Registration Form Used by Open-End Management Investment Companies
Federal RegisterMar 23, 1998
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SUMMARY: The Securities and Exchange Commission is adopting amendments
to Form N-1A, the form used by mutual funds to register under the
Investment Company Act of 1940 and to offer their shares under the
Securities Act of 1933. The amendments are intended to improve fund
prospectus disclosure and to promote more effective communication of
information about funds to investors. The amendments focus the
disclosure in a fund's prospectus on essential information about the
fund that will assist investors in deciding whether to invest in the
fund. The amendments also minimize prospectus disclosure about
technical, legal, and operational matters that generally are common to
all funds.
DATES:
Effective Date: June 1, 1998.
Compliance Dates:
1. Initial Compliance Date: All new registration statements filed
on or after December 1, 1998 must comply with the amendments to Form N-
1A.
2. Final Compliance Date: All funds with effective registration
statements must comply with the amendments to Form N-1A for post-
effective amendments filed to update their registration statements on
or after December 1, 1998, and no later than December 1, 1999.
FOR FURTHER INFORMATION CONTACT: Kathleen K. Clarke, Assistant
Director, Markian M.W. Melnyk, Deputy Chief, George J. Zornada, Team
Leader, Jonathan F. Cayne, Senior Counsel, John M. Ganley, Senior
Counsel, Doretha M. VanSlyke, Attorney, (202) 942-0721, Office of
Disclosure Regulation, or Anthony A. Vertuno, Senior Special Counsel,
(202) 942-0591, Office of the Associate Director (Legal and
Disclosure), Division of Investment Management, Securities and Exchange
Commission, 450 5th Street, N.W., Mail Stop 5-6, Washington, D.C.
20549-6009. Contact the Office of Chief Counsel, Division of Investment
Management, Securities and Exchange Commission, at (202) 942-0659, 450
5th Street, N.W., Mail Stop 5-6, Washington, D.C. 20549-6009 for
additional information, including interpretive guidance, about this
release or Form N-1A, as amended, and related rules.
SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission
(``Commission'') is adopting 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 adopting technical
amendments to rules 483, 485, 495, and 497 under the Securities Act [17
CFR 230.483, 230.485, 230.495, and 230.497]. In a companion release,
the Commission is adopting new rule 498 [17 CFR 230.498] under the
Securities Act and the Investment Company Act that permits a fund to
provide investors with a new short-form document, called a ``profile,''
which summarizes key information about the fund. If a fund makes a
profile available, an investor would have the option of purchasing the
fund's shares after reviewing the information in the profile or after
requesting and reviewing the fund's prospectus (and other information
about the fund) before making a decision about investing in the fund.
An investor deciding to purchase a fund's shares based on a profile
will receive a copy of the fund's prospectus with the purchase
confirmation.\1\
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\1\ Investment Company Act Release No. 23065 (Mar. 13, 1998)
(``Profile Adopting Release'').
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Table of Contents
I. Introduction and Background
II. Discussion
A. Part A--Information in the Prospectus
1. Risk/Return Summary:Investments, Risks, and Performance (Item
2)
a. Investment Objectives and Principal Strategies
b. Risks
2. Risk/Return Summary: Fee Table (Item 3)
3. Investment Strategies and Risk Disclosure (Item 4)
a. Principal Investment Strategies, Investment Objectives, and
Implementation of Investment Objectives b. Risk Disclosure
4. Management's Discussion of Fund Performance (Item 5)
5. Management, Organization, and Capital Structure (Item 6)
a. Management and Organization
b. Capital Structure
6. Shareholder Information (Item 7)
a. General Purchase and Sale Information
b. Valuation of Fund Shares and Net Asset Value
c. Restrictions on Portability
d. Tax Consequences
7. Distribution Arrangements (Item 8)
8. Financial Highlights Information (Item 9)
9. Front and Back Cover Pages (Item 1)
B. Part B--Statement of Additional Information
C. Part C--Other Information
D. General Instructions
1. Reorganizing and Simplifying the Instructions
2. Plain English Disclosure
3. Disclosure Guidelines
4. Modified Prospectuses for Certain Funds
5. Incorporation By Reference
6. Form N-1A Guidelines and Related Staff Positions
E. Technical Rule Amendments
F. Administration of Form N-1A
G. Coordination with the NASD
H. Effective Dates and Transition Period
III. Cost/Benefit Analysis and Effects on Competition, Efficiency,
and Capital Formation
IV. Paperwork Reduction Act
V. Summary of Final Regulatory Flexibility Analysis
VI. Statutory Authority
Text of Rule and Form Amendments
I. Introduction and Background
Over the last decade, the mutual fund industry has grown enormously
both in total assets and in the number of funds.\2\ Today, fund assets
exceed the deposits of commercial banks.\3\ Coincident with the
explosive growth of fund investments, the business operations of many
funds have become increasingly complex as funds offer 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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\2\ See Investment Company Institute (``ICI''), Mutual Fund Fact
Book 16-23 (37th ed. 1997) (``ICI Fact Book'') and ICI, Trends in
Mutual Fund Investing: September 1997, at 3 (Oct. 30, 1997) (ICI
News No. 97-93) (``ICI Trends'') (between 1990 and 1997, fund assets
increased from $1.1 trillion to $4.4 trillion and the number of
funds increased from 3,105 to 6,666).
\3\ Compare ICI Trends at 1 (fund net assets exceeded $4.4
trillion as of Sept. 1997) with Federal Reserve Bank Statistical
Release H.8: Assets and Liabilities of Commercial Banks in the
United States (Nov. 7, 1997) (commercial bank deposits were
approximately $3.0 trillion as of Oct. 1997).
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Many have criticized fund prospectuses, finding them
unintelligible, tedious, and legalistic.\4\
[[Page 13917]]
Although the prospectus remains the most complete source of information
about a fund, technical and unnecessarily long prospectus disclosure
often obscures important information about a fund investment and does
not serve the informational needs of the majority of fund investors.\5\
The millions of investors who turn to funds as their investment vehicle
of choice \6\ need clear and comprehensible information to help them
evaluate and compare fund investments.
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\4\ See, e.g., The Investment Company Act Amendments of 1995:
Hearings Before the Subcomm. on Telecommunications and Finance of
the House Comm. on Commerce, 104th Cong., 1st Sess. 56, 58 (1995)
(statement of Don Powell, President and CEO of Van Kampen American
Capital, Inc.) (noting the frequent complaint that prospectuses are
too long, cumbersome, and legalistic); J. Bogle, Bogle on Mutual
Funds 147 (1994); Rothchild, The War on Gobbledygook, Time, Oct. 31,
1994, at 51; Savage, SEC Doesn't Want 1987's Painful Lessons
Forgotten, Chicago Sun-Times, Oct. 26, 1997, at 53; Sloan, Selling
Attitude, Newsweek, June 17, 1996, at 52; Skrzycki, Prospectuses to
be in English, Donkeys to Fly Tomorrow, Wash. Post, Oct. 21, 1994,
at B1; ``Taking the Mystery Out of Mutual Funds,'' Remarks by Arthur
Levitt, Chairman, SEC, before the Boston Citizens Seminar, Boston,
MA (Feb. 25, 1997); ``Fulfilling the Promise of Disclosure,''
Remarks by Arthur Levitt, Chairman, SEC, before the American Savings
Education Council, New York, NY (July 23, 1997).
\5\ Levitt, Plain English in Prospectuses, N.Y. St. B. J., Nov.
1997, at 37 (``Levitt Article'') (``[D]isclosure is not disclosure
if it doesn't communicate.''). See also Report on the OCC/SEC Survey
of Mutual Fund Investors 12-13 (June 26, 1996) (although fund
investors surveyed 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); 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).
\6\ U.S. households own 74.2% of the mutual fund industry's
assets. ICI Fact Book, supra note 2, at 35.
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New Disclosure Initiatives
In seeking to improve the quality and usefulness of fund
disclosure, the Commission proposed two major disclosure initiatives on
February 27, 1997.\7\ First, the Commission issued for public comment a
release (the ``Form N-1A Proposing Release'') that proposed significant
amendments to the prospectus disclosure requirements for funds (the
``Proposed Amendments'').\8\ Second, the Commission proposed, in a
companion release, new rule 498 under the Securities Act and the
Investment Company Act that would allow a fund to offer investors the
option to purchase its shares after reviewing the information in the
fund's profile or after requesting and reviewing the fund's prospectus
(and other information about the fund) before making a decision about
investing in the fund.\9\ As proposed, the profile (the ``Proposed
Profile'') would summarize key information about a fund, including the
fund's investment objectives, strategies, risks, performance, and fees.
Under proposed rule 498, a fund would be required to send investors the
fund's prospectus and certain other information within 3 business days
of a request, and any investor purchasing the fund's shares on the
basis of a profile would receive the prospectus with the purchase
confirmation.
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\7\ As part of these disclosure initiatives, the Securities and
Exchange Commission (the ``Commission'') also proposed a new rule
that would address investment company names that are likely to
mislead investors about the investments and risks of an investment
company. Investment Company Act Release No. 22530 (Feb. 27, 1997)
[62 FR 10955], correction [62 FR 24161]. This proposed rule would
require, among other things, funds and other registered investment
companies with names suggesting a specific investment emphasis to
invest at least 80% of their assets in the type of investment
suggested by their name. The Commission received a number of
substantive comments on the proposed rule, many of which asserted
that the proposal had flaws that the Commission should address. The
Commission's Division of Investment Management (the ``Division'') is
analyzing the comments and expects to recommend a final rule for
Commission consideration in the near future.
\8\ Investment Company Act Release No. 22528 (Feb. 27, 1997) [62
FR 10898], correction [62 FR 24160] (``Form N-1A Proposing
Release'').
\9\ See Investment Company Act Release No. 22529 (Feb. 27, 1997)
[62 FR 10943], correction [62 FR 24160] (``Profile Proposing
Release'').
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The Commission's disclosure initiatives were intended to: improve
fund disclosure by requiring prospectuses to focus on information
central to investment decisions; provide new disclosure options for
investors; and enhance the comparability of information about funds.
Taken together, these initiatives are designed to promote more
effective communication of information about funds to investors without
reducing the amount of information provided to investors. The Proposed
Amendments reflected the Commission's strong belief that the primary
purpose of the disclosure in a fund's prospectus is to help an investor
make a decision about investing in the fund.\10\ Consistent with this
belief, the objective of the Proposed Amendments was to provide
investors with prospectus disclosure that presents clear, concise, and
understandable information about an investment in a fund.
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\10\ The Commission is adopting the amendments to Form N-1A
under its authority in section 10(a) of the Securities Act [15
U.S.C. 77j(a)] 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.
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Commenters expressed overwhelming support for the Commission's
disclosure initiatives.\11\ Commenters believed that the Commission's
disclosure initiatives would enhance the quality of disclosure that
funds provide to investors. Some commenters emphasized that improved
disclosure about funds was long overdue and would substantially benefit
investors. In particular, commenters strongly supported the Proposed
Amendments as effective steps toward improving fund prospectuses.
Commenters also provided numerous additional suggestions to improve
prospectus disclosure. The Commission is adopting the initiatives
substantially as proposed.
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\11\ Eighty-seven percent of the commenters supported the
Proposed Amendments. The Commission received 78 comment letters on
the Proposed Amendments, over half of which were from individual
investors (44 letters or 57%). The Commission also received comment
letters from 8 professional and trade associations, 13 fund groups,
4 law firms, 2 broker-dealers/investment advisers, and 7 other
interested organizations. The comment letters, as well as a comment
summary prepared by the Commission's staff, are available for public
inspection and copying at the Commission's Public Reference Room in
File No. S7-10-97. The Commission received 256 comment letters on
the fund profile, a large number of which were from individual
investors (226 letters or 88%). See Profile Adopting Release, supra
note 1.
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Prior Commission Disclosure Initiatives
The amendments to the prospectus disclosure requirements adopted
today are another important step in the Commission's ongoing efforts to
improve disclosure about funds. In 1983, the Commission introduced an
innovative approach to prospectus disclosure by adopting a two-part
disclosure format that permitted a fund to provide investors with a
simplified prospectus containing essential information about the fund
and to place more detailed information in a companion document called
the ``Statement of Additional Information'' (``SAI''), which investors
could obtain upon request.\12\ The Commission intended that, under this
format, a fund's prospectus would include essential information about
the fund that would be most useful to typical or average investors in
making an investment decision about the fund. The Commission
contemplated that more detailed discussions of matters geared to the
needs of more sophisticated investors would be available in the SAI,
which all fund 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
[[Page 13918]]
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] (``1983 Form N-1A Adopting Release'').
\13\ Investment Company Act Release No. 12927 (Dec. 27, 1982)
[48 FR 813, 814] (``1982 Form N-1A Proposing Release'').
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Since 1983, the Commission has implemented a number of other
initiatives to improve fund prospectus disclosure, including a uniform
fee table \14\ and a requirement that a fund's management discuss the
fund's performance over the past year in its prospectus or annual
report to shareholders (the management's discussion of fund performance
(``MDFP'')).\15\ While these changes have provided investors with clear
and helpful information about fund expenses and performance, they were
not intended to address the overall effectiveness of Form N-1A's
prospectus disclosure requirements. The Proposed Amendments and Form N-
1A, as amended, reflect the Commission's view that current prospectus
disclosure must be considered on a comprehensive basis to ensure that
the prospectus, as a whole, meets the information needs of investors.
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\14\ See Item 3 of current Form N-1A; Investment Company Act
Release No. 16244 (Feb. 1, 1988) [53 FR 3192] (``Fee Table Adopting
Release'').
\15\ Item 5A of current Form N-1A; Investment Company Act
Release No. 19382 (Apr. 6, 1993) [58 FR 19050] (``MDFP Adopting
Release'').
