# New Disclosure Option for Open-End Management Investment Companies > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A98-7071 ## Record - **Collection:** Federal Register - **Document type:** Rule - **Published:** March 23, 1998 - **Citation:** 63 FR 13968 ## Text SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 230 and 270 [Release Nos. 33-7513; IC-23065; File No. S7-18-96] RIN 3235-AH03 New Disclosure Option for Open-End Management Investment Companies AGENCY: Securities and Exchange Commission ACTION: Final rule ----------------------------------------------------------------------- SUMMARY: The Securities and Exchange Commission is adopting a new rule that would permit a mutual fund to offer investors a new disclosure document called a ``Aprofile,'' which summarizes key information about the fund, including the fund's investment strategies, risks, performance, and fees, in a concise, standardized format. A fund that offers a profile will be able to give investors a choice of the amount of information that they wish to consider before making a decision about investing in the fund; investors will 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). An investor deciding to purchase fund shares based on the information in a profile will receive the fund's prospectus with the confirmation of purchase. DATES: Effective on June 1, 1998. FOR FURTHER INFORMATION CONTACT: Kathleen K. Clarke, Assistant Director, George J. Zornada, Team Leader, or Laura J. Riegel, Attorney, (202) 942-0721, Office of Disclosure Regulation, Division of Investment Management, Securities and Exchange Commission, 450 Fifth 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 or 450 Fifth Street, N.W., Mail Stop 5-6, Washington, D.C. 20549-6009 for additional information, including interpretive guidance, relating to this release or the profile. SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission (the ``Commission'') today is adopting new rule 498 [17 CFR 230.498] under the Securities Act of 1933 [15 U.S.C. 77a, et seq.] (``Securities Act'') and the Investment Company Act of 1940 [15 U.S.C. 80a-1, et seq.] (``Investment Company Act''). Rule 498 permits an open-end management investment company that registers on Form N-1A [17 CFR 274.11A] (a ``fund'') to provide to investors a disclosure document called a ``profile,'' which summarizes key information about the fund and gives investors the option of purchasing the fund's shares based on the information in the profile. The Commission also is adopting amendments to rule 497 under the Securities Act [17 CFR 230.497] to require a fund to file a profile with the Commission at least 30 days prior to the profile's first use. In a companion release, the Commission is adopting revisions to the prospectus disclosure requirements in Form N-1A, the registration statement used by funds.\1\ These revisions seek to minimize prospectus disclosure about technical, legal, and operational matters that generally are common to all funds and to focus prospectus disclosure on essential information about a particular fund that would assist an investor in making a decision about investing in that fund. --------------------------------------------------------------------------- \1\ Investment Company Act Release No. 23064 (Mar. 13, 1998) (``Form N-1A Release''). --------------------------------------------------------------------------- TABLE OF CONTENTS I. Introduction and Background II. Discussion A. General 1. Overview of Comments 2. Liability 3. Plain English Disclosure 4. Use of the Profile by Other Types of Investment Companies 5. Standardized Format 6. Additional Disclosure Items 7. Eligibility 8. Number of Funds Described in a Profile B. Profile Disclosure 1. Cover Page 2. Risk/Return Summary 3. Other Disclosure Requirements 4. Application to Purchase Shares C. Filing Requirements D. Dissemination of Profiles E. Modified Profiles for Certain Funds III. Effective Date IV. Cost/Benefit Analysis and Effects on Competition, Efficiency, and Capital Formation V. Paperwork Reduction Act VI. Summary of Final Regulatory Flexibility Analysis VII. Statutory Authority Text of Rule I. Introduction and Background Over the last decade, the fund industry has grown tremendously. Over 6,000 funds are now available to investors and close to 40 million American households own funds.\2\ Today, fund assets exceed the deposits of commercial banks.\3\ --------------------------------------------------------------------------- \2\ See INVESTMENT COMPANY INSTITUTE (``ICI''), Trends in Mutual Fund Investing: September 1997 at 3 (Oct. 30, 1997) (ICI News No. 97-93) (``ICI Trends'') (as of Sept. 1997, there were 6,666 funds ) and ICI, Mutual Fund Ownership in the U.S., FUNDAMENTALS, Dec. 1996, at 1 (approximately 36.8 million households owned mutual funds either directly or through a retirement plan as of April 1996). \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). --------------------------------------------------------------------------- As more investors turn to funds for professional management of current and retirement savings, funds have introduced new investment options and shareholder services to meet the needs of investors. While benefiting from these developments, investors also face an increasingly difficult task in choosing among different fund investments. The Commission, fund investors, and others have recognized the need to improve fund disclosure documents to help investors evaluate and compare funds.\4\ In the Commission's view, the growth of the fund industry and the diversity of fund investors warrant a new approach to fund disclosure that will offer more choices in the format and amount of information available about fund investments.\5\ --------------------------------------------------------------------------- \4\ See, e.g., ``Fulfilling the Promise of Disclosure,'' Remarks by Arthur Levitt, Chairman, SEC, before the American Savings Education Council, New York, NY (July 23, 1997); Remarks by Steven M.H. Wallman, Commissioner, SEC, before the ICI's 1995 Investment Company Directors Conference and New Directors Workshop, Wash., D.C. (Sept. 22, 1995); ``Mutual Funds and the International Marketplace: ``A Regulatory Challenge,'' Remarks by Isaac C. Hunt, Jr., Commissioner, SEC, before the Sixth Annual Conference on International Issues, The University of Tulsa, Tulsa, Okla. (Mar. 6, 1997). See also McTague, Simply Beautiful: Shorn of Legalese, Even Prospectuses Make Sense, BARRON'S, Oct. 7, 1996, at F10 (concerning the recent efforts of the John Hancock funds and other fund groups to simplify their prospectuses). \5\ The Commission has demonstrated an on-going commitment to improve the information provided in fund disclosure documents to meet changes in the fund industry and investors' needs. The Commission has taken a number of steps in recent years to meet this goal. See Investment Company Act Release No. 20974 (Mar. 29, 1995) [60 FR 17172] (requesting comment on ways to improve risk disclosure and comparability of fund risk levels) (``Risk Concept Release''); Investment Company Act Release No. 19382 (Apr. 6, 1993) [58 FR 19050] (simplifying financial highlights information and requiring management's discussion of fund performance (``MDFP'')); Investment Company Act Release No. 16245 (Feb. 2, 1988) [53 FR 3868] (``Fund Performance Release'') (adopting a uniform formula for calculating fund performance); Investment Company Act Release No. 16244 (Feb. 1, 1988) [53 FR 3182] (adopting a uniform fee table in fund prospectuses). See also SEC, REPORT OF THE ADVISORY COMMITTEE ON THE CAPITAL FORMATION AND REGULATORY PROCESSES (July 24, 1996); SEC, REPORT OF THE TASK FORCE ON DISCLOSURE SIMPLIFICATION (1996) (recommending specific improvements in the disclosure provided by corporate issuers). --------------------------------------------------------------------------- [[Page 13969]] In seeking to meet this goal, the Commission proposed, on February 27, 1997, new rule 498, which would permit a fund to provide investors with a profile (the ``Proposed Profile'').\6\ The Proposed Profile would summarize key information about a fund, including the fund's investment objectives, strategies, risks, performance, fees, investment adviser and portfolio manager, purchase and redemption procedures, distributions, and the services available to the fund's investors. The Proposed Profile was designed to provide summary information about a fund that would assist an investor in deciding whether to invest in a fund or to request additional information about the fund before deciding whether to buy shares in that fund. Proposed rule 498 would require a fund to mail the prospectus and other information to the requesting investor within 3 business days of a request. An investor deciding to purchase fund shares based on the Proposed Profile would receive the fund's prospectus with the purchase confirmation. --------------------------------------------------------------------------- \6\ Investment Company Act Release No. 22529 (Feb. 27, 1997) [62 FR 10943], correction [62 FR 24160] (``Profile Proposing Release''). --------------------------------------------------------------------------- On the same day that it proposed rule 498 for comment, the Commission published a release in which it proposed major changes to the prospectus disclosure requirements in Form N-1A (``Form N-1A Proposing Release'').\7\ The proposed amendments to Form N-1A were designed to focus prospectus disclosure on essential information about a particular fund that would assist an investor in making a decision about investing in that fund. The proposed amendments reflected the Commission's strongly-held belief that a prospectus, as the primary disclosure document contemplated under the federal securities laws, should present clear, concise, and understandable information about an investment in a fund. --------------------------------------------------------------------------- \7\ Investment Company Act Release No. 22528 (Feb. 27, 1997) [62 FR 10898], correction [62 FR 24160] (``Form N-1A Proposing Release''). --------------------------------------------------------------------------- The Proposed Profile was based on a number of initiatives undertaken by the Commission to assess options for improving fund disclosure documents. One of these initiatives was a pilot program conducted by the Commission, with participation by the Investment Company Institute (``ICI'') and several large fund groups, in which the funds used profile-like summaries (``Pilot Profiles'') with their prospectuses.\8\ The Pilot Profiles, like the profile adopted today, summarized important information about funds. The purpose of the pilot program was to assess whether investors found the Pilot Profiles helpful in making investment decisions. Focus groups conducted on the Commission's behalf (``Focus Groups'') responded positively to the profile concept, indicating that a disclosure document such as the Pilot Profile would assist them in making investment decisions. Fund investors participating in a survey sponsored by the ICI also strongly supported the Pilot Profiles.\9\ --------------------------------------------------------------------------- \8\ 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 of Investment Management (``Division'') has permitted the pilot program to continue until adoption of proposed rule 498. See Investment Company Institute (pub. avail. July 16, 1997) (``1997 Profile Letter''). \9\ Letter from Paul Schott Stevens, Senior Vice President and General Counsel, ICI, to Barry P. Barbash, Director, Division of Investment Management, SEC, at 5-6 (May 20, 1996) (``ICI Survey Letter'') (enclosing Investment Company Institute, The Profile Prospectus: An Assessment by Mutual Fund Shareholders (1996) (survey of over 1,000 fund investors) (``ICI Profile Survey'')). --------------------------------------------------------------------------- The Commission received 256 comment letters on the Proposed Profile, a large percentage of which were from individual investors (226 letters or 88%).