[Federal Register Volume 62, Number 46 (Monday, March 10, 1997)]
[Proposed Rules]
[Pages 10898-10942]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-5368]
[[Page 10897]]
_______________________________________________________________________
Part II
Securities and Exchange Commission
_______________________________________________________________________
17 CFR Part 230, et al.
Registration Form Used by Open-End Management Investment Companies;
Proposed Rule
Proposed New Disclosure Option for Open-End Management Investment
Companies; Proposed Rule
Investment Company Names; Proposed Rule
Federal Register / Vol. 62, No. 46 / Monday, March 10, 1997 /
Proposed Rules
[[Page 10898]]
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 230, 239, 270, and 274
[Release Nos. 33-7398; 34-38346; IC-22528; S7-10-97]
RIN 3235-AE46
Registration Form Used by Open-End Management Investment
Companies
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission is proposing amendments
to Form N-1A, the form used by open-end investment companies to
register under the Investment Company Act of 1940 and to offer their
shares under the Securities Act of 1933. The proposed amendments would
revise disclosure requirements for fund prospectuses. Among other
things, the proposed amendments seek to minimize prospectus disclosure
about technical, legal, and operational matters that generally are
common to all funds and, in keeping with the purpose of Form N-1A, to
focus prospectus disclosure on essential information about a particular
fund that would assist an investor in deciding whether to invest in
that fund. The proposed amendments are intended to improve fund
prospectuses and to promote more effective communication of information
about funds.
DATES: Comments must be received on or before June 9, 1997.
ADDRESSES: Submit comments in triplicate to Jonathan G. Katz,
Secretary, Securities and Exchange Commission, 450 5th Street, NW,
Washington, DC 20549-6009. Comments can be submitted electronically at
the following E-mail address: [email protected]. All comment
letters should refer to File No. S7-10-97; this file number should be
included on the subject line if E-mail is used. All comments received
will be available for public inspection and copying in the Commission's
Public Reference Room, 450 5th Street, NW, Washington, DC 20549-6009.
Electronically submitted comment letters will be posted on the
Commission's Internet Web site (http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT: Jonathan F. Cayne, Attorney, John M.
Ganley, Senior Counsel, Markian M.W. Melnyk, Senior Counsel, David U.
Thomas, Senior Counsel, Kathleen K. Clarke, Special Counsel, or
Elizabeth R. Krentzman, Assistant Director, (202) 942-0721, Office of
Disclosure and Investment Adviser Regulation, Division of Investment
Management, Securities and Exchange Commission, 450 5th Street, NW,
Mail Stop 10-2, Washington, DC 20549-6009.
SUPPLEMENTARY INFORMATION:
The Securities and Exchange Commission (``Commission'') is
proposing for comment amendments to Form N-1A (17 CFR 274.11A), the
registration form used by open-end management investment companies
(``funds'') to register under the Investment Company Act of 1940 (15
U.S.C. 80a-1 et seq.) (``Investment Company Act'') and to offer their
shares under the Securities Act of 1933 (15 U.S.C. 77a et seq.)
(``Securities Act''). The Commission also is proposing technical
amendments to rules 481 and 497 under the Securities Act (17 CFR
230.481, .497). In a companion release, the Commission is proposing new
rule 498 under the Securities Act and the Investment Company Act, which
would permit an investor to buy a fund's shares based on a short-form
document, or ``profile,'' that contains a summary of key information
about the fund; each investor purchasing fund shares based on a profile
would receive a copy of the fund's prospectus with the purchase
confirmation.\1\ In another companion release, the Commission is
proposing new rule 35d-1 under the Investment Company Act, which would
require a fund with a name suggesting that it focuses on a particular
type of investment (e.g., a fund that calls itself the ABC Stock Fund,
the XYZ Bond Fund, or the QRS U.S. Government Fund) to invest at least
80% of its assets in the type of investment suggested by its name.\2\
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\1\ Investment Company Act Release No. 22529 (Feb. 27, 1997)
(``Profile Release'').
\2\ Investment Company Act Release No. 22530 (Feb. 27, 1997)
(``Fund Names Release''). Proposed rule 35d-1 would apply to all
registered investment companies, including funds, closed-end
investment companies, and unit investment trusts.
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Table of Contents
I. INTRODUCTION AND EXECUTIVE SUMMARY
II. DISCUSSION
A. Part A--Information in the Prospectus
1. Item 1--Front and Back Cover Pages
2. Item 2--Risk/Return Summary: Investments, Risks, and
Performance
a. Investment Objectives and Principal Strategies
b. Risks
3. Item 3--Risk/Return Summary: Fee Table
a. Fee Table Example
b. Shareholder Account Fees
c. Improving and Simplifying Fee Table Presentation
4. Item 4--Investment Strategies and Risk Disclosure
a. Investment Objectives and Implementation of Investment
Objectives
b. Risk Disclosure
5. Item 5--Management's Discussion of Fund Performance
6. Item 6--Management, Organization, and Capital Structure
a. Management and Organization
b. Capital Structure
7. Item 7--Shareholder Information
a. Purchase and Redemption
b. Tax Consequences
8. Item 8--Distribution Arrangements
a. Placement of Prospectus Disclosure
b. Rule 12b-1 Plans
c. Sales Loads
d. Multiple Class and Master-Feeder Funds
9. Item 9--Financial Highlights Information
B. Part B--Statement of Additional Information
C. Part C--Other Information
D. General Instructions
1. Reorganizing and Simplifying the Instructions
2. Form N-1A Guidelines and Related Staff Positions
E. Technical Rule Amendments
F. Transition Period
III. General Request for Comments
IV. Paperwork Reduction Act
V. Summary of Initial Regulatory Flexibility Analysis
VI. Statutory Authority
VII. Text of Proposed Amendments
I. Introduction and Executive Summary
Over the last decade, the fund industry has experienced enormous
growth both in total assets and in the number of funds.\3\ Today, fund
assets exceed the deposits of commercial banks.\4\ Coincident with the
explosive growth of fund investments, the business operations of many
funds have become increasingly complex as funds seek to offer investors
new investment options and a wider variety of shareholder services.
These factors, combined with new and more sophisticated fund
investments, have resulted in fund prospectuses that often include long
and complicated disclosure, as funds explain their operations,
investments, and services to investors.
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\3\ Investment Company Institute (``ICI'), Mutual Fund Fact Book
29-37 (36th ed. 1996) (``ICI Fact Book'') (between 1987 and 1996,
assets increased from $769.9 billion to $3.5 trillion and the number
of funds increased from 2,317 to 6,243).
\4\ Compare ICI, Trends in Mutual Fund Investing: November 1996
at 3 (Dec. 1996) (ICI News No. ICI-96-107) (fund net assets exceeded
$3.5 trillion as of Nov. 1996) with 82 Fed. Res. Bull. 12, table
1.21, at A13 (1996) (commercial bank deposits were approximately
$2.5 trillion as of Sept. 1996).
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Many have criticized fund prospectuses, finding them
unintelligible, tedious, and legalistic.\5\
[[Page 10899]]
Although the prospectus remains the most complete source of information
about a fund, technical and unnecessarily lengthy prospectus disclosure
often obscures important information relating to a fund investment and
does not serve the information needs of the majority of fund
investors.\6\ As millions of Americans have turned to funds as an
investment vehicle of choice,\7\ investors need to be provided with
clear and comprehensible information that will help them evaluate and
compare fund investments.
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\5\ See, e.g., ``The SEC and the Mutual Fund Industry: An
Enlightened Partnership,'' Remarks by Arthur Levitt, Chairman, SEC,
before the ICI's General Membership Meeting at the Washington Hilton
Hotel, Washington, D.C. (May 19, 1995); Simple Concept from SEC: Use
Plain English in Fund Prospectuses, L.A. Times, Mar. 2, 1995, at
D14; J. Bogle, Bogle on Mutual Funds 147 (1994); Rothchild, The War
on Gobbledygook, Time, Oct. 31, 1994, at 51; Skrzycki, Prospectuses
to be in English, Donkeys to Fly Tomorrow, Wash. Post, Oct. 21,
1994, at B1.
\6\ A 1995 survey conducted on behalf of the Commission and the
Office of the Comptroller of the Currency (``OCC'') found that,
although fund investors consulted the prospectus more than any other
source of information about the fund they bought, they considered
the prospectus only the fifth-best source of information, behind
employer-provided written materials, financial publications, family
or friends, and brokers. Report on the OCC/SEC Survey of Mutual Fund
Investors 12-13 (June 26, 1996). See also ICI, The Profile
Prospectus: An Assessment by Mutual Fund Shareholders 4 (1996)
(``ICI Profile Survey'') (about half of fund shareholders surveyed
had not consulted a prospectus before making a fund investment).
\7\ Over 30 million U.S. households own funds. ICI Fact Book,
supra note 3, at 92.
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The Commission is committed to improving the disclosure provided to
fund investors \8\ and is proposing two major initiatives to meet this
objective. First, the Commission is proposing changes to fund
disclosure requirements in an effort to focus prospectus disclosure on
essential information about a particular fund that would assist an
investor in deciding whether to invest in that fund.\9\ Second, in a
companion release, the Commission is proposing a new rule to permit
investors to buy fund shares based on a fund profile (the ``profile'')
that would provide a summary of key information about a fund, including
the fund's investment objectives, strategies, risks, performance, and
fees.\10\ Under this proposal, investors would receive the fund's
prospectus upon request or no later than with delivery of the purchase
confirmation.
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\8\ See ``Taking the Mystery Out of the Marketplace: The SEC's
Consumer Education Campaign,'' Remarks by Arthur Levitt, Chairman,
SEC, at the National Press Club, Washington, D.C. (Oct. 13, 1994);
``Investor Protection: Tips from an SEC Insider,'' Remarks by Arthur
Levitt, Chairman, SEC, before the Investors' Town Meeting at the
Adam's Mark Hotel, Philadelphia, Pa. (June 11, 1996).
\9\ As part of the improvements to prospectus disclosure, the
Commission is proposing a new rule intended to address certain broad
categories of investment company names that are likely to mislead
investors about an investment company's investments and risks. The
new rule would require funds and other registered investment
companies with names suggesting a particular investment emphasis to
invest at least 80% of their assets in the type of investment
suggested by their name.
\10\ Profile Release, supra note 1.
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These two initiatives are intended to improve fund disclosure by
requiring prospectuses to focus on information central to investment
decisions, to provide new disclosure options for investors, and to
enhance the comparability of information about funds. Taken together,
the proposals seek to promote more effective communication of
information about funds without reducing the amount of information
available to investors.
As part of its commitment to give investors improved disclosure
documents, the Commission recently proposed rule amendments to require
the use of plain English principles in drafting prospectuses and to
provide other guidance on improving the readability of
prospectuses.\11\ The Commission intends that the plain English
initiatives serve as the standard for all disclosure documents, and the
plain English proposals are an important counterpart of the proposed
fund disclosure initiatives. If adopted, the plain English requirements
would apply to fund prospectuses and the profile.
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\11\ Securities Act Release No. 7380 (Jan. 14, 1997) (62 FR
3152) (``Plain English Release'). In conjunction with these
proposals, the Commission's Office of Investor Assistance has issued
a draft of A Plain English Handbook: How to Create Clear SEC
Disclosure Documents to explain the plain English principles of the
proposed amendments and other techniques for preparing clear
disclosure documents. See also ``Plain English: A Work in
Progress,'' Remarks by Isaac C. Hunt, Commissioner, SEC, before the
First Annual Institute on Mergers and Acquisition: Corporate, Tax,
Securities, and Related Aspects, Key Biscayne, Fla. (Feb. 6, 1997).
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The Commission's efforts to improve fund disclosure are long-
standing. In 1983, the Commission introduced an innovative approach to
prospectus disclosure by adopting a two-part disclosure format.12
Under this format, the Commission intended that a fund would provide
investors with a simplified prospectus designed to contain essential
information about the fund that assists an investor in making an
investment decision. The Commission contemplated that more extensive
information and detailed discussions of matters included in the
prospectus would be available in a Statement of Additional Information
(``SAI'') that investors could obtain upon request. In adopting this
new format, the Commission's goal was to provide investors with more
useful information in ``a prospectus that is substantially shorter and
simpler, so that the prospectus clearly discloses the fundamental
characteristics of the particular investment company. . . .'' 13
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\12\ Investment Company Act Release No. 13436 (Aug. 12, 1983)
(48 FR 37928) (``Form N-1A Adopting Release').
\13\ Investment Company Act Release No. 12927 (Dec. 27, 1982)
(48 FR 813, 814) (``Form N-1A Proposing Release').
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Since 1983, the Commission has adopted a number of other
initiatives to improve fund disclosure, including a uniform fee table
and a requirement for management's discussion of fund performance
(``MDFP').14 While these changes have provided investors with
clear and helpful information about fund expenses and performance, they
were not intended to address overall prospectus disclosure
requirements. The Commission has concluded that a comprehensive review
and revision of fund disclosure requirements is necessary to improve
the information provided in fund prospectuses.15
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\14\ Investment Company Act Release Nos. 16244 (Feb. 1, 1988)
(53 FR 3192) (``Fee Table Adopting Release'') and 19382 (Apr. 6,
1993) (58 FR 19050) (``MDFP Adopting Release''). See also Investment
Company Act Release Nos. 21216 (July 19, 1995) (60 FR 38454)
(``Money Market Fund Prospectus Release'') (proposing amendments
designed to make money market fund prospectuses simpler and more
informative) and 16245 (Feb. 2, 1988) (53 FR 3868) (``Performance
Release'') (adopting a uniform formula for calculating fund
performance).
\15\ See, e.g., SEC, Report of the Advisory Committee on the
Capital Formation and Regulatory Processes (July 24, 1996); SEC,
Report of the Task Force on Disclosure Simplification (1996)
(``Disclosure Simplification Task Force Report'') (recommending
specific improvements in the disclosure provided by corporate
issuers).
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The Commission's consideration of disclosure issues has included
evaluating the use of the profile as a standardized, summary disclosure
document. The Commission, with the cooperation of the Investment
Company Institute (``ICI'') and several large fund groups, conducted a
pilot program permitting funds to use profiles (``pilot profiles'')
together with their prospectuses.16 The pilot profiles (like the
profile proposed today) contain a summary of key information about the
fund. The program's purpose was to determine whether investors found
the pilot profiles helpful in making investment decisions. Focus groups
conducted on the Commission's behalf
[[Page 10900]]
(``Focus Groups'') responded very positively to the profile concept.
Fund investors participating in a survey sponsored by the ICI also
strongly favored the pilot profiles.17
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\16\ See Investment Company Institute (pub. avail. July 31,
1995) (``1995 Profile Letter''). The Division of Investment
Management (the ``Division'') has permitted the pilot program, with
some modifications, to continue for another year. See Investment
Company Institute (pub. avail. July 29, 1996) (``1996 Profile
Letter''). The Division also has permitted variable annuity
registrants to use ``variable annuity profiles'' together with their
prospectuses. National Association for Variable Annuities (pub.
avail. June 4, 1996).
\17\ See ICI Profile Survey, supra note 6, at 31-32.
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In another recent initiative, the Commission issued a release
requesting comment on ways to improve risk disclosure and comparability
of fund risk levels (``Risk Concept Release'').18 The Commission
received over 3,700 comment letters, mostly from individual investors.
Commenters confirmed the importance of risk disclosure to investors
when evaluating and comparing funds and highlighted the need to improve
prospectus disclosure of fund risks. In particular, commenters
indicated that current risk disclosure is difficult to understand and
does not fully convey to investors the risks associated with an
investment in a fund.
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\18\ Investment Company Act Release No. 20974 (Mar. 29, 1995)
(60 FR 17172).
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The Commission remains committed to the same goals articulated in
adopting Form N-1A. The initiatives proposed today are intended to
further these goals and achieve clear and concise disclosure that would
assist fund investors in making investment decisions. Based on the
Commission's review of current fund prospectuses and related disclosure
requirements, the Commission has identified 5 major objectives that
form the basis for today's initiatives:
Improved prospectus disclosure: Although some funds
have made significant and commendable efforts to improve their
prospectuses,19 prospectus disclosure relating to a fund tends
to be overly complex and difficult to follow and should be revised
to focus on essential information about the fund to help an investor
make an informed investment decision.
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\19\ See, e.g., McTague, Simply Beautiful: Shorn of Legalese,
Even Prospectuses Make Sense, Barron's, Oct. 7, 1996, at F10 (about
the recent efforts of the John Hancock funds and other fund groups
to improve their prospectuses).
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Fund names: Although a fund's name (like any other
single piece of information about an investment) cannot tell the
whole story about a fund investment, names may communicate a great
deal to an investor, and investors should have greater assurance
that a fund whose name suggests that the fund focuses on certain
investments will make those investments.
Investor choice: Different investors prefer different
amounts of information before making an investment decision, and
regulatory requirements should not foreclose options that respond to
prospective investors'' information needs.
Standardized fund summaries: Investors have expressed a
strong preference for summary information about funds in a standard
format; summaries should provide investors with additional tools to
help them make better use of the extensive information available
about funds.
Clearer risk disclosure: The risks of investing in a
fund often are not readily apparent to investors and should be
communicated more effectively.
The proposed disclosure initiatives address these objectives.
Improved Prospectus Disclosure
The proposed amendments would change the disclosure requirements
for fund prospectuses. The Commission regards the prospectus as an
investor's primary source of information about a fund. A prospectus,
however, is not useful to investors if it is in a form that discourages
investors from reading it. The prospectus is intended to provide
information about matters of fundamental importance to most
investors.20 The Commission's proposals are intended to update and
streamline prospectus disclosure requirements to focus on essential
information about a particular fund and make the prospectus less
technical and easier to read.21 This initiative is designed to
eliminate prospectus clutter that tends to obscure information that
could help an investor make an investment decision. The proposed
amendments would:
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\20\ See Form N-1A Proposing Release, supra note 13, at 814.