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Reassessment of Fund Disclosure
The Commission's recent efforts to improve disclosure began with an
evaluation of the use of a standardized, summary disclosure document
that highlights key information about a fund. The Commission, with the
cooperation of the Investment Company Institute (``ICI'') and several
large fund groups, conducted a pilot program permitting funds to use
profile-like summaries (``Pilot Profiles'') together with their
prospectuses.\16\ The program's purpose was to determine whether
investors found the Pilot Profiles, which summarize important
information about a fund, helpful in making investment decisions. Focus
groups conducted on the Commission's behalf, and fund investors
participating in a survey sponsored by the ICI, responded very
positively to the profile concept.\17\
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\16\ See Investment Company Institute (pub. avail. July 31,
1995) (``1995 Profile Letter''); Investment Company Institute (pub.
avail. July 29, 1996) (``1996 Profile Letter''). The Division
permitted the pilot program to continue pending the adoption of
proposed rule 498. Investment Company Institute (pub. avail. July
16, 1997) (``1997 Profile Letter''). After the effective date of new
rule 498, a fund could continue to use a Pilot Profile as
supplemental sales literature. See Profile Adopting Release, supra
note 1.
\17\ See ICI Profile Survey, supra note 5, at 31-32.
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In considering fund disclosure issues, the Commission also has
evaluated over 3,700 letters submitted in response to a release
requesting comment on ways to improve risk disclosure in fund
prospectuses, as well as the comparability of fund risk levels (``Risk
Concept Release'').\18\ The commenters, mostly individual investors,
confirmed the importance of risk disclosure in evaluating and comparing
funds and emphasized 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\ See Investment Company Act Release No. 20974 (Mar. 29,
1995) [60 FR 17172] (``Risk Concept Release'').
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Plain English Initiatives
The fund disclosure initiatives being adopted today are part of the
Commission's broad undertaking to bring sweeping revisions to
prospectus disclosure for all public companies.\19\ As part of its
commitment to make all prospectuses simpler, clearer, and more useful,
and to eliminate jargon and boilerplate, the Commission recently
adopted rule amendments to require the use of plain English principles
in drafting prospectuses and to provide other guidance on improving the
readability of prospectuses.\20\ The Commission's plain English
principles reflect fundamentals of clear communication and contemplate
disclosure documents that:
\19\ See Levitt Article, supra note 5, at 36.
\20\ Rule 421 under the Securities Act [17 CFR 230.421]. See
Securities Act Release No. 7497 (Jan. 28, 1998) [63 FR 6370]
(``Plain English Release'') and discussion infra Section II.D.2. As
part of the plain English initiatives, the Commission plans to issue
A Handbook on Plain English: How to Create Clear SEC Disclosure
Documents, prepared by the Commission's Office of Investor Education
and Assistance.
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--Present information in an easily readable format;
--Use everyday language that investors can easily understand; and
--Eliminate repetition of disclosure that lengthens a document and
overwhelms the investor.
Improved Fund Disclosure
As one commenter on the disclosure initiatives pointed out, the
Commission's proposals reflect an unprecedented number and variety of
public comments and expert views, the results of Commission and other
research, and broad investor input. The Commission agrees with the
commenter's further observation that the Commission has never had a
more detailed, comprehensive, and compelling basis for a rulemaking
than that developed for the fund disclosure initiatives. Through focus
groups and written comments on the initiatives, investors have
confirmed that they concur strongly with the Commission's view that
fund disclosure documents will be useful only if they communicate
information effectively. The Commission has designed both the fund
prospectus and profile initiatives to meet this goal. The amendments to
Form N-1A seek to make the prospectus, which will remain a fund's
primary disclosure document, a more effective tool by focusing its
contents on information that is essential to an investment in the fund.
The profile responds to investors' strongly expressed desire for a new,
concise disclosure document that summarizes key fund information and
helps investors evaluate and compare funds more easily.
To encourage the use of disclosure that communicates effectively,
the Commission's fund disclosure initiatives include a number of
important innovations:
--The initiatives provide for a standardized risk/return summary at the
beginning of every fund prospectus and in the profile that: \21\
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\21\ These improvements are based in large part on comments
received in response to the Risk Concept Release. See Risk Concept
Release, supra note 18. 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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--Concisely summarizes information in a specific sequence about a
fund's investment objectives, strategies, risks and performance, and
fees;
--Discusses the risks of a fund's portfolio taken as a whole and
minimizes detailed and technical descriptions of the risks associated
with specific portfolio securities potentially held by the fund; and
--Provides a graphic presentation of a fund's annual returns over a 10-
year period in a bar chart that illustrates the variability of the
fund's returns and gives investors some idea of the risks of an
investment in the fund. To help investors evaluate a fund's risks and
returns relative to ``the market,'' a table accompanying the bar chart
compares the fund's average annual returns for 1, 5, and 10 years with
that of a broad-based securities market index.
--The initiatives require a fund to prepare disclosure documents using
plain English disclosure, which is designed to give investors
[[Page 13919]]
understandable disclosure documents.
--The initiatives eliminate prospectus clutter that obscures other
information helpful to investors when making a decision about an
investment in a fund. Specifically, the amendments to prospectus
disclosure requirements:
--Move certain disclosure about fund organization and legal
requirements from the prospectus to the SAI;
--Permit a fund that is offered as an investment alternative in a
participant-directed defined contribution plan (or certain other tax-
advantaged arrangements) to tailor its prospectus for the plan (or
other arrangement);
--Update and incorporate certain staff interpretive positions into Form
N-1A; \22\ and
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\22\ The amendments contemplate further that the Division will
consolidate its interpretive positions under the Investment Company
Act relating to, among other things, fund operations in a new
``Investment Company Registration Guide'' (``Registration Guide'').
The Registration Guide is discussed infra Section II.D.6. Form N-1A,
as amended, incorporates certain staff disclosure requirements to
identify those requirements that would apply to all funds regardless
of their particular circumstances. Among other things, this approach
addresses 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.
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--Simplify current disclosure instructions to provide clearer guidance
for preparing and filing fund registration statements.
Disclosure Principles
The Commission believes that, in revising Form N-1A and in
providing for the use of profiles, it has laid the foundation for the
development of fund disclosure documents of a significantly higher
quality than those often used today, which have drawn the consistent
criticism of fund investors and others. If the initiatives are to have
their intended effect, however, all those who participate in the
preparation and review of those documents--funds, their legal counsels
and other advisors, the Commission and its staff, and other regulators
and their staffs--should act consistently with the basic disclosure
principles that serve as the cornerstones of the initiatives. These
principles, which are referred to throughout this release, include the
following:
--Funds should design disclosure documents, particularly their
prospectuses, first and foremost, to communicate information to
investors effectively. Funds should present information in prospectuses
following the principles of plain English, using language that is
concise, straightforward, and easy to understand.
--A fund's prospectus principally should include essential information
about the fundamental characteristics of, and risks of investing in,
the fund. Whenever possible, a fund should present this information in
a manner that:
--Assists investors in comparing and contrasting the fund with other
funds;
--Avoids simply restating legal or regulatory requirements to which
funds generally are subject; and
--Avoids a disproportionate emphasis on possible investments or
activities of the fund that are not a significant part of the fund's
investment operations.
--Funds should limit disclosure in prospectuses generally to
information that is necessary for an average or typical investor to
make an investment decision. Detailed or highly technical discussions,
as well as information that may be helpful to more sophisticated
investors, dilute the effect of necessary prospectus disclosure and
should be placed in the SAI.
--Prospectus disclosure requirements should not lead to lengthy
disclosure that discourages investors from reading the prospectus or
obscures essential information about an investment in a fund.
The Commission has instructed its staff to use these principles
consistently in administering the requirements of both amended Form N-
1A and new rule 498 and strongly encourages all other participants in
the development of fund disclosure documents to apply these principles
in preparing their prospectuses and profiles.\23\
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\23\ The Commission expects that these disclosure principles
also will provide useful guidance in resolving disclosure issues
relating to funds under the federal securities laws as these issues
arise from time to time. See discussion of administration of Form N-
1A, infra Section II.F.
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II. Discussion
A. Part A--Information in the Prospectus
Form N-1A, as amended, retains the overall structure of current
Form N-1A. The most significant changes to Form N-1A adopted today are
the new risk/return summary at the beginning of the prospectus and
improved disclosure about the risks of investing in a fund. This
release first addresses these changes and then discusses other changes
to substantive prospectus disclosure requirements in Part A of Form N-
1A.\24\ Following this discussion, the release describes revisions to
requirements for information on the front and back cover pages of the
prospectus, the General Instructions to Form N-1A, which have been
updated and revised to make them easier to use, and other technical
revisions to Form N-1A's requirements.\25\
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\24\ A chart in Appendix A to this release compares the revised
Items in Form N-1A, as amended, to the current Items in Form N-1A.
\25\ Form N-1A, as amended, incorporates certain disclosure
requirements from the Guidelines to current Form N-1A (the
``Guides'') and the Generic Comment Letters (``GCLs'') that have
been issued over time by the Division. 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 the GCLs, see
infra notes 209-215 and accompanying text.
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1. Risk/Return Summary: Investments, Risks, and Performance (Item 2)
The Commission proposed to require a risk/return summary at the
beginning of every prospectus that would provide key information about
a fund's investment objectives, principal strategies, risks,
performance, and fees. The risk/return summary, also included in the
Proposed Profile, was intended to respond to investors' strong
preference for summary information about the fund in a standardized
format.\26\ The proposed risk/return summary in a fund's prospectus
would provide investors with a type of ``executive summary'' of key
information about the fund in a standardized, easily accessible place
that investors could use to evaluate and compare the fund to others,
regardless of whether the fund uses a profile.
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\26\ Participants in focus groups conducted on the Commission's
behalf (``Focus Groups''), for example, expressed strong support for
summary information in a standardized format. Many individuals in
commenting on the profile initiative have confirmed the need for
concise, summary information relating to a fund. See also Joe Six-
Pack: Public Favors Profile Plan, Fund Action, Oct. 1997, at 9;
Profile Prospectuses: An Idea Whose Time Has Come, Mutual Funds
Magazine, Aug. 1996, at 11.
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While most commenters supported the proposed risk/return summary,
several questioned whether it was necessary in a prospectus. These
commenters argued that the summary could repeat other information in
the prospectus and that it would undermine the Commission's goal of
making prospectus disclosure clear and concise.
The Commission is of the view that the prospectus risk/return
summary will not undermine, but further, the goal of making
prospectuses more useful for investors. The Commission believes that
[[Page 13920]]
the disclosure in the risk/return summary need not generally repeat
other information in the prospectus; much of the summary consists of
information that Form N-1A would not require to be disclosed elsewhere
in the prospectus, such as the bar chart, performance table, and fee
table. The Commission has concluded that the possibility that the risk/
return summary could repeat some information appearing elsewhere in the
prospectus is outweighed by the benefits of providing investors with
standardized and comparable fund information at the beginning of every
prospectus and in the profile. Thus, the Commission is adopting the
requirement that every prospectus and profile contain a risk/return
summary.\27\
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\27\ Items 2 and 3. Consistent with the goal of providing key
information in a standardized summary, General Instruction C.3(b) to
Form N-1A, as amended, precludes a fund from including information
in the prospectus risk/return summary that is not required or
otherwise permitted by Items 2 and 3. Form N-1A, as amended, does
not require a fund to include any risk disclosure elsewhere in the
prospectus if the requirements of Item 4 of Form N-1A are met by the
disclosure in the fund's risk/return summary (i.e., if a fund is
able to describe its risks, as required by Item 4, in its risk/
return summary, the fund would not need to describe those risks
elsewhere in its prospectus).
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The Commission proposed to require that the risk/return information
in the prospectus, like that in the Proposed Profile, appear in a
specific sequence and in a question-and-answer format. Many commenters
objected to the question-and-answer format, stating, among other
things, that rigid adherence to the format would not necessarily result
in effective communication of information to investors.\28\ To allow
funds to design effective disclosure documents, the Commission has
determined not to require this format in the prospectus or the profile.
Any fund that chose to do so could use a question-and-answer format in
its prospectus, profile, or in both documents.
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\28\ See Profile Adopting Release, supra note 1 (discussing
commenters' critiques of the question-and-answer format).
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a. Investment Objectives and Principal Strategies. The Proposed
Amendments would require a fund to disclose its investment objectives
in the risk/return summary and to summarize, based on the information
provided in its prospectus, how the fund intends to achieve those
objectives. The purpose of the proposed disclosure was to provide a
summary of the fund's principal investment strategies, including the
specific types of securities in which the fund principally invests or
will invest, and any policy of the fund to concentrate its investments
in an industry or group of industries.\29\ The Commission is adopting
this requirement as proposed.\30\
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\29\ See infra notes 91-101 and accompanying text (discussing
the criteria for determining whether a particular strategy is a
principal strategy and disclosure about concentration policies).
\30\ Items 2 (a) and (b).
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The information contained in the risk/return summary about a fund's
investment objectives and principal strategies is intended to meet the
needs of an average or typical fund investor. Recognizing that
disclosure about a fund's specific portfolio holdings may be important
to some investors, the Proposed Amendments would require a fund to
inform investors in its prospectus risk/return summary that additional
information about the fund's investments is available in the fund's
shareholder reports.\31\ While supporting the proposed disclosure, most
commenters suggested placing statements about how investors can obtain
a fund's SAI, shareholder reports, and other information about the fund
on the back cover page of the prospectus. According to these
commenters, this disclosure would be easier for investors to find if it
were located in one place rather than in different places in the
prospectus. The Commission agrees with the commenters that typical fund
investors may find a single reference to the availability of additional
information helpful. Therefore, Form N-1A, as amended, requires all
disclosure about the availability of additional information to appear
on the back cover page of the prospectus.\32\ The Commission is
adopting the disclosure as proposed, with minor adjustments to the
language to ensure that the disclosure clearly explains the
availability of additional information about a fund to a typical
investor.\33\
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\31\ The Commission proposed that the prospectus risk summary
refer to fund shareholder reports. A fund's reports to its
shareholders typically contain a discussion by the fund's management
of the fund's performance (``MDFP''). The Commission believes that
the information in a fund's MDFP, including the discussion of the
fund's performance during its most recent fiscal year, could be
useful to some investors considering an investment in the fund.