\10\ Commenters expressed strong support for the Proposed Profile.\11\ Many commenters cited the advantages of a document that is less technical and easier to read. Commenters believed that the Proposed Profile would assist investors in selecting a fund in which to invest. Many of those commenting on the Proposed Profile, particularly individual investors, endorsed the Proposed Profile's goal of providing standardized, summary information about a fund.\12\ --------------------------------------------------------------------------- \10\ In addition to the comment letters from individuals, the Commission received comment letters from 6 broker-dealers and investment advisers, 8 funds, 3 law firms, 1 rating agency, 4 trade associations, and 8 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. S7-18-96. \11\ Of the comment letters received by the Commission, 88% supported the Proposed Profile. \12\ See also Middleton, Cure on the Way for * * * Prospectusphobia, Mutual Funds Magazine, June 1997, at 58; Fosback, Profiles--A Valuable New Tool for Investors, Mutual Funds Magazine, May 1997, at 10; Profile Prospectuses: An Idea Whose Time Has Come, Mutual Funds Magazine, Aug. 1996, at 11. --------------------------------------------------------------------------- The Commission is adopting rule 498 with modifications that reflect the Commission's consideration of commenters' suggestions. Rule 498 permits a fund to provide investors with a new disclosure option in the form of a profile that summarizes key information about the fund.\13\ A fund that makes a profile available will be able to offer an investor the option of purchasing the fund's shares after reviewing the information in the profile or of requesting and reviewing the fund's prospectus (and other information) before making an investment decision. An investor deciding to purchase fund shares based on the profile will receive the fund's prospectus with the purchase confirmation. --------------------------------------------------------------------------- \13\ The ICI recently conducted a survey to assess information that investors considered before making a fund purchase. The results indicated that investors considered fund risk levels, total returns, and investment goals most frequently (listed respectively as first, second, and fourth). ICI, Uncerstanding Shareholders' Use of Information and Advisers at 4 (1997) (``ICI Shareholder Survey''). --------------------------------------------------------------------------- Under rule 498, as adopted, the profile will include: --Standardized Fund Summaries. The profile includes concise disclosure of 9 items of key information about a fund in a specific sequence. --Improved Risk Disclosure. A risk/return summary (also required at the beginning of a fund's prospectus) provides information about a fund's investment objectives, principal strategies, risks, performance, and fees. --Graphic Disclosure of Variability of Returns. The risk/return summary provides a bar chart of a fund's annual returns over a 10-year period that illustrates the variability of those 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-year periods to that of a broad-based securities market index. --Other Fund Information. The profile includes information on the fund's investment adviser and portfolio manager, purchase and redemption procedures, tax considerations, and shareholder services. --Plain English Disclosure. The Commission's recently adopted plain English disclosure requirements, which are designed to give investors understandable disclosure documents, will apply to the profile.\14\ The Commission's plain English rule requires the use of plain English writing principles, including short sentences, everyday language, active voice, tabular presentation of complex [[Page 13970]] material, no legal or business jargon, and no multiple negatives.\15\ --------------------------------------------------------------------------- \14\ See Securities Act Release No. 7497 (Jan. 28, 1998) [63 FR 6370] (``Plain English Release'') (adopting amendments to rule 421 under the Securities Act [17 CFR 230.421] requiring the use of plain English disclosure principles). \15\ Rule 421(d). Rule 498, as adopted, also permits a fund that serves as an investment option for a participant-directed defined contribution plan (or for certain other tax-deferred arrangements) to provide investors with a profile that includes disclosure that is tailored for the plan (or other arrangement). Profiles tailored for such use can exclude information relating to the purchase and sale of fund shares, fund distributions, tax consequences, and fund services otherwise required in a profile. The Commission has determined to adopt rule 498 and permit funds to use summary disclosure documents in accordance with the rule under the authority of section 10(b) of the Securities Act \16\ and other provisions of the federal securities laws.\17\ Section 10(b) gives the Commission the authority to adopt rules allowing the use of a summary prospectus if the Commission determines that doing so is ``necessary or appropriate in the public interest and for the protection of investors.'' \18\ In making this determination about profiles, the Commission considered, among other things: An extensive analysis of fund disclosure issues it recently conducted; its assessment of funds' use of Pilot Profiles; its assessment of certain other disclosure initiatives; and its substantial experience gained in administering the two-part disclosure format adopted in 1983 permitting a fund to provide investors with a simplified prospectus containing essential information about the fund and to place more detailed information about the fund in a Statement of Additional Information (``SAI''), which investors can obtain upon request.\19\ The Commission believes, and the broad support for the Proposed Profile confirms its belief, that rule 498 will benefit investors and promote effective communication of information about funds. --------------------------------------------------------------------------- \16\ 15 U.S.C. 77j(b). Section 10(b) of the Securities Act of 1933 (``Securities Act'') permits the use of a summary prospectus (which provides information the substance of which is included in the prospectus) to communicate information for purposes of an offer under section 5(b)(1) of the Securities Act [15 U.S.C. 77e(b)(1)]. Section 5(b)(2) of the Securities Act [15 U.S.C. 77e(b)(2)] requires, as a condition of selling a security, the delivery to investors of a prospectus that meets the requirements of section 10(a) of the Securities Act [15 U.S.C. 77j(a)]. \17\ Congress recently confirmed the authority of the Commission to permit the use of a summary prospectus by adding new section 24(g) to the Investment Company Act [15 U.S.C. 80a-24(g)]. National Securities Markets Improvement Act of 1996, Pub. L. 104-290 (1996) (``Improvements Act''), section 204 (amending section 24 to add new paragraph (g)). While the profile, as adopted, will include a summary of information that is required in the prospectus, the Commission may adopt other rules under section 24(g) allowing a fund to use a summary prospectus that includes information the substance of which is not included in the prospectus. \18\ See supra note 16. \19\ Investment Company Act Release No. 13436 (Aug. 12, 1983) [48 FR 37928] (``1983 Form N-1A Adopting Release''). See also supra note 5. --------------------------------------------------------------------------- Today, the Commission also is adopting the proposed amendments to Form N-1A.\20\ As they did with the Proposed Profile, commenters strongly supported the revised prospectus disclosure requirements. Taken together, these two disclosure initiatives are intended to allow funds flexibility to respond to the diverse information needs of investors and to improve fund disclosure.\21\ --------------------------------------------------------------------------- \20\ See Form N-1A Release, supra note 1. \21\ The Commission also proposed as part of these disclosure initiatives a new rule to 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]. The 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 Division is analyzing the comments and expects to recommend a final rule for Commission consideration in the near future. --------------------------------------------------------------------------- II. DISCUSSION A. General 1. Overview of Comments The vast majority of commenters on the Proposed Profile expressed strong support for the profile and specifically supported the concept of giving investors the option of purchasing shares of a fund on the basis of information contained in a summary disclosure document.\22\ A small number of commenters, however, questioned whether providing investors with this option was in the best interests of fund investors. These commenters asserted that investors may not appreciate the significance of an investment in a fund if they purchase its shares based on a summary document rather than the prospectus. These commenters also were concerned that widespread use of a profile could cause fewer investors to read the prospectus and asserted that the Commission would be better advised to direct its efforts to improving the prospectus. --------------------------------------------------------------------------- \22\ The Commission has long encouraged summary prospectuses under section 10(b) of the Securities Act to provide investors with a condensed statement of important information included in the prospectus. In 1956, the Commission adopted a rule permitting the use of a summary prospectus under section 10(b), which was extended to investment companies in 1972. See Securities Act Release No. 3722 (Nov. 23, 1956) (adopting rule 434A [17 CFR 230.434A] to permit the use of a summary prospectus); Securities Act Release No. 5248 (May 9, 1972) [37 FR 10071] (extending rule 434A to investment companies); Securities Act Release No. 6383 (Mar. 3, 1982) [47 FR 11380] (renumbering rule 434A as rule 431) [17 CFR 230.431]. The profile permitted by rule 498 is intended to replace the summary prospectuses that funds are currently permitted to use by rule 431 under the Securities Act, and the Commission is amending rule 431 to clarify that the rule no longer applies to funds. The Commission also is eliminating the ``Instructions as to Summary Prospectuses'' that now accompany Form N-1A. See Form N-1A Release, supra note 1. --------------------------------------------------------------------------- Implicit in these comments would seem to be the view that all investors should use a longer document--the prospectus--rather than a shorter document--the profile--in making a decision about investing in a fund. Such a view appears to be inconsistent with the sentiments of fund investors. The Commission and others, in seeking to identify ways to improve the disclosure of information about mutual funds to investors, have collected data about investors. This data demonstrates that different investors desire and use different types and amounts of materials in determining whether to invest in funds.