release, supra footnote 7, at nn.191-193 and
accompanying text.
---------------------------------------------------------------------------
We are adopting the instructions related to the line graph largely
as proposed, with some conforming changes to reflect other aspects of
the final rules. First, in a change from the proposal, the final rules
include an instruction that requires a fund to present performance
information for the class covered in the shareholder report. Second, as
proposed, the final rules remove the current instruction that allows
the line graph to cover periods longer than the past 10 fiscal years.
Third, as proposed, the final rules include an instruction that defines
a ``broad-based'' index as one that represents the overall applicable
domestic or international equity or debt markets, as appropriate.\198\
And as proposed, the instructions under the final rules will continue
to permit a fund to include narrower indexes that reflect the market
segments in which the fund invests in its performance presentation,
along with the required appropriate broad-based securities market
index.\199\
---------------------------------------------------------------------------
\198\ The amendments to the definition of an appropriate broad-
based securities market index would affect performance presentations
in fund prospectuses, as well as fund annual reports.
\199\ See Instruction 7 to Item 27A(d)(2) of amended Form N-1A.
This release sometimes refers to the appropriate broad-based
securities market index as the ``primary index'', and any narrower
index(es) as ``secondary index(es).''
---------------------------------------------------------------------------
Commenters generally supported the retention of the performance
line graph as well as the prohibition on showing more than 10 years of
performance.\200\ Some commenters requested enhancements to the line
graph. For example, one commenter suggested the line graph should
include percentage values along with dollar amounts to facilitate
comparisons.\201\ Additionally, one commenter suggested allowing funds
to add labels at each significant point in the line graph to enhance
comprehension of risk and improve the user experience.\202\ Two
commenters suggested funds should be required to include a bar chart of
returns, similar to what is currently included in the prospectus, along
with the line graph.\203\
---------------------------------------------------------------------------
\200\ See, e.g., Consumer Federation of America II Comment
Letter; Cornell Law School Comment Letter; Morningstar Comment
Letter; Morningstar Trustees Comment Letter; CFA Institute Comment
Letter. But see ICI Comment Letter (objecting to the prohibition
showing performance beyond 10 years).
\201\ Cornell Law School Comment Letter.
\202\ Morningstar Comment Letter.
\203\ Morningstar Trustees Comment Letter; CFA Institute Comment
Letter.
---------------------------------------------------------------------------
We continue to believe, as discussed more fully in the Proposing
Release, that limiting the performance line graph to 10 years is
important to avoid unrealistic investor performance-related
expectations and allow investors to easily identify volatility.\204\ We
also believe adding labels at significant points on the line graph may
clutter the presentation and hinder an investor's ability to understand
the information provided.
---------------------------------------------------------------------------
\204\ See Proposing Release, supra footnote 7, at text following
n.196 (discussing, for example, that for funds that have been in
existence for a long period of time (e.g., 40 years), a line graph
that shows the performance of a $10,000 investment at the outset of
the fund may not be particularly relevant for the average
shareholder, who likely has not been invested in the fund for such
an extended period of time).
---------------------------------------------------------------------------
Further, we continue to believe the line graph is more useful for
investors in the shareholder report than a bar chart. Like a bar chart,
a line graph helps illustrate the variability of a fund's returns
(e.g., whether the fund's returns have been volatile or relatively
consistent from year to year). But given the other benefits of the line
graph--particularly that it presents performance in dollar terms that
may be easier for some shareholders to assess--the final rules we are
adopting maintain the line graph presentation.\205\ Moreover, the line
graph presentation may help investors understand the general benefits
of long-term investments (e.g., compound interest).
---------------------------------------------------------------------------
\205\ This complements the percentage-based presentation in the
average annual total returns table. See Proposing Release, supra
footnote 8, at n.193.