The Proposed Amendments would require the risk/return summary to
provide disclosure to the following effect:
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
____________________.
\32\ Item 1(b). Rule 498, as adopted, requires this disclosure
to appear in the profile risk/return summary. See Profile Adopting
Release, supra note 1.
\33\ The Commission has made a few revisions to the disclosure
about the availability of additional information to make it clearer
and more understandable for investors. Item 1(b)(1) of Form N-1A, as
amended, requires a fund (other than a new fund) to include
disclosure to the following effect on the back cover page of its
prospectus:
Additional information about the fund's investments is available
in the fund's annual and semi-annual reports to shareholders. In the
fund's annual report, you will find a discussion of the market
conditions and investment strategies that significantly affected the
fund's performance during its last fiscal year.
---------------------------------------------------------------------------
b. Risks. Summary Risk Disclosure. The Proposed Amendments would
require the risk/return summary to include a discussion of the
principal risks of investing in a fund that summarizes information
about those risks set out in the fund's prospectus. Reflecting the
Commission's proposed new approach to risk disclosure, this discussion
was intended to summarize the risks of a fund's anticipated portfolio
holdings as a whole, and the circumstances reasonably likely to affect
adversely the fund's net asset value, yield, and total return.
Commenters generally supported the summary risk disclosure contemplated
by the Proposed Amendments, agreeing that it would be specific and
brief and would assist investors in identifying the principal risks of
investing in a particular fund. The Commission is adopting this
disclosure requirement with modifications to reflect certain
commenters' suggestions.\34\
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\34\ Item 2(c).
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Several commenters asked the Commission to clarify the scope of the
proposed summary risk disclosure, arguing that the requirement would
not serve its purpose if the risk disclosure simply repeated
information from other sections of the prospectus. In the Commission's
view, the purpose of the summary risk disclosure in a fund's prospectus
is to identify briefly the principal risks of investing in the
particular fund and to emphasize those risks reasonably likely to
affect the fund's performance. In light of this purpose, the Commission
expects a fund, in meeting this requirement, to present only a succinct
summary of the principal risks of investing in the fund and not to
repeat the fuller discussion of these risks required elsewhere in the
prospectus.\35\ On the other hand, the Commission believes that it
generally would be inconsistent with the summary risk requirement for a
fund to include a ``laundry list'' of generic risk factors that may
apply to any fund and
[[Page 13921]]
that does not identify the risks of investing in the fund.
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\35\ See discussion of risk disclosure, infra Section II.A.3.b.
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The Commission proposed to require that the prospectus risk summary
identify the types of investors for whom the fund may be an appropriate
or inappropriate investment.\36\ Commenters either opposed or raised
significant concerns about this provision, arguing that it could be
viewed as requiring a fund to determine whether its shares, among other
things, are a suitable investment for a particular investor.\37\
Commenters also stated that the disclosure would tend to be generic and
not meaningful or useful for investors.
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\36\ As discussed in the Form N-1A Proposing Release, supra note
8, at 10902, the purpose of this disclosure was to help investors
evaluate and compare funds based on their investment goals and
individual circumstances.
\37\ As several commenters pointed out, applicable regulatory
rules for brokers and other investment professionals require that
these determinations be made on the basis of a review of information
about the unique circumstances of an individual investor. See, e.g.,
rule 2310(a) of the National Association of Securities Dealers, Inc.
(``NASD'') Conduct Rules, NASD Manual (CCH) 4261 (suitability of
recommendations to customers) and rule 405 of the New York Stock
Exchange, 2 N.Y.S.E. Guide (CCH) para.2403 (the ``know your
customer'' rule).
---------------------------------------------------------------------------
The Commission is persuaded by commenters that disclosure about the
appropriateness of funds for particular investors should not be
required in all fund prospectuses and has deleted this requirement from
the prospectus risk summary. The Commission believes, however, that
disclosure indicating whether a fund is appropriate for specific types
of investors or is consistent with certain investment goals, even if
generic in nature, may be useful for some investors and may provide a
means for the fund to distinguish itself from other investment
alternatives.\38\ Therefore, Form N-1A, as amended, permits, but does
not require, a fund to include disclosure in the narrative risk summary
about the types of investors for whom the fund is intended or the types
of investment goals that may be consistent with an investment in the
fund.\39\
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\38\ In a recent review of fund prospectuses, the Division found
many examples of this type of disclosure, which was usually included
in a fund's discussion of the risks associated with an investment in
the fund. For example, one fund disclosed that it was not an
appropriate investment for investors seeking either preservation of
capital or high current income or for those investors unable to
assume the increased risks of higher price volatility and currency
fluctuations associated with investments in international equities
traded in non-U.S. currencies. Another fund urged investors to
remember that the fund was an aggressive capital appreciation fund
designed for long-term investors for a portion of their investments
and was not designed for investors seeking income or conservation of
capital. Tax-exempt funds frequently stated that an investment in
the fund is not appropriate for Individual Retirement Accounts or
other tax-advantaged accounts.
\39\ Instruction to Item 2(c)(1)(i).
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Under the Proposed Amendments, a fund could choose to discuss the
potential rewards of investing in the fund in the risk summary as long
as the discussion provided a balanced presentation of the fund's risks
and rewards. One commenter strongly questioned this provision of the
proposal, asserting that it would detract from a clear presentation of
risks in the risk summary. The Commission has reconsidered this
disclosure in light of the intended standardized and summary nature of
the risk summary and has concluded that the disclosure should focus
solely on the risks of investing in a fund. Thus, the Commission has
determined to eliminate the option to describe the rewards of investing
in a fund in the risk summary. A fund desiring to add this disclosure
elsewhere in its prospectus can do so subject to Form N-1A's general
rule with respect to information that is not required to be in a
prospectus. Under this general rule, a fund can disclose this
information, so long as it is not incomplete or misleading and would
not obscure or impede understanding of the information that is required
to be in the prospectus.\40\
---------------------------------------------------------------------------
\40\ See General Instruction C.3(b).
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Special Risk Disclosure Requirements. The Proposed Amendments were
intended to simplify the prospectus cover page and to avoid repeating
information on the cover page and in the risk summary discussion. In
seeking to meet this goal, the Commission proposed to move certain
cover page disclosure requirements relating to the risks associated
with specific types of funds to the risk summary where, the Commission
believed, it would be more meaningful to investors.
Form N-1A currently requires that each money market fund \41\
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. This required disclosure is
intended to alert investors that investing in a money market fund is
not without risk.\42\ In addition to moving this disclosure to the risk
summary, the Proposed Amendments would simplify the technical
disclosure that a money market fund may not be able to maintain a
stable net asset value.\43\ Commenters supported the proposed
disclosure for money market funds, and the Commission is adopting it as
proposed.\44\
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\41\ For these purposes, a money market fund is defined as a
fund that holds itself out to investors as a money market fund and
meets the conditions of paragraphs (c)(2), (c)(3), and (c)(4) of
rule 2a-7 under the Investment Company Act [17 CFR 270.2a-7].
General Instruction A.
\42\ 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 rule 2a-7 for money
market funds).
\43\ The Proposed Amendments would require the following
disclosure:
An investment in the Fund is not insured or guaranteed by the
Federal Deposit Insurance Corporation or any other government
agency. Although the Fund seeks to preserve the value of your
investment at $1.00 per share, it is possible to lose money by
investing in the Fund.
\44\ Item 2(c)(1)(ii).
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Form N-1A currently requires specific prospectus cover page
disclosure for a tax-exempt money market fund that concentrates its
investments in a particular state (a ``single state money market
fund''). Each such fund is required to disclose that it 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. This disclosure was intended to make investors
aware of special risks that could be associated with an investment in a
single state money market fund.\45\ In the Form N-1A Proposing Release,
the Commission asked whether it should continue to require this
disclosure in prospectuses. The Commission noted that this disclosure
may exaggerate the risk of investing in a single state money market
fund. As the Form N-1A Proposing Release pointed out, although these
funds are subject to less stringent issuer diversification provisions
under Commission rules than other money market funds, they are subject
to credit quality and maturity investment restrictions that are
comparable to other money market funds.\46\
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\45\ Form N-1A currently does not require this disclosure if,
with respect to 100% of its assets, a fund limits its investments in
a single issuer to no more than 5% of its assets.
\46\ See Form N-1A Proposing Release, supra note 8, at 10904.
Under rule 2a-7, a ``national'' tax-exempt money market fund
generally is limited to investing no more than 5% of its assets in
the securities of a single issuer. For a single state money market
fund, the 5% single issuer limitation applies with respect to 75% of
the fund's assets. This limitation recognizes that single state
money market funds concentrate their investments in debt securities
issued by a single state (or issuers located within that state),
making diversification more difficult to achieve. See Investment
Company Act Release Nos. 21837 (Mar. 21, 1996) [61 FR 13956] and
22921 (Dec. 2, 1997) [62 FR 64968].
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In response to the Commission's question regarding single state
money market funds, commenters indicated that the special disclosure
now required
[[Page 13922]]
on the cover page of fund prospectuses overstates the risks of
investing in single state money market funds, particularly in view of
the minimal risk that commenters asserted is associated with these
funds. The Commission is persuaded by these comments and has determined
not to require the disclosure in Form N-1A.
Form N-1A currently requires a fund that is advised by or sold
through a bank 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.\47\ This disclosure is intended to alert investors
that funds advised by or sold through banks are not federally
insured.\48\ The Commission proposed to move this disclosure to the
prospectus risk summary and to simplify the wording of the current
disclosure required for funds advised by or sold through banks.\49\
Commenters supported the revised disclosure requirements for bank-sold
funds, and the Commission is adopting them substantially as
proposed.\50\
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\47\ 1994 GCL, supra note 25; Letter to Registrants from Barbara
J. Green, Deputy Director, Division of Investment Management, SEC
(May 13, 1993) (``Division Bank Letter'').
\48\ See Division Bank Letter, supra note 47. See also Testimony
of Ricki Helfer, Chairman, Federal Deposit Insurance Corporation
(``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).
\49\ The Proposed Amendments would require a fund that is not a
money market fund but is advised by or sold through a bank to
disclose that its shares are not federally insured as follows:
An investment in the Fund is not insured or guaranteed by the
Federal Deposit Insurance Corporation or any other government
agency.
\50\ Item 2(c)(1)(iii). Some commenters asserted that the
proposed disclosure was inconsistent with that required by bank
regulators in the Interagency Statement on Retail Sales of
Nondeposit Investment Products. 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) (``Interagency Statement'')
(requiring disclosure that the fund is not a deposit or other
obligation of the bank). The Commission has confirmed with these
bank regulators that no such inconsistency exists, because the
disclosure required by the Interagency Statement applies to sales
material and not to fund prospectuses. In response to suggestions
from the bank regulators, the Commission has revised the legend
required for funds that are advised by or sold through banks, to
read as follows:
An investment in the Fund is not a deposit of the bank and is
not insured or guaranteed by the Federal Deposit Insurance
Corporation or any other government agency.
The requirement, as amended in this way, is consistent with the
requirement now in effect.
---------------------------------------------------------------------------
Risk/Return Bar Chart and Table. The Proposed Amendments would
require a fund's risk/return summary to include a bar chart showing the
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 1-,
5-, and 10-fiscal years to those of a broad-based securities market
index. Commenters generally supported the proposed bar chart and
performance table, but had a number of suggestions about the content
and presentation of the information in both. The Commission is adopting
the proposed bar chart and table requirements with modifications to
reflect suggestions of commenters.\51\
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\51\ Item 2(c)(2). An example of the bar chart and performance
table is attached as Appendix B to this release.
---------------------------------------------------------------------------
The bar chart reflects the Commission's determination that
investors need improved disclosure about the risks of investing in a
fund. The bar chart is intended to illustrate graphically the
variability of a fund's returns (e.g., whether a fund's returns for a
10-year period have changed significantly from year to year or were
relatively even over the period) and thus provide investors with some
idea of the risk of an investment in the fund.\52\ The average annual
return information in the table should enable investors to evaluate a
fund's performance and risks relative to ``the market.''
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\52\ In adopting the bar chart requirement, the Commission does
not mean to suggest that all, or even a significant portion of all,
fund investors equate variability in a fund's returns with the risks
of investing in the fund. As discussed below, the Commission
acknowledges that investors have a wide range of ideas of what
``risk'' means. See infra Section II.A.3. Nonetheless, the
Commission's bar chart proposal was supported by many investors who
expressed strong interest in seeing prospectuses include a version
of the bar chart. Focus group participants, for instance, found the
bar chart helpful in evaluating and comparing fund investments. Over
75% of individual investors responding to the Risk Concept Release
favored a bar chart presentation of fund volatility. Risk Concept
Release, supra note 18. See also ICI, Understanding Shareholders'
Use of Information and Advisers (1997) (``ICI Shareholder Use
Study'') at 20 and 30 (discussing investors' interest in receiving
and understanding fund risk information) and ICI Risk Survey, supra
note 21. 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 10-year bar chart reflecting a money
market fund's yield. 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).
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In the Form N-1A Proposing Release, the Commission requested
comment about alternative presentations that could improve fund risk
disclosure.\53\ In particular, the Commission expressed interest in
disclosure that would show a fund's highest and lowest returns (or
``range'' of returns) for annual or other periods as an alternative, or
in addition, to the bar chart. The Commission suggested that a fund
could present the information in a separate table or could include it
in the performance table.
---------------------------------------------------------------------------
\53\ See Form N-1A Proposing Release, supra note 8, at 10907.