\23\ The Commission believes that the data supports its conclusion to allow funds the option of offering their shares through the profile with delivery of a prospectus with the confirmation of purchase. --------------------------------------------------------------------------- \23\ As noted above, Focus Groups responded very positively to the profile option. A number of individual investors also have written to the Commission and expressed strong support for the profile. See Profile Proposing Release, supra note 6, at 10944. See also ICI Profile Survey, supra note 9, at 22, 26; ICI Shareholder Survey, supra note 13, at 4. --------------------------------------------------------------------------- The Commission's strongly held belief is that the principal goal of fund disclosure, whether it takes the form of a long or short document, should be to provide investors with useful and relevant information. Each of the disclosure initiatives that the Commission is adopting today has this goal, which the Commission believes complements the themes underlying the recently adopted plain English rule.\24\ To further this goal, the Commission encourages all funds that decide to use profiles to take the steps necessary to ensure that their prospectuses effectively communicate information to investors. The Commission believes that funds need to take this action if the initiatives adopted today are to achieve their objectives. --------------------------------------------------------------------------- \24\ See Plain English Release, supra note 14. --------------------------------------------------------------------------- 2. Liability In its release proposing new rule 498 (``the Profile Proposing Release''), the Commission discussed the protections [[Page 13971]] afforded investors under the federal securities laws for false and misleading statements in a profile.\25\ These protections include the provisions of sections 12(a)(2) and 17(a) of the Securities Act, which impose civil and criminal liability upon any person who offers or sells securities using an untrue statement of material fact or who omits to state a material fact necessary in order to make a statement, in light of the circumstances under which it was made, not misleading.\26\ Investor protections applicable to a profile also include the antifraud provisions of section 10(b) of the Securities Exchange Act of 1934 and rule 10b-5 under that Act.\27\ --------------------------------------------------------------------------- \25\ See Profile Proposing Release, supra note 6, at 10950. \26\ 15 U.S.C. 77l(a)(2); 15 U.S.C. 77q(a). \27\ 15 U.S.C. 78j(b); 17 CFR 240.10b-5. In addition, the Commission has the authority under section 10(b) of the Securities Act to suspend the use of a profile, as a summary prospectus, if the profile includes a false or misleading statement or omits to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading. This authority supplements the Commission's authority under section 8(b) of the Securities Act [15 U.S.C. 77h(b)] to issue an order to stop the sale of securities by means of a materially inaccurate or incomplete section 10(a) prospectus. --------------------------------------------------------------------------- When it gave the Commission the authority to permit the use of a summary prospectus under section 10(b) of the Securities Act, Congress provided a specific exception from strict liability for misleading statements and omissions imposed under section 11 of the Securities Act \28\ for these type of disclosure documents. The purpose of the exception was to encourage the use of a summary prospectus while maintaining investor protection by requiring delivery of a section 10(a) prospectus at or before the time that the investor receives the confirmation of the purchase of the security described in the summary prospectus.\29\ --------------------------------------------------------------------------- \28\ 15 U.S.C. 77k. \29\ See I LOSS & SELIGMAN, SECURITIES REGULATION 480 and n.214 (3d ed. 1989) (citing S. Rep. 1036, 83d Cong., 2d Sess. 17-18 (1954) and H.R. Rep. 1542, 83d Cong., 2d Sess. 26 (1954)). Although section 11 liability would not apply to the profile, section 11 liability would apply to the sale of a fund's securities if a misleading statement is included in both the profile and the prospectus. --------------------------------------------------------------------------- The Commission believes that the profile fits squarely within the statutory framework contemplated by Congress for the offering and sale of securities under the federal securities laws. The profile of a fund will be a summary prospectus under section 10(b) of the Securities Act, but the fund's section 10(a) prospectus will remain the primary disclosure document under the federal securities laws. To inform investors about the availability of the prospectus, a profile includes a legend on the cover page (or at the beginning of the profile) explaining that the profile is a summary document and stating that more information about the fund is available in the prospectus.\30\ --------------------------------------------------------------------------- \30\ The legend also indicates that other information about the fund is available in addition to the prospectus. See infra Section II.B.1 for a discussion of the profile legend. --------------------------------------------------------------------------- While most commenters strongly favored the profile, several commenters expressed concern that a fund using a profile could face increased liability under the federal securities laws. These commenters argued in particular that a fund's use of a profile could result in claims under section 12(a)(2) of the Securities Act alleging that the profile is misleading because it omits information disclosed in the fund's prospectus.\31\ --------------------------------------------------------------------------- \31\ Section 12(a)(2) imposes liability for material misstatements or omissions when the seller cannot demonstrate the exercise of ``reasonable care.'' An action under section 12(a)(2) does not require proof of scienter (i.e., intent to mislead investors), e.g., Wigand v. Flo-Tek, Inc., 609 F.2d 1028, 1034 (2d Cir. 1979), or investor reliance on a misleading statement or omission, e.g., MidAmerica Fed. S. & L. Assoc. v. Shearson/American Express, Inc., 886 F.2d 1249, 1256 (10th Cir. 1989); Sanders v. John Nuveen & Co., 619 F.2d 1222, 1225 (7th Cir. 1980), cert. denied, 450 U.S. 1005 (1981). In contrast, claims by private plaintiffs under the antifraud provisions of section 10(b) of the Securities Exchange Act of 1934 (``Securities Exchange Act'') require proof of scienter and investor reliance. Under either type of claim, however, it must be established that the misrepresentation or omission was ``material,'' which generally means that a substantial likelihood exists that a reasonable investor would consider the information important in making an investment decision. TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976); Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988). Commenters cited several cases as examples of the claims funds may face under section 12(a)(2) for alleged nondisclosures in profiles. See, e.g., In re TCW/DW North Am. Gov. Income Trust Secs. Litigation, 941 F. Supp. 326, 337-38 (S.D.N.Y. 1996) (dismissing certain allegations that fund misstated and omitted information regarding risks of international investing on the basis that a reasonable investor would not have been misled); In Re Alliance North Am. Gov. Income Trust, Inc. Secs. Litigation, 1996 U.S. Dist. LEXIS 14209 (S.D.N.Y. 1996) (same); Tabankin v. Kemper Short-Term Global Income Fund, 1994 U.S. Dist. LEXIS 965 (N.D.Ill. 1994) (dismissing allegations that fund failed to disclose adequately the risks of investment). --------------------------------------------------------------------------- To address this concern, several commenters urged the Commission to permit funds to incorporate by reference the prospectus into the profile to provide funds with a defense against unwarranted claims that a profile omits material information. As stated in the Profile Proposing Release, however, the Commission believes that allowing funds to incorporate by reference the prospectus into the profile would be inconsistent with the purpose of the profile and not in the public interest.\32\ The profile is designed to provide summary information about a fund in a self-contained format that will assist an investor in deciding to invest in, or in deciding to request additional information about, the fund. Permitting a fund to incorporate by reference the prospectus into the profile would result in the prospectus being considered a part of the profile and would be inconsistent with the profile being a self-contained document.\33\ --------------------------------------------------------------------------- \32\ Profile Proposing Release, supra note 6, at 10950. One commenter suggested as an alternative to incorporation by reference that the Commission create a liability ``safe harbor'' for funds using profiles. Under such a provision, a fund using a profile meeting the requirements of rule 498 would be deemed to have disclosed all material information about a fund for purposes of the profile if the fund's prospectus contained all material information. Such a provision, in effect, would amount to incorporation by reference and, in the Commission's view, would be inconsistent with the purpose of the profile. \33\ See White v. Melton, 757 F. Supp. 267, 271-72 (S.D.N.Y. 1991). See also 1983 Form N-1A Adopting Release, supra note 19, at 37930. --------------------------------------------------------------------------- On the basis of, among other things, its prior experience with summary documents, such as advertisements designed to meet the requirements of rule 482 under the Securities Act,\34\ the Commission does not agree with commenters' claims that the use of profiles will lead to significant potential liabilities under the federal securities laws. In the Commission's view, a fund using a profile generally should not face liability for omitting information included in the fund's prospectus if the profile includes the information required or permitted by rule 498; potential liability would arise only if a profile contains a material misstatement or omits a statement necessary to make the disclosure in the profile not materially misleading. The mere omission of information from the profile that is required or permitted in the prospectus should not, in the Commission's view, give rise to liability under the federal securities laws.\35\ --------------------------------------------------------------------------- \34\ In 1979, the Commission adopted rule 434d under the Securities Act [17 CFR 230.434d], subsequently redesignated rule 482 [17 CFR 230.482], which permits investment companies to use advertisements that are designed to be omitting prospectuses of the type contemplated by section 10(b) of the Securities Act. Securities Act Release No. 6116 (Aug. 31, 1979) [44 FR 52816]. \35\ Like those commenting on the Proposed Profile, commenters on proposed rule 434d argued that a fund using an advertisement under the rule would be subject to potential liability under section 12(a)(2) if the advertisement did not contain all of the information included in the fund's prospectus. In adopting rule 434d, the Commission stated its belief that a fund should not be liable under section 12(a)(2) merely because information included in the fund's section 10(a) prospectus was not included in the advertisement. 