\21\ Under the authority in section 10(a) of the Securities Act
(15 U.S.C. 77j(a)), the Commission is proposing amendments to
current prospectus disclosure requirements based on its
determination that certain disclosure requirements result in
information that, while useful to some investors, is not necessary
in the public interest or for the protection of investors to be
included in the prospectus.
Move certain disclosure about fund organization and
legal requirements from the prospectus to the SAI to focus
prospectus disclosure on essential information about a fund, while
continuing to assure that the information is available to those
interested in reviewing it;
Permit a fund that is offered as an investment
alternative in a participant-directed defined contribution plan to
tailor its prospectus for use by plan participants;
Update and incorporate certain staff disclosure
requirements into the amended registration form and include guidance
about legal, interpretive, and operational matters in a new
``Investment Company Registration Package,'' which, together, would
provide more effective guidance about disclosure and legal matters;
22 and
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\22\ Incorporating certain staff disclosure requirements into
the revised form is intended to formally identify those disclosure
requirements that would apply to all funds regardless of their
particular circumstances. Among other things, the proposed approach
seeks to address disclosure requirements that have been developed in
connection with an issue presented by a specific fund, but applied
to all funds regardless of their particular circumstances. See
Securities Act Release No. 5906 (Feb. 15, 1978) (regarding a 1977
report of the Advisory Committee on Corporate Disclosure, which,
among other things, recommended that, after identifying a disclosure
problem of general significance, the Commission initiate rulemaking
and not rely for prolonged periods on ad hoc procedures such as
commenting on filings and enforcement actions).
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Simplify current disclosure instructions to provide
clearer guidance for preparing and filing fund registration
statements.
Fund Names and Investments
In a companion release, the Commission is proposing a new rule
under the Investment Company Act that would address certain broad
categories of investment company names that are likely to mislead
investors about an investment company's investments and risks. The rule
would require a fund or any other registered investment company with a
name that suggests a particular investment emphasis (e.g., a fund that
calls itself the ABC Stock Fund, the XYZ Bond Fund, or the QRS U.S.
Government Fund) to invest at least 80% of its assets in the type of
investment suggested by its name.23 Under current positions of the
Division of Investment Management (the ``Division''), these funds and
investment companies generally are subject to a 65% investment
requirement. The rule would address investment companies with names
that suggest the company focuses its investments in a particular
country or geographic region and investment companies with names that
indicate the company's distributions are exempt from income tax. In
addition, the rule would prohibit an investment company from using a
name that suggests that the company or its shares are guaranteed or
approved by the U.S. Government.
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\23\ Fund Names Release, supra note 2.
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Investor Choice
The proposed initiatives would give investors new disclosure
options so that they could determine the amount of information they
want to review before investing in a fund. The proposed profile would
contain a summary of key information about a fund and enable investors
who are comfortable with that level of information to purchase a fund's
shares based on the profile.24 Each investor using the profile to
make an investment decision would receive the
[[Page 10901]]
fund's prospectus with the confirmation of his or her investment.
Investors also would have the option to request and review the fund's
prospectus and other information about the fund (e.g., the fund's
shareholder reports and SAI) before making an investment decision.
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\24\ The profile would be a summary prospectus adopted under
sections 10(b) of the Securities Act (15 U.S.C. 77j(b)) and 24(g) of
the Investment Company Act (15 U.S.C. 80a-24(g)).
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Standardized Fund Summaries
The proposals would require standardized information in the profile
and in a new risk/return summary at the beginning of all fund
prospectuses. The profile would include disclosure of 9 items in a
specific order and in a question-and-answer format designed to help
investors evaluate and compare funds.25 The risk/return summary at
the beginning of the prospectus (also included as the first 4 items in
the proposed profile) would highlight information about a fund's
investment objectives, strategies, risks and performance, and fees, and
make this information readily available to investors in a consistent
presentation.
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\25\ The profile would include disclosure about a fund's
investment objectives, strategies, risks and performance, fees,
investment adviser and portfolio manager, purchase and redemption
procedures, tax implications, and the services available to
shareholders. See Profile Release, supra note .
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Clearer Risk Disclosure
The proposals seek to improve prospectus disclosure about the risks
of investing in a particular fund. Based in large part on comments
received in response to the Risk Concept Release,26 the proposals
would improve risk disclosure as follows:
\26\ The Commission also considered other information about fund
risk disclosure, including the results of an investor survey
sponsored by the ICI. See ICI, Shareholder Assessment of Risk
Disclosure Methods (1996) (``ICI Risk Survey').
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Overall fund risks--A fund would be required to discuss in the
prospectus the overall risks of investing in the fund. The proposed
amendments are designed to minimize the detailed and technical
descriptions of the risks associated with specific portfolio
securities typically included in a fund's prospectus and to elicit
risk disclosure that relates to the particular fund and would be
more useful to investors.
Narrative risk summary--The profile and the prospectus risk/
return summary would include a narrative risk summary. The risk
summary would provide a concise description of a fund's overall
risks that could be used to evaluate and compare the risks of
different funds.
Graphic presentation of risk--The profile and prospectus risk/
return summary would include a bar chart reflecting a fund's returns
over a ten-year period, which would illustrate fund risks by showing
changes in the fund's performance from year to year. To help
investors evaluate a fund's risks and returns relative to ``the
market,'' a table accompanying the bar chart would compare the
fund's performance to that of a broad-based securities market index.
* * * * *
The proposed initiatives are designed to promote more effective
communication of information about funds without reducing the amount of
information available to investors and other interested parties (e.g.,
financial analysts and advisers). The proposals would further
Commission actions to improve prospectus disclosure beginning with the
two-part disclosure format adopted in 1983. Permitting funds to use
profiles would respond to investor support for a concise disclosure
document highlighting key fund information. The profile would
complement the revised prospectus, which, as the primary disclosure
document, would be delivered to all investors that purchase fund
shares. Taken together, these initiatives are intended to better
realize the Commission's commitment to improving disclosure for fund
investors.
II. Discussion
Release Organization. The revised Form would retain the overall
structure of current Form N-1A. To make the proposed requirements of
revised Form N-1A easy to follow and to highlight the proposed changes,
this release addresses revised Items in the order that they would
appear in the Form. While some Items in proposed Part A (the
prospectus) would not be changed (except for technical revisions to
improve clarity), other Items would be new or extensively revised.
Certain disclosure currently required in the prospectus would be moved
to Part B (the SAI), where the information would continue to be
available to investors and others who are interested in the
information.27 The proposed amendments would incorporate certain
disclosure requirements from the Guidelines for Form N-1A (the
``Guides'') and the Generic Comment Letters (``GCLs'') that have been
issued over time by the Division.28
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\27\ In addition, Parts B and C of proposed Form N-1A would
include a number of technical revisions to clarify and simplify the
Form's requirements.
\28\ See Letters to Registrants (Jan. 11, 1990) (``1990 GCL'');
(Jan. 3, 1991) (``1991 GCL''); (Jan. 17, 1992) (``1992 GCL''); (Feb.
22, 1993) (``1993 GCL''); (Feb. 25, 1994) (``1994 GCL''); (Feb. 3,
1995) (``1995 GCL''); (Feb. 16, 1996) (``1996 GCL''). For a
discussion of the Guides and GCLs, see infra notes 255-261 and
accompanying text.
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The proposed amendments also would revise the General Instructions
to Form N-1A to update the Instructions and make them easier to use.
The release discusses in detail the proposed changes to the General
Instructions after discussing changes to the Form's disclosure
requirements.29 The proposed amendments would add several
definitions to the General Instructions to standardize certain terms
used in the Form. In particular, a new definition of ``fund'' would
accommodate the use of Form N-1A by series funds.30 The General
Instructions also would address other matters regarding the use of Form
N-1A, including disclosure relating to multiple funds and classes,
prospectuses used in the defined contribution plan market, and
incorporation by reference.
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\29\ See infra Part II.D.
\30\ Funds often organize as series funds and offer investors an
opportunity to invest in one or more ``portfolios,'' each of which
has a specific investment objective. The revised Form would define a
``fund'' to include both the registrant and a series of the
registrant unless otherwise indicated.
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Plain English. Investment company registration statement forms
currently include instructions, which govern all prospectus disclosure,
directing a fund to provide information in the prospectus in a clear,
concise, understandable manner by, among other things, avoiding the use
of technical or legal terms, complex language, or excessive
detail.31 The Commission's plain English proposals also would
apply to prospectus disclosure.32 Initially, the proposed plain
English principles would apply to the front and back cover pages of a
fund's prospectus and to the summary of the prospectus, if any.33
Because the Commission issued the plain English release before this
release proposing amendments to Form N-1A, the proposed requirement for
plain English risk factors disclosure does not specifically identify
the proposed risk/return summary, which is the parallel type of
disclosure for funds and is not a summary of the prospectus. If the
proposed plain English requirements and the proposed risk/return
summary are adopted, the Commission intends to clarify that plain
English disclosure principles apply to the risk/return summary.34
The Commission also requested comment whether the plain English
disclosure principles should be modified for fund prospectuses.
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\31\ See, e.g., General Instruction G of Form N-1A.
\32\ See Plain English Release, supra note 11.
\33\ Id. (proposing amendments to add new paragraph (d) to rule
421 under the Securities Act (17 CFR 230.421)).
\34\ To improve the clarity of prospectus disclosure, the Plain
English Release also proposed revisions to Regulation S-K (17 CFR
229.10 et seq.), which sets out general disclosure requirements for
corporate issuers. Similar requirements are included in specific
rules for funds, and conforming changes to these rules would be made
in connection with this and other fund disclosure initiatives. See
proposed amendments to rule 481(b)(1) (disclaimer about the
Commission's approval of securities offered in a prospectus), infra
note 31.
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[[Page 10902]]
A. Part A--Information in the Prospectus
1. Item 1--Front and Back Cover Pages
Form N-1A requires certain information to appear on the outside
front cover page of a fund's prospectus. In an effort to ``unclutter''
the prospectus cover page and avoid repeating information contained in
the proposed risk/return summary at the beginning of the prospectus,
the proposed amendments would simplify the disclosure currently
required on the front cover page and require certain information to be
included on the outside back cover page.
The front cover page would be required to include a fund's
name.35 The front cover page also would include the disclaimer
about the Commission's approval of the securities being offered and the
accuracy and adequacy of the information included in the prospectus.
The wording of the disclaimer would be simplified and the disclaimer
would no longer be required to be in large capital letters and bold-
faced type.36
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\35\ When a prospectus relates to one or more series, both the
name of the registrant and the series would be required to appear on
the back cover page. The name of the registrant may assist investors
in obtaining additional information about a particular series or the
registrant.
\36\ Proposed amendments to rule 481(b)(1) under the Securities
Act (17 CFR 230.481(b)(1)). Amended rule 481(b)(1) would require
disclosure to the effect that: The Securities and Exchange
Commission has not approved or disapproved these securities or
passed upon the adequacy of this prospectus and any representation
to the contrary is a criminal offense. The same revisions to Item
501 of Regulation S-K (17 CFR 229.501) were recently proposed for
corporate registrants. See Plain English Release, supra note 11. See
also Disclosure Simplification Task Force Report, supra note 15, at
18.
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The proposed amendments would not require cover page disclosure
that would repeat information required to be disclosed in the proposed
risk/return summary. This information would include the identification
of the type of fund offered (or a brief statement of the fund's
investment objectives) and certain disclosure required for money market
funds.37 The proposed amendments also would no longer require a
fund to provide statements that the prospectus sets forth concise
information about the fund that a prospective investor ought to know
before investing and should be retained for future reference.38
These statements do not appear to be particularly helpful to investors.
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\37\ See infra notes 52-58 and accompanying text.
\38\ See Disclosure Simplification Task Force Report, supra note
15, at 19 (recommending elimination of many legal warnings to make
the cover page more inviting and present any necessary legal
warnings in a more readable style and format). See also Plain
English Release, supra note 11, at 3160.
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The proposed amendments would consolidate disclosure regarding the
availability of additional information about a fund on the back cover
page of the fund's prospectus. The back cover page would include
disclosure about the availability and date of the SAI, which would be
revised to require a telephone number that investors could use to
obtain the SAI without charge. To ensure prompt delivery of the SAI to
those investors who request it, a new Instruction would require a fund
to send the SAI within 3 days of the receipt of a request.39 The
back cover page would include information (if applicable) regarding the
incorporation by reference of a fund's SAI or financial information
from the annual report into the prospectus and disclosure that other
information about the fund has been filed with, and is available from,
the Commission.40 The back cover page also would include
disclosure about how a shareholder can make inquires about the
fund.41
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\39\ See Letter from Paul Schott Stevens, Senior Vice President
and General Counsel, ICI, to Barry P. Barbash, Director, Division of
Investment Management, SEC, at 11 (May 20, 1996) (``ICI Survey
Letter'') (recommending that funds be required to deliver
shareholder reports within 3 days of a request); Form N-2 (17 CFR
274.11a-1) (requiring closed-end investment companies to include a
telephone number for investors to request a SAI and to send the SAI
within 2 days of a request).
\40\ The disclosure would be revised to indicate, among other
things, that information about the fund (including the SAI) is
available on the Commission's Internet Web site. Currently, only
funds that disseminate prospectuses electronically are required to
provide disclosure about the Commission's Web site. See Investment
Company Act Release No. 21946 (May 9, 1996) (61 FR 24652).
\41\ This information currently is required by Item 6(e) to be
disclosed in the prospectus. To assist the Division in responding to
investor inquiries, the proposed amendments would require a fund to
include its Investment Company Act file number on the back cover
page.
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2. Item 2--Risk/Return Summary: Investments, Risks, and Performance
The proposed amendments would require at the beginning of every
prospectus a risk/return summary that would provide key information
about a fund's investment objectives, principal strategies, risks,
performance, and fees. This information would be required to appear in
a specific sequence and to be presented in a question-and-answer
format.42 The proposed question-and-answer format, frequently used
by many funds, is intended to help communicate the required information
effectively. The Commission requests comment on this format and whether
funds instead should be permitted to choose the type of heading for the
prescribed disclosure topics.
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\42\ The information in the risk/return summary would be
substantially the same as the first 4 items of the proposed profile.
See Profile Release, supra note 1.
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The risk/return summary, like the profile, is intended to respond
to investors' strong preference for summary information about a fund in
a standardized format.43 Since the profile would be optional, the
proposed risk/return summary in the prospectus would provide all
investors with key information about a fund in a standardized, easily
accessible place that could be used to evaluate and compare fund
investments.
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\43\ Focus Group participants, for example, expressed strong
support for summary information in a standardized format. In
addition, in connection with the profile initiative, many individual
investors have written to the Commission about the need for concise,
summary information relating to a fund. See also Profile
Prospectuses: An Idea Whose Time Has Come, Mutual Funds Magazine,
Aug. 1996, at 11. In keeping with the goal of providing key
information in a standardized summary, proposed General Instruction
C.2(b) would not permit a fund to include in the risk/return summary
information that is not required or otherwise permitted.
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a. Investment Objectives and Principal Strategies
The proposed amendments would require a fund to disclose in the
risk/return summary its investment objectives and to summarize, based
on the information provided in the prospectus, how the fund intends to
achieve those objectives. The summary would be required to identify the
fund's principal investment strategies, including the particular types
of securities in which the fund invests or will invest principally, and
any policy of the fund to concentrate in an industry or group of
industries.44
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\44\ The criteria for determining whether a particular strategy
is a principal strategy and disclosure about concentration policies
are discussed infra notes--and accompanying text.
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A fund also would be required to inform investors about the
availability of additional information about the fund's investments in
the fund's shareholder reports. Fund annual reports typically include
the MDFP, which discusses a fund's strategies that materially affected
the fund's performance during the most recent fiscal year.45 The
Division's review of and experience with MDFP disclosure indicates that
the annual report may be a valuable resource for investors.46 The
[[Page 10903]]
proposed amendments would require the risk/return summary to contain
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disclosure to the following effect:
\45\ See proposed Item 5 (current Item 5A) (requiring the MDFP
to be disclosed in the prospectus unless disclosed in the annual
report).
\46\ Commenters also have cited the annual report as a source of
valuable information. See Voss Sanders, Dear Shareholder,
Morningstar Mutual Funds, Apr. 26, 1996, at 1 (commenting on
improved annual report disclosure).
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Additional information about the fund's investments is available
in the fund's annual and semi-annual reports to shareholders. In
particular, the fund's annual report discusses the relevant market
conditions and investment strategies used by the fund's investment
adviser that materially affected the fund's performance during the
last fiscal year. You may obtain these reports at no cost by calling
________________.47
\47\ If applicable, a fund could indicate that its annual and
semi-annual reports are available on its Internet site or by E-mail.
In addition, a fund that provides its MDFP in the prospectus or a
money market fund (which is not required to prepare a MDFP) would
omit the second sentence of this disclosure.
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The proposed amendments would require this disclosure to appear in
the context of information about a fund's investments. The Commission
requests comment on this approach. For example, would disclosure about
the availability of additional information about the fund (e.g., the
fund's shareholder reports, SAI, or any other information) be more
helpful to investors if the disclosure was presented under a separate
caption in the risk/return summary or on the back cover page of the
prospectus? Should this disclosure include an explanation about the
various types of information available to investors? 48
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\48\ As proposed, the back cover page of the prospectus would
include more general disclosure about the availability of additional
information.
---------------------------------------------------------------------------
b. Risks
Narrative Risk Disclosure. The proposed amendments would require a
fund to summarize the principal risks of investing in the fund based on
the information provided in the prospectus. More than 75% of the
individual investors commenting on the Risk Concept Release
specifically favored requiring a risk summary in fund prospectuses.
This disclosure would be required to focus on the risks to which the
fund's particular portfolio as a whole is subject and the circumstances
reasonably likely to affect adversely the fund's net asset value,
yield, and total return.49 The risk section of the risk/return
summary also would include disclosure about the risk of losing money
and identify the types of investors for whom the fund may be an
appropriate or inappropriate investment (based on, for example, an
investor's risk tolerance and time horizon).50 A fund, at its
option, could discuss in the risk section the potential rewards of
investing in the fund as long as the discussion provides a balanced
presentation of the fund's risks and rewards.51
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\49\ See infra notes 133-138 and accompanying text. The proposed
amendments also would require a fund to disclose, if applicable,
that it is non-diversified. See section 5(b) of the Investment
Company Act (15 U.S.C. 80a-5(b)) (regarding diversified and non-
diversified funds). To help investors understand this disclosure, a
non-diversified fund would be required to describe the effects and
to summarize the risks of non-diversification.