---------------------------------------------------------------------------
In response to the Commission's request, some commenters suggested
including in a fund's bar chart one or more indexes or other benchmarks
(such as 3-month Treasury returns or the rate of inflation) to help
investors evaluate the fund's returns by comparisons to other measures
of market performance or economic factors.\54\ Most commenters,
however, opposed requiring additional information in the bar chart,
asserting that it could complicate and reduce the effectiveness of the
bar chart.
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\54\ Form N-1A, as amended, permits a fund to use other indexes
in the presentation of the average annual return information in the
table accompanying the bar chart. Instruction 2(b) to Item 2(c)(2).
---------------------------------------------------------------------------
Several commenters supported the inclusion of return information in
the bar chart on a quarterly or semi-annual rather than an annual
basis. They argued that this change to the bar chart would respond to
concerns that investors may not sufficiently appreciate that an
investment in a fund may be subject to the risk of a short-term decline
in value. This risk, commenters asserted, may not be apparent from the
annual returns proposed to be shown in the bar chart. One commenter
recommended that the Commission require quarterly returns in the bar
chart so that investors would have more information about returns over
shorter periods to use in assessing the variability reflected in a
fund's past returns. The commenter argued that including returns on an
annual basis in the bar chart may not show a significant amount of
shorter-term price fluctuation.
The Commission acknowledges that a fund's returns may vary
significantly and could decrease in value over short periods and that
the annual returns in the bar chart will not necessarily reflect this
pattern. On the other hand, the Commission is concerned that requiring
quarterly returns over a 10-year period would make the bar chart more
complex and less useful in communicating information to investors. In
balancing the desire to make typical fund investors aware that fund
shares may
[[Page 13923]]
experience fluctuations over shorter periods with its underlying goal
that fund documents communicate information in as straightforward and
uncomplicated a manner as possible, the Commission has determined to
require a fund to disclose, in addition to the bar chart, its best and
worst returns for a quarter during the 10-year (or other) period
reflected in the bar chart.\55\ The Commission believes that this
information will assist investors in understanding the variability of a
fund's returns and the risks of investing in the fund by illustrating,
without adding unwarranted complexity to the bar chart, that the fund's
shares may be subject to short-term price fluctuations.
---------------------------------------------------------------------------
\55\ Item 2(c)(2)(ii).
---------------------------------------------------------------------------
Presentation of Return Information. The Proposed Amendments would
require a fund to include the bar chart and table in the risk section
of the prospectus risk/return summary under a separate sub-heading that
referred to both risk and performance. Several commenters argued that
the separate sub-heading requirement was unnecessary and suggested that
a fund should be able to choose whether to include any sub-heading.
Consistent with the objective of encouraging funds to develop
disclosure formats that are most helpful to investors, Form N-1A, as
amended, does not require the sub-heading included in the Proposed
Amendments.\56\ To help investors use the information in the bar chart
and table, Form N-1A, as amended, however, does require a fund to
provide a brief narrative explanation of how the information
illustrates the variability of the fund's returns.\57\
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\56\ General Instruction C.1(a) to Form N-1A, as amended,
encourages funds to use document design techniques that promote
effective communication.
\57\ Item 2(c)(2)(i).
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Bar Chart Return Information. The Proposed Amendments would require
that a fund's prospectus bar chart show the fund's annual returns for
the last 10 calendar years of the fund's existence. The purpose of the
calendar year requirement was to facilitate the comparison of annual
returns among funds, which typically have fiscal periods that do not
correspond to the calendar year.\58\ Unlike the proposed bar chart, the
proposed performance table required disclosure of a fund's returns for
fiscal year periods. In requiring this disclosure to be made for fiscal
year periods, the proposal was consistent with existing disclosure
requirements for the presentation of other financial information
included in a fund's prospectus.
---------------------------------------------------------------------------
\58\ The Commission understands that funds increasingly organize
themselves as series companies and tend to stagger the financial
periods of their series so that audits and financial reporting
periods are spread over an entire calendar year.
---------------------------------------------------------------------------
Several commenters argued that using different time periods for the
proposed bar chart and performance table would confuse investors and
urged the Commission to minimize potential investor confusion by
adopting consistent time periods for this information. The Commission
is persuaded by these comments and believes that requiring both the bar
chart and the performance table to be based on calendar year periods
will promote understandable information in fund prospectuses.
Therefore, Form N-1A, as amended, requires calendar year periods for
both the bar chart and table.\59\ Rule 498, as adopted, also requires
the bar chart and table in the profile to show calendar year data so
that both the profile and the prospectus of a fund will have virtually
the same risk/return information.\60\
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\59\ Item 2(c)(2). Form N-1A, as amended, requires a fund to
have at least one calendar year of returns before including the bar
chart and requires a fund to modify the narrative explanation
accompanying the bar chart and table if the fund does not include
the bar chart (e.g., by stating that the information gives some
indication of the risks of an investment in the fund by comparing
the fund's performance with a broad measure of market performance).
Form N-1A, as amended, also requires the bar chart of a fund in
operation for fewer than 10 years to include calendar year returns
for the life of the fund.
\60\ Rule 498(c)(2)(iii). Unlike Form N-1A, as amended, rule
498, as adopted, requires average annual return information in the
performance table in the profile to be as of the most recent
calendar quarter and updated as soon as practicable after each
quarter of a calendar year. See Profile Adopting Release, supra note
1. A fund would update the average annual return information
included in its prospectus when filing the annual update of its
registration statement required by section 10(a)(3) of the
Securities Act.
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The Commission is adopting, as proposed, the requirement that a
fund calculate the annual returns in the bar chart using the same
method required for calculating annual returns in the financial
highlights information included in fund prospectuses.\61\ The bar chart
does not reflect sales loads assessed upon the sale of a fund's shares,
although the average annual return information for the fund in the
table would reflect the payment of any sales loads.\62\ Commenters
generally supported this presentation of annual return information. The
Commission believes that, in light of the different types of sales
loads that may be charged on funds shares, it would be difficult for
funds to compute annual returns for the purposes of the bar chart and
to communicate the information effectively to investors.\63\ In
addition, the Commission has concluded that more precise return
information is not necessary for the bar chart to serve the purpose of
graphically showing fund annual returns and illustrating the
variability of an investment in a fund over a 10-year period.
---------------------------------------------------------------------------
\61\ Instruction 1(a) to Item 2(c)(2). Form N-1A, as amended,
requires a fund to present the corresponding numerical return
adjacent to each bar. Item 2(c)(2)(ii).
\62\ Instruction 2(a) to Item 2(c)(2). Form N-1A, as amended,
requires a fund whose shares are sold subject to a sales load to
disclose that the load is not reflected in the bar chart and that,
if it were included, returns would be less than those shown.
Instruction 1(a) to Item 2(c)(2).
\63\ In contrast, sales loads can be accurately and fairly
reflected in annual 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.
---------------------------------------------------------------------------
Bar Chart Presentation. The Proposed Amendments would allow a
single bar chart to include return information for more than one fund.
Most commenters supported the proposal, agreeing that it would give
funds the appropriate amount of flexibility to present the information
in the bar chart in a manner designed to assist investors in making
investment decisions. Under Form N-1A, as amended, the bar chart may
include returns for more than one fund, subject to the general
requirement that the information presented in the bar chart appear in a
clear and understandable manner.\64\
---------------------------------------------------------------------------
\64\ See General Instruction C.3(c).
---------------------------------------------------------------------------
Multiple Class Funds. Although the Commission proposed to permit
return information for more than one fund to be included in a single
bar chart, the Proposed Amendments would require a fund offering more
than one class of its shares in a prospectus to limit the information
in the fund's bar chart to one class. Commenters uniformly supported
this approach, and the Commission is adopting it as proposed.\65\
Unlike individual funds, classes of a fund represent interests in the
same portfolio of securities, and the returns of each class differ only
to the extent the classes do not have the same expenses. The Commission
believes that including return information for all classes offered
through a fund's prospectus is not necessary to provide some indication
of the risks of investing in the fund. In addition, the table
accompanying such a fund's bar chart would provide return information
for each class offered in the prospectus so that investors would be
able to identify and compare the performance of each class.\66\
---------------------------------------------------------------------------
\65\ Instruction 3(a) to Item 2(c)(2).
\66\ Instruction 3(c) to Item 2(c)(2).
---------------------------------------------------------------------------
The Proposed Amendments would require the bar chart of a fund
offering more than one class of shares through a prospectus to reflect
annual return
[[Page 13924]]
information for the class offered in the prospectus that had the
longest performance history over the last 10 years. When two or more
classes have returns for at least 10 years, or returns for the same
period but fewer than 10 years, the Proposed Amendments would require
annual returns for the class with the greatest net assets as of the end
of the most recent calendar year. Most commenters addressing the issue
opposed this approach. They argued that, if all classes had existed for
the same amount of time, the largest class could change from year to
year, thus requiring a fund to change the class reflected in the bar
chart. According to the commenters, changes in the information each
year could be confusing for investors and result in unwarranted
administrative burdens for funds. Commenters suggested that the
Commission permit a fund having classes with performance histories
extending over the same period of time to include the performance of
any existing class in the bar chart, maintaining that the effect of
expenses on the returns for different classes of shares is not
significant.\67\ The Commission is persuaded that allowing a multiple
class fund in such a case to choose the class reflected in the fund's
bar chart will simplify compliance with Form N-1A's requirements and
provide investors with sufficient information to evaluate the
variability of returns for any class of the fund. Therefore, Form N-1A,
as amended, permits a fund to choose the class to be reflected in the
bar chart, subject to certain limitations.\68\ Under Form N-1A, as
amended, the bar chart must reflect the performance of any class that
has returns for at least 10 years (e.g., a fund could not present a
class in the bar chart with 2 years of returns when another class has
returns for at least 10 years). In addition, if two or more classes
offered in the prospectus have returns for different periods shorter
than 10 years, the bar chart must reflect returns for the class that
has returns for the longest period.
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\67\ In making this argument, commenters cited rule 18f-3 under
the Investment Company Act [17 CFR 270.18f-3], which provides that a
class of shares may have different expenses for shareholder service
fees, distribution fees, or other expenses actually incurred in a
different amount by the class. The rule does not permit expenses for
advisory or custodial fees, or other management fees, to vary among
classes.
\68\ Instruction 3(a) to Item 2(c)(2).
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Tabular Presentation of Fund and Index Returns. The Proposed
Amendments would require a table accompanying a fund's bar chart to
present the fund's average annual returns for the last 1-, 5-, and 10-
fiscal years (or for the life of the fund, if shorter) and to compare
that information to the returns of a broad-based securities market
index for the same periods. The purpose of including return information
for a broad-based securities market index was to provide investors with
a basis for evaluating a fund's performance and risks relative to the
market. The proposed approach also was consistent with the line graph
presentation of fund performance required in MDFP disclosure.\69\
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\69\ See MDFP Adopting Release, supra note 15, at 19054.
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Commenters generally supported the proposed performance table, but
had several technical suggestions. The Commission is adopting the
performance table with revisions to clarify the disclosure requirements
for the table.\70\
---------------------------------------------------------------------------
\70\ Item 2(c)(2)(ii). Consistent with the Proposed Amendments,
Form N-1A, as amended, requires a fund to calculate average annual
returns 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
Item 2(c)(2) (incorporating the requirements of Item 21).
---------------------------------------------------------------------------
One commenter suggested that the Commission allow funds that have
existed for more than 10 years to include average annual returns for
the life of the fund in the performance table. The Commission agrees
that this information could be helpful for typical investors in such a
fund. Form N-1A, as amended, permits, but does not require, a fund to
include performance information in the table for the life of the fund
if it exceeds 10 years.\71\
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\71\ Item 2(c)(2)(iii). Form N-1A, as amended, permits a fund
that has not had the same adviser for the last 10 years 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. Instruction 4 to Item 2(c)(2). Form
N-1A, as amended, also requires a fund that changes the index shown
in the table to explain the reasons for the change and provide
information for both the newly selected and the former index.
Instruction 2(c) to Item 2(c)(2). Each of these provisions is
consistent with the requirement applicable to the MDFP line graph.
Instructions 7 and 11 to Item 5(b).
---------------------------------------------------------------------------
The Proposed Amendments would require a money market fund, in
meeting the proposed performance table requirement, to provide its 7-
day yield as of the end of its most recent fiscal year. One commenter
questioned this requirement, arguing that it would result in money
market funds giving outdated information to investors and suggested
that disclosure describing how an investor can obtain the fund's
current 7-day yield would be preferable. As amended, Form N-1A gives a
money market fund the option of providing in its performance table its
7-day yield ending on the date of its most recent calendar year or
disclosing a toll-free (or collect) telephone number that an investor
can use to contact the fund to obtain its current 7-day yield.\72\
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\72\ Item 2(c)(2)(iii).
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2. Risk/Return Summary: Fee Table (Item 3)
The Proposed Amendments would continue to require a fee table in
the prospectus that summarizes the sales charges and fund operating
expenses associated with an investment in a fund. Proposed rule 498
also incorporates the fee table requirement in the risk/return summary
included in the profile. Including the fee table in both the prospectus
and the profile reflects the Commission's strongly held belief in the
importance of fees and expenses in a typical investor's decision to
invest in a fund. The fee table is designed to help investors
understand the costs of investing in a fund and to compare those costs
with the costs of other funds. Commenters generally supported the fee
table disclosure, and the Commission is adopting it substantially as
proposed.
The Commission proposed certain amendments designed to improve
communication of the information in the fee table. The Commission
proposed to require a narrative explanation of the purpose of the
``Example'' that accompanies the fee table.\73\ Recognizing the trend
that the typical fund investment is increasing in size,\74\ the
Proposed Amendments would increase the initial hypothetical investment
included in the Example from $1,000 to $10,000.