44 FR at 52817. The Commission is not aware of any lawsuits brought since the adoption of rule 434d in which a fund was found liable for an advertisement meeting the requirements of the rule on the basis that the advertisement failed to include information contained in the fund's prospectus. --------------------------------------------------------------------------- [[Page 13972]] The Commission believes that the intended purpose of a profile as a summary disclosure document supports the view that a fund using a profile should not be subject to liability under the federal securities laws for omitting information from the profile that is included in the fund's prospectus. Rule 498 specifies the information that can or must be included in a fund's profile and requires the fund to state that the profile contains a summary of certain information in the fund's prospectus. The Commission's goal in adopting rule 498, which is to facilitate the use of a short, summary disclosure document that investors can use to evaluate and compare funds, would not be met unless rule 498 is read as limiting the information required to be included in the profile. Commenters on the Proposed Profile requested that the Commission provide guidance about the applicability of section 19(a) of the Securities Act to a fund that uses a profile under new rule 498. By its terms, section 19(a) protects a defendant from liability for actions taken in good faith in conformity with any rule of the Commission.\36\ The Commission believes that a fund that provides investors with a profile in good faith compliance with rule 498 would be able to rely on section 19(a) against a claim that its profile did not include information that is disclosed in the fund's prospectus. --------------------------------------------------------------------------- \36\ 15 U.S.C. 77s(a). See also section 38(c) of the Investment Company Act [15 U.S.C. 80a-37(c)]. --------------------------------------------------------------------------- 3. Plain English Disclosure In seeking to encourage all issuers, including funds, to provide disclosure materials required under the federal securities laws that are simpler, clearer, and more useful to investors, the Commission recently adopted initiatives that would require the use of plain English in drafting those materials.\37\ These initiatives contemplate disclosure documents using plain English writing principles including short sentences, everyday language, active voice, tabular presentation of complex material, no legal or business jargon, and no multiple negatives. The Commission strongly believes that, by drafting profiles in strict compliance with plain English principles, funds can provide improved disclosure to investors. Rule 498, as adopted, reflects this belief. The rule requires that funds disclose the information in the profile using the plain English writing principles set out in the Commission's plain English rule.\38\ --------------------------------------------------------------------------- \37\ See Plain English Release, supra note 14. 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. \38\ Instruction 2 to rule 498(b) (requiring funds to use the plain English writing principles set out in rule 421(d) in drafting the disclosure in the profile). See supra note 14 and accompanying text. --------------------------------------------------------------------------- 4. Use of the Profile by Other Types of Investment Companies The Commission proposed to permit funds to use profiles, but did not propose to permit other types of investment companies, such as closed-end investment companies, unit investment trusts, and separate accounts that offer variable annuities, to rely on rule 498. Several commenters disagreed with the Commission's decision and urged the Commission to allow other types of investment companies to use profiles. The Commission is not persuaded at this time by these commenters, and rule 498, as adopted, is available only to funds. Although it recognizes that a short, summary disclosure document such as the profile could potentially benefit investors in other types of investment companies, the Commission has concluded that it should assess the use of profiles by funds over a period of time before considering a rule that would allow other types of investment companies to use similar summary documents. As the Commission gains experience with funds' use of the profile and analyzes the results of other pilot profile programs that are underway,\39\ it will consider expanding use of the concept to other types of investment companies.\40\ --------------------------------------------------------------------------- \39\ See National Association for Variable Annuities (pub. avail. June 4, 1996) (staff no-action letter allowing pilot program for variable annuity profiles). The Division has permitted this program to continue pending its taking any further action with respect to variable annuity profiles. National Association for Variable Annuities (pub. avail. May 30, 1997) (staff no-action letter). \40\ The Proposed Profile refined the prototype profile used in the pilot program, which allowed the Commission to evaluate use of the profile concept for funds. See supra note 8 and accompanying text. The Commission believes that further initiatives to adapt the profile concept for other types of investment companies should follow a similar approach that includes a review of existing prospectus disclosure requirements and an assessment of investor responses to a different disclosure format. --------------------------------------------------------------------------- 5. Standardized Format The Proposed Profile required disclosure of 9 items of key information presented in a specific sequence following a question-and- answer format. The purpose of standardizing the order of the items was to help investors locate similar information in the profiles of different funds and compare the funds. The proposed question-and-answer format, frequently used by many funds in their prospectuses, was intended to help communicate the required information effectively. Most commenters supported a standardized presentation in profiles, but several commenters criticized the prescribed question-and-answer format, suggesting that funds should be able to choose other formats to set out the information required in a profile. The Commission is adopting the standardized presentation requirement as proposed because it believes that requiring the profile items in a specific sequence will substantially assist investors in locating information and comparing funds. Consistent with the goal of allowing funds to design effective disclosure documents, however, rule 498 does not limit the presentation of the required information to a question-and-answer format.\41\ Any fund that chose to do so could use a question-and- answer format in its profile. --------------------------------------------------------------------------- \41\ The profile is, however, subject to certain other format requirements. Under rule 498, as adopted, profiles must meet requirements with respect to font size and legibility set out in rule 420 under the Securities Act [17 CFR 230.420]. Rule 420 requires, among other things, that prospectuses be in roman type at least as large and as legible as 10-point modern type. --------------------------------------------------------------------------- 6. Additional Disclosure Items Several commenters suggested that additional disclosure items would be useful in a profile, including: --a fund's top ten portfolio holdings; --an investment style box; --additional measures of risk; and --financial highlights. The Commission acknowledges that the disclosure suggested by the commenters could be useful to some fund investors and could generally enhance the information available about funds. Nonetheless, the Commission has concluded that none of these items should be required by rule 498 at this time. In considering fund disclosure requirements, the Commission must balance many factors, including, among other things, the amount of information that is consistent with the purpose of a particular disclosure document. The purpose of the profile is to provide investors with a short, standardized disclosure document containing summary information about a fund. In the Commission's view, the additional items suggested by commenters could be of interest to some fund investors but are not necessarily essential information for the average or typical investor. The Commission believes that some of the [[Page 13973]] types of information cited by commenters may be more helpful in connection with a fund's discussion of its current investment activities that is presently included in fund shareholder reports.\42\ The Commission has directed the Division of Investment Management (``Division'') to begin work on a comprehensive assessment of the Commission's existing rules specifying the disclosure to be included in fund reports to shareholders to assess whether other types of information should be added to those reports.\43\ --------------------------------------------------------------------------- \42\ See section 30(d) of the Investment Company Act [15 U.S.C. 80a-29(d)] and rule 30d-1 [17 CFR 270.30d-1] (requiring funds to provide investors with semi-annual reports about a fund's current operations). \43\ See Form N-1A Release, supra note 1. In proposing changes to improve the disclosure in fund prospectuses, the Commission recognized that revisions to shareholder report requirements could enhance the disclosure provided to investors. See Form N-1A Proposing Release, supra note 7, at 10912. Recent legislation gives the Commission greater authority to specify the content of annual reports and to require additional disclosure in annual and semi- annual reports as necessary or appropriate in the public interest or for the protection of investors. Improvements Act, supra note 16, section 206(f) (amending section 30 of the Investment Company Act [15 U.S.C. 80a-29] to add new paragraph (f)). The Commission notes its preliminary view that an ``integrated'' approach to registration and reporting requirements applicable to funds could improve the overall information about funds available to investors. See Form N- 1A Release, supra note 1. --------------------------------------------------------------------------- 7. Eligibility In the Profile Proposing Release, the Commission suggested that certain funds might not be eligible to use a profile. In particular, the Commission stated that, if material information about a fund exists but is not addressed by the 9 items of disclosure required to be in a profile, the fund might not appropriately use a profile.\44\ Several commenters strongly objected to this assertion. They argued that it is inconsistent with the premise underlying the profile initiative that a typical fund investor would have enough information to make an investment decision about a fund using a summary disclosure document containing the 9 required items accompanied by a statement about the availability of additional information in the fund's prospectus and other documents. One commenter suggested that the Commission address the eligibility issue by requiring the profile to provide additional summary information about other items of disclosure that are required in prospectuses. Another commenter suggested that, as an alternative, the Commission provide for a tenth item in the profile in response to which a fund could include at its option any other information that the fund believed was material to an investor's consideration of an investment in the fund. Several other commenters, however, argued that such an item was not consistent with the Commission's purpose in developing the Proposed Profile as a short, standardized, self- contained disclosure document. --------------------------------------------------------------------------- \44\See Profile Proposing Release, supra note 6, at 10945. --------------------------------------------------------------------------- After consideration of these comments, the Commission has determined to adopt rule 498 to require funds to include only the information specified by the 9 items in the rule and to delete any suggestion that certain funds may be ineligible to use profiles.