---------------------------------------------------------------------------
Comments on Broad-Based Securities Market Index
Commenter reactions to the proposed definition of an appropriate
broad-based securities market index were mixed. Some commenters
supported the retention of the requirement to present performance
relative to a broad-based index, as well as the proposed
definition.\206\ One commenter stated that the requirement to compare
performance to the overall applicable securities markets would be
useful to investors, as it makes the information more comparable across
funds, and should ``also help prevent funds from selecting for
comparison a narrow index designed to make their own performance look
artificially strong.'' \207\ Another, supporting the proposed
requirement, stated that the requirement would ``ensure that investors
have a simple, readily-accessible window into the performance of a
specific investment fund against the broader performance of the
securities markets.'' \208\ Some commenters asked for additional
guidance. For example, one commenter suggested that the definition
incorporate more specific criteria regarding index methodology.\209\
Another commenter requested the Commission to provide additional
clarity on indexes that would satisfy the proposed definition, such as
country-specific indexes, ESG indexes, and indexes of particular
capitalizations.\210\ Further, another commenter suggested that the
Commission publish a list of permissible indexes.\211\
---------------------------------------------------------------------------
\206\ See, e.g., Comment Letter of Index Industry Association
(Jan. 4, 2021) (``Index Industry Association Comment Letter'');
Consumer Federation of America II Comment Letter; NASAA Comment
Letter; Tom and Mary Comment Letter; Ubiquity Comment Letter.
\207\ See Consumer Federation of America II Comment Letter; see
also Index Industry Association Comment Letter (comparing fund
performance against a broad-based market index in fund reporting
materials ``promotes transparency and helps shareholders evaluate
their goals''); see also Abdullah Comment Letter (stating that it is
problematic that funds include narrow indexes as their broad-based
index).
\208\ See NASAA Comment Letter.
\209\ Id.
\210\ Tom and Mary Comment Letter.
\211\ Ubiquity Comment Letter.
---------------------------------------------------------------------------
In contrast, many industry commenters objected to the proposed
definition.\212\ These commenters argued that, for some fund strategies
like multi-asset funds and alternative strategy funds, a comparison to
an index representing the entire market would be less useful and could
be misleading to investors because these fund strategies are not
designed to invest in, nor provide the performance associated with, any
particular overall market. Commenters also questioned the default
requirement to include a broad-based index in a fund's performance line
graph. Although the proposal allows funds to show a secondary index
that is more tailored to the fund's strategy, commenters argued
including any broad-based market index would be confusing to investors
in certain
[[Page 72777]]
circumstances.\213\ For example, one commenter argued that investor
confusion could result if the Commission were to require an index fund
that seeks to track a narrow index as a principal investment strategy
to compare itself to a different, broad-based index.\214\ Furthermore,
some commenters argued the proposed broad-based index requirement would
impose additional licensing fees on funds.\215\ Similarly, one
commenter argued retaining the current ``widely recognized and used''
standard for using an affiliated index as a fund's primary index
disadvantages smaller funds, whose affiliated indexes would be less
likely to meet this standard and for which the expense of licensing a
``widely recognized and used'' index may be more significant.\216\
---------------------------------------------------------------------------
\212\ See, e.g., ICI Comment Letter (suggests changing index
definition to ``appropriate index''); SIFMA Comment Letter;
Morningstar Comment Letter; Fidelity Comment Letter; Capital Group
Comment Letter; John Hancock Comment Letter; TIAA Comment Letter;
Comment Letter of IHS Markit (Jan. 4, 2021) (``IHS Markit Comment
Letter'').
\213\ Id.
\214\ Supplemental Comment Letter of the Investment Company
Institute (Oct. 10, 2022) (``ICI Comment Letter on the OIAD
Benchmark Study''). But see Abdullah Comment Letter (``Since 40% of
fund assets are index funds, it would be interesting to see whether
the performance [of] an index that lines up quite closely with an
index fund is useful to investors. I hypothesize that such a
presentation provides no benefit to an investor and so should not be
permitted as the sole benchmark.'').
\215\ ICI Comment Letter; SIFMA Comment Letter; Vanguard Comment
Letter; Dimensional Comment Letter; Fidelity Comment Letter; T. Rowe
Price Comment Letter; see also infra paragraph accompanying
footnotes 751-752 (discussing potential effects of the final rules'
changes to the term ``appropriate broad-based securities market
index'' on the costs that funds bear, including additional costs to
funds in the form of index-licensing fees, and stating that the
amount of these costs will depend, among other things, on market
competition among index providers). But see Index Industry
Association Comment Letter (stating fees charged by broad-based
index providers are small and costs to funds would be minimal).
