SEC Requires Tailored Shareholder Reports And Amends Fund Advertising Rules – Shareholders

Recently, the U.S. Securities and Exchange Commission (SEC)
adopted rule and form amendments for registered open-end funds (Final Rules) that will substantially change the
form and content of fund shareholder reports. The SEC also adopted
related amendments to the fund advertising rules. Effective January
24, 2023, the Final Rules reflect the SEC’s ongoing effort to
require funds to provide clear and concise disclosures to
shareholders, particularly retail shareholders. Notably, a fund
must prepare and deliver shareholder reports that are specific to
each share class of a single fund. Such reports are expected to be
as short as three or four pages. Expanding on the SEC’s
approach to layered disclosures, the Final Rules also require that
more detailed information must be available online or by request.
The new streamlined and tailored reports are intended to help
retail investors monitor their fund holdings more easily.

The Final Rules also exclude funds registered on Form N-1A from
Rule 30e-3, meaning that all reports must be mailed to
shareholders, unless the shareholders have consented to e-delivery,
in a sharp departure from recent rulemaking.

As noted above, the Final Rules will become effective on January
24, 2023, and the compliance date is

July 24, 2024.

Tailored Shareholder Reports (Mutual Funds and Exchange-Traded
Funds)

The Final Rules amend Item 27 of Form N-1A and fundamentally
change the structure and presentation of fund shareholder reports.
The SEC emphasized that the new reports should be “concise and
visually engaging,” utilizing tables and graphical
representations of certain fund characteristics such as fees,
performance, and holdings. Under the new structure, the SEC expects
each shareholder report to be as few as three pages. This is to be
achieved by shifting many of the disclosures that are currently
included in shareholder reports onto Form N-CSR and limiting each
report to a single share class of a single fund.

Under the Final Rules, shareholder reports will generally have
the following structure:

• Fund/Class Name and Ticker. Funds will be required to
  prepare and mail reports that are specific to a single share class
  of a single fund and are required to identify the applicable
  class/fund and ticker on the report’s cover page. Currently,
  many fund managers present information applicable to many funds,
  each with multiple share classes, in a single report.




• Principal U.S. Market(s) (Exchange-Traded Funds (ETFs)
  only). If the fund is an ETF, the ETF must disclose the
  principal U.S. market(s) where the ETF is traded.




• Identifying Statement and Legend. The cover page will
  be required to include a statement identifying the report as annual
  or semi-annual, as well as a standardized legend disclosing the
  time period of the report and contact information where
  shareholders can request additional information.




• Statement on Material Changes. If a shareholder report
  includes a discussion of material changes during a specific time
  period (discussed below), the report will be required to include a
  prominent statement noting that the report includes this
  information.




• Expense Example. Reports will be required to include a
  table reflecting the expenses associated with a hypothetical
  $10,000 investment during the reporting period, both as a
  percentage of a shareholder’s investment (expense ratio) and in
  dollars.




• Management’s Discussion of Fund Performance
  (MDFP). As is currently the case, the MDFP section will be
  optional for semi-annual reports and not required for money market
  funds. The Final Rules encourage the MDFP to “briefly
  summarize” the “key” factors that impacted a fund
  over the reporting period. Funds will not be permitted to include
  additional discussions, such as a letter to shareholders from the
  adviser, interviews with portfolio managers, or a discussion of the
  general market conditions that are not specific to the applicable
  fund. The MDFP section will continue to include performance line
  graphs and performance tables reflecting 1-, 5-, and 10-year
  returns, as applicable.
  
  Regarding the performance table and the presentation of performance
  information generally (including in prospectuses), the Final Rules
  will amend the definition of “appropriate broad-based
  securities market index” to be “an index that represents
  the overall applicable domestic or international equity or debt
  markets, as appropriate.” This reflects the SEC’s position
  that certain benchmarks are not sufficiently broad and will
  effectively require all funds to compare their performance, both in
  shareholder reports and prospectuses, to the overall securities
  market in which a fund invests. While the particular details of
  which benchmarks are sufficiently representative of an overall
  securities market remain unclear, the SEC explained, for example,
  “an appropriate benchmark for a fund that invests primarily in
  the equity securities of a subset of the U.S. market, such as
  healthcare companies, should show its performance against the
  overall U.S. equities market, rather than a benchmark consisting of
  only healthcare companies.” The SEC extended this logic to
  “indexes that include characteristics such as
  ‘growth,’ ‘value,’ ‘ESG,’ or ‘small- or
  mid-cap’ . . . and therefore these indexes would not be
  appropriate broad-based securities market indexes under the final
  rules.” Funds may continue to compare performance against more
  narrowly tailored benchmarks in addition to the applicable broader
  index.