\45\ The Commission has selected these items because it believes that they fulfill the goal of providing investors with a short, summary disclosure document on the basis of which investors can make decisions about investing in a fund. Under rule 498, as adopted, an investor who believes that he or she needs more information before making such a decision has the option of obtaining additional information by requesting the fund's prospectus or other disclosure materials.\46\ --------------------------------------------------------------------------- \45\ Rule 498(b). The profile generally will provide a summary of certain items in the prospectus, while the prospectus will provide a fuller description of each of these items. The prospectus, for example, discloses the amount of any rule 12b-1 fees charged by a fund in the fee table and includes a narrative discussion about the fund's rule 12b-1 fees. In contrast, the profile as a summary disclosure document discloses the amount of the fund's rule 12b-1 fees as part of the fee table disclosure. Similarly, a prospectus identifies each investment adviser of a fund, including a sub- adviser of the fund, while, in certain cases, a profile could disclose the number of sub-advisers managing the fund's portfolio without identifying each sub-adviser. See Form N-1A Release, supra note 1, and infra notes 90 and 93-94 and accompanying text. \46\ Proposed rule 498 provided that a fund could not use footnotes or include cross-references within the profile or to information appearing in another of the fund's disclosure documents, unless specifically required or permitted in the rule. See Profile Proposing Release, supra note 6, at 10945 n.22. The Commission believes that footnotes and cross-references should generally be unnecessary in a summary document such as a profile. The Commission acknowledges, however, that circumstances may exist under which footnotes or cross-references within the profile may result in better disclosure. Thus, the Commission is revising rule 498 to discourage, but not to preclude, the use of footnotes or cross- references within a profile; under the rule, a fund may use footnotes or cross-references within a profile if their use promotes a better understanding of the information about the fund contained in the profile. Instruction 1 to rule 498(b). Rule 498, as adopted, continues to preclude use of cross-references to information appearing in another of the fund's disclosure documents. Such cross- references would be inconsistent with the purpose that the profile be a self-contained document. For purposes of the profile only, a hyperlink to a fund's prospectus from the fund's profile when both documents are available electronically would not be deemed a cross- reference. See infra note 120 (describing and explaining the use of hyperlinks in a profile). --------------------------------------------------------------------------- 8. Number of Funds Described in a Profile Rule 498, as proposed, would permit a profile to describe more than one fund. As discussed in the Profile Proposing Release, the Commission concluded, on the basis of the Pilot Program and Focus Group responses, that a profile that describes more than one fund can be consistent with the goal of a summary disclosure document that assists investors in evaluating and comparing funds. Describing more than one fund or class in a profile, for example, could be a useful means of providing investors with information about related investment alternatives offered by a fund group (e.g., a range of tax-exempt funds or different types of money market funds) or about the classes of a multiple class fund. Recognizing that too much information could make the profile lengthy, complex, and difficult to understand, the Commission requested comment whether use of a profile should be limited to one fund or to some other number of funds. Most commenters supported the proposal to allow a profile to describe more than one fund. One commenter expressed concerns about the proposal and suggested that funds instead be allowed to bind separate profiles together. The Commission believes that the ability to describe different investment options in one summary document will enable funds to develop profiles that help investors compare investment alternatives offered by a fund group. Therefore, the Commission is adopting rule 498, as proposed, with no express limitation on the number of funds that can be described in a profile. Information about multiple funds in a single profile, however, would need to be set out in a concise and summary manner in a format designed to communicate the information effectively.\47\ --------------------------------------------------------------------------- \47\ Instruction 2 to rule 498(b). A fund must use plain English writing principles in drafting disclosure in the profile. See supra note 37. In response to a comment, the Commission is modifying rule 498 to clarify that information that is common to all funds or classes described in a profile need be stated only once and not repeated for each fund or class. Instruction 4 to rule 498(b). Rule 498, as adopted, does not preclude binding separate profiles for different funds together in one document. --------------------------------------------------------------------------- B. Profile Disclosure 1. Cover Page Proposed rule 498 would require the cover page of a fund's profile to include certain basic information about the fund [[Page 13974]] and to disclose that the profile is a summary disclosure document. As proposed, the cover page would identify the disclosure document as a ``profile,'' would include a legend explaining the profile's purpose, and would include the fund's name. A fund also could describe its investment objectives or its type or category (e.g., that the fund is a growth fund or invests its assets in a particular country). Proposed rule 498 also would require the cover page to state the approximate date of the profile's first use and, if applicable, the date of the most recent updated performance information included in the profile. The Commission is adopting the proposed cover page requirements with modifications to reflect the suggestions of various commenters.\48\ Some commenters questioned the proposed requirement to state on a profile's cover page the date of the most recent performance information included in the profile, asserting that this requirement would necessitate a fund's reprinting its profile frequently to reflect updated performance information. These commenters suggested that, as an alternative, the Commission permit the date of the most recent performance information to accompany that information in the body of the profile. The Commission has concluded that the date of performance information included in a profile can be communicated to investors effectively if the date accompanies the disclosure of performance information. Rule 498, as adopted, reflects this conclusion.\49\ --------------------------------------------------------------------------- \48\ One commenter requested clarification whether a profile must include a separate cover page. Rule 498, as adopted, clarifies that a profile need not have a separate cover page so long as the specified cover page disclosure is included as introductory information at the beginning of the profile. The proposed cover page requirements were intended to identify introductory information that should appear at the beginning of a profile. \49\ Rule 498(c)(2)(iii). Rule 498 permits a fund to reflect updated performance information in a ``sticker'' or similar means to avoid requiring frequent reprinting of the profile to change this section of the profile. Instruction to rule 498(c)(2)(iii). --------------------------------------------------------------------------- Proposed rule 498 would require funds to identify the document on the cover page as a ``profile'' without using the term ``prospectus.'' \50\ Several commenters asserted that funds should be able to refer to the profile as a prospectus because a profile is a summary prospectus under the federal securities laws.\51\ When proposing the profile as an optional disclosure document, the Commission made it clear that the profile was not intended to supersede the section 10(a) prospectus as the primary disclosure document for funds under the federal securities laws.\52\ In restricting funds from referring to the profile as a prospectus, the Commission intended to avoid investor confusion by distinguishing between the two documents. The Commission believes that, if a profile is labeled a prospectus, investors may not understand the difference between the two documents. In the Commission's view, the technical legal status of the profile as a summary prospectus should not be determinative of the appropriate label for the document. The Commission believes that investors will benefit from clear identification of the disclosure documents and is adopting rule 498, as proposed, with the restriction on the use of the term ``prospectus.''\53\ --------------------------------------------------------------------------- \50\ Proposed rule 498(c)(1)(ii). \51\ See supra note 16. \52\ See Profile Proposing Release, supra note 6, at 10950. See also supra Section II.A.2. \53\ Rule 498(c)(1)(ii). --------------------------------------------------------------------------- The Commission proposed that the cover page of the profile include a legend designed to alert an investor to the summary nature of a fund's profile and to inform the investor that he or she can obtain the fund's prospectus and other disclosure materials of the fund before making a decision about investing in the fund. In considering an appropriate profile legend, the Commission sought a concise, clear statement that minimized technical or legal jargon; provided investors with a description of a fund's profile; and informed them about the availability of other information about the fund. The Profile Proposing Release set out two alternative legends about which a number of commenters expressed strong views.\54\ --------------------------------------------------------------------------- \54\ See Profile Proposing Release, supra note 6, at 10946. --------------------------------------------------------------------------- The primary difference between the two legends proposed by the Commission was the reference to information in the prospectus. The first legend, which was similar to that used in the Pilot Profile, stated that the profile summarizes key information in the prospectus.\55\ The second legend added a statement that the prospectus includes additional material information about the fund.