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\73\ The Example currently discloses the cumulative amount of
fund expenses over 1, 3, 5, and 10 years based on a hypothetical
investment of $1,000 and an annual 5% return. The Commission
proposed to require funds to include 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.
\74\ 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 to
25,000, with the median investment probably in the range of $6,000
to 7,000).
---------------------------------------------------------------------------
Several commenters criticized the Example, arguing that, because it
is an arbitrary approximation of a fund's actual expenses, the Example
is not helpful to investors. These commenters recommended that the
Commission eliminate the Example from the fee table disclosure.
The Commission recognizes that any example necessarily has
limitations. On balance, however, the Commission believes that the
Example provides
[[Page 13925]]
useful information that helps a typical investor understand and compare
the expenses of different funds.\75\ The Example is a relatively
straightforward means of illustrating the effect of costs in investing
in a fund over time. Expressing expense amounts solely as a percentage
amount, as is done in the fee table, may not give the average investor
enough information to assess the likely effect of a fund's expenses on
a dollar amount of an investment in the fund. The addition of a clear
narrative explanation of the purpose of the Example should increase its
effectiveness in assisting investors' understanding of the Example, and
the Commission is adopting this disclosure requirement as proposed.\76\
---------------------------------------------------------------------------
\75\ See Fee Table Adopting Release, supra note 14, at 3194.
\76\ Item 3.
---------------------------------------------------------------------------
To ensure that all account fees (e.g., administrative fees charged
to maintain an account) paid directly by shareholders are disclosed,
the Proposed Amendments would require a new line item in the
shareholder transaction section of the fee table describing account
fees charged by a fund. The Commission is adopting this requirement as
proposed.\77\ In response to comments on the Proposed Amendments, Form
N-1A, as amended, clarifies that the table should include account fees
that affect a typical investor in a fund and not miscellaneous fees
that apply to only a limited number of shareholders based on their
particular circumstances.\78\
---------------------------------------------------------------------------
\77\ Form N-1A, as amended, clarifies that a fund should
disclose only fees charged by or on behalf of the fund, not fees
charged by unrelated third parties. Instruction 1(c) to Item 3.
\78\ Instruction 2(d) to Item 3. For example, Form N-1A would
not require a fund to include in the fee table a fee charged to
accounts with small balances (e.g., $10 annual fee on accounts less
than $2,500).
---------------------------------------------------------------------------
The Commission proposed to modify some of the captions in the fee
table relating to fees and expenses. The revisions were intended to
result in fee tables referring consistently to different types of
expenses as ``fees.'' In particular, the Proposed Amendments would
change the captions for ``sales loads'' to ``sales fees (loads).'' The
Proposed Amendments also would revise the caption ``12b-1 Fees'' to
read ``Marketing (12b-1) Fees.'' Commenters generally criticized these
changes. They maintained that the caption sales fees (loads) was not
typically used by the industry or industry commentators and could be
confusing to investors. The commenters recommended that the caption in
the fee table refer to ``sales charges.'' Commenters also recommended
that the caption ``Distribution [and/or Service] (12b-1) Fees'' would
better describe these fees than the term ``Marketing (12b-1) Fees.''
Commenters said that the types of fees that can be paid in accordance
with rule 12b-1 under the Investment Company Act extend beyond
marketing fees so that referring to rule 12b-1 fees as marketing fees
would be inaccurate.
The Commission believes that the terms suggested by commenters are
commonly used by the industry and by the press in covering the industry
and may be more easily understood by investors than those proposed.
Form N-1A, as amended, modifies the caption for sales fees (loads) to
refer to sales charges (loads).\79\ The Commission is retaining the
reference to loads because many investors are familiar with this term.
Form N-1A, as amended, also requires funds to use the captions
suggested by the commenters in referring to distribution fees in the
fee table.
---------------------------------------------------------------------------
\79\ Item 3.
---------------------------------------------------------------------------
The Commission proposed to continue to require a fund to reflect in
the fee table its operating expenses for the most recent fiscal year,
taking into account expense reimbursements and fee waiver
arrangements.\80\ As required by current Form N-1A, a footnote to the
fee table would disclose the amount of expenses that would have been
incurred had there been no waiver or reimbursement. One commenter
expressed strong opposition to showing expenses in the fee table that
are reduced by reimbursements or fee waivers. The commenter asserted
that investors would interpret the disclosure to mean that the net fee
disclosed in the table is what they can expect for the life of their
investment in the fund, which may not be the case.
---------------------------------------------------------------------------
\80\ In an expense reimbursement arrangement, the adviser
reimburses the fund for any expenses that exceed a predetermined
amount. Under a fee waiver arrangement, the adviser agrees to waive
a portion of its fees in order to limit fund expenses to a
predetermined amount.
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The Commission believes that typical investors need clear
disclosure of information about fees charged by funds.\81\ Reflecting
its continuing concern about the quality of disclosure about fees, the
Commission has reconsidered the disclosure of expense reimbursement and
fee waiver arrangements. The Commission believes that typical investors
may tend to overlook or disregard information about a fund's fee
structure if it is included in a footnote. Moreover, requiring the fee
table to show fees that a fund will charge under its contractual
arrangement with its investment adviser, without regard to temporary
arrangements that may decrease these fees, is consistent with other
Form N-1A requirements.\82\
---------------------------------------------------------------------------
\81\ See, e.g., Testimony of Arthur Levitt, Chairman, SEC,
before the Subcomm. on Finance and Hazardous Materials of the House
Comm. on Commerce (Mar. 6, 1997) (explaining the Commission's
concern about investor confusion with fund fees); Remarks by Steven
M.H. Wallman, Commissioner, SEC, before the ICI's 1995 Investment
Company Directors Conference and New Directors Workshop, Washington,
D.C. (Sept. 22, 1995) (noting investors' confusion about the
assessment of advisory fees).
\82\ See, e.g., Instruction 2(a)(i) to Item 3 (requiring funds
to disclose deferred sales charges even though they apply only to
investors leaving the fund). See also ``From Security to Self-
Reliance: American Investors in the 1990s,'' Remarks by Arthur
Levitt, Chairman, SEC, before the ICI's General Membership Meeting
at the Washington Hilton Hotel, Washington, D.C. (May 22, 1996)
(citing a survey by the Investor Protection Trust that found that 2
out of 3 investors believed that no-load mutual funds involve no
sales charges or fees, as an example of why the Commission should be
concerned about the quality of disclosure of fees charged by funds);
Testimony of Barry P. Barbash, Director, Division of Investment
Management, SEC, 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 a 1994 survey by the American Association of Retired
Persons, the Consumer Federation of America, and the North American
Securities Administrators, Inc. that found that the vast majority of
American bank customers who hold shares of mutual funds are unaware
of the risks and fees involved in the sale of mutual funds).
---------------------------------------------------------------------------
In view of its desire to improve the quality of fee disclosure, the
Commission has revised Form N-1A to require a fund to disclose in the
fee table its operating expenses, not taking into account expense
reimbursements and fee waiver arrangements.\83\ To ensure that
investors have current information about a fund's expenses, however,
Form N-1A, as amended, permits a fund to disclose its operating
expenses net of reimbursements and waivers in a footnote to the fee
table.\84\ The Commission believes that the fee table disclosure of
fund expenses, as amended, will give an investor clearer information
about the long-term costs of an investment in a fund, while at the same
time allowing the fund to provide current information about its
operating expenses.
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\83\ Instructions 3(d)(i) and 5(a) to Item 3.
\84\ Instructions 3(e) and 5(b) to Item 3. A fund also must
disclose the period for which the expense reimbursement or fee
waiver is expected to continue, or whether it can be terminated at
any time at the option of the fund. The Commission expects that, in
the latter case, a fund would provide adequate notice to investors
and fund shareholders in advance of the termination of the
arrangement.
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3. Investment Strategies and Risk Disclosure (Item 4)
In the Form N-1A Proposing Release, the Commission discussed its
concerns about disclosure of fund investments
[[Page 13926]]
and risks typically found in many fund prospectuses.\85\ This
disclosure generally consists of descriptions of the types of
securities in which a fund may invest and the risks associated with
each of those securities.\86\ In the Commission's view, disclosing
information about all of the securities in which a fund might invest
does not help a typical fund investor evaluate how the fund's portfolio
will be managed or the overall risks of investing in the fund. The
disclosure also adds substantial length and complexity to fund
prospectuses, which discourages investors from reading them.
---------------------------------------------------------------------------
\85\ See Form N-1A Proposing Release, supra note 8, at 10909.
\86\ 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.
---------------------------------------------------------------------------
The Commission has concluded that prospectus disclosure would be
more useful to a typical fund investor 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.\87\ The Commission believes
that funds are appropriately viewed as a means through which a
professional money manager provides its services to investors \88\ and
that, for that reason, the focus of disclosure about a fund's
prospective investments should center 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 would require prospectus disclosure that is designed to help
investors understand how a particular fund's portfolio will be managed.
The purpose of the Proposed Amendments was to implement more
effectively the Commission's original goal in adopting Form N-1A that
the prospectus should describe a fund's ``fundamental
characteristics.'' \89\ Commenters generally supported the proposed
approach to disclosure of the fund's investment operations and
attendant risks, and the Commission is adopting it substantially as
proposed.
---------------------------------------------------------------------------
\87\ The ICI has supported prospectus disclosure that focuses
primarily on a fund's broad investment objectives, practices, and
associated risks, and not on particular types of securities in which
the fund may invest. See, e.g., Letter from Paul Schott Stevens,
General Counsel, ICI, to Jonathan G. Katz, Secretary, SEC, at 5
(Apr. 8, 1996); 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).
\88\ See ``Can We Make Donkeys Fly?,'' Remarks by Barry P.
Barbash, Director, Division of Investment Management, SEC, before
the Business Law Section of the ABA, Washington, D.C., at 13 (Nov.
11, 1994); see also 1 T. Lemke, G. Lins & A.T. Smith III, Regulation
of Investment Companies Sec. 1.01, at 1-1 (1997).
\89\ See 1982 Form N-1A Proposing Release, supra note 13, at
815; 1983 Form N-1A Adopting Release, supra note 12, at 39729.
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a. Principal Investment Strategies, Investment Objectives, and
Implementation of Investment Objectives. To assist investors in
determining whether a fund meets their investment needs, Form N-1A, as
amended, continues to require prospectus disclosure of a fund's
investment objectives.\90\ The Commission proposed to shift the focus
of disclosure about how a fund intends to achieve its investment
objectives away from the current practice of listing all types of
securities in which a fund may invest to a discussion of the fund's
overall portfolio management.\91\ The Commission proposed to require a
fund to disclose in its prospectus the principal strategies that it
used to achieve its investment objectives, which would include the
particular type or types of securities in which the fund will invest
principally. This approach was designed to focus disclosure on a fund's
anticipated investment operations rather than on investments that the
fund might make.
---------------------------------------------------------------------------
\90\ Item 4(a). A fund may refer to its investment objectives as
investment goals or any other term that clearly communicates the
principal investment design of the fund. Form N-1A, as amended,
continues to require a fund to disclose in its prospectus when it
may change its investment objectives without a shareholder vote. Id.
Under current practice, some funds disclose in their prospectuses
when a shareholder vote is required to change its investment
objectives. The Commission believes that disclosure of this sort is
of limited significance to the typical fund investor. In the
Commission's view, most investors typically would not expect the
investment objectives of their funds to change without their
approval. Consistent with this view, Form N-1A, as amended, requires
a fund to disclose in its SAI, and not in its prospectus, when a
shareholder vote is required to change its investment objectives.
Item 12(c)(1)(vii).
\91\ 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 the
fund will use in connection with investing in those securities. Form
N-1A also requires disclosure, subject to certain limitations, about
``significant investment policies or techniques'' that a fund
intends to use. One of those limitations directs a fund to limit
prospectus disclosure about practices that place no more than 5% of
the fund's assets at risk. Many funds disclose in their prospectuses
information about securities and investment practices that do not,
and may not ever, place more than 5% of the fund's assets at risk,
often to retain the flexibility to exceed the 5% threshold in the
future. The Commission proposed to eliminate the 5% standard. Form
N-1A Proposing Release, supra note 8, at 10909. The standard has
been deleted in Form N-1A, as amended.
---------------------------------------------------------------------------
The Commission continues to believe that a clear, concise, and
straightforward discussion of investment objectives and strategies is
central to effective prospectus disclosure. Therefore, the Commission
is adopting the requirement for a fund to disclose how it intends to
achieve its investment goals as proposed.\92\
---------------------------------------------------------------------------
\92\ Item 4(b). Instruction 1 to Item 4(b)(1) defines a strategy
to include any policy, practice, or technique used to achieve a
fund's investment objectives.
---------------------------------------------------------------------------
Under Form N-1A, as amended, whether a particular investment
strategy (including a strategy to invest in a particular type of
security) is a principal investment strategy depends 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.\93\ The Commission believes that a fund should disclose those
strategies that are expected to be the most important means of
achieving the fund's objectives and that the fund anticipates will have
a significant effect on its performance. Form N-1A, as amended,
requires a fund, when determining whether a strategy is a principal
investment strategy, to consider, among other things, the portion of
assets that it expects to commit to the strategy, the portion of assets
that it expects to place at risk by the strategy, and the likelihood
that it will lose some or all of those assets in implementing the
strategy.\94\
---------------------------------------------------------------------------
\93\ Instruction 2 to Item 4(b)(1). Form N-1A currently 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 Item 4(b)(1) retains this limitation by providing
that a negative strategy is not a principal investment strategy.
Avoiding disclosure about negative strategies is intended to ensure
that prospectus disclosure states what the fund will do to achieve
its investment objectives, rather than what the fund will not do.
\94\ Instruction 2 to Item 4(b)(1). As amended, Form N-1A
requires a fund to disclose strategies that are not principal
strategies in the SAI. Item 12(b).