\216\ ICI Comment Letter.
---------------------------------------------------------------------------
Some commenters suggested alternatives designed to alleviate
investor confusion concerns and to enhance benchmark indexes'
informational value. For example, some commenters urged the Commission
to consider requiring labeling the primary index as a ``general market
index'' (or similar) to clarify how an investor should use the
information it presents.\217\ Other commenters suggested the primary
index should be one that is specifically tailored to the fund's
strategy and the secondary index should be one that represents the
overall market.\218\ Some of these commenters also suggested that funds
be permitted to provide additional information about more narrowly
tailored indexes, such as the index's underlying components and their
weights,\219\ and an explanation of why the fund believes that the
chosen index is an appropriate indicator of the fund's
performance.\220\
---------------------------------------------------------------------------
\217\ Fidelity Comment Letter; CFA Institute Comment Letter.
\218\ Morningstar Comment Letter; Federated Hermes Comment
Letter; John Hancock Comment Letter; IHS Markit Comment Letter; T.
Rowe Price Comment Letter.
\219\ T. Rowe Price Comment Letter.
\220\ IHS Markit Comment Letter.
---------------------------------------------------------------------------
After considering comments and the findings of the OIAD Benchmark
Study, we are adopting the proposed definition of ``appropriate broad-
based securities market index'' and retaining the current requirement
that a fund must include such an index in its performance line graph.
We continue to believe all funds should compare their performance to
the overall market and that including a broad-based index in
performance disclosure gives investors readily-accessible contextual
information about market performance.\221\ While performance disclosure
that includes an index based on a narrow segment of the market may be
useful for comparison purposes, this does not substitute for the
inclusion of an index that provides information about the performance
of the fund against the broader market. For example, if the Commission
were to permit an index fund that seeks to track a narrow index as a
principal investment strategy to show only the performance of the
narrow index it seeks to track, and the performance of the fund and the
index were very similar (as they would be to the extent that the fund
tracks the index closely), such a performance presentation would show
the extent to which the fund tracks the index but would be less helpful
to investors to provide broader performance context.\222\ As another
example, the inclusion of a broad-based index helps an investor in a
sector-specific fund determine not only how the fund's performance
relates to that of its peers, but how the fund's performance relates to
the performance relative to the market as a whole. Therefore, investors
in such funds would benefit from additional contextual information
regarding the performance of the overall market.\223\
---------------------------------------------------------------------------
\221\ See supra footnotes 206-208 and accompanying text.
\222\ See supra footnote 214.
\223\ See, e.g., CFA Institute Comment Letter (``Even if a fund
outperforms its benchmark, that may be slight consolation if the
strategy itself performs poorly against the market. Therefore, the
investor should also compare a fund's returns against the market as
a whole.'').
---------------------------------------------------------------------------
The final rules' approach is supported in part by the findings of
the OIAD Benchmark Study, which observed that benchmarks can help
contextualize a fund's performance information for investors, and that
some investors use this information to make investment decisions.\224\
The study also found that investors of varying levels of sophistication
report preferring performance disclosure that includes both broad and
narrow benchmarks.\225\ Furthermore, while commenters suggested that
narrower benchmarks could provide more useful comparative information,
the OIAD Benchmark Study concluded that investors' decision-making was
generally driven by the positioning of the fund's performance relative
to the benchmark presented (i.e., whether the fund underperformed or
outperformed the benchmark), irrespective of whether the benchmark
presented is narrow or broad.\226\ Therefore, as we continue to believe
a comparison to the overall market is important contextual information
for investors, the evidence that the study provided does not, in our
view, support changing the proposed approach or adopting an alternative
requirement (for example, requiring the
[[Page 72778]]
inclusion of an ``appropriate'' benchmark as opposed to an
``appropriate broad-based'' benchmark). In addition, the study showed
that investors find a fund significantly less attractive when a
performance graph shows the fund's performance accompanied by a single
benchmark that outperforms the fund. Therefore, to the extent that it
could be easier for a fund to find a narrow benchmark that
underperforms the fund than a broad benchmark, we do not see a reason
to discontinue the current requirement to include a broad benchmark, as
the requirement to include only a narrower benchmark could lead to
gaming behavior. Two commenters specifically addressed the OIAD
Benchmark Study and raised concerns regarding the methodology used by
the study and the impact such methodology had on the study's
conclusions.\227\ However, the elements of the OIAD Benchmark Study
that support the approach under the final rules are not impacted by the
methodology concerns that commenters raised.\228\
---------------------------------------------------------------------------
\224\ See OIAD Benchmark Study, supra footnote 53; see also ICI
Comment Letter on the OIAD Benchmark Study (noting the importance of
performance benchmarks to investors).