\56\ --------------------------------------------------------------------------- \55\ See id. The first proposed legend read as follows: This Profile summarizes key information about the Fund that is included in the Fund's prospectus. If you would like more information before you invest, you may obtain the Fund's prospectus and other information about the Fund at no cost by calling ______. \56\ See id. The second proposed legend read as follows: This Profile summarizes key information about the Fund that is included in the Fund's prospectus. The prospectus includes additional material information about the Fund that you may want to consider before you invest. You may obtain the Fund's prospectus and other information about the Fund at no cost by calling ______. --------------------------------------------------------------------------- No commenters expressed support for the first proposed legend, and the comments on the second were mixed. Many commenters believed that the second legend would clearly inform investors that the profile contains summary disclosure of key information about a fund and that additional important information about the fund is available in the prospectus. Several of these commenters, however, strongly urged the Commission to delete the word material from the legend. They asserted that the use of that term would imply incorrectly that a fund's profile may be legally deficient simply because it did not contain all of the information contained in the fund's prospectus. Several commenters suggested that both of the proposed legends were insufficient and should be strengthened to alert investors more clearly about the summary nature of the profile and the availability of additional information in the prospectus. The Commission believes that the profile legend serves an important purpose and that the numerous comments that it received on the proposed legends clearly indicate that commenters share this belief. To ensure that the legend sufficiently serves its purpose of informing investors of the summary nature of the profile, the Commission has determined to strengthen the legend and include specific language offered by commenters. As adopted, rule 498 requires the following legend on the cover page, or at the beginning, of a profile: This profile summarizes key information about a Fund that is included in the Fund's prospectus. The Fund's prospectus includes additional information about the Fund, including a more detailed description of the risks associated with investing in the Fund that you may want to consider before you invest. You may obtain the prospectus and other information about the Fund at no cost by calling ______.\57\ --------------------------------------------------------------------------- \57\ Rule 498(c)(1)(iv). A fund will be required to provide a toll-free or collect telephone number for investors to request the prospectus or other information. A fund also may, if applicable, indicate that the prospectus is available on its Internet web site or by E-mail. Rule 498(c)(1)(v). Rule 498 requires that an application to purchase shares of a fund that accompanies the fund's profile present with equal prominence the option to invest in the fund based on the information included in the profile or to request the prospectus and other information before making an investment decision. Rule 498(c)(3). See infra note 104 and accompanying text. To ensure that fund investors who, after reviewing a profile, request other information about a fund receive that [[Page 13975]] information promptly, the Commission proposed to require a fund to send its prospectus to the requesting investors within 3 business days of a request. Those commenters addressing this requirement generally supported it, although one commenter maintained that revising the requirement to state that mailings need to be made ``reasonably promptly,'' which the commenter stated should normally be deemed to be within 3 business days of a request, would protect funds against claims that they failed to meet the requirements as a result of unforeseen circumstances. The Commission continues to believe, as discussed in the Profile Proposing Release, that prompt mailing of the prospectus to investors who request it is an essential component of the profile initiative and the goal of promoting effective communication of information about funds.\58\ Therefore, the Commission is adopting the 3-business day mailing requirement as proposed.\59\ --------------------------------------------------------------------------- \58\ See Profile Proposing Release, supra note 6, at 10946. \59\ Instruction to rule 498(c)(1)(v). The Commission's Office of Compliance Inspections and Examinations will, as a part of its routine periodic inspections of a fund's operations, examine a fund's compliance with the 3-business day mailing requirement. In addition to the 3-business day mailing requirement for prospectuses, rule 498 requires a fund to send within 3 business days of a request its annual or semi-annual shareholder report and Statement of Additional Information (``SAI''). Id. The Commission staff also will examine a fund's compliance with this requirement. Failure to comply with either requirement could result in action by the Commission to ensure compliance, including an enforcement action in an appropriate case. --------------------------------------------------------------------------- Some commenters requested clarification from the Commission about the procedure that a fund should follow in responding to requests for additional information when its shares are sold through financial intermediaries, such as broker-dealers or banks. Commenters recommended that the Commission revise rule 498 to permit the legend to state that additional information in such a case may be obtained from financial intermediaries. The Commission acknowledges that many funds use intermediaries in distributing or servicing their shares and that investors may look to these intermediaries for information about the funds. Thus, rule 498, as adopted, allows funds to state that additional information about a fund is available from a financial intermediary.\60\ A fund whose information is available through another entity, however, retains the obligation to ensure that information is sent to investors within 3 business days of an investor's request. The Commission expects that funds will fulfill this obligation through contractual arrangements with broker-dealers, banks, or other financial intermediaries. --------------------------------------------------------------------------- \60\ Instruction to Rule 498(c)(1)(v). --------------------------------------------------------------------------- 2. Risk/Return Summary The Commission proposed that the first 4 items of the profile elicit information that would be substantially identical to the proposed risk/return summary at the beginning of every prospectus. Most commenters supported the risk/return summary in the profile, and the Commission is adopting it generally as proposed. The Form N-1A Release discusses in detail the prospectus risk/return summary.\61\ The risk/ return summary required in the profile by rule 498, as adopted, will incorporate substantially all of the requirements for the summary in Form N-1A, as amended. The following discussion summarizes the main features of the risk/return summary required by Form N-1A and discusses specific disclosure required in the profile. --------------------------------------------------------------------------- \61\ See Form N-1A Release, supra note 1. --------------------------------------------------------------------------- --Fund Investment Objectives/Goals To assist investors in identifying funds that meet their general investment needs, the proposed risk/return summary would require a fund to disclose its investment objectives or goals. The Commission is adopting this disclosure requirement in rule 498 as proposed.\62\ --------------------------------------------------------------------------- \62\ Rule 498(c)(2)(i). --------------------------------------------------------------------------- --Principal Investment Strategies The proposed risk/return summary would require a fund to summarize, based on the information provided in its prospectus, how the fund intends to achieve its investment 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 invests or will invest principally, and any policy of the fund to concentrate its investments in an industry or group of industries. The Commission is adopting this requirement in rule 498 as proposed.\63\ --------------------------------------------------------------------------- \63\ Rule 498(c)(2)(ii). --------------------------------------------------------------------------- In seeking to supplement the information about a fund's principal investment strategies set out in a profile, the Commission proposed to require that a fund's risk summary inform investors about the availability in the fund's shareholder reports of additional information about the fund's investments.\64\ Some commenters questioned the proposed placement of this disclosure, arguing that the disclosure should appear together with the legend on the cover page of the profile, while other commenters supported requiring the disclosure in the profile's risk/return summary. The Commission believes that requiring this disclosure on the cover page of the profile would result in too much information on the cover page. Therefore, the Commission is adopting the proposal requiring a fund's profile to indicate in its risk summary that additional information about a fund's investments is available in its shareholder reports.\65\ --------------------------------------------------------------------------- \64\ A fund's annual report to its shareholders typically contains a 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. \65\ Rule 498(c)(2)(ii). This provision requires a fund (other than a new fund) to include disclosure in the risk/return summary 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 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 the last fiscal year. You may obtain either or both of these reports at no cost by calling __________. Unlike rule 498, as adopted, Form N-1A, as amended, requires that the statement about the availability of a fund's shareholder reports appear together with disclosure about the availability of the fund's SAI and other information about the fund on the back cover page of the fund's prospectus. Item 1(b)(1) of Form N-1A. --------------------------------------------------------------------------- --Principal Risks of Investing in the Fund Summary Risk Disclosure. The proposed risk/return summary would require a fund to summarize the information contained in the fund's prospectus about the principal risks of investing in the fund. Reflecting the Commission's proposed new approach to risk disclosure described in the Form N-1A Proposing Release, the profile disclosure 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.\66\ Commenters generally supported the summary risk disclosure contemplated by proposed rule 498, agreeing that it would be focused 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.\67\ --------------------------------------------------------------------------- \66\ See Form N-1A Proposing Release, supra note 7 (regarding fund risk disclosure required in the prospectus). \67\ Rule 498(c)(2)(iii) (incorporating Item 2(c)(1)(i) of Form N-1A). --------------------------------------------------------------------------- The Commission proposed to require that the risk summary identify the types [[Page 13976]] of investors for whom the fund may be an appropriate or inappropriate investment. 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 an investment suitable for a particular investor.\68\ Commenters also stated that the disclosure would tend to be generic and not meaningful or useful for investors. --------------------------------------------------------------------------- \68\ 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) para.4261 (suitability of recommendations); 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 profiles and has deleted this requirement from the 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. Therefore, the risk summary requirement, as adopted, will give a fund the option to include disclosure in its profile about the types of investors for whom the fund is intended and the types of investment goals that may be consistent with an investment in the fund.