\50\ Information about whether a fund is appropriate for
particular types of investors is designed to help investors evaluate
and compare funds based on their investment goals and individual
circumstances. In the pilot profiles, this information is presented
under a separate caption relating to the appropriateness of an
investment for certain investors. Because this information is
closely related to the risks of investing in a fund, the proposed
amendments would integrate this disclosure into the risk section of
the risk/return summary.
\51\ The 1996 Profile Letter, in contrast, permits disclosure
about the rewards of investing in a fund only if presented
separately from disclosure about the fund's risks. 1996 Profile
Letter, supra note 16, at 2.
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Special Risk Disclosure Requirements. Certain types of funds are
required to provide special disclosure on the cover page of their
prospectuses. Form N-1A requires a money market fund to disclose on the
cover page of its prospectus that an investment in the fund is neither
insured nor guaranteed by the U.S. Government, and that there can be no
assurance that the fund will be able to maintain a stable net asset
value of $1.00 per share.52 The Form requires a tax-exempt money
market fund that concentrates its investments in a particular state (a
``single state money market fund'') to disclose that the fund may
invest a significant percentage of its assets in a single issuer and
that investing in the fund may be riskier than investing in other types
of money market funds.53 The disclosure required for all money
market funds is intended to alert investors that investing in a money
market fund is not without risk.54 The disclosure required for
single state money market funds seeks to inform investors about the
particular risks associated with a single state money market fund and
to distinguish these funds from other money market funds.55 In
addition, a fund that is advised by or sold through a bank is required
to disclose on the cover page of its prospectus that the fund's shares
are not deposits or obligations of, nor guaranteed or endorsed by, the
bank, and that the shares are not insured by the Federal Deposit
Insurance Corporation (``FDIC'') or any other government agency.56
This disclosure is intended to alert investors that funds advised by or
sold through banks are not federally insured.57
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\52\ Item 1(a)(vi).
\53\ Item 1(a)(vii). This disclosure is not required if the fund
limits its investments in a single issuer to no more than 5% of the
fund's assets.
\54\ See Investment Company Act Release Nos. 17589 (July 17,
1990) (55 FR 30239, 30247) and 18005 (Feb. 20, 1991) (56 FR 8113,
8123) (proposing and adopting revisions to rules relating to money
market funds).
\55\ Unlike other money market funds, a single state money
market fund is not subject to the issuer diversification
requirements of rule 2a-7 (17 CFR 270.2a-7). In March 1996, the
Commission adopted amendments to rule 2a-7 that would require a
single state money market fund, with respect to 75% of its assets,
to invest no more than 5% of its assets in securities of a single
issuer. Investment Company Act Release No. 21837 (Mar. 21, 1996) (61
FR 13956). The Commission has suspended the compliance date for
these amendments pending the adoption of technical changes to
amended rule 2a-7. Investment Company Act Release Nos. 22135 (Aug.
13, 1996) (61 FR 42786) and 22283 (Dec. 10, 1996) (61 FR 66621).
\56\ 1994 GCL, supra note 28, at II.B; Letter to Registrants
from Barbara J. Green, Deputy Director, Division of Investment
Management, SEC (May 13, 1993) (``Division Bank Letter'').
\57\ See Division Bank Letter, supra note 56. See also Testimony
of Ricki Helfer, Chairman, FDIC, on FDIC Survey of Nondeposit
Investment Sales at FDIC-Insured Institutions Before the Subcomm. on
Capital Markets, Securities, and Government Sponsored Enterprises of
the House Comm. on Banking and Financial Services, 104th Cong., 2d
Sess. (June 26, 1996) (citing surveys in October 1995 and April 1996
indicating that approximately one-third of bank customers either
thought that, or did not know whether, funds sold through banks were
insured).
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The proposed amendments would move the required disclosure for all
money market funds, single state money market funds, and funds advised
by or sold through banks to the risk section of the risk/return
summary. Since this disclosure relates directly to a particular fund's
risks, it would appear to be more meaningful to investors when
presented in the context of information about the fund's risks. The
proposed approach also would help streamline the prospectus cover page
and avoid repeating information on the cover page and in the risk
section of the risk/return summary.
The proposed amendments would revise the wording of the current
disclosure required for all money market funds and funds advised by or
sold through banks. The proposed amendments would simplify the
disclosure that fund shares are not federally insured as follows:
An investment in the fund is not insured or guaranteed by the
FDIC or any other government agency.
The proposed amendments also would simplify the technical disclosure
that a money market fund may not be able to maintain a stable net asset
value. The revised disclosure would state:
Although the fund seeks to preserve the value of your investment
at $1.00 per share,
[[Page 10904]]
it is possible to lose money by investing in the fund.58
\58\ The proposed disclosure, which would be required to be
given by a money market fund in place of the proposed general risk
disclosure about losing money, seeks to strike a balance between the
potential to lose money in a money market fund and the relative risk
of losing money in a money market fund as compared to other types of
funds.
---------------------------------------------------------------------------
The Commission requests comment whether the disclosure required for
all money market funds, single state money market funds, and funds
advised by or sold through banks should be moved from the prospectus
cover page to the risk/return summary. If the disclosure is moved from
the cover page, should it be highlighted in a typographically
distinctive manner (e.g., boldface or italics)? The Commission also
requests comment on the wording of the proposed disclosure. In
addition, the Commission requests comment whether the disclosure for
single state money market funds should continue to be required. The
disclosure, for example, may exaggerate the risks of a single state
money market fund since these funds, like all money market funds, may
purchase only those portfolio instruments that meet the credit quality
and maturity requirements of rule 2a-7.59
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\59\ Among other things, rule 2a-7 requires a money market fund
to invest in securities that are rated in one of the two highest
categories by a nationally recognized statistical rating
organization (or, if unrated, to be of comparable quality) and have
a maturity of 13 months or less. Rules 2a-7 (a)(9) and (c)(3).
---------------------------------------------------------------------------
Risk/Return Bar Chart and Table. The proposed amendments would
require a bar chart showing a fund's annual returns for each of the
last 10 calendar years and a table comparing the fund's average annual
returns for the last one, five, and ten fiscal years to those of a
broad-based securities market index.60 The bar chart would
illustrate graphically a fund's past risks by showing changes in the
fund's returns over time. The information in the table would enable
investors to evaluate a fund's performance and risks relative to ``the
market.'' Over 75% of individual investors responding to the Risk
Concept Release favored a bar chart presentation of fund risks.61
Focus Group participants found both a bar chart and tabular
presentation of fund performance helpful in evaluating and comparing
fund investments, particularly when the table included return
information for a broad-based index.
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\60\ Proposed Item 2(c)(2).
\61\ Risk Concept Release, supra note 18. See also ICI Risk
Survey, supra note 26, at 21, 37 (51% of survey participants
indicated they were very confident about using a bar chart to
compare the risks of different funds and 49% of survey participants
indicated they were very confident in using a bar chart to assess
the risks of a single fund). In addition, all commenters responding
to the Commission's initiative to simplify money market fund
prospectuses supported the proposal to replace the financial
highlights information in money market fund prospectuses with a ten-
year bar chart reflecting a money market fund's returns. See Summary
of Comment Letters on Proposed Amendments to the Rules Regulating
Money Market Fund Prospectuses Made in Response to Investment
Company Act Release No. 21216, at 2 (File No. S7-21-95) (``Money
Market Prospectus Comment Summary'').
---------------------------------------------------------------------------
The proposed amendments would require the bar chart and table to be
included in the risk section of the risk/return summary under a
subheading that refers to both risk and performance.62 To help
investors use the information in the bar chart and table, the proposed
amendments would require a fund to explain how the information
illustrates the fund's risks and performance.
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\62\ The 1996 Profile Letter, in contrast, requires the bar
chart and table to appear under a caption relating to a fund's past
performance. 1996 Profile Letter, supra note 16, at 2.
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An example of the risk/return bar chart and table is set forth
below:
BILLING CODE 8010-01-P
[[Page 10905]]
[GRAPHIC] [TIFF OMITTED] TP10MR97.000
BILLING CODE 8010-01-C
[[Page 10906]]
Bar Chart Return Information. 63 The proposed amendments would
require the bar chart to reflect annual returns for a fund's last 10
calendar years. 64 Requiring calendar year returns is intended to
help investors compare the risks of different funds over similar time
periods.
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\63\ Funds generally file Form N-1A electronically on the
Commission's electronic data gathering analysis and retrieval system
(``EDGAR''). Although EDGAR currently does not reproduce graphic
images like the bar chart, the EDGAR rules require a fair and
accurate narrative description or tabular presentation in the place
of any omitted material. Rule 304(a) of Regulation S-T (17 CFR
232.304(a)). The Commission anticipates future modifications that
would permit EDGAR to reflect graphic images on electronically-filed
documents.
\64\ A fund also would be required to present the corresponding
numerical return next to each bar. The proposed amendments would
require a fund to have at least one calendar year of returns before
including the bar chart. A fund that includes a single bar in the
bar chart or a fund that does not include the bar chart because the
fund does not have annual returns for a full calendar year would be
required to modify, as appropriate, the narrative explanation
accompanying the bar chart and table (e.g., by stating that the
information shows the fund's risks and performance by comparing the
fund's performance to a broad measure of market performance). The
proposed amendments would require the bar chart of a fund in
operation for fewer than 10 years to include annual returns for the
life of the fund.
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A fund would calculate the annual returns in the bar chart by using
the same method required for calculating annual returns in the
financial highlights information included in fund prospectuses. 65
Like the returns in the financial highlights information, the returns
in the bar chart would not reflect sales loads. Sales loads can be
accurately and fairly reflected in return information of the type
contained in the table by deducting sales loads at the beginning (or
end) of particular periods from a hypothetical initial fund investment.
66 Reflecting sales loads in the bar chart, however, may be
impracticable. In addition, reflecting the payment of sales loads may
be less important in the bar chart than in the table, since the bar
chart is intended primarily to depict fund risks graphically. The
proposed amendments would require a fund that charges sales loads to
disclose that sales loads are not reflected in the bar chart and that
if the loads were included, returns would be less than those shown.
67
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\65\ Instruction 1(a) to proposed Item 2(c)(2). See also
Instruction 3 to proposed Item 9(a) (regarding the calculation of
total returns provided in financial highlights information).
\66\ As a consequence, the fund's average annual returns in the
table would reflect the payment of sales loads (if any).
\67\ Instruction 1(a) to proposed Item 2(c)(2) (requiring
similar disclosure if a fund charges account fees).
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The Commission requests comment on the proposed bar chart. In
particular, the Commission requests comment whether the bar chart
communicates information about fund risks effectively or whether the
bar chart has limitations that detract from its usefulness. 68 The
Commission requests comment whether the bar chart should include return
information for additional or different time periods. For example,
should the bar chart reflect return information for shorter time
periods (e.g., calendar quarters) or longer time periods (e.g., for the
life of the fund when more than 10 years)? The Commission also requests
comment whether the return information in the bar chart should include
sales loads and, specifically, how sales loads could be accurately and
fairly reflected.
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\68\ See, e.g., Remarks by Steven M.H. Wallman, Commissioner,
SEC, before the ICI's 1995 Investment Company Directors Conference
and New Directors Workshop, Washington, DC. (Sept. 22, 1995)
(discussing circumstances when a bar chart's presentation of fund
risks may be confusing to investors, such as when bar charts use
different scales).
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Bar Chart Presentation for More than One Fund. The proposed
amendments would not limit the number of funds for which return
information could be included in a single bar chart. While the proposed
approach would give funds flexibility in preparing the bar chart,
including return information in a single bar chart for a number of
funds could make the graphic presentation of the bar chart complex and
difficult to follow. 69 Bar charts included in the pilot profiles
reflect information for only one fund. 70 In addition, Focus Group
participants found prototype bar charts that included information for 6
funds (i.e., 6 bars per year) to be confusing. The Commission requests
comment whether the number of funds that could be included in a single
bar chart should be limited to one fund or to some other number of
funds (e.g., 2, 4, or no more than 6 funds). This approach could
enhance the clarity of the bar chart presentation. Limiting the number
of funds that could be included in a single bar chart, however, could
require a prospectus offering several funds to include more than one
chart, which, in turn, could complicate bar chart disclosure and
lengthen the prospectus.
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\69\ While the proposed amendments would not impose a specific
limit on the number of funds included in a bar chart, the
presentation of the bar chart would be subject to the general
requirement that information in the prospectus be set forth in a
clear and understandable manner. See proposed General Instruction
C.1(a).
\70\ See 1995 Profile Letter, supra note 16 (permitting the
pilot profiles to include disclosure for a single fund or series of
a fund).
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Multiple Class Funds. In contrast to the proposed approach with
respect to the bar chart presentation for funds, the proposed
amendments would require a multiple class fund to include annual return
information in the bar chart for only one class. 71 Unlike
individual funds, classes represent interests in the same investment
portfolio, and the returns of each class differ only to the extent the
classes do not have the same expenses. Including return information for
all classes appears to be unnecessary to illustrate the risks of
investing in the fund. In addition, the proposed amendments would
require the table accompanying the bar chart to provide return
information for each class so that investors would be able to identify
and compare the performance of the classes offered in the prospectus.
---------------------------------------------------------------------------
\71\ Instruction 3(a) to proposed Item 2(c)(2).
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The proposed amendments would require the bar chart to reflect
annual return information for the class offered in the prospectus that
has returns for the longest period over the last 10 years. This
approach is intended to provide the greatest amount of information
about changes in the fund's returns. When two or more classes have
returns for at least 10 years or returns for the same period but fewer
than 10 years, the fund would be required to provide annual returns for
the class with the greatest net assets as of the end of the most recent
calendar year. Focusing on the class with the greatest net assets is
intended to provide returns in the bar chart for a ``representative''
class offered in the prospectus.
The proposed requirements may result in including returns in the
bar chart for a class that has lower annual operating expenses (and
better performance) than other classes offered in the prospectus. The
Commission considered several other approaches, including requiring a
fund to show returns in the bar chart for the class with the highest
annual operating expenses. The Commission has not proposed these
alternatives because they would make the bar chart requirements too
complex and difficult to apply. In addition, the bar chart primarily is
designed to show graphically the risks of investing in a fund and not
the costs of investing in the fund. The Commission requests comment
whether the bar chart presentation for multiple class funds should be
limited to one class. If so, should the selection of the class be made
on a basis other than that proposed?
Tabular Presentation of Fund and Index Returns. The proposed
amendments would require the table accompanying the bar chart to
present the fund's average annual returns for the
[[Page 10907]]
last one, five, and ten fiscal years (or for the life of the fund, if
shorter) 72 and to compare that information to the returns of a
broad-based securities market index. 73 Requiring comparative
return information for a broad-based securities market index would
provide investors with a basis for evaluating a fund's performance and
risks relative to the market. 74 The proposed approach also would
be consistent with the line graph presentation of fund performance
required in MDFP disclosure. 75
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\72\ The proposed amendments would require a money market fund
to provide its 7-day yield in the table. A non-money market fund
would be permitted to disclose its yield, and any fund (including a
money market fund) would be permitted to disclose its tax-equivalent
yield. When yield information is disclosed, a fund would be required
to include a telephone number that investors can use without charge
to obtain current yield information.
\73\ A fund's average annual returns would be calculated using
the same method required to calculate fund performance included in
advertisements, which reflects the payment of sales loads and
recurring shareholder account fees. Instruction 2(a) to proposed
Item 2(c)(2) (incorporating the requirements of proposed Item 21).
See also proposed Item 5 (requiring sales loads and recurring
shareholder account fees to be reflected in the return information
shown in the MDFP line graph). Consistent with the preparation of
the MDFP line graph, if a fund has not had the same adviser for the
last 10 years, the fund would be permitted to begin the bar chart
and performance information in the table on the date the new adviser
began to provide advisory services to the fund so long as certain
conditions are met.
\74\ See MDFP Adopting Release, supra note 14, at 19054.
Consistent with the preparation of the MDFP line graph, if a fund
changes indexes, the fund would be required to explain the reasons
for the change and provide information for both the newly selected
and the former index.
\75\ See Instruction 5 to proposed Item 5(b) (defining
``appropriate broad-based securities market index'). See also 1996
Profile Letter, supra note 16, at 3 (permitting a fund, at its
option, to compare its returns to those of an appropriate broad-
based securities market index).
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Consistent with the requirements for preparing the MDFP line graph,
the proposed amendments would allow a fund to include return
information for other indexes, including a ``peer group'' index of
comparable funds. 76 Focus Group participants indicated that
comparing fund returns to a broad-based securities market index and a
peer group index could be useful in evaluating and comparing fund
investments. 77
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\76\ If an additional index is included, the fund would be
required to discuss the additional index in the narrative
explanation accompanying the bar chart and table. Instruction 2(b)
to proposed Item 2(c)(2).
\77\ Other commenters have suggested different ways to provide
comparative return information. See Letter from John C. Bogle,
Chairman of the Board, The Vanguard Group, to Jonathan G. Katz,
Secretary, SEC, at 3 (July 28, 1995) (File No. S7-10-95)
(recommending disclosure of fund and market index returns on a
quarterly basis over a 10-year period); Letter from Daniel Pierce,
Chairman of Board, Scudder, Stevens & Clark, Inc., to Jonathan G.
Katz, Secretary, SEC, at 2 (July 28, 1995) (recommending that a
fund's returns be compared to both a benchmark index (e.g., the S&P
500) and a risk-free measure (e.g., the yield on 3-month U.S.
Treasury bills)); ICI Survey Letter, supra note 39, at 8-9
(recommending that a fund be permitted to show either a broad-based
market index or an appropriate index of fund performance).