\225\ OIAD Benchmark Study, supra footnote 53 at ``Figure 9.
Preferences for benchmarks.'' In the sections of the OIAD Benchmark
Study that analyze benchmarks that currently exist in the mutual
fund industry, the study identified funds' broad-based benchmarks
first by identifying data from the Morningstar Direct open-end fund
database that capture ``primary'' and ``secondary'' indexes, and
then by reclassifying these indexes as broad and narrow benchmarks
based on the correlation of each index with the S&P 500 Index.
Commenters objected to the use of the S&P 500 Index in the study's
methodology, arguing that the Commission should not ``define or
insinuate that a broad-based index must or should have certain
correlation to the S&P 500 Index.'' See Abdullah Comment Letter; see
also ICI Comment Letter on the OIAD Benchmark Study (stating that
``de facto SEC endorsement of certain indexes would create market
distortions and likely increase fund licensing costs''). The OIAD
Benchmark Study, including its methodology and findings, does not
reflect findings or conclusions by the Commission as to what
constitutes a broad-based index under the final rules. See infra
text accompanying footnotes 230-233 (providing general guidance and
examples of the indexes that would qualify as broad-based indexes
under the rule).
\226\ See OIAD Benchmark Study, supra footnote 53; see also ICI
Comment Letter on the OIAD Benchmark Study (stating that ``the
underlying results do not find evidence that survey participants
believed that the broad benchmark is a better reference point than
the narrow benchmark''). A different academic study also examines
fund performance benchmarks, but with a focus on funds' behavior
with respect to the performance benchmarks that they select, how
benchmark changes affect the appearance of funds' benchmark-adjusted
performance, as well as fund flows that result from changes in
performance benchmarks. See Kevin Mullally and Andrea Rossi, Moving
the Goalposts? Mutual Fund Benchmark Changes and Performance
Manipulation (June 24, 2022), available at Mullally, Kevin and
Rossi, Andrea, Moving the Goalposts? Mutual Fund Benchmark Changes
and Performance Manipulation (June 24, 2022) available at <a href="https://ssrn.com/abstract=4145883">https://ssrn.com/abstract=4145883</a>.
\227\ See Abdullah Comment Letter; see also ICI Comment Letter
on the OIAD Benchmark Study.
\228\ Those concerns chiefly focused on the sections of the OIAD
Benchmark Study that analyze benchmarks that currently exist in the
mutual fund industry (Section 2, ``Institutional Background on
Benchmark Requirements,'' Section 7, ``Analysis of Benchmark
Performance Data,'' and Section 8, ``General Discussion''). These
concerns focused on the methodology for determining which benchmark
in a fund's disclosure is the broad-based benchmark that is required
to appear in its performance disclosure. The discussion of the OIAD
Benchmark Study included in this section of the release, on the
other hand, relates to the results of the large behavioral
experiment that the study describes, as well as the qualitative
pilot study.
---------------------------------------------------------------------------
We recognize that there is a broad diversity of investment
strategies that funds employ, and that certain funds, such as multi-
asset and alternative strategy funds, do not invest within a single
overall market or attempt to provide returns that are related to the
returns of any single overall market. However, comparing the
performance of these types of funds against an overall market index
will provide shareholders with valuable information regarding how their
investments might have performed had their money been invested directly
in the holdings included in the index. Further, as discussed above we
continue to believe that such a presentation may be useful to
investors. And investors may continue to prefer such a presentation, as
the OIAD Benchmark Study did not find evidence supporting the notion
that study participants believe that a narrow benchmark is a better
reference point than a broad benchmark.\229\ Additionally, the final
rules will allow funds to include narrower indexes, reflecting the
market segments in which the fund invests, in the performance
presentation. This flexibility will allow funds with unique investment
strategies to show the performance of an index that is more closely
aligned with the fund's investments.