\69\ --------------------------------------------------------------------------- \69\ Rule 498(c)(2)(iii) (incorporating Item 2(c)(1)(i) of Form N-1A). --------------------------------------------------------------------------- Under the proposed risk/return summary, a fund could at its option 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 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 there should focus solely on the risks of investing in the fund. Thus, the Commission has determined to eliminate the option to describe the rewards of investing in a fund in the risk summary.\70\ --------------------------------------------------------------------------- \70\ In keeping with the disclosure flexibility provided to funds under Form N-1A, as amended, a fund could discuss the potential rewards of investing in the fund elsewhere in its prospectus as long as the information is not incomplete, inaccurate, or misleading. See Form N-1A Release, supra note 1. --------------------------------------------------------------------------- Special Risk Disclosure Requirements. The Commission proposed to require special disclosure in the risk summary for money market funds\71\ and for funds advised by or sold through banks. Commenters supported the proposed disclosure requirements, and the Commission is adopting them substantially as proposed.\72\ --------------------------------------------------------------------------- \71\ For these purposes, a money market fund is 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]. \72\ Rule 498(c)(2)(iii) (incorporating Item 2(c)(1)(ii) of Form N-1A). This provision, as adopted, requires the following disclosure by a money market fund in the risk summary of its profile: 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. A fund advised by or sold though a bank would disclose in the risk summary of its profile: 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. 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 bank regulators, the Commission has revised the required disclosure to add language indicating that an investment in a fund advised by or sold through a bank is not a deposit of the bank. The requirement, as amended in this way, is consistent with the requirement now in effect. The Commission is making conforming amendments to the disclosure requirement contained in rule 482(a)(7) for advertisements by money market funds. The Commission also is amending rule 482(d) under the Securities Act and rule 34b-1 under the Investment Company Act [17 CFR 270.34b-1] to conform to changes made in Item 21 of Form N-1A, as amended. See Form N-1A Release, supra note 1. --------------------------------------------------------------------------- The Commission proposed to require a tax-exempt money market fund that concentrates its investments in a particular state (a ``single state money market fund'') to include specific disclosure in its profile risk summary describing certain risks associated with an investment in such a fund.\73\ In the Form N-1A Proposing Release, the Commission asked, however, whether it should continue to require this disclosure in prospectuses.\74\ The Commission noted that this disclosure may exaggerate the risk of investing in single state money market funds. 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. --------------------------------------------------------------------------- \73\ Proposed rule 498 would require a single state money market fund to make disclosure similar to that Form N-1A currently requires such a fund to disclose in its prospectus. Existing Form N-1A requires a single state money market fund to disclose that it may invest a significant percentage of its assets in a single issuer and that investing in it may be riskier than investing in other types of money market funds. See Form N-1A Proposing Release, supra note 7, at 10903. \74\ See Form N-1A Proposing Release, supra note 7, at 10904. --------------------------------------------------------------------------- In response to the Commission's question regarding single state money market funds, commenters indicated that the special disclosure now required in 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 commenters and has determined not to require the disclosure in either the profile or the prospectus.\75\ --------------------------------------------------------------------------- \75\ See Form N-1A Release, supra note 1. --------------------------------------------------------------------------- Risk/Return Bar Chart and Table. The proposed risk/return summary would require a fund's profile 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. 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 annual returns for a 10-year period have varied significantly from year to year or were relatively even over the period). Presenting return information in this format was designed to give investors some indication of the variability of a fund's annual returns and thus some idea of the risk of an investment in the fund. The average annual return information in the table would assist investors in evaluating a fund's performance and risks relative to ``the market.'' Commenters generally supported the proposed bar chart and performance table, and the Commission is adopting these requirements with [[Page 13977]] modifications to reflect suggestions of commenters.\76\ --------------------------------------------------------------------------- \76\ Rule 498(c)(2)(iii) (incorporating Item 2(c)(2) of Form N- 1A). This provision requires a fund to have at least one calendar year of returns before including the bar chart and requires a fund whose profile does not include a bar chart because the fund does not have annual returns for a full calendar year to modify the narrative explanation to refer only to information presented in the table. The provision also requires the bar chart of a fund in operation for fewer than 10 years to include annual returns for the life of the fund. 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 the variation in a fund's returns to the risk of investing in the fund. As it indicated in the Form N-1A Release, the Commission acknowledges that investors have a wide range of ideas of what ``risk'' means. See Form N-1A Release, supra note 1. --------------------------------------------------------------------------- In the Form N-1A Proposing Release, the Commission requested comment about alternative presentations that could improve fund risk disclosure.\77\ 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 this information could be presented in a separate table or included in the performance table. --------------------------------------------------------------------------- \77\ See Form N-1A Proposing Release, supra note 7, 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.\78\ Most commenters, however, opposed requiring additional information in the bar chart, asserting that it could complicate and reduce the effectiveness of the bar chart. --------------------------------------------------------------------------- \78\ Rule 498, as adopted, in incorporating the requirements of 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. Rule 498(c)(2)(iii) (incorporating Instruction 2(b) to Item 2(c)(2) of Form N-1A). --------------------------------------------------------------------------- Several commenters supported the inclusion of annual 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 fund 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. 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, as proposed, would 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 experience price 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.\79\ 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. --------------------------------------------------------------------------- \79\ Rule 498(c)(2)(iii) (incorporating Item 2(c)(2)(ii) of Form N-1A). --------------------------------------------------------------------------- Presentation of Return Information. The proposed risk/return summary would require a fund to include the bar chart and table 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, the profile risk/return summary, as adopted, does not require the sub-heading including the proposed risk/return summary. To help investors use the information in the bar chart and table, the profile risk/return summary, as adopted, however, does require a fund to provide a brief narrative explanation of how the information illustrates the variability of the fund's returns.\80\ --------------------------------------------------------------------------- \80\ Rule 498(c)(2)(iii) (incorporating Item 2(c)(2)(i) of Form N-1A). --------------------------------------------------------------------------- Bar Chart Return Information. The Commission proposed to require that a fund's 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 the annual returns among funds, which typically have fiscal periods that do not correspond to the calendar year.\81\ 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. --------------------------------------------------------------------------- \81\ The Commission understands that funds increasingly organize themselves as series companies and tend to stagger the financial periods of their series to spread audits and financial reporting periods 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 periods will promote understandable information in the profile. Therefore, the risk/ return summary, as adopted, requires calendar-year periods for both the bar chart and table.\82\ Under rule 498, as adopted, the average annual return information in the table in a fund's profile risk/return summary must be as of the most recent calendar quarter and updated quarterly.\83\ --------------------------------------------------------------------------- \82\ Rule 498(c)(2)(iii) (incorporating Item 2(c)(2) of Form N- 1A). \83\ Rule 498(c)(2)(iii). Unlike rule 498, as adopted, Form N- 1A, as amended, requires the fund's prospectus risk/return summary to reflect average annual return information as of the end of a fund's most recent calendar year. Item 2(c)(2) of Form N-1A, as amended. A fund would update the information in the prospectus in connection with the filing of an annual post-effective amendment to update a fund's registration statement. --------------------------------------------------------------------------- The proposed bar chart would 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. 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 fund shares, it would be difficult for funds to compute annual returns for the purpose of the bar chart and to communicate the information effectively to investors.\84\ In addition, the Commission has concluded that more precise return information is not necessary for the bar chart to serve the purposes of graphically showing a fund's annual returns and illustrating [[Page 13978]] the variability of an investment in the fund over a 10-year period. Therefore, the bar chart, as adopted, is not required to show returns adjusted for sales loads. --------------------------------------------------------------------------- \84\ In contrast, sales loads can be accurately and fairly reflected in return information of the type contained in the table by deducting sales loads at the beginning (or end) of particular periods from a hypothetical initial fund investment. --------------------------------------------------------------------------- Bar Chart Presentation. Consistent with the bar chart as proposed, the bar chart, as adopted, may include return information for more than one fund.