---------------------------------------------------------------------------
The Commission believes that a comparison of a fund's performance
to a broad-based securities market index can assist investors in
evaluating the risk of a fund investment. The proposed amendments would
include this information in the table accompanying the bar chart to
minimize the complexity of the graphic presentation of a fund's risks
and returns. The Commission recognizes that other presentations could
improve fund risk disclosure and requests comment on alternative
approaches. 78 Specifically, the Commission requests comment on
requiring the annual returns of a broad-based securities market index
(and any optional peer group or other index) to appear in the bar chart
instead of the table. By providing investors with a graphic
illustration of the relationship between the returns of the fund and
the index(es), this approach could help investors evaluate the
comparative risk of the fund and the index(es). Including additional
bars or lines for index comparisons in the bar chart, however, could
complicate the chart (especially if the chart included return
information for more than one fund) and make it difficult for investors
to follow.
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\78\ Focus Group participants did not express a preference as to
the placement of this information in the bar chart or accompanying
table.
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As an alternative to, or in addition to the bar chart, the
Commission requests comment on requiring a fund to show its highest and
lowest annual returns (or ``range'' of returns) over a ten-year or
other period compared with the same information for a broad-based
market index (and any optional peer group or other index). This
information, which could be presented as a separate table or included
in the proposed table showing a fund's average annual returns, could
help investors assess fund risks.
3. Item 3--Risk/Return Summary: Fee Table
Form N-1A would continue to require a fee table in the prospectus,
which summarizes the sales loads and expenses associated with an
investment in a fund. The fee table seeks to provide uniformity,
simplicity, and comparability in fee disclosure. 79 Consistent
with this objective, the Commission is proposing several amendments
designed to improve fee table disclosure.
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\79\ See Fee Table Adopting Release, supra note 14, at 3194.
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a. Fee Table Example
Form N-1A requires an ``Example'' to accompany the fee table that
discloses the cumulative amount of fund expenses over one, three, five,
and ten year periods based on a hypothetical investment of $1,000 and
an annual 5% return. The Example primarily is intended to provide
information about the cost of investing in one fund that can be
compared with similar information about another fund. 80 Focus
Group participants, however, had difficulty understanding and using the
information in the Example.
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\80\ Id. (also noting that the Example provides information
about the cost of a fund investment).
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The proposed amendments seek to improve the Example by requiring a
fund to provide a specific narrative description that explains the
purpose of the information presented. The revised Form would require a
narrative explanation to the following effect:
This Example is intended to help you compare the cost of
investing in the fund to the cost of investing in other mutual
funds. 81
\81\ Like the current Form, the proposed amendments would
require a fund that charges sales loads on reinvested dividends to
disclose that these loads are not reflected in the Example and that,
if the loads were included, the expenses reflected in the Example
would be higher. Instruction 4(d) to proposed Item 3 would require
this disclosure to follow the Example to avoid informing investors
about what is not included in the Example before they have an
opportunity to review what is included.
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To further assist investors in understanding the Example, the
proposed amendments would revise the description of how the Example is
calculated. 82
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\82\ See proposed Item 3. Instruction 4(a) to proposed Item 3
also would permit a fund to adjust the expenses included in the
Example to reflect the completion of the amortization period for
expenses associated with the initial organization of the fund. See
Money Market Fund Prospectus Release, supra note 14, at 38458
(proposing this change).
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The proposed amendments also would increase the initial
hypothetical investment in the Example from $1,000 to $10,000. The
increase is intended to reflect a typical fund investment (many funds
have minimum investments exceeding $1,000) and more closely approximate
the amount of expenses that may be paid over time. 83 Using the
$10,000 figure in the Example also would be consistent with the $10,000
[[Page 10908]]
hypothetical initial account value used in the MDFP line graph. 84
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\83\ See Letter from John C. Bogle, Chairman of the Board, The
Vanguard Group, to Barry P. Barbash, Director, Division of
Investment Management, SEC (Sept. 16, 1996) (suggesting that few
investors have as little as $1,000 invested in a given fund, and
that the average fund investment typically amounts to $10,000-
25,000, with the median investment probably in the range of $6,000-
7,000).
\84\ See proposed Item 5(b).
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The Commission requests comment on the proposed amendments. The
Commission also requests comment whether the Example communicates
useful information to investors and, specifically, whether the Example
should continue to be required. The Commission requests comment about
other ways to provide information that investors can use to compare the
costs of fund investments.
b. Shareholder Account Fees
Instructions to the fee table require a fund to include, under the
caption ``Other Expenses,'' fees that are charged to all shareholder
accounts. 85 Funds that have account fees (e.g., account
maintenance fees) typically charge these fees as a fixed dollar amount
and disclose the fees in a separate line item to the fee table. 86
Because account fees are paid directly by shareholders and are not fund
operating expenses, the proposed amendments would create a new line
item in the shareholder transaction section of the fee table that would
describe the type of account fees charged by a fund. 87 Like the
fee table requirements applicable to sales loads, the proposed
amendments would require a fund to show the maximum account fee
imposed. 88
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\85\ Instruction 10 to Item 2(a).
\86\ Certain funds charge shareholder account fees as a
percentage of assets invested. A small number of funds charge
account fees based on the fund's average net assets.
\87\ Instruction 2(d) to proposed Item 3. This Instruction would
address when account fees must be included in the fee table. For
example, account fees would be required in the fee table even if a
fund waived the fees for certain shareholders, such as employees of
the fund's investment adviser and investors with large account
balances. In certain circumstances, case-by-case determinations
would continue to be made regarding the inclusion (or exclusion) of
account fees from the fee table based on the number and type of
shareholders subject to the fee and the services provided.
\88\ If an account fee is charged only to accounts that do not
meet a certain threshold (e.g., accounts under $2,500) or if an
account fee is non-recurring (e.g., it is paid to open or close an
account), a fund would be permitted to disclose the threshold or the
type of fee imposed in a parenthetical to the caption or in a
footnote to the fee table.
In computing the expenses shown in the Example, Instruction 4(d)
to proposed Item 3 would allow the allocation of account fees when
they are charged to invest in more than one fund. See Money Market
Fund Prospectus Release, supra note 14, at 38461 (proposing this
change). In addition, a fund that charges account fees based on a
minimum investment requirement would be permitted to prorate its
account fees for purposes of the Example if the fund's minimum
account requirement exceeds $10,000 (the proposed hypothetical
investment). For instance, adjusting an account fee of $100 to $50
would be appropriate to avoid overstating the fee in the Example
when the fund's minimum investment requirement is $20,000.
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c. Improving and Simplifying Fee Table Presentation
Fee Table Narrative. Form N-1A requires a fund to provide a
narrative description following the fee table explaining the purpose of
the table. 89 To help investors use the information presented, the
proposed amendments would require the narrative explanation to appear
before (rather than after) the fee table and to include disclosure to
the following effect:
\89\ Instruction 1 to Item 2(a).
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This table describes the fees and expenses you may pay in
connection with an investment in the fund.
New Fee Table Headings and Captions. The fee table is divided into
two sections: ``Shareholder Transaction Expenses'' and ``Annual Fund
Operating Expenses.'' Captions beneath the two general headings list
the fees that make up transaction and operating expenses. The general
heading for the shareholder transaction section of the fee table refers
to shareholder transaction ``expenses'' and captions underneath this
heading refer to sales ``loads'' and redemption and exchange ``fees.''
The proposed amendments would revise the shareholder transaction
section so that the general heading and captions consistently refer to
``fees.'' As a result of this change, captions relating to sales loads
would refer to ``sales fees.'' Since some investors are familiar with
the term ``load'' and many funds use the term ``no load'' in marketing
materials, however, these captions would include the term ``load'' in
parentheses (e.g., ``Maximum Sales Fee (Load) Imposed on
Purchases').90
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\90\ See ICI Survey Letter, supra note 39 (changing the caption
from ``sales load'' to ``sales charge,'' without using the term
``load').
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The proposed amendments also would revise the caption ``12b-1
Fees,'' which includes any distribution and other expenses a fund pays
under a rule 12b-1 plan.91 The proposed amendments would change
the caption to ``Marketing (12b-1) Fees.'' 92 Retaining the
designation ``12b-1'' would enable investors familiar with rule 12b-1
plans to identify those fees in the fee table. The Commission requests
comment whether another caption (e.g., ``Distribution (12b-1) Fees'')
would be more appropriate.
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\91\ 17 CFR 270.12b-1.
\92\ Focus Group participants indicated that the term
``marketing fees'' would help them understand the expenses included
in the line item.
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To help explain the difference between the fees paid by
shareholders and expenses paid by the fund, the proposed amendments
would require the following parentheticals after each heading:
``Shareholder Fees (fees paid directly from your account)'' and
``Annual Fund Operating Expenses (expenses that are deducted from the
fund's assets).'' 93
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\93\ See ICI Survey Letter, supra note 39 (enclosing a prototype
profile that includes similar explanatory information).
---------------------------------------------------------------------------
Fee Schedules. Instructions to the fee table permit a fund to
include a tabular presentation within the fee table that shows a range
of deferred sales loads over time and a range of exchange fees.94
Since the presentation of a table within the larger fee table tends to
complicate the fee disclosure and may discourage investors from
reviewing the information presented, the proposed amendments would no
longer permit this disclosure in the fee table. Like the current Form,
the proposed amendments would continue to permit a fund to explain the
range of deferred sales loads or exchange fees in a footnote.95
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\94\ Instructions 5 and 7 to Item 2(a).
\95\ Instructions 2(a)(i) and 2(c) to proposed Item 3. The GCLs
require a fund to disclose wire redemption charges in a footnote to
the fee table. 1991 GCL, supra note 28, at II.G. Given the small
amount of these fees (typically $5 to $10 per redemption) and since
these fees are charged only when shareholders elect to receive
redemption proceeds by wire, the proposed amendments would not
require disclosure of wire redemption charges in the fee table. A
fund may include this disclosure in a footnote to the table or
together with other prospectus disclosure regarding redemption
procedures.
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Expense Reimbursement and Fee Waiver Arrangements. Instructions to
the fee table require a fund that has an expense reimbursement or fee
waiver arrangement to reflect the arrangement in the fee table if the
reimbursement or waiver will continue.96 The proposed amendments
would clarify that a fund is required to reflect expense reimbursement
and fee waiver arrangements without regard to whether the arrangement
has been guaranteed for a full fiscal year.97 This approach is
intended to assure that investors are informed about decreases in
expense reimbursement and fee waiver arrangements that could affect the
fund's performance.
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\96\ Instruction 13 to Item 2(a).
\97\ Instruction 3(e) to proposed Item 3. See Money Market Fund
Prospectus Release, supra note 14, at 38458 (proposing this
clarification).
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Other Expenses. Instructions to the fee table permit a fund to
subdivide the line item for ``Other Expenses'' into 3 subcategories of
its own choosing.98 Since some funds identify the fees that make
up this line item by adding a parenthetical following the ``Other
Expenses'' caption, the proposed amendments would permit a fund to
[[Page 10909]]
identify the expenses that comprise this line item either under
separate subcaptions or in a parenthetical following the ``Other
Expenses'' caption.99 When subcaptions are provided, the proposed
amendments would clarify that the subcaptions must identify the 3
largest expenses that comprise ``Other Expenses.''
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\98\ Instruction 10(b) to Item 2(a).
\99\ Instruction 3(c)(iii) to proposed Item 3.
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4. Item 4--Investment Strategies and Risk Disclosure
Prospectus disclosure about fund investments and risks typically
consists of descriptions of each type of security in which a fund may
invest and the risks associated with those securities. The investments
described often include instruments, such as illiquid securities,
repurchase agreements, and options and futures contracts, that do not
have a significant role in achieving a fund's investment objectives.
Disclosing information about each type of security in which a fund
might invest does not appear to help investors evaluate how the fund's
portfolio will be managed or the risks of investing in the fund. This
disclosure also adds substantial length and complexity to fund
prospectuses, contributing to investor perceptions that prospectuses
are too complicated and discouraging investors from reading a fund's
prospectus.100
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\100\ See Money Market Fund Prospectus Release, supra note 14,
at 38456 (giving examples of lengthy and technical disclosure about
portfolio holdings frequently found in money market fund
prospectuses).
---------------------------------------------------------------------------
The Commission believes that prospectus disclosure would be more
useful to investors if it emphasized the principal investment
strategies of a fund and the principal risks of investing in the fund,
rather than the characteristics and risks of each type of instrument in
which the fund may invest.101 Since funds are intended to offer
investors professional investment management,102 the focus of
investment disclosure should be on the fund's investment objectives and
the principal means used by the fund's adviser to achieve those
objectives. Consistent with this view, the proposed amendments seek to
encourage prospectus disclosure that would help investors understand
how a fund's portfolio will be managed. The proposed amendments are
designed to be consistent with, and to implement more effectively, the
Commission's intention in adopting Form N-1A that the prospectus should
describe a fund's ``fundamental characteristics.'' 103
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\101\ The ICI has recommended that prospectus disclosure focus
primarily on a fund's broad investment objectives, practices, and
associated risks, and not on particular types of securities in which
the fund invests. See, e.g., Letter from Paul Schott Stevens,
General Counsel, ICI, to Jonathan G. Katz, Secretary, SEC, at 4-6
(July 28, 1995) (``1995 ICI Risk Comment Letter'); Letter from Amy
B.R. Lancellotta, Associate Counsel, ICI, to C. Gladwyn Goins,
Associate Director, Division of Investment Management, SEC, at 7
(Mar. 7, 1995) (``1995 ICI Disclosure Letter').
\102\ See, e.g., 1 T. Lemke, G. Lins & A.T. Smith III,
Regulation of Investment Companies Sec. 1.01, at 1-1 (1996).
\103\ See Form N-1A Proposing Release, supra note 13, at 815;
Form N-1A Adopting Release, supra note 12, at 39729. See also Money
Market Fund Prospectus Release, supra note 14 (proposing amendments
that would permit money market funds to include in their
prospectuses ``basic, general statements about their investment
objectives and portfolio composition'').
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a. Investment Objectives and Implementation of Investment Objectives
To assist investors in identifying funds that meet their investment
needs, the proposed amendments, like the current Form, would require
prospectus disclosure of a fund's investment objectives.104 The
proposed amendments, however, would change the disclosure requirements
regarding how a fund intends to achieve its investment objectives. Form
N-1A currently requires a fund to disclose the types of securities in
which it invests or will invest principally as well as any ``special
investment practices and techniques'' that will be used in connection
with investing in those securities.105 Form N-1A also requires
disclosure about ``significant investment policies or techniques'' that
a fund intends to use, subject to certain limitations.106
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\104\ Proposed Item 4(a). A fund may refer to its investment
objectives as investment goals. If a fund's investment objectives
can be changed without a shareholder vote, the proposed amendments
would continue to require disclosure of this fact in the prospectus.
Although not required by Form N-1A, some funds disclose in the
prospectus that their investment objectives may not be changed
without a shareholder vote. Since investors generally do not expect
fund investment objectives to change, this disclosure does not
appear to help investors evaluate and compare funds. This disclosure
would be moved to the SAI and proposed Item 12(c)(1)(vii) would
require a fund to disclose when its investment objectives may not be
changed without a shareholder vote.
\105\ Item 4(a)(ii)(B)(1).
\106\ Item 4(a)(ii)(D).
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One of those limitations directs a fund to limit prospectus
disclosure about practices that place no more than 5% of a fund's
assets at risk.107 Many funds disclose in their prospectuses
information about securities and investment practices that do not and
may not ever place more than 5% of a fund's assets at risk, often to
retain the flexibility to exceed the 5% threshold in the
future.108
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\107\ Item 4(b)(ii). Item 4(b)(i) directs a fund not to disclose
so-called ``negative'' practices (i.e., practices in which a fund
may not or does not intend to engage). Instruction 3 to proposed
Item 4(b)(1) would retain this limitation by providing that a
negative strategy is not a principal strategy. Avoiding disclosure
about negative strategies should help keep prospectus disclosure
focused on what the fund will do to achieve its investment
objectives, rather than on what the fund will not do.
\108\ A fund, within a short period of time, may increase its
holdings of a particular type of security from less than 5% of its
assets to more than 5%, which, under the current Form, requires a
different level of disclosure about the security. To avoid having to
amend their prospectuses in response to changes in portfolio
holdings, many funds include information in their prospectuses about
any security or strategy that might at some point place more than 5%
of the fund's assets at risk.
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The proposed amendments would eliminate the 5% standard. Instead,
the revised Form would require a fund to disclose in the prospectus the
principal strategies to be used to achieve its investment objectives,
including the particular type or types of securities in which the fund
will invest principally.109 This approach is designed to shift
prospectus disclosure away from an inventory of the various investments
a fund may make and to focus disclosure on a fund's overall portfolio
management. Whether a particular strategy (including a strategy to
invest in a particular type of security) would constitute a principal
strategy that must be disclosed in the fund's prospectus would depend
upon the strategy's anticipated importance in achieving the fund's
investment objectives and how the strategy affects the fund's potential
risks and returns.110 In determining what is a principal strategy,
a fund would consider, among other things, the amount of assets
expected to be committed to the strategy, the amount of assets expected
to be placed at risk by the strategy, and the likelihood of losing some
or all of those assets.111 The proposed amendments would require
disclosure about non-principal strategies to appear in the SAI.112
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\109\ Proposed Item 4(b)(1). A bond fund, for example, typically
would discuss the maturities, durations, ratings, and issuers of the
bonds in which the fund principally invests.
\110\ Instruction 1 to proposed Item 4(b)(1) would define a
strategy to include any policy, practice, or technique used to
achieve a fund's investment objectives.
\111\ Instruction 2 to proposed Item 4(b)(1).
\112\ Proposed Item 12(b).