---------------------------------------------------------------------------
\229\ See supra paragraph accompanying footnote 212; see also
id.
---------------------------------------------------------------------------
A ``broad-based'' index that ``represents the overall applicable''
market will of course not necessarily include every security in a given
market.\230\ The revised definition is designed to ensure that a fund's
broad-based index is one that reasonably represents the applicable
market. To assist funds in their selection of indexes, we are providing
some general guidance and examples of the types of indexes that would
satisfy the final rules. For example, 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.\231\ In contrast, 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. Such a fund could
also show its performance against an additional, more narrowly tailored
healthcare index.\232\ We similarly do 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.
---------------------------------------------------------------------------
\230\ ICI Comment Letter (stating that, when selecting an index,
funds will have to make judgements on how broad an index should be).
\231\ See Disclosure of Mutual Fund Performance and Portfolio
Managers, Investment Company Act Release No. 19382 (Apr. 6, 1993)
[58 FR 19050 (Apr. 12, 1993)], at n.21 and accompanying paragraph.
\232\ See Instruction 7 to Item 27A(d)(2) of amended Form N-1A.
---------------------------------------------------------------------------
An ``appropriate'' broad-based securities market index that a fund
selects may include components that do not directly overlap with the
fund's investments, if the index's components share similar economic
characteristics to the fund's investments such that they provide an
appropriate point of comparison. For example, funds such as multi-asset
and alternative strategy funds that do not invest within a single
overall debt or equity market could select an index that shares other
economic characteristics with the fund, such as an index that has
similar volatility to the fund. Additionally, as the Commission stated
in the Proposing Release, a fund that invests in both equity and debt
securities could include more than one appropriate broad-based
securities market index.\233\ Such a fund could also include a blended
index--one that combines the performance of more than one index, such
as equity and debt indexes--as an additional index to supplement the
appropriate broad-based securities market index(es) that the fund
includes.
---------------------------------------------------------------------------
\233\ Proposing Release, supra footnote 8, at text accompanying
n.202.
---------------------------------------------------------------------------
Furthermore, because the indexes that are available for funds to
select change over time, we are not publishing a list of permissible
indexes. We also are not further restricting permissible indexes by
incorporating more specific criteria regarding index methodology, as
maintaining more specific criteria that are evergreen would be
challenging in light of developments in funds' investment strategies
and changes in the availability of indexes over time. We also are not
adopting commenter suggestions to label indexes or to allow funds to
provide additional contextual information regarding indexes because we
think the name of the index itself is sufficient for investor
understanding and will give investors the opportunity to seek further
information on the indexes chosen by the fund.\234\
---------------------------------------------------------------------------
\234\ See OIAD Benchmark Study, supra footnote 53 (finding no
evidence to support the claim that textual clarifications of
benchmark's improved investor comprehension or otherwise altered
investment decisions). But see Abdullah Comment Letter (stating that
the final rules should require funds to provide textual
clarifications of indexes where the index components are not obvious
from the index's name or is not otherwise well known to investors).
Funds that wish to provide further information regarding the fund's
performance as it compares to the indexes provided may do so in the
narrative MDFP section of the release to the extent that such
disclosure meets the requirements of that section.