---------------------------------------------------------------------------
The Commission intends that focusing disclosure on a fund's
principal investment strategies \95\ will improve the fund's prospectus
by eliminating discussions of securities and strategies that do not
have a significant role in achieving the fund's investment objectives.
Under Form N-1A, as amended, for example, it generally will be
unnecessary for a fund (other than, for example, a money market fund)
to disclose in its prospectus its cash management practices (e.g.,
entering into overnight repurchase agreements), because these
[[Page 13927]]
practices are not typically among the principal investment strategies
that a fund uses to achieve its investment objectives.\96\
---------------------------------------------------------------------------
\95\ A bond fund, for example, typically would discuss generally
the maturities, durations, ratings, and types of issuers of the
bonds in which the fund invests principally.
\96\ Under the disclosure principles incorporated into Item 4 of
Form N-1A, as amended, a fund that has a principal investment
strategy of allocating its assets among stocks, bonds, and money
market instruments also would need to disclose its use of cash
equivalents. Whether a fund needs to include disclosure in its
prospectus about matters such as holding or trading stock futures
and option contracts, engaging in securities lending, purchasing
securities on a ``when-issued'' basis, or investing in illiquid or
restricted securities will depend on the extent to which these
instruments or practices have a significant role in achieving the
fund's investment objectives. A fund generally would not need to
include disclosure about restricted securities in its prospectus
because investments in this type of security usually would not be so
significant as to constitute a principal investment strategy of the
fund. Whether a fund's use of stock futures, option contracts, or
other derivatives would need to be disclosed in the fund's
prospectus would depend in large part on whether the strategy poses
the risk of substantial gains or losses for the fund.
---------------------------------------------------------------------------
The Proposed Amendments would require a fund, in discussing its
principal investment strategies in its prospectus, to explain in
general terms how the fund's adviser decides what securities to buy and
sell. This requirement sought to provide investors with essential
information about the fund's investment approach and how the fund's
portfolio would be managed. One commenter questioned this requirement,
arguing that it could place undue emphasis on a fund's decisions to
invest in or sell particular securities and result in boilerplate
disclosure. The Commission continues to believe that a general
discussion of the methods of analysis and investment strategies that a
fund's adviser will use in managing the fund will provide typical
investors with information that will help them in deciding whether to
invest in a fund. Therefore, the Commission is adopting the proposed
disclosure requirement regarding the manner in which the investment
adviser determines to buy and sell securities.\97\
---------------------------------------------------------------------------
\97\ Item 4(b)(2). In meeting this requirement, an equity fund
could describe, for example, whether it emphasizes value or growth,
or blends the two approaches. A value-oriented fund might state that
the fund's adviser selects stocks that it considers to be
undervalued by recognized measures of economic value such as
earnings, cash flow, and book value. Other types of disclosure about
a fund's investment philosophy might include whether the fund
invests in stocks based on a ``top-down'' analysis of economic
trends or a ``bottom-up'' analysis based on the financial condition
and competitiveness of individual companies.
---------------------------------------------------------------------------
Concentration. The Commission proposed to continue to require a
fund to disclose in its prospectus any policy to concentrate its
investments in any industry or group of industries. This requirement
reflects the view that such a policy is likely to be central to a
fund's ability to achieve its investment objectives,\98\ and that a
fund that concentrates its investments will be subject to greater risks
than funds that do not follow the policy. The Commission's staff has
taken the position for purposes of the concentration disclosure
requirement that a fund investing more than 25% of its assets in an
industry is concentrating in that industry.\99\ The Proposed Amendments
incorporated this percentage test into Form N-1A.
---------------------------------------------------------------------------
\98\ That such a policy can be central to a fund's meeting its
investment objective is suggested by section 8(b)(1) of the
Investment Company Act [15 U.S.C. 80a-8(b)(1)], which requires a
fund to disclose in its registration statement any policy to
concentrate its investments in a particular industry or group of
industries. Under section 13(a)(3) [15 U.S.C. 80a-13(a)(3)], a fund
must obtain shareholder approval to change a policy to concentrate
its investments.
\99\ Guide 19 to Form N-1A.
---------------------------------------------------------------------------
Commenters supported requiring a fund to disclose in its prospectus
its policies on industry concentration,\100\ and the Commission
continues to believe that 25% is an appropriate benchmark to gauge the
level of investment concentration that could expose investors to
additional risk. Therefore, the Commission is adopting this disclosure
requirement as proposed.\101\
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\100\ Some commenters questioned an existing position of the
Commission's staff regarding the ability of a fund to adopt a policy
of shifting between concentrated and non-concentrated status. One
commenter requested reconsideration of the staff's long-standing
position that a fund cannot, consistent with the provisions of
sections 8(b)(1) and 13(a)(3), have an investment policy permitting
the fund to concentrate or not concentrate its investments as
determined by the fund's board in its discretion. The commenter
argued that this position was too rigid and that a fund's board of
directors should have the flexibility to shift the fund's
concentration policy, subject to making appropriate disclosure to
fund shareholders. The Commission recognizes that fund investment
practices have changed as a result of the growth of securities
markets and assets invested in funds. The Commission believes that
it may be appropriate to reconsider the issue raised by the
commenter, but has concluded that the issue should not be
reconsidered in the context of the revisions of Form N-1A being
adopted today. The Commission has requested that the Division review
its positions on concentration, consulting with industry
representatives as appropriate, with a view toward allowing funds a
greater degree of flexibility in establishing concentration
policies.
\101\ Instruction 4 to Item 4(b)(1).
---------------------------------------------------------------------------
Temporary Defensive Positions. The Proposed Amendments would
require disclosure about a fund's policy that permits the fund to take
``temporary defensive positions'' to respond to adverse market,
economic, political, or other conditions. The purpose of the
requirement was to make investors aware of potential changes in a
fund's investments that are not generally contemplated by, or are
otherwise inconsistent with, a fund's principal investment objectives
and policies. 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. Although commenters
generally supported disclosure that a fund may take temporary defensive
positions, they found problematic disclosure of the percentage of
assets that may be committed to temporary defensive positions and the
likely effect of these positions on the fund's performance. Commenters
argued that, to maintain flexibility, a fund typically would disclose
that all of its assets could be committed to temporary positions. The
commenters maintained that such disclosure was boilerplate and would
not be meaningful to investors. In addition, commenters asserted that
funds would find it difficult to predict the likely effect of temporary
defensive positions on their performance.
The Commission believes that a typical fund investor would want to
know about investment positions that a fund can take from time to time
that are inconsistent with the fund's central investment focus. On the
other hand, the Commission is aware that, in practice, the disclosure
about temporary investment positions currently appearing in some fund
prospectuses is so lengthy and detailed as to suggest incorrectly that
a fund's temporary investment policies are more important than the
fund's investment objectives and the principal investment strategies
used to achieve them. The Commission believes that disclosure of this
sort, which discusses possible but not probable investments of funds,
is inconsistent with the fundamental disclosure principles underlying
Form N-1A. In the Commission's view, however, disclosure that a fund
may take temporary defensive positions to respond to market conditions
will alert investors to the possibility that a fund may vary its
investments on a temporary basis. Therefore, Form N-1A, as amended,
requires a fund to disclose, if applicable, that in response to
unfavorable market conditions it may make temporary investments that
are not consistent with its principal investment objectives and
policies.\102\
---------------------------------------------------------------------------
\102\ Instruction 6 to Item 4(b)(1).
---------------------------------------------------------------------------
Portfolio Turnover. Form N-1A currently requires all funds to state
their portfolio turnover rates in their financial highlights tables
included in their
[[Page 13928]]
prospectuses.\103\ Under the Proposed Amendments, a fund would be
required to supplement the information in its financial highlights
table by disclosing certain information about its portfolio turnover
rate if it anticipated having a turnover rate of 100% or more in the
coming year.\104\ The disclosure would be required to include an
explanation of the tax consequences and effect of increased trading
costs on the fund's performance.\105\ Most commenters questioned or
opposed the proposed disclosure about portfolio turnover rate. Some
commenters suggested that the Commission move this disclosure to the
SAI or require it in the MDFP in fund shareholder reports. Other
commenters argued that a fund's portfolio turnover rate may reflect the
fund's response to particular market events, or special circumstances
affecting the fund's investments, that are difficult to predict. These
commenters argued further that the unpredictable nature of fund
portfolio turnover rates would lead to generic or boilerplate
disclosure that would not be meaningful to investors in assessing
various funds. The commenters suggested that Form N-1A should instead
require disclosure about portfolio turnover rates as part of a
discussion of a fund's principal investment strategies when a fund's
investment approach is expected to include active and frequent trading
(as opposed to, e.g., a ``buy and hold'' strategy).
---------------------------------------------------------------------------
\103\ Item 3 of Form N-1A. Form N-1A, as amended, retains this
requirement. Item 9.
\104\ See Form N-1A Proposing Release, supra note 8, at 10910.
\105\ The Proposed Amendments would require a fund to disclose
its 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). 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 continues to believe that a discussion about a
fund's portfolio turnover in some cases is relevant to typical fund
investors. The Commission notes, for instance, that increased portfolio
turnover can on some occasions result in tax consequences that can be
significant to investors and that can be viewed as a cost to an
investor of holding fund shares. Moreover, investors may find
information about portfolio turnover particularly relevant in light of
recent changes to the tax laws that reduce the tax rate on capital
gains.\106\ The Commission agrees with commenters, however, that
disclosure about portfolio turnover and its consequences should be made
only if an increased portfolio turnover rate is likely to result from
the fund's investment objectives and principal investment strategies
and would have a significant effect on a fund's returns. Therefore,
Form N-1A, as amended, requires a fund to discuss the consequences of
its portfolio turnover rate if the fund anticipates that active and
frequent trading of portfolio securities will be a likely result of
implementing its principal investment strategies.\107\
---------------------------------------------------------------------------
\106\ See infra note 164.
\107\ Instruction 7 to Item 4(b)(1).
---------------------------------------------------------------------------
Classification and Policies. The Commission proposed to move to the
SAI disclosure about a fund's legal status as an open-end management
company,\108\ as well as disclosure relating to certain policies
identified under the Investment Company Act, such as borrowing money,
issuing senior securities, underwriting securities issued by other
persons, investing in real estate or commodities, and making
loans.\109\ Commenters supported moving this disclosure, agreeing that
it is not likely to be significant to a typical fund investor. Form N-
1A, as amended, requires the disclosure to appear in the SAI.\110\
---------------------------------------------------------------------------
\108\ As explained in the Form N-1A Proposing Release, this
information is technical in nature and repetitive of other
information required to be disclosed elsewhere in a fund's
prospectus. All funds that register on Form N-1A must be classified
as management companies under section 4 of the Investment Company
Act and subclassified as open-end companies under section 5. 15
U.S.C. 80a-4, -5. Funds may be further subclassified as diversified
or non-diversified under section 5.
\109\ Section 8 of the Investment Company Act requires a fund to
disclose these policies in its registration statement. Section 8
also requires a fund to disclose in its registration statement its
policies on concentration and portfolio turnover, see supra notes
100 and 105 and accompanying text, and any other policies that the
fund deems fundamental or that may not be changed without
shareholder approval. Although they are not required to do so, some
funds disclose in their prospectuses their policies with respect to
the practices identified in section 8. As noted in the Form N-1A
Proposing Release, supra note 8, at 10911, the Proposed Amendments
sought to provide a clearer directive to disclose these policies in
the SAI. To the extent it is a principal investment strategy of a
fund within the meaning of Item 4(b)(1) of Form N-1A, as amended,
however, a practice identified in section 8 would be required to be
disclosed in the fund's prospectus.
\110\ Items 12(a) and (c). Form N-1A, as amended, continues to
require a non-diversified fund to disclose its non-diversified
status in the prospectus. See Item 2(c)(iv). In particular, the Form
requires 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.
---------------------------------------------------------------------------
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 communicate effectively to investors 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 effectively
communicate to them the overall risks of investing in the fund. In the
Commission's view, disclosing the risks of each possible portfolio
investment, rather than the overall risks of investing in a fund, does
not help investors evaluate a particular fund or compare the risks of
the fund with those of other funds.
The Commission proposed, consistent with its conclusion that mere
inventories of potential portfolio securities do not assist typical
investors in selecting among funds, to modify prospectus disclosure
requirements in Form N-1A about the risks associated with specific
securities. The Proposed Amendments would require a fund to disclose
the risks to which the fund's particular portfolio as a whole is
expected to be subject and to discuss the circumstances that are
reasonably likely to affect adversely the fund's net asset value,
yield, or total return. Commenters generally supported the proposed
approach to the disclosure of risk, and the Commission is adopting it
as proposed.\111\
---------------------------------------------------------------------------
\111\ Item 4(c). 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 be required to
disclose the risks of the types of growth stocks in which the fund
invests or expects to invest, as opposed to describing the general
risks of equity securities.
---------------------------------------------------------------------------
The Commission notes that a fund could meet the risk disclosure
requirements of Form N-1A, as amended, by including in its prospectus a
discussion of the risks of the asset class or classes that the fund
expects to hold principally, together with a discussion of the risks to
the fund of holding specific types of securities within the asset class
or classes. Under such an approach, a fund investing in the equity
securities of companies with small market capitalizations, for example,
would discuss market risk as a general risk of holding equity
securities, as well as the specific risks associated with investing in
small capitalization companies (e.g., that these stocks may be more
volatile and have returns that vary, sometimes
[[Page 13929]]
significantly, from the overall stock market).\112\
---------------------------------------------------------------------------
\112\ The Commission emphasizes that this approach is one way,
but not the only way, that a fund can seek to use in meeting the
risk disclosure requirements of Form N-1A, as amended.
---------------------------------------------------------------------------
The Commission did not propose to require a fund to disclose
information designed to quantify its expected risk levels, citing,
among other things, the lack of a broad consensus as to what measure of
risk would best serve fund investors.\113\ Comments submitted in
response to the Commission's Risk Concept Release asserted 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.