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Focusing disclosure requirements on a fund's principal strategies
is intended to improve prospectus disclosure by eliminating the need
for disclosure about securities and strategies that do not have an
important role in achieving the fund's investment objectives. Under the
revised Form, for example, it generally would be unnecessary to include
in the prospectus disclosure about a fund's cash management
[[Page 10910]]
practices (e.g., entering into overnight repurchase agreements) since
these practices are not typically among a fund's principal
strategies.113
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\113\ Similarly, in most cases, a fund would be able to move to
the SAI disclosure about hedging strategies that limit downside
risk, securities lending, purchasing securities on a ``when-issued''
basis, short selling ``against the box'' to defer recognition of
gains or losses, and investing in illiquid or restricted securities,
since these strategies typically are not principal strategies.
---------------------------------------------------------------------------
To further focus prospectus disclosure on a fund's principal
strategies, the proposed amendments would require the prospectus to
explain in general terms how the fund's adviser decides what securities
to buy and sell.114 This disclosure is intended to provide
investors with general information about the fund's investment approach
and how the fund's portfolio will be managed. The information might
describe, for example, whether an equity fund emphasizes value or
growth, or blends the two approaches, or whether the fund invests in
stocks based on a ``top-down'' analysis of economic trends or a
``bottom-up'' analysis that focuses on the financial condition and
competitiveness of individual companies.115
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\114\ Proposed Item 4(b)(2). The prospectus of a value-oriented
fund might state, for example, that the fund's adviser selects
stocks it considers to be undervalued by recognized measures of
economic value such as earnings, cash flow, and book value. A growth
and income fund might state that it invests in the stock of issuers
whose earnings have increased from year to year and issuers that
have paid dividends continuously for a certain period of time.
\115\ Because proposed Item 4(b)(2) would require the prospectus
to explain in general terms how the fund's adviser decides what
securities to buy and sell, a fund (or its adviser) would not be
required to provide proprietary information about its investment
strategies.
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Concentration. Form N-1A requires a fund to disclose in its
prospectus any policy to concentrate (i.e., invest 25% or more of its
total assets) in a particular industry or group of industries. The
proposed amendments would retain this requirement since concentrating
in an industry or group of industries is likely to be a principal
strategy in achieving a fund's investment objectives.116 The
proposed amendments also would continue to require a single state money
market fund to discuss its concentration in securities issued by a
particular state or by issuers located within a state.
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\116\ Proposed Item 4(b)(3).
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Temporary Defensive Positions. Many funds adopt policies permitting
them to take ``temporary defensive positions'' to avoid losses in
response to adverse market, economic, political, or other conditions.
When a fund assumes a temporary defensive position, the fund may depart
from its usual investment strategies without a shareholder vote or
specific notice to shareholders. The GCLs require a fund to disclose,
if applicable, certain information about the possibility of taking
temporary defensive positions.117
---------------------------------------------------------------------------
\117\ 1994 GCL, supra note 28, at II.E.
---------------------------------------------------------------------------
The proposed amendments would continue to require disclosure about
temporary defensive positions to alert investors of potential changes
in a fund's investments.118 In particular, the proposed amendments
would require a fund to disclose the percentage of its assets that may
be committed to temporary defensive positions (e.g., up to 100% of the
fund's assets), the risks, if any, associated with the positions, and
the likely effect of these positions on the fund's performance. The
Commission requests comment on requiring this information given the
temporary nature of defensive positions and the proposed approach of
focusing prospectus disclosure on a fund's principal
strategies.119
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\118\ Proposed Item 4(e). See also Fund Names Release, supra
note 2 (permitting a fund with a name suggesting that the fund
focuses on a particular type of investment to make other investments
while assuming a temporary defensive position).
\119\ In light of these considerations, the revised Form, unlike
the 1994 GCL, supra note 28, would not require a fund to disclose
the types of securities in which it may invest while taking a
temporary defensive position.
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Portfolio Turnover. The Guides require a fund that has had in the
past year, or anticipates having, a portfolio turnover rate of
approximately 100% or more to disclose in the prospectus any tax and
brokerage consequences that will result from the fund's ``high''
portfolio turnover rate.120 The proposed amendments would require
prospectus disclosure only when a fund anticipates having a portfolio
turnover rate of 100% or more in the coming year.121 This approach
is designed to focus prospectus disclosure on a fund's expected
portfolio practices, not past practices.122
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\120\ Guide 5.
\121\ Proposed Item 4(b)(4). A fund that expects its portfolio
turnover rate to be less than 100% would continue to be required to
disclose the anticipated rate of its portfolio turnover in the SAI.
As under the current requirements, a money market fund would not be
required to discuss portfolio turnover in either the prospectus or
the SAI. See MDFP Adopting Release, supra note 14, at 19051 n.3.
\122\ Information about a fund's portfolio turnover rate in
previous fiscal years is disclosed in the financial highlights
table. See proposed Item 9.
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The proposed amendments would require disclosure of the fund's
anticipated portfolio turnover rate and what that rate means (e.g.,
that a portfolio turnover rate of 200% is equivalent to the fund buying
and selling all of the securities in its portfolio twice in the course
of a year).123 Disclosing the anticipated turnover rate and
explaining its meaning are intended to enable investors to evaluate how
actively a fund buys and sells portfolio securities and to compare the
anticipated portfolio turnover rates of different funds.
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\123\ Like any other fund, a ``balanced'' fund would discuss its
anticipated turnover rate with respect to its entire portfolio.
Guide 5, in contrast, requires a balanced fund to discuss portfolio
turnover separately for the stock and bond portions of the fund's
portfolio.
---------------------------------------------------------------------------
The proposed amendments also would require a fund to explain the
tax consequences to shareholders of the fund's high portfolio turnover
rate. In addition, the proposed amendments would require a fund to
explain how trading costs associated with the fund's high portfolio
turnover may affect the fund's performance.
The Commission requests comment on the proposed requirements. In
particular, the Commission requests comment whether a fund with a
portfolio turnover rate of 100% should be viewed as having a high
portfolio turnover rate. An informal review by the Division of fund
portfolio turnover rates suggests that nearly half of all funds have
portfolio turnover rates exceeding 100%. The Commission also requests
comment whether specific information about portfolio turnover should be
required in connection with prospectus disclosure about a fund's
investment strategies. In response to current disclosure requirements,
for example, funds often make generic statements that do not appear to
help investors evaluate and compare fund investments.124
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\124\ Prospectuses, for example, state that high portfolio
turnover rates will likely result in higher transaction costs and
may increase taxable gains.
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Classification and Subclassification. All funds that register on
Form N-1A are classified as management companies and subclassified as
open-end companies under sections 4 and 5 of the Investment Company
Act.125 Funds may be further subclassified as diversified or non-
diversified under section 5. Form N-1A requires a fund to disclose its
classification and subclassifications in the prospectus.126
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\125\ See 15 U.S.C. 80a-4, -5.
\126\ Item 4(a)(i)(B).
---------------------------------------------------------------------------
The proposed amendments would move to the SAI disclosure about a
fund's legal status as an open-end management company.127 This
information is technical and repetitive of information required to be
disclosed in the prospectus. A fund's classification as a management
company is communicated to investors through
[[Page 10911]]
disclosure about the fund's investment adviser and portfolio
management. A fund's open-end status is communicated through disclosure
about the redeemability of the fund's shares.
---------------------------------------------------------------------------
\127\ Proposed Item 12(a).
---------------------------------------------------------------------------
The proposed amendments also would move to the SAI disclosure that
a fund is diversified under section 5. Since most funds are
diversified, this information (which often includes a technical
description of the diversification requirements under the Investment
Company Act) does not appear to provide investors with useful
information about a particular fund. A non-diversified fund would
continue to be required to disclose its non-diversified status in the
prospectus.128 To avoid technical disclosure, the proposed
amendments would require a non-diversified fund to describe the effects
of non-diversification (e.g., by indicating that, compared to
diversified funds, the fund may invest a greater percentage of its
assets in a particular issuer) and to disclose the risks of investing
in the fund.
---------------------------------------------------------------------------
\128\ Proposed Item 4(d).
---------------------------------------------------------------------------
Section 8 Policies. Section 8 requires a fund to disclose in its
registration statement the fund's policies with respect to borrowing
money, issuing senior securities, underwriting securities issued by
other persons, investing in real estate or commodities, and making
loans.129 Most funds do not engage in these practices to a
significant extent, because the Investment Company Act limits their use
by funds.130 Although they are not required to do so, some funds
disclose in the prospectus their policies with respect to the practices
identified under section 8.131 To provide a clearer directive to
disclose this information in the SAI, the proposed amendments
specifically would require disclosure about these policies in the
SAI.132
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\129\ 15 U.S.C. 80a-8. Section 8 also requires a fund to
disclose in the registration statement its policies on concentration
and portfolio turnover, see supra note 121 and accompanying text,
and any other policies that the fund deems fundamental or that may
not be changed without shareholder approval.
\130\ See, e.g., section 18(f) (15 U.S.C. 80a-18(f)) (limiting a
fund's ability to issue senior securities and borrow money); section
12(c) (15 U.S.C. 80a-12(c)) (limiting the underwriting practices of
a diversified fund).
\131\ See Items 4(a)(ii)(C), 4(b); Guides 3, 14.
\132\ Proposed Item 12(c). If a policy specified in section 8 is
a principal strategy, Instruction 4 to proposed Item 4(b)(1) would
require the fund to disclose the policy in the prospectus.
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b. Risk Disclosure
Risk disclosure in fund prospectuses typically consists of
detailed, and often technical, descriptions of the risks associated
with particular securities in which a fund may invest. Just as
disclosure about each type of security in which a fund may invest does
not appear to effectively communicate how the fund's portfolio will be
managed, disclosure about the risks associated with each type of
security in which the fund may invest does not appear to effectively
communicate the overall risks of investing in the fund. Disclosing the
risks of each portfolio investment, rather than the overall risks of
investing in a fund, does not appear to help investors evaluate a
particular fund or compare the risks of different funds.
Consistent with the proposal to shift prospectus disclosure away
from an inventory of the various securities that may be held by a fund,
the proposed amendments would revise Form N-1A to shift prospectus
disclosure away from the risks associated with specific securities. The
revised Form would require a fund to disclose the risks to which the
fund's particular portfolio as a whole is expected to be
subject.133 As part of this disclosure, a fund would be required
to discuss the circumstances that are reasonably likely to affect
adversely the fund's net asset value, yield, or total return.
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\133\ Proposed Item 4(c). See supra note 101. The requirement
that a fund disclose the risks to which its particular portfolio as
a whole is subject is intended to elicit risk disclosure specific to
that fund. In meeting this requirement, a growth fund, for example,
would have to disclose the risks of the growth stocks in which the
fund invests as opposed to describing the general risks of equity
securities.
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The proposed approach is intended to improve fund risk disclosure.
Comments from both individual investors and members of the fund
industry responding to the Risk Concept Release strongly supported
improving narrative discussions of fund risks. In a survey of fund
investors sponsored by the ICI (``ICI Risk Survey''), respondents were
asked to consider various methods that could be used to describe risk
and expressed the greatest overall confidence about using narrative
information.134
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\134\ ICI Risk Survey, supra note 26, at 21, 37.
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The Risk Concept Release requested comment whether quantitative
risk measures, such as standard deviation, beta, and duration, would
help investors evaluate and compare fund risks.135 While more than
half of the individual commenters and some industry members expressed a
desire for some form of quantitative risk information, commenters did
not broadly support any one risk measure. In addition, a number of
commenters strongly opposed requiring disclosure of quantitative risk
information.136 These commenters, among other things, questioned
the value of quantitative risk measures, suggesting that investors have
too wide a range of investment goals and ideas of what ``risk'' means
to be well-served by a single quantitative risk measure.137 The
ICI Risk Survey suggests that investors who use quantitative measures
may not understand the measures well enough to use them for the special
purposes for which they were designed.138
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\135\ Risk Concept Release, supra note 18, at 17176. Standard
deviation measures the volatility of a fund's total return; beta
measures the sensitivity of a fund's total return to the market's
performance; and duration measures the sensitivity of a bond fund's
return to changes in interest rates. Id. at 17174-76.
\136\ See, e.g., 1995 ICI Risk Comment Letter, supra note 101,
at 10-16 (questioning, among other things, the feasibility of
developing a single, all-encompassing measure of fund risks and
whether quantitative information would be understood and accurately
used by fund investors).
\137\ See also P. Bernstein, Against the Gods: The Remarkable
Story of Risk 269-303 (1996) (suggesting it is inaccurate to assume
that investors evaluate investments based on risk and return and
that investors' attitudes towards risk may overrule a decision that
may be appropriate based on quantitative measures).
\138\ ICI Risk Survey, supra note 26, at 14-18 (e.g., 45% of
respondents who had used duration, 44% of those who used standard
deviation, and 23% of those who used beta reported using these
measures to estimate future performance).
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Based on these and other considerations, the Commission is not
proposing at this time to require funds to use quantitative risk
measures. The proposed prospectus risk/return summary and the proposed
amendments to the narrative discussion of risk within the prospectus
are designed to improve fund risk disclosure, without raising the
issues associated with Commission-mandated quantitative information.
The Commission's determination not to require quantitative risk
information is not intended to suggest, however, that this information
is not useful to some investors. Funds that wish to include
quantitative risk disclosure in their prospectuses may continue to do
so.
Item 5--Management's Discussion of Fund Performance
The proposed amendments would continue to require a fund to provide
its MDFP and the related line graph comparing the fund's returns to a
broad-based securities market index in either the prospectus or the
annual report. The Division's review of and experience with MDFP
disclosure indicates that the discussion of fund performance and the
line graph have been successful in providing fund shareholders with
useful, comparative information about a fund's performance. Other than
technical and conforming changes, the proposed amendments would not
modify these disclosure requirements.
[[Page 10912]]
Funds typically include the MDFP in their annual reports, rather
than in their prospectuses, which may be, in part, due to the relevance
of the MDFP to other current financial information appearing in annual
reports. As a result of recent legislation, the Commission has more
flexibility to specify the content of annual reports and to require
additional disclosure in annual and semi-annual reports as necessary or
appropriate in the public interest or for the protection of
investors.139 The Commission is not proposing to modify fund
shareholder report disclosure requirements in this release, but
recognizes that revisions to shareholder report requirements could
further enhance the disclosure provided to fund investors. The Division
currently is evaluating whether funds should be required to include the
MDFP in the annual report. The Division also is considering whether
certain disclosure required by Form N-1A would be more useful to
investors in shareholder reports. An ``integrated'' approach to
registration and reporting requirements could improve the overall
information about a fund available to investors.140 Shareholder
reports, for example, could disclose information about a fund's
investments and operations for a current period (such as information
about the fund's portfolio turnover or the tax consequences of
investing in the fund). Fund prospectuses could disclose more general
information about the fund's intended investments and operations (such
as its investment objectives, anticipated risks, and fees). The
Commission requests comment on specific prospectus disclosure that
could be more appropriately disclosed in a fund's shareholder reports.
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\139\ National Securities Markets Improvement Act of 1996, Pub.
L. No. 104-290 (1996) (the ``1996 Securities Act''), section 206(f)
(amending section 30 of the Investment Company Act (15 U.S.C. 80a-
29)] to add new paragraph (f)).
\140\ In the past, the concept of ``integrated'' disclosure for
funds has addressed eliminating duplicative registration
requirements under the Investment Company Act and the Securities
Act. See Investment Company Act Release No. 10378 (Aug. 28, 1978)
(43 FR 39548) (``Integrated Registration Statement Release'')
(adopting integrated registration statements for funds and closed-
end investment companies by replacing separate registration
statement forms under the Investment Company Act and Securities
Act). New ``integrated'' disclosure initiatives for funds could
expand the concept of integrated disclosure to include an approach
similar to that adopted for corporate issuers, which integrates
registration statement disclosure requirements with periodic
reports. See Securities Act Release Nos. 6235 (Sept. 2, 1980) (45 FR
63693) and 6383 (Mar. 3, 1982) (47 FR 11386) (proposing and adopting
new forms for the offering of securities under the Securities Act).
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Item 6--Management, Organization, and Capital Structure
a. Management and Organization
The proposed amendments would streamline the current disclosure
requirements concerning a fund's management and organization.
Consistent with the intent of Form N-1A to provide investors with
essential information about a fund, the revised Form would require
prospectus disclosure about the fund's investment adviser, the advisory
fee paid by the fund, and the person or persons primarily responsible
for the day-to-day management of the fund's portfolio.141 As in
the current Form, the revised Form would require prospectus disclosure
of fees paid to any sub-adviser.142 The Commission requests
comment whether information about individual sub-advisory fees helps
investors evaluate and compare fund investments or whether this
disclosure obscures the aggregate investment advisory fee associated
with investing in a particular fund. The Commission requests specific
comment whether a fund should be required to disclose only the fund's
aggregate investment advisory fee.
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\141\ Proposed Items 6(a)(1), (2).
\142\ See section 2(a)(20) (15 U.S.C. 80a-2(a)(20)) (defining
``investment adviser'' to include a sub-adviser).
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The revised Form would continue to require prospectus disclosure of
any material pending legal proceedings involving the fund, investment
adviser, or principal underwriter, which would be incorporated in the
management and organization Item because the disclosure is related to
the other management information required to be disclosed.143 The
proposed amendments would modify or move to the SAI other disclosure
requirements relating to the management and organization of a fund
because this information generally is common to all funds and does not
appear to assist an investor in evaluating a particular fund or
comparing different funds.
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\143\ Item 9. The legal proceedings disclosure is intended to be
substantially the same as Item 103 of Regulation S-K under the
Securities Act (17 CFR 229.103) and would be modified to conform to
Item 103. See Investment Company Act Release No. 19155 (Nov. 30,
1992) (57 FR 56862) (modifying Form N-2 to conform to Item 103).
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Board of Directors. Form N-1A requires a fund's prospectus to
include a brief description of the responsibilities of the fund's board
of directors under the applicable laws of the jurisdiction where the
fund is organized.144 The proposed amendments would move this
disclosure to the SAI.145 The responsibilities of fund directors
are governed by the Investment Company Act and state law.146 The
summary, generic disclosure typically provided in fund prospectuses
about the responsibilities of directors does not appear to assist an
investor in deciding whether to invest in a particular fund.
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\144\ Item 5(a).
\145\ Proposed Item 13(a).