---------------------------------------------------------------------------
While we appreciate commenters' concerns regarding index licensing
fees, we continue to believe comparative performance disclosure
provides contextual information investors need in order to make
informed investment decisions. After considering suggestions that
smaller funds could more readily use affiliated indexes if the
Commission were to amend the current requirement for such indexes to be
``widely recognized and used,'' we are retaining the current
requirement. This is an important protection against potential
conflicts of interest, including the potential ability of an affiliated
index
[[Page 72779]]
provider to manipulate an underlying index to the benefit of the fund.
iii. Performance Table
Substantially as proposed, the final rules will retain the current
requirement that funds' annual reports include a table presenting
average annual total returns for the past 1-, 5-, and 10-year periods,
with certain amendments designed to reflect that a shareholder report
will cover a single class of a multiple-class fund.\235\ Specifically,
as proposed, the final rules will require the table to include several
additional pieces of information: (1) the average annual total returns
of an appropriate broad-based securities market index; \236\ and (2)
the fund's average annual total returns without sales charges (in
addition to current disclosure showing returns reflecting applicable
sales charges). While the proposal would have required average annual
total return information for all available share classes, the final
rules require this information only for the share class to which the
report relates, and therefore the final rules will not include this
proposed requirement.
---------------------------------------------------------------------------
\235\ See Item 27A(d)(2) of amended Form N-1A and related
instructions.
\236\ As proposed, the final rules also will permit funds to
include returns information for one or more other relevant indexes,
such as a more narrowly based index that reflects the market sectors
in which the fund invests. See Proposing Release, supra footnote 7,
at n.215 and accompanying text.
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Additionally, as proposed, the final rules simplify the statement
that currently accompanies the line graph and table.\237\ Also as
proposed, funds will be required to use text features to make this
statement noticeable and prominent through, for example, graphics,
larger font size, or different colors or font styles. Furthermore,
substantially as proposed, the final rules include a new instruction
allowing funds to add brief additional disclosure that would
contextualize the line graph and average annual returns table.
Specifically, if a material change occurred to the fund during the
relevant performance period, such as a change in investment adviser or
a change to the fund's investment strategies, the fund may include a
brief legend or footnote to describe the change and when it
occurred.\238\ Finally, as proposed, the final rules require funds that
provide updated performance information through widely accessible
mechanisms, such as fund websites, to include a statement in the
shareholder report directing shareholders to where they can find this
information.\239\
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\237\ Under the final rules, funds will be required to include a
statement to the effect that the fund's past performance is not a
good predictor of how the fund will perform in the future. The final
rules also make a conforming change to similar language that must
appear in the prospectus. See Item 4(b)(2) of amended Form N-1A.
\238\ Funds will have discretion to determine when to disclose
information about a prior material change to a fund in connection
with its performance presentation. However, a fund will need to
disclose information about such a change if, absent that disclosure,
the fund's performance presentation would otherwise be misleading.
See Proposing Release, supra footnote 7, at nn.227-229 and
accompanying text.
\239\ If a fund were to include such a statement, it also would
be required to provide a means of facilitating access to the updated
performance information, including, for example, a hyperlink to
where the information may be found if the shareholder report is
provided electronically or a URL address or QR code if the
shareholder report is delivered in paper format.
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Commenters generally supported the proposed changes to the average
annual total returns table, noting that the changes will better align
this table in the shareholder report with the returns reported in the
prospectus.\240\ One commenter suggested that funds should be required
to show the 3-year period of returns, in addition to the proposed 1-,
5- and 10-year periods.\241\ This commenter stated that an additional
intermediate time horizon is especially important for funds with less
than 10 years of performance. Because funds with less than 10 years of
performance will be required to show performance for the life of the
fund, we do not believe that an additional intermediate period of
returns would benefit investors, particularly since the performance
table already shows two other intermediate periods that are relatively
close in time (i.e., 1- and 5- year periods).\242\
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\240\ See, e.g., ICI Comment Letter; Morningstar Comment Letter;
Consumer Federation of America II Comment Letter; Capital Group
Comment Letter (also suggested changing the order of items in report
to show the average annual total returns table before fund
expenses). We are maintaining the ordering of the items in the
shareholder report as proposed because we believe that expense
information should be highlighted first for shareholders.
\241\ Morningstar Comment Letter.
\242\ Additionally, shareholders interested in reviewing
performance during periods not shown in the performance table can
find this information in the performance line graph. See supra text
accompanying footnote 196.