• Fund Statistics and Graphical Representation of
  Holdings. Funds will be required to disclose net assets, total
  number of holdings, portfolio turnover rate (not applicable to
  money market funds), and the total advisory fee paid during the
  reporting period. Reports will continue to be required to present a
  graphical representation of fund holdings by category.




• Material Fund Changes. Funds will be required to
  disclose and briefly describe any material fund changes that
  occurred during the reporting period. “Material changes”
  in this context includes changes to a fund’s name, investment
  objectives, strategy, annual expenses (including termination or
  introduction of expense caps), principal risks, and investment
  adviser.




• Changes in and Disagreements with Accountants. If
  applicable, annual reports will be required to include a statement
  of whether a fund’s former accountant resigned, declined to
  stand for re-election, or was dismissed and the date thereof, and a
  brief, plain English description of management’s
  disagreement(s) with the former accountant during the fund’s
  two most recent fiscal years.




• Availability of Additional Information. Shareholder
  reports will be required to note that additional information is
  available on a fund’s website.




• Householding Disclosure (Optional). Shareholder
  reports will continue to be permitted to explain how to revoke
  consent to householding.

As noted above, much of the information currently included in
shareholder reports will be moved to Form N-CSR, and investors can
access this more in-depth information using the SEC’s website
or by request if they so choose. Below are the items currently
included in shareholder reports that will transition to Form
N-CSR:

• Financial Statements, including the Schedule of Investments and
  Notes to Financial Statements;




• Financial Highlights;




• Results of any shareholder vote;




• Trustee and Officer table; and




• Disclosures pursuant to the requirements of Section 15(c) of
  the 1940 Act (annual advisory contract approval).

Additionally, the statement regarding a fund’s liquidity
risk management program will no longer be required to be provided
in the report or on Form N-CSR.

E-Delivery Exclusion

In a disappointment to the open-end fund industry, the Final
Rules exclude mutual funds and ETFs from Rule 30e-3 and rescind
Rule 30e-1(d). Currently, Rule 30e-3 permits mutual funds and ETFs
to satisfy shareholder report delivery obligations by posting their
reports online and notifying shareholders of their availability
online (i.e., access equals delivery). Rule 30e-1(d)
currently permits mutual funds and ETFs to send a prospectus or
statement of additional information in place of a shareholder
report as long as all of the required information is included.
Together, but particularly in Rule 30e-3, these delivery rules
provided significant cost savings and logistical ease for mutual
funds and ETFs with little impact on disclosures available to
investors. Under the Final Rules, however, mutual funds and ETFs
will be required to mail shareholder reports to investors on a
single share class and single fund basis unless a shareholder
affirmatively consents to e-delivery. In the release, the SEC
argued that for any shareholders who have not opted into
e-delivery, funds are still required to mail a notice of report
availability. Since the new shareholder reports are intended to be
very short, the SEC believes the mailing costs under the Final
Rules would be low.

Advertising Rules (Including Closed-end Funds and Business
Development Companies (BDCS))

The Final Rules also adopt amendments to the rules governing
investment company advertisements (including closed-end funds and
BDCs) that include fee and expense information. The amendments are
similar in nature to the new Marketing Rule under the Investment
Advisers Act of 1940 (Rule 206(4)-1) and will require
advertisements that include fee and expense data to include both
gross and net fees with equal prominence and clear explanations of
any waivers, limitations, or caps. The amendments are intended to
standardize how fees and expenses are presented across essentially
all fund documents, from sales literature to prospectuses.

Next Steps

While the compliance date for the new Final Rules is not until
July 2024, the operational changes to how shareholder reports are
drafted and delivered will be dramatic for many open-end fund
managers. In particular, advisers that manage a suite of mutual
funds should be considering the ease or difficulty involved in
adjusting to creating and reviewing, in most cases, many more
reports than it currently produces. Advisers should be prepared for
the coordinated efforts across multiple service providers (for
example, financial printers) that will be required to implement the
new report structures and filings on Form N-CSR.

Because of the generality of this update, the information
provided herein may not be applicable in all situations and should
not be acted upon without specific legal advice based on particular
situations.

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