\146\ These responsibilities include, among other things: (i)
Evaluating and approving the fund's investment advisory and
principal underwriting contracts (sections 15 (a), (c) (15 U.S.C.
80a-15 (a), (c))) and the use of fund assets to pay for the
distribution of fund shares (rule 12b-1); (ii) selecting the fund's
independent public accountants (section 32(a)(1) (15 U.S.C. 80a-
31(a)(1))); and (iii) reviewing and approving transactions with
affiliates under various rules (e.g., rule 10f-3 (17 CFR 270.10f-3);
rule 17a-7 (17 CFR 270.17a-7); rule 17e-1 (17 CFR 270.17e-1)).
Directors have fiduciary duties to the fund and its shareholders
under section 36(a) of the Investment Company Act (15 U.S.C. 80a-
35(a)) and under state law. See 3 W. Fletcher, Cyclopedia of the Law
of Private Corporations Sec. 838 (rev. perm. ed. 1994); Hanson Trust
PLC v. ML SCM Acquisition, Inc., 781 F.2d 264, 275 (2d Cir. 1986).
See also Burks v. Lasker, 441 U.S. 471 (1979) (upholding the
authority of independent directors to take actions under state law
to the extent not inconsistent with the policies of the Investment
Company Act and the Investment Advisers Act of 1940 (15 U.S.C. 80b-1
et seq.) (the ``Advisers Act')).
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The Commission requests comment whether disclosure in the
prospectus of the names, experience, and compensation of a fund's
directors, along with an address, telephone number, or other means to
contact the directors would be more useful to investors. The Commission
also requests comment whether this information should be given only for
a fund's independent directors, accompanied by disclosure of the number
of independent directors in relation to the number of directors on the
fund's board.147 The Commission requests specific comment whether
information about a fund's directors is essential information that
should be required to be disclosed in the prospectus to assist
investors in deciding whether to invest in a fund. The Commission also
requests specific comment whether information about the compensation
paid to directors warrants prospectus disclosure in light of the
relatively small portion of a fund's total expenses represented by
director compensation.
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\147\ Section 10(a) of the Investment Company Act (15 U.S.C.
80a-10(a)) requires that at least 40% of a fund's board of directors
consist of individuals who are not ``interested persons,'' as
defined in section 2(a)(19) (15 U.S.C. 80a-2(a)(19)).
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Controlling Persons. Form N-1A requires disclosure of the name of
any person that controls the fund's investment adviser and the name of
any person that controls the fund.148 The proposed amendments
would no longer
[[Page 10913]]
require this information in the prospectus. Transactions between
controlling persons and a fund are subject to restrictions under the
Investment Company Act.149 When transactions with controlling
persons are permitted, a fund's board of directors is responsible for
reviewing and approving the arrangements.150 Disclosure about
controlling persons of the investment adviser and the fund would
continue to be available in the SAI.151
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\148\ Items 5(b)(i) and 6(b).
\149\ See, e.g., section 17 (15 U.S.C. 80a-17) and rules 17a-6,
17d-1 (17 CFR 270.17a-6, .17d-1).
\150\ See supra note 146.
\151\ Items 14(a), 15(a)(1). In addition, information about any
person who owns 10% or more of a fund's voting stock is required to
be disclosed in a proxy statement seeking shareholder approval of
the fund's investment adviser, which provides more timely
information about the possibility that a person could influence the
approval of the advisory contract. Item 22(c)(4) of Schedule 14A (17
CFR 240.14a-101) under the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.) (the ``Securities Exchange Act').
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Affiliated Brokers. Form N-1A requires a fund to state, if
applicable, that the fund engages in brokerage transactions with
affiliated persons and allocates brokerage transactions based on the
sale of fund shares.152 The proposed amendments would no longer
require this disclosure in the prospectus. The information called for
by the Form typically results in disclosure that restates applicable
legal requirements.153 This type of generic disclosure does not
appear to assist investors in deciding whether to invest in a
particular fund. Payment of commissions to affiliated brokers is
governed by section 17(e) of the Investment Company Act and rule 17e-1.
In addition, the SAI requires disclosure about affiliated brokers and
how brokers are selected to effect the fund's portfolio
transactions.154
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\152\ Item 5(g).
\153\ Some funds, for example, state that an affiliated broker
may effect portfolio transactions for the fund on an exchange or
board of trade, if the commissions, fees, or other remuneration
received by the affiliated broker are reasonable and fair compared
to the commissions, fees, or other remuneration paid to other
brokers or futures commission merchants in connection with
comparable transactions involving similar securities being purchased
or sold on an exchange or board of trade during a comparable period
of time. With respect to allocation of brokerage transactions, funds
typically disclose that they may consider sales of fund shares as a
factor in selecting brokers to execute portfolio transactions.
\154\ Item 16. The Commission has undertaken initiatives
designed to improve disclosure about fund brokerage transactions by
requiring certain expenses paid by directed brokerage to be treated
as an expense in a fund's financial statements and fee table and by
requiring average commission rates to be disclosed in the financial
highlights information. Investment Company Act Release No. 21221
(July 21, 1995) (60 FR 38918).
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Form of Organization. Form N-1A requires disclosure about a fund's
form of organization (along with the date) and state of
incorporation.155 Since most funds are organized in one of a few
states as corporations or business trusts that seek to provide limited
liability to their shareholders,156 disclosure about a fund's
organization does not appear to help investors evaluate a particular
fund or compare different funds. The proposed amendments would move
this disclosure to the SAI,157 unless a fund is organized outside
the United States and registered under the Investment Company Act
pursuant to section 7(d).158
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\155\ Item 4(a).
\156\ See SEC, Division of Investment Management, Protecting
Investors: A Half Century of Investment Company Regulation,
Investment Company Governance 275 (May 1992) (reporting that in 1991
over 84% of funds were organized as Maryland corporations or
Massachusetts business trusts) (citing Lipper Analytical Services,
The ``Form'' Used by Mutual Funds to Organize State by State (Mar.
1991) (survey prepared for the ICI)).
\157\ Proposed Item 11(a). Information about a fund's operating
history (including information about the lack of an operating
history for a newly organized fund) would continue to be provided in
the bar chart, performance table, and the fee table in the risk/
return summary, and in the financial highlights information.
\158\ 15 U.S.C. 80a-7(d). See proposed Item 6(b).
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Expenses. Form N-1A requires a fund to provide a statement about
its expenses.159 The proposed amendments would no longer require
this disclosure since it duplicates information about the fund's
expenses required in the fee table. Expense information also would
continue to be available in the fund's financial statements and
SAI.160
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\159\ Item 5(f).
\160\ Item 15.
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b. Capital Structure
Form N-1A requires certain information to be disclosed in the
prospectus about a fund's shares and capital structure. The proposed
amendments would reorganize and revise these disclosure requirements
consistent with the intent of Form N-1A to focus prospectus disclosure
on essential information about a particular fund that would assist an
investor in deciding whether to invest in that fund.
Transferability, Material Obligations, and Potential Liabilities.
Form N-1A requires disclosure about any limits on the transferability
of, and material obligations or potential liabilities associated with,
a fund's shares. Funds rarely restrict share transferability and
generally are organized as corporations or business trusts to provide
limited liability to their shareholders. If, however, any restrictions
or special liabilities applied to the purchase of a fund's shares,
information about the restrictions or liabilities would appear to help
an investor decide whether to invest in the fund. As a consequence, the
proposed amendments would continue to require this information in the
prospectus.161 The Commission requests comment on the types and
likelihood of restrictions and liabilities imposed on fund shares and
on what disclosure, if any, should be required.
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\161\ For funds organized as business trusts under Massachusetts
law, prospectuses sometimes include disclosure that, under
Massachusetts law, fund shareholders may, under certain limited
circumstances, be held personally liable as partners for the fund's
obligations. In adopting Form N-1A, the Commission stated that
disclosure of possible contingent shareholder liability under this
form of organization should not be required if a fund believes that,
because of arrangements to protect shareholders, the likelihood of
loss or expense to shareholders is remote. Form N-1A Adopting
Release, supra note 12, at 37933-34. See 3 T. Frankel, The
Regulation of Money Managers 79 (1980) (for funds organized as
Massachusetts business trusts, personal liability generally is
considered remote). The Division's review of fund prospectuses
indicates that certain funds include disclosure about Massachusetts
business trusts and state that shareholder liability is remote.
Funds should continue to evaluate whether this disclosure is
necessary.
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Shareholder Voting Rights. Form N-1A requires a fund to discuss
shareholder voting rights and disclose if the rights of shareholders
can be modified by other than a majority vote.162 Because the
Investment Company Act requires all fund shares to have equal voting
rights 163 and prescribes the vote required for significant
matters,164 voting rights disclosure typically is generic and does
not appear to assist investors in evaluating and comparing funds. The
proposed amendments would move this disclosure to the SAI.165
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\162\ Item 6 (a), (c).
\163\ Section 18(i) (15 U.S.C. 80a-18(i))].
\164\ See, e.g., section 15(a) (approval of investment advisory
contract); section 16(a) (15 U.S.C. 80a-16(a)) (election of
directors); section 13(a) (15 U.S.C. 80a-13(a)) (changes in
fundamental investment policies). See also section 2(a)(42) (15
U.S.C. 80a-2(a)(42)) (defining ``voting security'' and a ``vote of a
majority of the outstanding voting securities'' for purposes of the
Investment Company Act); rules 18f-2, 18f-3 (17 CFR 270.18f-2, -3)
(specifying certain voting rights with respect to series funds and
multiple class funds, respectively).
\165\ Proposed Item 17(a).
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Senior Securities. Form N-1A requires disclosure about any class of
senior securities issued by a fund.166 The proposed amendments
would delete this requirement. Senior securities issued by funds are
limited to borrowings, which are subject to significant legal
restrictions under the Investment Company Act 167 and
[[Page 10914]]
required to be disclosed in a fund's financial statements.168
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\166\ Item 3(b).
\167\ Section 18(f)(1) (requiring, for example, asset coverage
of at least 300% for bank borrowings).
\168\ The financial statement requirements in Regulation S-X
specify that a fund disclose in its balance sheet any amounts
payable to banks and others for borrowings. Rule 6-04 of Regulation
S-X (17 CFR 210.6-04).
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Fund Classes. Form N-1A requires disclosure about ``other classes''
of fund shares (excluding borrowings that are not senior
securities).169 The proposed amendments would delete this
requirement. Funds are not permitted to issue other classes of shares
except for series funds under section 18f-2 and related rule 18f-2, and
multiple class funds under rule 18f-3. When a series or class is
offered in the prospectus, disclosure about the series or class would
be required to be given.
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\169\ Item 6(d).
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7. Item 7--Shareholder Information
Form N-1A requires prospectus disclosure about a fund's purchase
and redemption procedures, dividends and distributions, and the tax
consequences of investing in the fund. While most of these disclosure
requirements would remain substantially the same, the proposed
amendments would make certain revisions, particularly with respect to
tax disclosure, to focus this disclosure on essential information about
a fund.170
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\170\ Information about purchase and redemption procedures
typically takes up a number of pages in fund prospectuses and may
contribute to the perception that prospectuses are too long and
complicated. At the same time, this disclosure (e.g., information on
dividend reinvestment plans, automatic investment programs, and
checkwriting privileges) appears to be included in prospectuses in
response to investor interest in the information.
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a. Purchase and Redemption
Pricing of Fund Shares. Form N-1A requires a fund to explain that
the price of fund shares is based on the fund's net asset value and to
identify the methods used to value the fund's assets.171 The
proposed amendments would no longer require this information in the
prospectus because it does not appear to assist investors in deciding
whether to invest in a particular fund. The pricing of fund shares and
the valuation of portfolio securities are technical, subject to legal
requirements, and disclosed in the SAI.172
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\171\ Item 7(b)(i).
\172\ Item 19(b). A fund's securities are required to be valued
based on market quotations or, in the absence of market quotations,
at fair value as determined by the board of directors. See section
2(a)(41) (15 U.S.C. 80a-2(a)(41)) (defining ``value''). See also
rule 2a-7 (regarding the amortized cost method of valuation for
money market funds).
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The proposed amendments would continue to require a fund to state
when calculations of net asset value are made and that the price at
which a purchase is effected is based on the next calculation of net
asset value after the order is placed. A fund also would continue to be
required to identify in a general manner any national holidays when
shares will not be priced and to identify specifically any additional
local or regional holidays when the fund will be closed.173
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\173\ See Guide 28; proposed Item 7(a)(2). The Instruction to
proposed Item 7(a)(2) would incorporate the disclosure required by
Guide 28 concerning funds with portfolio securities listed on
foreign exchanges that trade on weekends and U.S. holidays. If a
fund does not price on days when foreign securities are traded, the
Instruction would require the fund to disclose in the prospectus
that the net asset value of the fund's shares may change on days
when shareholders cannot purchase or redeem fund shares.
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Although not specifically required, many funds disclose in their
prospectuses how net asset value is determined. Funds, for example,
often disclose that net asset value equals assets minus liabilities
divided by the number of outstanding shares.174 Although this
disclosure tends to be generic because the calculation of net asset
value is the same for all funds, the Commission requests comment
whether disclosure about what constitutes net asset value would be
helpful to investors.
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\174\ See section 2(a)(41) (15 U.S.C. 80a-2(a)(41)) and rule 2a-
4 (17 CFR 270.2a-4).
---------------------------------------------------------------------------
Principal Underwriter. Form N-1A requires a fund to disclose the
name and address of the fund's principal underwriter, and whether any
affiliated person of the principal underwriter is an affiliated person
of the fund.175 This information would be moved to the SAI because
it does not appear to provide investors with essential information that
would assist them in deciding whether to invest in a particular
fund.176 The name and address of the underwriter typically are not
necessary for investors to purchase and redeem a fund's shares.177
The fund's board of directors is responsible for approving the fund's
contract with the principal underwriter. Conflicts of interest that
could influence transactions between a principal underwriter and a fund
are governed by legal protections in the Investment Company
Act.178
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\175\ Item 7(a).
\176\ Proposed Item 15(b).
\177\ Fund investors often effect purchases and redemptions
through financial intermediaries (such as broker-dealers and banks)
without the involvement of the fund's underwriter. When information
about the underwriter is necessary to effect purchase and redemption
requests, a fund would disclose this information in the prospectus
in connection with the description of how to purchase and redeem the
fund's shares.
\178\ See supra note .
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Service Providers. Form N-1A requires a fund to disclose the
identity of any person (other than the investment adviser) who provides
significant administrative or business management services for the fund
(e.g., an administrator), including a description of, and the fees paid
for, the services.179 The Form also requires the name and address
of the fund's transfer agent and dividend paying agent.180 The
proposed amendments would move this disclosure to the SAI.181
While a fund could include in the prospectus information about its
service providers in describing the fund's purchase and redemption
procedures, disclosure about persons that perform administrative or
``back-office'' functions unrelated to the purchase and sale of fund
shares does not appear to assist investors in evaluating and comparing
fund investments. The fund's investment adviser or board of directors
is responsible for overseeing the fund's contractual arrangements with
service providers and their costs to the fund. In addition, the costs
incurred for services provided to the fund are included in the
prospectus fee table and in the fund's financial statements.182
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\179\ Item 5(d).
\180\ Item 5(e).
\181\ Proposed Item 15(h). In addition, Item 5(b)(ii) requires a
statement, if applicable, that the investment adviser is responsible
for overall management of the fund's business. This disclosure would
be provided in the SAI in response to proposed Item 15(c)(1).
\182\ Rule 6-07 of Regulation S-X (17 CFR 210.6-07); Instruction
3(c) to proposed Item 3.
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Account Transfers. The GCLs require certain information about
transfers of shares held in street name accounts.183 This
disclosure would be retained in a simplified form in the prospectus. In
particular, the proposed amendments would require a fund to disclose
any restrictions on, or costs associated with, transferring shares held
in street name to inform investors holding shares in street name about
these restrictions and costs.184
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\183\ 1990 GCL, supra note 28, at II.D.
\184\ Proposed Item 7(b)(7).
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b. Tax Consequences
General Tax Disclosure. Form N-1A requires a fund to describe in
its prospectus the tax consequences of an investment in the
fund.185 Prospectus tax disclosure often includes lengthy
information about the tax treatment of the fund and, in some cases, the
tax treatment of specific securities held by
[[Page 10915]]
a fund.186 This disclosure tends to obscure information about the
tax treatment of a fund's distributions and the direct tax consequences
to investors of investing in the fund.
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\185\ Item 6(g). Form N-1A provides guidance about the tax
disclosure to be provided in the prospectus, indicating, among other
things, that if a fund intends to qualify under Subchapter M of the
Internal Revenue Code (I.R.C. 851 et seq.), the fund should state
that it will distribute all of its net income and gains to
shareholders and that these distributions are taxable.
\186\ Many prospectuses, for example, include information about
the conditions a fund must meet to qualify for pass-through tax
treatment under Subchapter M and, when applicable, the tax treatment
of private activity bonds, foreign currency contracts, and other
fund investments. In addition, tax disclosure frequently includes
technical jargon by referring, for example, to a fund's status as a
``regulated investment company'' and the fund's payment of
``spillback distributions'' and ``net investment income.'' See
proposed General Instruction C.1(a), which would continue to
instruct a fund not to use technical or legal terminology in the
prospectus.
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The proposed amendments would revise the tax disclosure required in
fund prospectuses. In particular, the proposed amendments would require
information about a fund's qualification under Subchapter M of the
Internal Revenue Code to appear in the SAI.187 Subchapter M
confers pass-through tax treatment for funds that meet certain
conditions.188 Disclosure about Subchapter M, which relates to the
tax treatment of the fund, does not appear to help investors evaluate
the tax consequences of investing in the fund. In addition, because
virtually all funds qualify for pass-through tax treatment, disclosure
about the conditions of, or a fund's qualification under, Subchapter M
does not appear to help investors evaluate or compare fund
investments.189
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\187\ Proposed Item 19(a). The proposed amendments would
eliminate the requirement that a fund disclose in the SAI any
special tax consequences resulting from offering more than one class
of capital stock or being a series fund, since the tax consequences
of investing in a multiple class or series fund are no different
from those of investing in a single class or single series. While in
the past a series fund could offset the gains of one portfolio
against the losses of another, a series fund no longer may offset
the gains and losses of its various portfolios. See I.R.C. 851(h)(1)
(treating each portfolio of a series fund as a separate entity for
tax purposes).