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iv. Other MDFP Amendments
As proposed, the final rules simplify the current annual report
requirement for a fund to discuss the effect of any policy or practice
of maintaining a specified level of distribution to shareholders (a
``stable distribution policy'') on the fund's investment strategies and
per share net asset value during the last fiscal year, as well as the
extent to which the fund's distribution policy resulted in
distributions of capital. Specifically, under the final rules, a fund
that has a stable distribution policy and was unable to maintain the
specified level during the past fiscal year would need to disclose
this.\243\ As proposed, the final rules also maintain disclosure
concerning distributions that resulted in returns of capital.\244\ The
final rules' requirements, which--as proposed--modify current
requirements by focusing on circumstances when a fund was unable to
meet the specified level of distribution in its stable distribution
policy or had distributions that resulted in returns of capital, are
designed to provide more meaningful disclosure to shareholders.\245\ No
commenters discussed these requirements.
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\243\ See Item 27A(d)(3) of amended Form N-1A.
\244\ See id.
\245\ The Commission recently adopted amendments to limit the
requirement that ETFs provide premium and discount information in
their annual reports to only those ETFs that do not provide premium
and discount disclosure on their websites in accordance with 17 CFR
270.6c-11 [Investment Company Act rule 6c-11]. See Exchange-Traded
Funds, Investment Company Act Release No. 33646 (Sept. 25, 2019) [84
FR 57162 (Oct. 24, 2019)]. As proposed, the final rules do not amend
this annual report requirement beyond a technical amendment to
clarify that it only applies to ETFs.
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The final rules, like current annual report requirements, do not
require money market funds to include MDFP. Two commenters supported
maintaining the current approach for money market funds.\246\ One
requested that the Commission clarify that money market funds are
permitted, but not required, to provide MDFP in their shareholder
reports, and are allowed to include some, but not all the required MDFP
disclosures.\247\ The final rules permit money market funds to retain
the current option of including MDFP discussion in their shareholder
reports and clarify that they are permitted but not required to
disclose some or all of the information required in the MDFP so long as
the information they choose to include meets the requirements of the
relevant item, and related instructions on the form, and is not
incomplete, inaccurate, or misleading.\248\
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\246\ ICI Comment Letter; Fidelity Comment Letter.
\247\ ICI Comment Letter.
\248\ See Item 27A(d) of amended Form N-1A.
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d. Fund Statistics
Substantially as proposed, the final rules require a fund to
disclose certain fund statistics in its annual report, including 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
[[Page 72780]]
during the reporting period.\249\ As proposed, the final rules also
permit a fund to disclose any additional statistics that the fund
believes would help shareholders better understand the fund's
activities and operations during the reporting period. These provisions
are designed to provide succinct fund information, in a user-friendly
format, that encourage investors to focus on certain significant
factors in evaluating the fund's operations and performance.
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\249\ See Item 27A(e) of amended Form N-1A. In a change from the
proposal, the final rules include a new statistic related to the
disclosure of the total advisory fees the fund paid. Additionally,
in a change from the proposal, which would have required all funds
to disclose their portfolio turnover rate, the final rules exclude
money market funds from the requirement to disclose portfolio
turnover rate. See infra footnote 260 and accompanying text.
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The final rules include several related instructions.\250\ First,
in a change from the proposal (which did not include such an
instruction), under the final rules the required fund statistics must
precede any additional permitted statistics the fund chooses to
include. We believe that disclosing the required statistics first will
enhance comparability of the required fund statistics across funds.
Next, as proposed, if a fund provides a statistic also required under
Form N-1A, the fund must follow Form N-1A instructions describing the
calculation method for the relevant statistic. Additionally, as
proposed, the final rules include an instruction that encourages a fund
to use tables, bullet lists, or other graphics or text features to
present the fund statistics.
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\250\ See Instructions to Item 27A(e) of amended Form N-1A.
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As proposed, if a statistic is included in, or could be derived
from, a fund's financial statements or financial highlights, the final
rules require a fund to use or derive such statistic from the fund's
most recent financial statements or financial highlights. Substantially
as proposed, the final rules permit a fund to describe briefly the
significance or limitations of any disclosed statistics in a
parenthetical or similar presentation. The proposed instruction also
would have permitted a footnote explaining the significance or
limitation of any disclosed statistic. In a change from the proposal
and consistent with commenters' suggestio
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