In addition, commenters argued that, if the Commission mandated a risk
measure, investors might rely on it as a definitive standard despite
the lack of general agreement on how to measure risk.
---------------------------------------------------------------------------
\113\ See Form N-1A Proposing Release, supra note 8, at 10911.
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. Risk Concept Release,
supra note 18, at 17176. 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 criticized requiring disclosure of quantitative risk
information. See, e.g., 1995 ICI Risk Comment Letter, supra note 87,
at 10-16 (questioning, among other things, the feasibility of
developing a single, all-encompassing measure of fund risk and
whether quantitative information would be understood and accurately
used by fund investors).
---------------------------------------------------------------------------
As adopted, the prospectus risk/return summary and amendments to
the general risk disclosure requirements of Form N-1A are designed to
improve fund risk disclosure without raising the concerns associated
with Commission-mandated quantitative information. While it is not
adopting specific quantitative risk disclosure requirements, the
Commission believes that new approaches to measuring risk are emerging
and that quantitative risk information may be useful to some
investors.\114\ The Commission notes that a fund may include
quantitative risk disclosure in its prospectus if the information is
presented in a manner consistent with the guidelines on the inclusion
of information not required by Form N-1A.\115\
---------------------------------------------------------------------------
\114\ See, e.g., Walbert, What's the Risk?, Institutional
Investor, June 1997, at 188; Whitford, Why Risk Matters, Fortune,
Dec. 29, 1997, at 147.
\115\ See General Instruction C.3(b).
---------------------------------------------------------------------------
4. Management's Discussion of Fund Performance (Item 5)
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 its prospectus or its
annual report. The Commission is adopting the MDFP as proposed with
minor changes.\116\ The Commission notes in support of this decision
that a review of MDFP disclosure by the Commission's Division of
Investment Management (``Division'') indicates that the discussion of
fund performance and the line graph have generally provided fund
shareholders with useful, comparative information about a fund's
performance.
---------------------------------------------------------------------------
\116\ Item 5.
---------------------------------------------------------------------------
As discussed in the Proposed Amendments, funds typically choose to
include the MDFP in their annual reports, rather than in their
prospectuses. This choice may be explained, in part, by the relevance
of the MDFP to other current financial information appearing in annual
reports.\117\ As a result of recent amendments to the Investment
Company Act, the Commission has the authority to require additional
disclosure in annual and semi-annual reports as necessary or
appropriate in the public interest or for the protection of
investors.\118\ Several commenters recommended that the Commission
exercise this authority and require the MDFP to appear in fund annual
reports, asserting, among other things, that shareholders read these
reports more frequently than prospectuses. Commenters also suggested
that, like other information contained in an annual report, the MDFP
analyzes a fund's past performance rather than the fund's anticipated
future course of action, which is the central focus of a fund's
prospectus.
---------------------------------------------------------------------------
\117\ See Form N-1A Proposing Release, supra note 8, at 10912.
\118\ National Securities Markets Improvement Act of 1996, Pub.
L. 104-290 (1996) (``Improvements Act''), section 206(f) (amending
section 30 of the Investment Company Act [15 U.S.C. 80a-29] to add
new paragraph (f)).
---------------------------------------------------------------------------
Although it acknowledges that a fund's annual report may be the
preferred location for the MDFP disclosure, the Commission is deferring
consideration of its requirements as to the placement of the MDFP
discussion. The Commission has concluded that MDFP disclosure should be
considered as part of a comprehensive reassessment of the Commission's
existing rules specifying the disclosure to be included in fund reports
to shareholders. The Commission believes that such an initiative would
be an important future step in improving the quality of fund disclosure
documents and has directed the Division to begin work on proposed
amendments to fund periodic reporting requirements. The Commission has
asked that, in connection with such a proposal, the Division consider
whether certain disclosure required by Form N-1A would be more useful
to investors in shareholder reports. In this regard, the Commission
notes its preliminary view that an ``integrated'' approach to
registration and reporting requirements could improve the overall
information about a fund available to investors.\119\
---------------------------------------------------------------------------
\119\ 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] (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 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). At least
one commenter has cited potential benefits to fund shareholders of
an integrated approach to fund disclosure. T. Lemke, Mutual Fund
Disclosure Revisited, Investment Companies 1989 (Practising Law
Institute's Corporate Law and Practice Course Handbook Series No.
605).
---------------------------------------------------------------------------
5. Management, Organization, and Capital Structure (Item 6)
a. Management and Organization. The Commission proposed to
abbreviate disclosure in the prospectus about a fund's management and
organization and move certain of this information to the SAI.
Commenters generally supported the Proposed Amendments, and the
Commission is adopting them as proposed with modifications to reflect
suggestions of commenters.
Management Disclosure. Under existing Form N-1A, all funds must
disclose the rate of fees that they pay their investment advisers in
their fee tables. As stated above, the Commission has retained this
requirement, which the Commission believes is among the core
requirements of the Form. The Proposed Amendments would continue to
require, in addition to the disclosure contained in the fee table,
prospectus disclosure about investment advisory services provided to,
and investment advisory fees paid by, a fund. Some commenters
recommended eliminating disclosure about the investment advisory fees,
which they argued is merely duplicative of the information in the fee
table. The Commission disagrees with this argument. The Commission
believes that a concise and straightforward description of the services
that an investment adviser provides to a fund along with disclosure
[[Page 13930]]
of the investment advisory fee rate for a recent fiscal year, as well
as providing this information in a single place in a prospectus, can
help a typical investor understand the management of the fund.
Therefore, the Commission is adopting the disclosure requirements as
proposed.\120\
---------------------------------------------------------------------------
\120\ Item 6(a).
---------------------------------------------------------------------------
In the Form N-1A Proposing Release, the Commission requested
comment whether information about the amount of fees paid to a sub-
adviser or sub-advisers of a fund helps investors evaluate and compare
the fund to other funds. The Commission also asked whether this type of
disclosure obscures the aggregate investment advisory fee paid by a
particular fund.\121\ Most commenters supported disclosure of the
aggregate fee only, maintaining that information about individual sub-
advisory fees is not relevant to investors because it does not help
them compare the fees charged by different funds. The Commission is
persuaded that information about sub-advisory fees is not necessary for
a typical fund investor, but may be of interest to some investors.
Therefore, Form N-1A, as amended, requires prospectus disclosure of the
aggregate advisory fees paid by a fund and disclosure in the SAI of the
amount of sub-advisory fees paid by the fund.\122\
---------------------------------------------------------------------------
\121\ See Form N-1A Proposing Release, supra note 8, at 10912.
\122\ Instruction 3 to Item 6(a)(1) and Item 15(a)(3).
---------------------------------------------------------------------------
Portfolio Manager. The Proposed Amendments would continue to
require prospectus disclosure indicating the person or persons
responsible for the day-to-day management of a fund's portfolio. Under
the Proposed Amendments, and as currently permitted by instructions to
Form N-1A, a fund could, in meeting this requirement, indicate that a
committee was responsible for a fund's portfolio management if, under
the organizational arrangements of the fund (or its investment
adviser), no one person was responsible for making recommendations to
the committee.
One commenter criticized the proposed portfolio manager disclosure
requirement, arguing that it may have the effect of creating the false
impression that the identity of the individual portfolio manager of a
fund is paramount to the fund's performance. According to the
commenter, the collective experience, resources, personnel, and
reputation of a fund's investment adviser often are of greater
importance to the fund's performance than the fund's portfolio manager.
The commenter recommended that, to enable funds to describe their
management structures more accurately than they can under Form N-1A's
existing provisions, the Commission require disclosure of the identity
of a fund's portfolio manager only when a change in the identity of the
manager would be material to investors (e.g., when a fund group
promotes the identity of individual portfolio managers). The commenter
suggested that the Commission, in the alternative, clarify the
disclosure obligations of a fund for which the day-to-day
responsibilities for the fund's portfolio investments are shared by a
committee and certain individuals.
The Commission is not persuaded that it should adopt the
commenter's recommendation that the Commission tie portfolio manager
disclosure to a fund group's marketing efforts. Such a recommendation
is substantially similar to proposals considered and rejected by the
Commission when it adopted Form N-1A's existing portfolio manager
disclosure requirement.\123\ The Commission believes that typical
investors in a fund should have clear and succinct information about
the individuals who significantly affect the fund's investment
operations. In the Commission's experience, Form N-1A's existing
requirement appropriately serves this purpose and should not be changed
significantly. To the Commission's knowledge, the requirement has not
generally resulted in funds inaccurately describing the individuals
responsible for their management.
---------------------------------------------------------------------------
\123\ See MDFP Adopting Release, supra note 15, at 19051-52.
---------------------------------------------------------------------------
Although the Commission believes that Form N-1A's portfolio manager
disclosure requirements should not be changed significantly, the
Commission has concluded that it is appropriate to provide additional
guidance in Form N-1A as to the disclosure obligations of a fund for
which day-to-day management responsibilities are shared. New
instructions to Form N-1A's portfolio manager disclosure requirements
have been added for this purpose.\124\
---------------------------------------------------------------------------
\124\ Instructions to Item 6(a)(2).
---------------------------------------------------------------------------
Legal Proceedings. The Proposed Amendments would continue to
require prospectus disclosure of any material pending legal proceedings
involving a fund, its investment adviser, or principal underwriter. The
Commission also proposed to expand Form N-1A's legal proceedings
disclosure requirement to cover those proceedings contemplated by a
governmental authority. In proposing this change, the Commission sought
to conform Form N-1A's requirements to those included in other
Commission forms applying to other types of issuers.\125\
---------------------------------------------------------------------------
\125\ See Item 12 of Form N-2 [17 CFR 274.11a-1] for closed-end
investment companies; Item 103 of Regulation S-K [17 CFR 229.103]
for non-investment company issuers. See also Investment Company Act
Release No. 19155 (Nov. 30, 1992) [57 FR 56862] (modifying Form N-2
to conform to Item 103).
---------------------------------------------------------------------------
Some commenters questioned the requirement that a fund disclose
contemplated proceedings, arguing that a fund would find it difficult
to assess whether proceedings of a governmental entity are in fact
contemplated. The Commission is not persuaded by this argument and has
adopted the legal proceedings requirement as proposed.\126\ In support
of its decision, the Commission notes that issuers that have been
subject to the requirement appear not to have experienced significant
difficulty in complying with it.
---------------------------------------------------------------------------
\126\ Item 6(a)(3).
---------------------------------------------------------------------------
Board of Directors. Form N-1A currently requires a fund to include
in its prospectus a brief description of the responsibilities of the
fund's board of directors under the applicable laws of the jurisdiction
in which the fund is organized. Recognizing that the disclosure
provided by a fund in response to this item typically recites the
substance of specific legal requirements, the Commission proposed to
move this disclosure to the SAI. Commenters supported disclosing the
director information in the SAI, arguing that the information does not
help a typical investor make a decision to invest in a fund. Form N-1A,
as amended, requires a fund to disclose this information in the
SAI.\127\
---------------------------------------------------------------------------
\127\ Item 13(a).
---------------------------------------------------------------------------
The Commission requested comment in the Form N-1A Proposing Release
whether a fund's prospectus should include the names, experience, and
compensation of a fund's directors, as well as information, such as
addresses and telephone numbers, indicating how a shareholder could
contact the directors.\128\ The Commission also requested comment
whether this information, if required, should be given only for a
fund's independent directors, accompanied by disclosure of the number
of independent directors in comparison to the number of directors on
the fund's board.\129\
---------------------------------------------------------------------------
\128\ Form N-1A Proposing Release, supra note 8, at 10912.
\129\ The Investment Company Act contains a number of
requirements relating to the composition of a fund's board. See,
e.g., sections 10(a) and 15(f) of the Investment Company Act [15
U.S.C. 80a-10(a), -15(f)].
---------------------------------------------------------------------------
Most commenters strongly opposed additional disclosure about
directors in
[[Page 13931]]
the prospectus. While a few commenters supported identifying the
directors in the prospectus, most argued that this information is not
essential to a typical investor in making a decision about investing in
a fund and would only serve to lengthen the prospectus. The commenters
recommended that the SAI or annual report to shareholders would be a
better place for disclosing the identity of directors.
Commenters addressing the issue uniformly opposed requiring a fund
to disclose directors' compensation in the prospectus, arguing that
these fees are only a small part of total fund expenses and are not
relevant to a typical investor in a making a decision to invest in a
fund. The commenters also noted that director compensation is disclosed
in a fund's SAI, where it can be used by those investors interested in
the information, and in a fund's proxy statement, where it can be
assessed by all shareholders of the fund in the context of an election
of directors.\130\
---------------------------------------------------------------------------
\130\ Item 13(d); Item 22(b)(6) of Schedule 14A [17 CFR 240.14a-
101].
---------------------------------------------------------------------------
All commenters addressing the issue emphatically opposed the
disclosure of information in either the prospectus or the SAI
indicating how shareholders can contact directors. Commenters,
particularly independent directors of funds, argued that this
information would result in an unwarranted loss of privacy for board
members and numerous calls to directors to which they would be ill-
equipped to respond. Commenters also argued that disclosure of this
information would serve as a disincentive for qualified individuals to
serve as directors and that all investor comments regarding a fund
should be directed to representatives of the fund's management, and not
to its directors.
The Commission believes that mandating more information about fund
directors than is available under its existing disclosure rules may be
appropriate in light of independent directors' role as ``watchdogs'' of
fund shareholders as contemplated by the Investment Company Act.\131\
The Commission, however, is not convinced, particularly in light of the
overwhelmingly negative comment on this issue, that the prospectus is
the appropriate document for this disclosure. Therefore, Form N-1A, as
amended, does not require additional information of the sort described
in the Proposed Amendments to be provided about a fund's directors. The
Commission, however, has directed the Division to consider director
disclosure issues as part of an initiative to improve shareholder
reports.\132\
---------------------------------------------------------------------------
\131\ These responsibilities of directors 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 section 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'')).