\188\ To qualify for pass-through tax treatment under Subchapter
M, a fund must, among other things: derive at least 90% of its gross
income from certain specified sources; derive less than 30% of its
gross income from the sale of securities and certain other specified
investments held for less than 3 months; meet certain
diversification requirements; and distribute at least 90% of its
taxable income (which does not include capital gains) and net tax-
exempt income for the year. See I.R.C. 512(a)(5), 851.
\189\ In the rare case of a fund that does not expect to qualify
for pass-through tax treatment under Subchapter M, proposed Item
7(d)(3) would require the fund to explain in the prospectus the tax
consequences of not qualifying (e.g., by disclosing that income and
gains realized by the fund would be subject to double taxation--that
is, both the fund and shareholders could be subject to tax
liability). This disclosure would distinguish the fund from other
funds and help investors appreciate the tax consequences of
investing in the fund. Similarly, a fund that expects to pay an
excise tax under the Internal Revenue Code with respect to its
distributions would be required to disclose in the prospectus the
consequences of paying the tax. See I.R.C. 4982.
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To focus prospectus disclosure on the tax consequences of investing
in a particular fund, the proposed amendments would require a
description of the tax consequences to shareholders of buying, holding,
exchanging, and selling the fund's shares.190 The proposed
amendments would require a fund to state, as applicable, that the fund
intends to make distributions that may be taxed as ordinary income and
capital gains. If a fund, as a result of its investment objectives or
strategies, expects its distributions primarily to consist of ordinary
income (or short-term capital gains that are taxed as ordinary income)
or long-term capital gains, the fund would be required to provide
disclosure to that effect. Providing specific disclosure about the
anticipated tax consequences of a fund's distributions could help
investors decide whether to invest in a particular fund and to compare
fund investments.191 The proposed amendments also would require a
fund to state that it will provide each shareholder by a specified date
(typically, January 31 of each year) with specific information about
the amount of ordinary income and capital gains, if any, distributed
during the prior calendar year.192
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\190\ Proposed Item 7(d).
\191\ The proposed disclosure requirement would apply to funds
that have investment objectives or strategies that make it possible
to anticipate the tax consequences of the fund's distributions
(e.g., funds described as ``tax-managed,'' ``tax-sensitive,'' or
``tax-advantaged'' often have investment strategies to maximize
long-term capital gains and minimize ordinary income; conversely,
money-market funds have investment objectives and strategies to
maximize ordinary income).
\192\ See Item 6(g)(iii) (consistent with this requirement).
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The proposed amendments would require a fund to disclose that its
distributions will be taxable whether received in cash or reinvested in
additional shares. The proposed amendments also would require a fund
offering exchange privileges to disclose that exchanging shares of one
fund for shares of another fund will be treated as a sale and that any
gain from the transaction may be subject to federal income tax.
Disclosure about the tax treatment of reinvested dividends and share
exchanges would alert investors that reinvested distributions and
exchange transactions are subject to tax.
Special Tax Disclosure for Tax-Exempt Funds. The proposed
amendments would require a tax-exempt fund to inform investors of the
special tax consequences associated with investing in the fund.193
Because investors may be unaware that a portion of the distributions
received from a tax-exempt fund may be subject to federal, state, or
local income taxes, the proposed amendments would require a tax-exempt
fund to disclose, as applicable, that:
\193\ The proposed amendments also would require a tax-exempt
fund to amend the general tax disclosures discussed above to reflect
that the fund intends to distribute tax-exempt income.
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(1) The fund may invest a portion of its assets in securities
that generate income that is not exempt from federal or state income
tax; 194
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\194\ A fund that holds itself out as a tax-exempt fund can
invest up to 20% of its assets in securities that generate taxable
income. See Investment Company Act Release No. 9785 (May 31, 1977)
(42 FR 29130); Guide 1. See also Fund Names Release, supra note .
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(2) Income exempt from federal income tax may be subject to
state and local income tax;
(3) Any capital gains distributed by the fund may be taxable;
and
(4) A portion of the tax-exempt income distributed by the fund
may be treated as a tax preference item for purposes of determining
whether the shareholder is subject to the federal alternative
minimum tax.195
\195\ See Guide 30 (requiring substantially the same
disclosure); Letter from Mary Joan Hoene, Associate Director, SEC,
to Matthew P. Fink, Senior Vice President and General Counsel, ICI
(Nov. 3, 1987) (if a fund uses a name that implies its distributions
will be exempt from federal income tax, it may not consider any
investments in municipal obligations that pay interest subject to
the alternative minimum tax as part of the 80% of the fund's assets
that must be invested in tax-exempt securities).
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Item 8--Distribution Arrangements
a. Placement of Prospectus Disclosure
Rule 12b-1 fees and sales loads directly affect an investor's
return on a fund investment, and information about these charges is
important to many investors. Currently, narrative explanations about a
fund's distribution arrangements may appear in different places in the
prospectus, making it difficult for investors to review and compare
additional information about rule 12b-1 fees and sales loads.196
The proposed amendments would require information about distribution
arrangements to appear together in the prospectus.197 This
approach would help investors locate information designed to assist
them in evaluating a
[[Page 10916]]
particular fund and comparing fund investments.
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\196\ A summary of a fund's fees and expenses, which includes
information about rule 12b-1 fees and sales loads, is contained in
the fee table.
\197\ Proposed General Instruction C.2(a). Proposed Item 8 would
consolidate prospectus disclosure requirements for rule 12b-1 fees,
sales loads, and multiple class and master-feeder funds. Consistent
with the proposed amendments to the fee table requirements, rule
12b-1 fees and sales loads would be referred to as ``marketing (12b-
1) fees'' and ``sales fees (loads)'' in the narrative discussion of
a fund's distribution arrangements in the prospectus.
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b. Rule 12b-1 Plans
Prospectus Disclosure. Form N-1A requires detailed prospectus
disclosure about rule 12b-1 plans.198 The technical nature of this
disclosure tends to obscure information about the amount of fees paid
under a fund's rule 12b-1 plan. Although distribution fees are charged
on an on-going basis in lieu of, or in addition to, sales loads,
investors may not appreciate the continuing nature of distribution fees
or that distribution fees cumulatively could exceed other types of
sales charges.199
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\198\ Item 7(e), (f).
\199\ See Updegrave, Fund Investors Need to Go Back to School,
Money, Feb. 1996, at 98, 100 (of approximately 1,400 investors
surveyed by Money magazine and The Vanguard Funds Group, only 22%
knew that rule 12b-1 fees are charged against fund assets to pay for
distribution of fund shares). Based on information compiled by the
Division from Form N-SAR (17 CFR 274.101) filings, approximately 50%
of funds charge rule 12b-1 fees.
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The proposed amendments would revise disclosure requirements for
rule 12b-1 plans to focus prospectus disclosure on the fees paid under
these plans. Focusing disclosure on fee information, rather than on
technical, legal matters relating to a fund's rule 12b-1 plan, would
appear to provide greater assistance to an investor in deciding whether
to invest in the fund. In particular, the prospectus of a fund with a
rule 12b-1 plan would be required to state the amount of the fee and
provide disclosure to the following effect:
The fund has a rule 12b-1 plan that allows the fund to
pay fees for the sale and distribution of its shares; and
Since these fees are paid out of the fund's assets on
an on-going basis, over time these fees will increase the cost of
your investment and may cost you more than paying other types of
sales loads.
The proposed requirement to disclose that, over time rule 12b-1
fees will increase investment costs and may exceed other types of sales
loads is intended to help an investor appreciate the continuing effect
of rule 12b-1 fees on an investment in a fund. Similar, but more
complex, disclosure is required by rules of the National Association of
Securities Dealers, Inc. (``NASD').200 The proposed amendments
seek to simplify the disclosure so that it may be more readily
understood by investors. The Commission requests comment on the
proposed disclosure and whether the disclosure should appear with the
narrative explanation about rule 12b-1 fees or in connection with the
fee table disclosure of these fees.201
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\200\ Rule 2830(d)(4) of the NASD Conduct Rules (NASD Manual
(CCH) 4624) (requiring a fund with a rule 12b-1 plan to disclose
adjacent to the fee table that ``long-term shareholders may pay more
than the economic equivalent of the maximum front-end sales charges
permitted by (NASD rules)''). Rule 2830(d)(2) of the NASD Conduct
Rules (NASD Manual (CCH) 4623) limits aggregate front-end, deferred,
and asset-based sales charges to 6.25% of total new gross sales for
funds that pay service fees and to 7.25% of total new gross sales
for funds that do not pay service fees. Because these aggregate caps
apply on a fund-wide basis, over time an individual investor may pay
fees exceeding the applicable cap. The NASD disclosure is intended
to address this issue. See Securities Exchange Act Release No. 30897
(July 7, 1992) [57 FR 30985, 30987].
\201\ If the proposed disclosure requirement is adopted, the
Commission intends to discuss with the NASD its disclosure
requirement so that similar disclosure is not required to be
repeated in the prospectus. More generally, the Commission intends
to discuss with the NASD other prospectus disclosure requirements
imposed by NASD rules with the goal of incorporating these
requirements, when appropriate, in applicable Commission rules or
forms. In addition to streamlining disclosure requirements, this
approach would give the Commission an opportunity to reassess NASD
disclosure requirements in light of the Commission's broad
initiatives to improve fund disclosure.
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A fund may pay ``service fees'' alone or combined with fees for the
sale and distribution of its shares.202 If a fund pays service
fees under a rule 12b-1 plan, the fund would reflect the payment of
service fees in its rule 12b-1 disclosure. When service fees are paid
outside of a rule 12b-1 plan, the fund would be required to disclose
the amount and purpose of the fee in connection with information in the
prospectus about any sales loads and rule 12b-1 fees charged by the
fund.
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\202\ See Rule 2830(b)(9) of the NASD Conduct Rules (NASD Manual
(CCH) 4622) (defining ``service fees'' as payments for personal
service and/or the maintenance of shareholder accounts). Rule
2830(d)(5) of the NASD Conduct Rules (NASD Manual (CCH) 4624) limits
service fees to .25% of a fund's average annual net assets. See also
Item 7(e) (requiring prospectus disclosure about the amount or rate
of any trail fees paid out of fund assets to dealers or other
persons that provide investors with advice concerning the purchase,
sale, or holding of fund shares).
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Additional Information. Form N-1A requires a fund with a rule 12b-1
plan to describe the plan briefly and list the principal activities for
which payments under the plan will be made. A fund also must disclose
the relationship between amounts paid to and expenses incurred by the
distributor (i.e., whether the plan reimburses the distributor only for
expenses incurred or compensates the distributor regardless of its
expenses).203 The Form requires additional disclosure if the fund
engages in joint distribution activities with another fund 204 or
if the fund's underwriter has incurred unreimbursed expenses under the
fund's 12b-1 plan.205
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\203\ Guide 29.
\204\ A fund that engages in joint distribution activities must
disclose that its rule 12b-1 fees may be used to finance another
fund's distribution activities and how it allocates costs between
funds.
\205\ A fund must disclose both the amount of unreimbursed
expenses and the amount as a percentage of the fund's net assets,
and indicate whether it is obligated to pay the expenses. In
addition, under Generally Accepted Accounting Principles, the amount
of any unreimbursed expenses under a rule 12b-1 plan is provided in
the fund's financial statements. For a fund that has agreed to pay
unreimbursed expenses if its rule 12b-1 plan is terminated, any
unreimbursed expenses appear as a liability on the fund's financial
statements. See Financial Accounting Standards Board, Statement of
Financial Accounting Standards No. 5 -- Accounting for Contingencies
(Mar. 1975); American Institute of Certified Public Accountants,
Statement of Position 95-3, at 5-8 (July 28, 1995).
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The proposed amendments would move this disclosure to the SAI. The
information adds unnecessary complexity to rule 12b-1 disclosure and,
as a consequence, tends to obscure the amount and purpose of rule 12b-1
fees, which does not appear to help investors evaluate and compare fund
investments.206 Rule 12b-1 establishes requirements for a rule
12b-1 plan. In particular, a fund's board of directors must approve the
rule 12b-1 plan and related fees.207 NASD rules provide additional
protection by limiting rule 12b-1 fees (including the payment of
unreimbursed expenses) to a percentage of the fund's new gross
sales.208
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\206\ Fund prospectuses typically include lengthy and generic
descriptions of rule 12b-1 plans and related distribution
activities. Prospectus disclosure, for example, consists of
statements that distribution fees will be used to compensate broker-
dealers and other financial intermediaries for providing
distribution assistance and administrative, accounting, and other
services to fund shareholders and to promote sales of fund shares
through the printing and distribution of prospectuses, sales
literature, and advertising materials. Some prospectuses include
detailed descriptions of the requirements of rule 12b-1.
\207\ See rule 12b-1(e) (permitting a fund's directors to
implement or continue a rule 12b-1 plan only if they conclude that
there is a reasonable likelihood that the plan will benefit the fund
and its shareholders). See also rule 12b-1(d) (requiring directors
to request and evaluate information reasonably necessary to make an
informed decision about whether to adopt or continue a rule 12b-1
plan); rule 12b-1(a)(3)(ii) (requiring a rule 12b-1 plan to provide
that directors review, at least quarterly, the amount and purposes
of expenditures under the plan).
\208\ See supra note 200. The Commission previously expressed
concerns about the carryover of a large amount of unreimbursed
expenses under a rule 12b-1 plan. Investment Company Act Release No.
16431 (June 13, 1988) (53 FR 23258, 23267) (proposing amendments to
rule 12b-1). These concerns generally have been addressed by the
NASD sales charge rule.
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c. Sales Loads
Form N-1A requires disclosure in the prospectus about the amount of
any sales load charged on an investment in a fund and when a sales load
may be reduced or eliminated (e.g., for larger
[[Page 10917]]
investments).209 The proposed amendments would continue to require
most of this disclosure to appear in the prospectus.210 The
proposed amendments, however, would modify certain requirements that
call for detailed and technical information about sales loads because
the disclosure tends to obscure information about the amount of the
sales load charged by a fund and does not appear to help investors
evaluate and compare fund investments.
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\209\ Item 7(b), (c). See section 22(d) [15 U.S.C. 80a-22(d)]
(prohibiting the sale of fund shares other than at the current
public offering price described in the prospectus) and rule 22d-1
(17 CFR 270.22d-1) (requiring disclosure about sales load
breakpoints and waivers).
\210\ The proposed amendments would clarify that a fund is
required to disclose any sales loads imposed on shares purchased
with reinvested dividends or other distributions. The proposed
amendments also would codify the requirement in Guide 28 to explain
in the prospectus that the term ``offering price'' includes a front-
end load.
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Dealer Reallowances. A fund is required to include a table in the
prospectus showing any front-end load as a percentage of both the
offering price and the net amount invested for each breakpoint, and any
amounts reallowed to dealers as a percentage of the offering price. The
proposed amendments would move disclosure about dealer reallowances to
the SAI 211 because it adds unnecessary complexity to sales load
disclosure and does not appear to provide helpful information to
investors. NASD rules address concerns about financial incentives
brokers may have in recommending that customers buy or hold fund
shares. These rules require a broker who recommends investments to a
customer to have reasonable grounds for believing that the
recommendation is suitable for that customer.212
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\211\ Proposed Item 15(f).
\212\ Rule 2310 of the NASD Conduct Rules (NASD Manual (CCH)
4261). When the Commission proposed amendments to rule 6c-10 (17 CFR
270.6c-10) in 1995, it requested comment whether reallowances to
dealers in connection with deferred sales loads should be disclosed
in fund prospectuses. Investment Company Act Release No. 20917 (Mar.
2, 1995) (60 FR 11890, 11894). In adopting amended rule 6c-10, the
Commission deferred consideration of reallowances because the NASD
is studying dealer compensation practices. Investment Company Act
Release No. 22202 (Sept. 9, 1996) (61 FR 49011, 49016). Consistent
with this approach, the proposed amendments would not revise the SAI
disclosure of dealer reallowances to include deferred sales loads.
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Waivers and Sales Load Breakpoints. Sales loads often are waived
when fund directors and other affiliated persons of the fund (e.g.,
employees of the fund's adviser) purchase the fund's shares. 213
Form N-1A requires a fund to provide information about these
arrangements in the prospectus. The proposed amendments would move this
disclosure to the SAI because the disclosure concerns arrangements that
are not available to the majority of investors and, as a consequence,
adds unnecessary length to fund prospectuses. 214
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\213\ For example, sales loads may be waived for investment
advisory employees who are already knowledgeable about the fund,
which may render marketing and other services unnecessary.
\214\ Proposed Item 13(e).
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The proposed amendments also would move to the SAI disclosure about
sales load breakpoints and waivers in connection with a merger or other
reorganization. 215 This information does not appear to be
important to investors unless and until a reorganization is announced.
Because fund reorganizations generally require shareholder approval,
this information would be provided to investors in proxy materials at a
time when it would be more meaningful to them. 216
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\215\ Proposed Item 18(b).
\216\ Form N-14 under the Securities Act (17 CFR 239.23), which
is used by funds to register securities issued in a merger or other
reorganization and as the proxy statement for the transaction,
requires disclosure about material information concerning the
transaction. See Item 4(a) of Form N-14. See also Item 14(a)(3) of
Schedule 14A under the Securities Exchange Act (requiring the same
information in proxy statements).
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Third-Party Fees. Form N-1A requires a fund to disclose in the
prospectus any fees charged by a bank, broker-dealer or other person in
connection with the purchase of the fund's shares, if the fees are
charged with the fund's knowledge. 217 The proposed amendments
would no longer require this disclosure, since these fees are not
charged by the fund. 218 Investors are informed of (and pay) the
fees as part of their relationship with, and the services provided by,
the third party. 219
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\217\ Item 7(b). Prospectus disclosure is not required if the
fees are ``adequately disclosed'' in a wrapper to the prospectus.
\218\ In some cases, fees charged by a third party, in effect,
represent fees of the fund (e.g., when the fees are charged to all
shareholders to invest in the fund) and would be required to be
disclosed in the prospectus.
\219\ For fee disclosure requirements applicable to banks,
broker-dealers and investment advisers, see Board of Governors of
the Federal Reserve System, FDIC, Office of the Comptroller of the
Currency, and Office of Thrift Supervision, Interagency Statement on
Retail Sales of Nondeposit Products, 6 Fed. Banking L. Rep. (CCH)
para. 70-113, at 82,598 (Feb. 15, 1994); rule 2230 of the NASD
Conduct Rules (NASD Manual (CCH) 4211); rule 204-3(a) under the
Advisers Act (17 CFR 275.204-3(a)) and Item 1 of Form ADV, Part II
(17 CFR 279.1).
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d. Multiple Class and Master-Feeder Funds
Form N-1A requires certain information to be included in the
prospectus about the different distribution and service arrangements of
multiple class and master-feeder funds. 220 Consistent with the
proposed approach for sales loads and rule 12b-1 fees, the proposed
amendments would require this information to appear in one place in the
prospectus. The proposed amendments also would simplify prospectus
disclosure requirements for master-feeder funds by eliminating the
requirement that a feeder fund discuss the possibility and consequences
of no longer investing in the master fund (e.g., if the master fund
changes its investment objectives to be inconsistent with those of the
feeder fund). Since master-feeder arrangements typically are designed
to accommodate feeder funds, the possibility of a feeder fund not
investing in the master fund is likely to be remote. 221
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\220\ General Instruction I; Item 6(h); Guide 34.
\221\ Potential changes in fund operations and investments also
are not unique to a feeder fund. With any fund investment, changes
may occur that significantly affect the nature of the fund. The
interests of all fund shareholders, including those of feeder funds,
are represented by a board of directors. In addition, as with all
shareholders, a feeder fund's shareholders would receive notice of
and have an opportunity to vote on fundamental changes relating to
the master fund's operations and investments.
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Item 9.--Financial Highlights Information
Condensed Financial Information. The financial highlights
information currently required at the beginning of the prospectus
provides summary financial information about a fund, including the
fund's total return for each of the last 10 fiscal years. 222 The
proposed amendments would retain the table, but no longer require this
information to appear at the front of the prospectus. 223
Requiring detailed financial information at the beginning of a fund's
prospectus may unnecessarily impede a fund's ability to present
prospectus disclosure in an effective format.
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\222\ Item 3(a); General Instruction G to Form N-1A.
\223\ Proposed Item 9; proposed General Instruction C.2(a).
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Form N-1A requires a brief explanation of the nature and source of
the information included in the financial highlights table as well as a
statement that the auditor's report is available upon request. To meet
this requirement, funds generally disclose that the table presents
financial information and how shareholders can obtain the auditor's
report. The proposed amendments seek to assist investors in using the
financial highlights information by requiring a narrative explanation
to the following effect:
[[Page 10918]]
The financial highlights table is intended to help you
understand the fund's financial performance for the past 10 years
(or, if shorter, for the period of the fund's operations). Certain
information reflects financial results for a single fund share. The
total returns in the table represent the rate an investor would have
earned [or lost] on an investment in the fund for the period
indicated (assuming reinvestment of all dividends and
distributions). This information has been audited by ________, whose
report, along with the fund's financial statements, is included in
(the SAI or annual report), which is available upon request.
224
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\224\ Since the financial highlights information is required to
be audited for the latest 5 years, the standardized narrative would
continue to refer to the auditor's report and its location.
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The financial highlights disclosure requires performance
information for a partial year to be annualized. The proposed
amendments would require performance information for a period of less
than a year to be stated without annualization. As previously
indicated, the Commission is concerned that annualization of
performance information may result in a performance figure that could
mislead investors. 225
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\225\ See, e.g., Money Market Fund Prospectus Release, supra
note 14, at 38458.
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Apart from certain other technical and conforming changes, the
proposed amendments would not revise the requirements for financial
highlights disclosure. The Commission recognizes, however, that
additional changes may further improve the financial highlights
information, which often takes up a full page or more in the
prospectus. The Commission intends to revisit this disclosure in a
separate rulemaking initiative that would revise fund financial
statement requirements generally and requests specific comment on
simplifying and updating the financial highlights information. In
particular, the Commission requests comment on reducing the number of
captions to simplify the table and decreasing the period for which
information is required from 10 years to 5 years. Because the proposed
amendments would require a bar chart illustrating a fund's returns for
a 10-year period, the Commission requests comment whether the financial
highlights information should be moved to the SAI, eliminated for
certain or all funds, 226 or provided in other disclosure, such as
in a fund's Form N-SAR filings.
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\226\ In connection with the proposal to simplify money market
fund prospectuses, the Commission proposed to replace the financial
highlights table with a 10-year bar graph of fund returns. See Money
Market Fund Prospectus Release, supra note 14, at 38455. The summary
financial information does not appear to be useful for money market
funds because these funds typically do not have changes in net
assets or realized capital gains.
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Calculation of Performance Data. Form N-1A requires a brief
explanation in the prospectus of how the fund calculates performance
data if it includes performance information in advertisements permitted
under rule 482 of the Securities Act. 227 This disclosure was
required because an advertisement under rule 482 is an omitting
prospectus under section 10(b) of the Securities Act and, as an
omitting prospectus, was required to contain information ``the
substance of which'' is contained in the prospectus. The proposed
amendments would eliminate this disclosure requirement. Recent
legislation added section 24(g) to the Investment Company Act, which
authorizes the Commission to adopt rules permitting a fund to use a
summary or omitting prospectus that includes information the substance
of which is not included in the prospectus. 228 In the near
future, the Commission intends to propose to amend rule 482 to
eliminate the ``substance of which'' requirement, which would make the
disclosure of performance data unnecessary. Disclosure about how
performance is calculated does not appear to assist investors in
deciding whether to invest in a particular fund and would continue to
be available in the SAI. 229
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\227\ Item 3(c); 17 CFR 230.482(a).
\228\ See 1996 Securities Act supra note 139, at section 204.
\229\ Proposed Item 21. For a money market fund, SAI disclosure
would include, when applicable, the calculation of the fund's 7-day
tax-equivalent yield and tax-effective yield. See Money Market
Prospectus Release, supra note 14, at 38458.
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Part B--Statement of Additional Information
The SAI provides a more detailed discussion of matters described in
the prospectus as well as additional information about a fund. 230
The proposed amendments would make a number of technical and conforming
revisions to the SAI disclosure requirements to reflect the proposed
changes in the prospectus disclosure requirements. After completion of
the prospectus initiative, the Commission intends to review the SAI
requirements and propose amendments to simplify and update SAI
disclosure.
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\230\ See proposed General Instruction C.1(b) (current General
Instruction G). See also supra notes 39 and 47 accompanying text.
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Part C--Other Information
Part C of Form N-1A contains information in support of a fund's
registration statement that is not included in the prospectus or the
SAI. 231 The proposed amendments would revise Part C to eliminate
unnecessary filing requirements. 232 As amended, Part C would no
longer require a fund to file model retirement plans that are used to
offer the fund's shares 233 because funds routinely offer their
shares in connection with retirement plans and the terms and other
aspects of these plans are governed by the Employee Retirement Income
Security Act of 1974 (``ERISA'') and by the Internal Revenue Code.
234 Amended Part C also would no longer require a fund to file a
schedule showing how it calculates performance data, 235 since
these calculations have become routine and the Commission staff can
verify a fund's performance calculations during a fund
examination.236
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\231\ Items 24 to 32.
\232\ The proposed amendments also would eliminate the
``Instructions as to Summary Prospectuses'' that follow Part C. To
the Commission's knowledge, no fund has used a summary prospectus
under these instructions and the proposed profile would give funds
the flexibility, at their option, to provide a summary disclosure
document to investors. See Profile Release, supra note 1.
\233\ Item 24(b)(14) (also requiring information about the costs
and fees charged under the plans).
\234\ See 29 U.S.C. 1104(c); I.R.C. 401-409. The Commission
adopted this requirement in 1978, when the use of funds as vehicles
for retirement planning was relatively new. Integrated Registration
Statement Release, supra note 140, at 39553, 39557.
\235\ Item 24(b)(16).
\236\ See Money Market Fund Prospectus Release, supra note 14,
at 38458 (proposing to eliminate this requirement). The Commission
required funds to file these calculations in connection with the
standardization of performance information used in fund
advertisements to assure that funds would follow the formula
correctly. Performance Release, supra note 14, at 3876.
The proposed amendments also would eliminate the requirement in
Item 23(b)(3) to file voting trust agreements, because funds are not
permitted to use these agreements under section 20(b) (15 U.S.C.
80a-20(b)). The undertaking required by Item 32(c) relating to the
delivery of a fund's annual reports would be deleted because the
requirement would be incorporated in proposed Item 5.
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Part C requires a newly organized fund to provide an undertaking to
file a post-effective amendment to its registration statement
containing updated financial statements within 4 to 6 months of the
effective date of the registration statement. 237 The purpose of
this requirement is to assure the availability of financial information
reflecting the fund's operations and investment of the fund's assets in
accordance with its investment objectives and strategies. The Division
has provided limited relief with respect to the timing of filing the
updated financial information in two circumstances: (i) When a fund
defers commencement of operations after the
[[Page 10919]]
effective date of its registration statement; and (ii) when the 4 to 6
month period following the effective date of the registration statement
ends near the date of the financial statements to be used in the fund's
next annual or semi-annual report. 238 The proposed amendments
would codify the requirement to file updated financial information.
239 The proposed amendments would permit a fund to file a post-
effective amendment within 4 to 6 months from the date the fund
commences operations. The amendments also would give a fund up to 8
months to file updated financial statements that are included in the
fund's semi-annual or annual report, if the post-effective amendment is
filed within 30 days of the date of the latest balance sheet included
in the annual or semi-annual report. The Commission requests comment
whether the requirement to provide updated financial information should
be retained. In particular, because the financial information may
reflect a fund's operations for a very short period of time, is this
information useful to investors?
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\237\ Item 32(b).
\238\ 1994 GCL, supra note 28, at V.
\239\ Proposed Item 22(a)(2). A conforming change would be made
to rule 485(b)(1)(iv) under the Securities Act (17 CFR
230.485(b)(1)(iv)), which currently includes a reference to the
undertaking required by Item 32(b) of Part C.
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D. General Instructions
1. Reorganizing and Simplifying the Instructions
The General Instructions to Form N-1A provide guidance on the use
and content of the Form. The proposed amendments would update and
reorganize the General Instructions to make the Instructions easier to
use. 240 The revised General Instructions would consist of: (1)
Definitions; (2) Filing and Use of Form N-1A; (3) Preparation of the
Registration Statement; and (4) Incorporation by Reference.
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\240\ Certain information would be deleted as unnecessary (e.g.,
current Instruction H (Electronic Filers) would be deleted since
this Instruction includes only a cross-reference to Item 24(b)(17),
which requires a financial data schedule to accompany an electronic
filing as an exhibit).
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Definitions. Proposed General Instruction A would define certain
terms generally used in Form N-1A. The definitions would provide
greater clarity and avoid repeated references throughout the Form (for
example, to the Investment Company Act). The proposed amendments would
specify that all sections and rules used in Form N-1A refer to sections
and rules under the Investment Company Act, unless otherwise indicated,
and that all terms defined in the Investment Company Act and related
rules have the same meaning in Form N-1A, unless otherwise defined.
The proposed amendments would add several definitions to
standardize certain terms, which would be capitalized throughout the
Form. The term ``Fund'' would be defined as a registrant or a series of
the registrant. 241 General Instruction A also would define
``Registrant'' and ``Series'' and these terms would be used when
information is specifically required for a registrant or a series.
242
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\241\ Form N-1A generally calls for disclosure about the
``Registrant'' (meaning the investment company registered under the
Investment Company Act), although the Form sometimes refers to a
series. Because the Form may be filed for one or more series of a
registered investment company, the current references may cause
confusion about the entity for which disclosure is required.
\242\ General Instruction A would define a ``Master-Feeder
Fund'' and a ``Multiple Class Fund,'' which currently are defined in
Instruction I. The proposed amendments also would define a ``Money
Market Fund'' as a fund that holds itself out as a money market fund
and meets the maturity, quality, and diversification requirements of
rule 2a-7.
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Filing and Use of Form N-1A; Preparation of the Registration
Statement. Proposed General Instruction B would incorporate a more
user-friendly, question-and-answer format regarding the filing and use
of Form N-1A and would replace current Instructions A through D and F.
Proposed General Instruction C would provide streamlined requirements
for preparing the registration statement and would replace Instruction
G. The new Instruction would continue to emphasize the need to provide
clear and concise prospectus disclosure and permit a fund to include in
its prospectus or SAI additional information that is not misleading and
that does not, because of its nature, quantity, or manner of
presentation, obscure the information required to be included.
Instructions to the Form permitting information to be added to the
prospectus and SAI would be deleted, with Instruction C providing this
guidance for purposes of all fund disclosure. 243
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\243\ See, e.g., Item 1(b) (permitting other information to be
included on the cover page of the prospectus). Similarly, specific
Instructions in Part A that call for brief and concise prospectus
disclosure would be deleted, since Instruction C would include this
requirement for purposes of all prospectus disclosure.
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Instruction C also would instruct a fund to avoid referring to the
SAI or shareholder reports in the prospectus, unless specifically
required by the Form. 244 Repeated cross-references to the SAI and
shareholder reports appear to add unnecessary length and complexity to
fund prospectuses and detract from the purpose of prospectus
disclosure, which is to provide essential information that enables fund
investors to make informed investment decisions. Instruction C would
allow cross-references to be used within the prospectus when the cross-
reference would assist investors in understanding the information
presented and would not add complexity to prospectus disclosure. The
Commission requests comment on the proposed approach to cross-
references.
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\244\ See supra notes 39-40, 45, and 224 and accompanying text.
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Instruction C would provide guidance on the use of Form N-1A by
more than one fund and a multiple class fund. Fund prospectuses
frequently contain information for multiple series and classes that
offer investors different investment alternatives and distribution
arrangements. Because this practice was not common in 1983 when Form N-
1A was adopted, certain Form requirements may have the unintended
effect of making prospectus disclosure for multiple funds and classes
more complex than necessary. 245 When information is presented
clearly, prospectuses offering more than one fund may make it easier
for investors to compare funds and may be more efficient for funds and
investors by eliminating the need to provide investors with multiple
prospectuses containing repetitive information. Instruction C generally
would give funds the flexibility to organize information about multiple
funds and classes in an effective manner based on their particular
circumstances as long as the presentation is consistent with the goal
of providing clear and concise information about a fund. 246
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\245\ See John Hancock Funds, Inc. (pub. avail. June 28, 1996).
\246\ A fund, for example, may decide that using a horizontal
rather than vertical presentation for the fee table would provide
the most effective presentation of the required fee information. In
responding to the proposed risk/return summary requirements, a fund
may find that different formats communicate the required information
effectively. Depending on the number and type of funds offered in
the prospectus, for example, a fund may find it useful to group the
required information for all funds together under each caption or to
present the information sequentially for each fund. See id. (using a
two-page disclosure format for each of 7 funds offered in a single
prospectus).
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Instruction C would permit a fund that is offered as an investment
alternative in a participant-directed defined contribution plan
qualified under the Internal Revenue Code (``plan'') to modify its
prospectus for use
[[Page 10920]]
by plan participants.247 Certain prospectus disclosure appears to
be unnecessary for plan participants because of the way plans are
structured and regulated. The requirements of ERISA and the Internal
Revenue Code and the terms of individual plans govern, among other
things, participant investments and plan distributions (including the
tax consequences of distributions).248 A prospectus used to offer
fund shares to plan participants would be permitted to omit the
information required by proposed Items 7 (shareholder information) and
8 (distribution arrangements). The Commission requests comment whether
it would be appropriate to omit or modify other disclosure requirements
for prospectuses provided to plan participants. The Commission also
requests comment whether the flexibility to omit certain disclosure
requirements should be expanded to non-qualified participant-directed
defined contribution plans.249
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\247\ See Profile Release, supra note 1 (permitting a profile to
be modified for use by plan participants).
\248\ See supra note 234.
\249\ E.g., eligible plans under section 457 of the Internal
Revenue Code sponsored by a state, a political subdivision of a
state, or certain nongovernmental tax-exempt organizations.
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Incorporation by Reference. By adopting a two-part disclosure
format for Form N-1A, the Commission intended Part A of the
registration statement to provide investors with a simplified
prospectus that, standing alone, would meet the requirements of section
10(a) of the Securities Act.250 Part B, the SAI (which is
available to investors upon request), includes additional information
that the Commission has determined may be useful to some investors, but
is not necessary in the public interest or for the protection of
investors to be in the prospectus.251 Form N-1A currently permits,
but does not require, a fund to incorporate the SAI by reference into
the prospectus. The two-part disclosure format has been widely used by
funds, and the Commission has found that the current approach to
incorporation by reference supports the intended purpose of Form N-1A
and should be retained.252
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\250\ Form N-1A Adopting Release, supra note 12, at 37930.
\251\ Id. See White v. Melton, 757 F. Supp. 267 (S.D.N.Y. 1991)
(citing the Form N-1A Adopting Release, supra note 12, as authority
for the principle that certain matters are required to appear in the
prospectus and others may be appropriately disclosed in the SAI,
which may be incorporated by reference into the prospectus).
\252\ See Form N-1A Proposing Release, supra note 13, at 818
(suggesting that prohibiting incorporation by reference of the SAI
into the prospectus or, alternatively, requiring delivery of the SAI
with the prospectus, would ``vitiate the Commission's attempt to
provide shorter, simpler prospectuses'').
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Proposed General Instruction D would address incorporation by
reference and replace current Instruction E.