\132\ See supra note 119 and accompanying text.
---------------------------------------------------------------------------
Management and Organization. The Commission proposed to move to the
SAI two items of disclosure about a fund's management and organization
that the Commission believes are only of minimal importance to typical
fund investors. The Proposed Amendments would no longer require a fund
to disclose in its prospectus the name of any person that controls the
fund's investment adviser and the name of any person that controls the
fund.\133\ The Proposed Amendments also would no longer require a fund
to state in its prospectus, if applicable, that the fund engages in
brokerage transactions with affiliated persons and allocates brokerage
transactions based on the sale of fund shares.\134\ The information
called for in response to these two items typically results in generic
disclosure that restates applicable legal requirements and does not
appear to assist investors in deciding whether to invest in a
particular fund. Commenters generally supported placing this
information in the SAI. Form N-1A, as amended, requires a fund to
disclose information in the SAI regarding controlling persons of the
investment adviser and brokerage transactions with affiliated
persons.\135\
---------------------------------------------------------------------------
\133\ Transactions between controlling persons and a fund are
subject to restrictions under the Investment Company Act. See, e.g.,
section 17 [15 U.S.C. 80a-17] and rules 17a-6 and 17d-1 [17 CFR
270.17a-6, .17d-1].
\134\ Payment of commissions to affiliated brokers is governed
by section 17(e) of the Investment Company Act [15 U.S.C. 80a-17(e)]
and rule 17e-1 [17 CFR 270.17e-1].
\135\ Items 15(a) and 16(b)(1).
---------------------------------------------------------------------------
The Commission proposed to move to the SAI disclosure about a
fund's form of organization along with the date and state of the fund's
incorporation. Because most funds are organized in one of a few states
as corporations or business trusts, disclosure about a fund's
organization does not appear to help investors evaluate a particular
fund or compare the fund to other funds. For that reason, the
Commission is adopting its proposal to move information about a fund's
organization to the SAI.\136\
---------------------------------------------------------------------------
\136\ Item 11(a). The Commission proposed to continue to require
a fund to disclose its form of organization and place of
incorporation in the prospectus if a fund is organized outside the
United States and registered under section 7(d) of the Investment
Company Act [15 U.S.C. 80a-7(d)]. Although this type of organization
is permitted by the Investment Company Act, only a limited number of
funds that are organized and incorporated outside of the United
States have registered under the Act. A fund organized in this
manner would be subject to certain legal requirements under the
Investment Company Act, regardless of whether those requirements
were described in the fund's prospectus. Following one of Form N-
1A's underlying principles to avoid prospectus disclosure that
simply restates applicable legal provisions, the Commission has
determined to incorporate this disclosure requirement in Item 11(a)
of the SAI.
---------------------------------------------------------------------------
The Proposed Amendments would not include the disclosure about a
fund's expenses currently required by Form N-1A in the discussion of
the fund's management. This information is included in the fee table
and the financial highlights table. Additional information about fund
expenses also is available in a fund's SAI. Eliminating repetitive
information is one of the basic objectives of the Commission's efforts
to improve fund disclosure documents. Consistent with this goal, Form
N-1A, as amended, does not require this additional information about
fund expenses in disclosure about a fund's management.
b. Capital Structure. The Proposed Amendments would continue to
require prospectus disclosure about any limits on the transferability
of, and material obligations or potential liabilities associated with,
a fund's shares. One commenter suggested that disclosure should appear
in the SAI rather than in the prospectus, asserting that the
information is technical and generally does not vary among funds. The
commenter recommended that the Commission instead limit disclosure in a
fund's prospectus to unusual provisions that may pose special risks to
the fund's shareholders. The Commission agrees that descriptions of all
potential restrictions and possible consequences of holding fund shares
are of only marginal significance to typical investors in selecting
among funds. Form N-1A, as amended, thus requires prospectus disclosure
of only unique or unusual restrictions or potential liabilities
associated with holding a fund's shares (other than investment risks)
that may expose an investor in the
[[Page 13932]]
fund to significant risks.\137\ Under Form N-1A, as amended, a fund
would be required to discuss in its SAI generally applicable legal
provisions relating to holding fund shares.\138\
---------------------------------------------------------------------------
\137\ Item 6(b). The prospectuses of funds organized as business
trusts under Massachusetts law sometimes include disclosure that,
under Massachusetts law, fund shareholders may be held personally
liable as partners for the fund's obligations under certain limited
circumstances. In adopting Form N-1A in 1983, 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. 1983 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). In connection with the Proposed Amendments, the
staff undertook a review of fund prospectus disclosure. The review
indicated, among other things, that certain funds continue to
include disclosure about Massachusetts business trusts and state
that shareholder liability is remote. In the Commission's view, this
disclosure appears to be unwarranted, and the Commission encourages
funds to re-evaluate whether this disclosure is necessary in light
of the Commission's goal to minimize the disclosure of events that
have only a remote possibility of affecting an investor's investment
in a fund. See Form N-1A Proposing Release, supra note 8, at 10913.
\138\ Item 17(a).
---------------------------------------------------------------------------
The Proposed Amendments would move disclosure about shareholder
voting rights to the SAI. In explaining this decision, the Commission
stated that the Investment Company Act sets out specific rights of fund
shareholders,\139\ which typically results in this disclosure being
generic in nature and of little consequence to investors in evaluating
and comparing funds. Commenters generally supported including this
information in the SAI, agreeing that it is not essential to an
investment decision. Form N-1A, as amended, requires this disclosure in
the SAI.\140\
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\139\ The Investment Company Act requires all fund shares to
have equal voting rights and prescribes the vote required for
certain significant matters. See, e.g., section 18(i) [15 U.S.C.
80a-18(i)] (equal voting rights); section 15(a) [15 U.S.C. 80a-
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).
\140\ Item 17(a).
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Form N-1A currently requires a fund to describe in its prospectus
any class of senior securities issued by the fund, and any ``other
class'' of its shares that is outstanding. In the Commission's
experience, disclosure in fund prospectuses made in response to this
requirement merely restates legal requirements in the Investment
Company Act and its rules, which limit a fund's ability to issue
certain classes of shares or senior securities.\141\ The Commission
concluded that disclosure of this sort is only of minimal significance
to a typical investor in deciding whether to invest in a fund, and
proposed to delete it from fund prospectuses.\142\ Commenters agreed
with the Commission's conclusion, and Form N-1A, as amended, does not
require prospectus disclosure of information about other classes of
fund shares (including senior securities).\143\ The SAI would continue
to require a fund to disclose the rights of any authorized securities
of the fund other than capital stock.\144\
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\141\ Under section 18(f) of the Investment Company Act, a fund
generally is prohibited from issuing senior securities. By its
terms, however, this prohibition does not preclude a fund from
borrowing from any bank, so long as the borrowing is undertaken in
accordance with the requirements of the Investment Company Act. See
section 18(f)(1) (a fund must have asset coverage of at least 300
percent of all borrowings). In addition, the Commission has taken
the position that certain types of portfolio transactions that
involve leverage engaged in by a fund would not be deemed senior
securities if the fund establishes a segregated account with liquid
assets that collateralize 100% of the market value of the
obligations under these transactions. See Investment Company Act
Release No. 10666 (Apr. 18, 1979) [44 FR 25128]; see also Merrill
Lynch Asset Management, L.P. (pub. avail. July 2, 1996) (staff no-
action letter). Series funds and multiple class funds, each of which
may raise issues under section 18(f), are expressly contemplated by
section 18(f)(2) of the Investment Company Act and related rules
18f-2 and 18f-3.
\142\ Under the proposal, a fund, however, would be required to
disclose information in its prospectus about any series or class of
the fund offered in the prospectus. Form N-1A, as amended, adopts
this requirement. See, e.g., Item 8(c).
\143\ Form N-1A, as amended, does not require disclosure in the
prospectus of any measures taken by a fund (e.g., formation and
maintenance of segregated accounts) to ensure that certain
instruments that it holds are not deemed senior securities for
purposes of the Investment Company Act's limitations. Form N-1A, as
amended, would continue to require a fund that has a fundamental
policy to borrow monies or that employs leverage to include
disclosure about these practices in its prospectus. See supra
Section II.A.3.a (discussing required disclosure of principal
investment strategies).
\144\ Item 17(b).
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6. Shareholder Information (Item 7)
a. General Purchase and Sale Information. The Proposed Amendments
would retain most of the disclosure requirements concerning a fund's
purchase and redemption procedures, dividends, and distributions
currently required by Form N-1A. The Commission believes that the
required information is relevant to a typical investor contemplating an
investment in a fund. In the Form N-1A Proposing Release, the
Commission acknowledged that disclosure about purchase and redemption
procedures is often quite lengthy and may contribute to the perception
that prospectuses are too long and complicated and not worth
reading.\145\ The Commission also observed, however, that much of the
purchase and redemption disclosure typically contained in fund
prospectuses is not required by Form N-1A, but is included by funds for
marketing or other business purposes. The Commission believes that it
is appropriate for a fund to have the option to add disclosure to its
prospectus for these purposes, and thus the Commission did not propose
to limit prospectus disclosure of funds' purchase and sale procedures
to that expressly required by Form N-1A. The Commission is adopting the
requirements to disclose purchase, redemption, and other shareholder
information substantially as proposed with modifications to reflect
commenters' suggestions.\146\
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\145\ See Form N-1A Proposing Release, supra note 8, at 10914.
\146\ Item 7. The Commission also is adopting, as proposed, the
requirement that a fund disclose in its SAI, and not in its
prospectus, information about the fund's principal underwriter and
service providers. Item 15. Requiring the information in the SAI
does not preclude a fund from including it in the prospectus (e.g.,
for marketing and other business purposes).
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Several commenters on the Form N-1A Proposing Release suggested
that the Commission specifically acknowledge as consistent with its
rules the ability of a fund at its option to place certain information
about purchase and redemption procedures in a separate document that
would be delivered to an investor no later than with the confirmation
of the investor's purchase of the fund's shares. According to the
commenters, this separate document, or ``owner's manual,'' can help
streamline prospectus disclosure and provide an efficient means for a
fund group to provide disclosure about purchase and redemption
procedures that is common to all funds in the group. The Commission
believes that this sort of disclosure document is consistent with the
disclosure principles underlying the revisions to Form N-1A and that
investors may find it easier and less confusing to consult and retain a
separate document describing certain procedures relating to purchasing
and redeeming fund shares, which are typically mechanical in nature. In
the Commission's view, as long as the purchase and sale information in
a fund's prospectus is not reduced below the minimum required by Form
N-1A, the fund would be able to create and use
[[Page 13933]]
a separate purchase and sale disclosure document as supplemental sales
literature.
A second way in which a fund could create a separate purchase and
sale disclosure document would be for the fund to include in its SAI
the information to be contained in the document. A fund could set out
this information in a separate section of the SAI and make it
available, as a separate document, to investors upon request. To
accommodate this option, the Commission is revising Form N-1A to
include an instruction in the SAI that permits a fund to provide a
separate document with additional purchase and sale information that
can be made available to fund investors, along with the SAI or as a
stand-alone document, in response to investor requests.\147\
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\147\ Instruction to Item 18(a).
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Form N-1A, as amended, provides a third means for developing a
purchase and sale manual. As amended, the Form permits a fund to remove
all information regarding its purchase and sale procedures from its
prospectus and place the information in a separate document. The use of
the separate document in this manner, however, would mean that required
prospectus disclosure would appear only in the owner's manual.
Therefore, the use of this kind of separate document is conditioned on
incorporating it by reference into the fund's prospectus and providing
it to investors with the prospectus.\148\
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\148\ Item 7(f).
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b. Valuation of Fund Shares and Net Asset Value. Valuation. The
Commission proposed to eliminate an existing requirement of Form N-1A
that a fund disclose in its prospectus that the price at which
investors' purchase and redemption requests are effected is calculated
on the basis of the fund's current net asset value and that the fund
identify the methods used to value its portfolio securities (e.g.,
market price or fair value).\149\ The Commission proposed to take this
action principally because, in meeting the requirement, funds typically
go beyond the required identification of the methods used and repeat
the substance of rules under the Investment Company Act specifying the
way in which the net asset value of a fund must be calculated. In
addition, the information presented by a fund usually repeats
information required to be included in the SAI. This disclosure has
tended to be lengthy and technical and, as discussed below, appears not
to have been very informative for investors.
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\149\ Under the Investment Company Act and its rules, funds
generally are required to use market quotations to value portfolio
securities. If market quotations are not readily available, the fund
must value the securities at ``fair value as determined in good
faith by the board of directors.'' Section 2(a)(41) [15 U.S.C. 80a-
2(a)(41)]; rule 2a-4 [17 CFR 270.2a-4].
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The Commission has re-evaluated the disclosure of information in
fund prospectuses about the calculation of net asset value in light of
numerous complaints from investors that the Commission received
recently regarding the manner in which some funds determined their net
asset value. In response to volatility in various markets, some funds
recently valued certain of their securities on the basis of fair value
rather than on the basis of the last market quotations for the
securities.\150\ In taking this action, the funds appear to have relied
on a long-standing position of the Commission's staff that a fund may
(but is not required to) value portfolio securities traded on a foreign
exchange using fair value, rather than the closing price of the
securities on the exchange, when an event occurs after the close of the
exchange that is likely to have changed the value of the
securities.\151\ Many investors complained that they were unaware that
their funds could use fair value pricing in such a situation. In
response to these complaints, the Division undertook a review of the
disclosure documents of funds using such fair value pricing and found
that, although the funds disclosed the practice in their prospectuses,
the funds' discussions of their pricing procedures would have been
enhanced if they had followed the principles of plain English.\152\
Investors' recent questions about fund pricing procedures confirm the
general importance of this information to at least
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