\85\ In contrast, the risk/return summary, as adopted, would require a fund offering more than one class of shares in a profile to include annual return information in its bar chart for only one class.\86\ Unlike individual funds, classes of funds represent interests in the same portfolio of securities and the returns of each class differ only to the extent that the classes do not have the same expenses. The Commission believes that including return information for all classes offered through a fund's profile is not necessary to provide an 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 profile so that investors will be able to identify and compare the performance of each class.\87\ --------------------------------------------------------------------------- \85\ While rule 498 does not limit the number of funds whose return information may be included in a bar chart, the presentation of the bar chart is subject to the general requirement that disclosure should be presented in a format designed to communicate information effectively. Instruction 2 to rule 498(b). \86\ Rule 498(c)(2)(iii) (incorporating Instruction 3(a) to Item 2(c)(2) of form N-1A). \87\ Rule 498(c)(2)(iii) (incorporating Instruction 3(b) to Item 2(c)(2) of form N-1A). --------------------------------------------------------------------------- The proposed risk/return summary would require the bar chart of a fund offering more than one class of shares through a profile to reflect annual return information for the class offered in the profile that had the longest performance history over the last 10 years. Most commenters considering the issue suggested that the Commission instead permit such a fund 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.\88\ 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 the bar chart requirement and provide investors with sufficient information to evaluate the variability of returns for any class of the fund. Therefore, the profile risk/return summary, as adopted, permits a fund to choose the class to be reflected in the bar chart, subject to certain limitations.\89\ \88\ 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 services, 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. \89\ Rule 498(c)(2)(iii) (incorporating Instruction 3(a) to Item 2(c)(2) of Form N-1A). 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 profile have returns for less than 10 years, the bar chart must reflect returns for the class that has returns for the longest period. --------------------------------------------------------------------------- --Fees and Expenses of the Fund The proposed risk/return summary would require a table accompanying a fund's bar chart showing the fund's fees and expenses, including any sales loads charged in connection with an investment in the fund. Including the fee table in both the profile and the prospectus 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. The Commission is adopting the requirement for a fee table with modifications incorporating suggestions from commenters.\90\ --------------------------------------------------------------------------- \90\ Rule 498(c)(2)(iv) (incorporating Item 3 of Form. N-A). The modifications adopted by the Commission are discussed in Form N-1A Release, supra note 1. --------------------------------------------------------------------------- 3. Other Disclosure Requirements The Commission proposed to require the profile of a fund to include not only the risk/return summary, but also disclosure about other key aspects of investing in the fund. Commenters generally supported these disclosure requirements, which are summarized below, and the Commission is adopting them substantially as proposed. --Investment Adviser and Portfolio Manager of the Fund Proposed rule 498 would generally require a fund to identify in its profile its investment adviser and the person or persons primarily responsible for the day-to-day management of the fund's portfolio (``portfolio manager''). The proposed disclosure in the profile about portfolio managers also would require a fund to indicate the length of time that a portfolio manager has managed the fund and to summarize the portfolio manager's business experience for the last 5 years. Proposed rule 498 contemplated that a fund for which a committee or other group shared day-to-day management of its portfolio would disclose that it was managed in this fashion and not identify any individual portfolio manager. Commenters supported all of these proposed requirements, which the Commission has determined to adopt.\91\ --------------------------------------------------------------------------- \91\ Rule 498(c)(2)(v). Item 6(a)(2) of Form N-1A sets out the disclosure requirements for Form N-1A covering this information. As discussed in the Form N-1A Release, the Commission has provided additional guidance in Form N-1A regarding the prospectus disclosure obligations of a fund for which day-to-day management responsibilities are shared. See Form N-1A Release, supra note 1 (Instructions to Item 6(a)(2)). --------------------------------------------------------------------------- In seeking to meet its goal that profile disclosure be clear, concise, and summary in nature, the Commission proposed that, subject to one exception, a fund having 3 or more portfolio managers, each with responsibility over a portion of the fund's portfolio, could choose to disclose the number, and not the names, of its portfolio managers. Under the proposed exception, a fund would be required to disclose the identity of a portfolio manager who was responsible for managing 40% or more of its portfolio.\92\ One commenter questioned the operation of these provisions and suggested that the Commission instead adopt a requirement that a fund disclose the name and experience of only those portfolio managers having responsibility over the day-to-day management of a significant portion of the fund's investments. The commenter suggested further that 30 to 40% of a fund's portfolio should be deemed significant for this purpose. --------------------------------------------------------------------------- \92\ Under the 1996 Profile Letter, supra note 8, at 3, a fund could disclose that 3 or more persons managed the fund's portfolio, without regard to the percentage of the portfolio managed by any one person. --------------------------------------------------------------------------- The Commission believes that the commenter's suggestions are consistent with the goal underlying the profile and could result in better disclosure than that contemplated by the Commission's proposal. Thus, under rule 498, as adopted, a fund with 3 or more portfolio managers need not identify each of the managers, except that the fund must identify any manager who is (or is reasonably expected to be) responsible for the management of a significant portion of the fund's assets.\93\ Under rule 498, as adopted, a portfolio manager of 30% or more of a fund's net assets generally would be deemed to be responsible for the management of a [[Page 13979]] significant portion of the fund's net assets.\94\ --------------------------------------------------------------------------- \93\ Rule 498(c)(2)(v)(C). In tying this disclosure to the portion of a fund's net assets over which a person has day-to-day responsibility, the Commission intends to provide funds with a standard way of determining whether a person has responsibility over a significant portion of a fund's portfolio. Like Form N-1A, as amended, rule 498, as adopted, does not require disclosure about the portfolio manager of a money market fund or an index fund. \94\ Rule 498, as adopted, requires disclosure about a portfolio manager of a fund who is, or who is reasonably expected to be, responsible for the management rather than one who ``manages'' a significant portion of the fund's portfolio. The revised language recognizes that the portion of a fund's portfolio over which a manager has responsibility may change from time to time. Proposed rule 498 generally would require a fund to identify in its profile any person or entity serving as a sub-adviser of the fund.\95\ Under the proposal, a fund would not need to identify a sub-adviser whose sole responsibility for the fund is limited to managing the fund's cash positions on a day-to-day basis.\96\ Commenters supported, and the Commission has adopted, this provision, with a clarification that recognizes that responsibility for cash management generally is incidental to a fund's investment objectives and unlikely to affect the fund's overall portfolio management and risks.\97\ --------------------------------------------------------------------------- \95\ See section 2(a)(20) of the Investment Company Act [15 U.S.C. 80a-2(a)(20)] (defining ``investment adviser'' broadly so as to include a sub-adviser). \96\ In contrast the 1996 Profile Letter, supra note 8, at 3, required disclosure about a sub-adviser only if it managed a material portion of a fund's portfolio. \97\ Rule 498(c)(2)(v). As adopted, this exception does not apply to any sub-adviser for a money market fund because the primary investment objective for such a fund can be viewed as cash management. The exception also does not apply to any other type of fund with a principal strategy of regularly holding cash or cash equivalent instruments. A fund, for example, with a principal strategy of allocating its assets among cash equivalents, equity securities, and income securities, and which employed different sub- advisers to manage each of these asset categories, would need to identify all of the sub-advisers. --------------------------------------------------------------------------- Under rule 498, as proposed, a fund with 3 or more sub-advisers, each of which manages a portion of the fund's portfolio, could choose to disclose the number, and not the identity, of its sub-advisers, subject to one exception. Under the exception, a fund would be required to identify any sub-adviser that manages 40% or more of its net assets. Consistent with the modification to the disclosure requirement for portfolio managers, rule 498, as adopted, requires a fund to identify any sub-adviser that is (or is reasonably expected to be) responsible for the management of a significant portion of the fund's net assets. The rule defines a significant portion of the fund's net assets for this purpose generally to be 30% or more of the fund's net assets.\98\ --------------------------------------------------------------------------- \98\ Rule 498(c)(2)(v)(B)(2). --------------------------------------------------------------------------- --Purchase and Sale of Fund Shares The Commission proposed to require a fund to describe in its profile how to purchase its shares under one caption and how to redeem its shares under another caption. Proposed rule 498 would require, under the purchase caption, information about the fund's minimum investment requirements (e.g., initial and minimum account balances) and, when applicable, any breakpoints in or waivers of sales loads. Several commenters criticized the generic nature of the information on purchases and sales of fund shares contemplated by proposed rule 498. They argued that without some guidance as to the specific kinds of information relating to purchases and sales of fund shares that the Commission believes is of importance to investors, funds would include an excessive amount of information in their profiles. The Commission believes that such a result would be inconsistent with the profile's intended purpose as a summary disclosure document and has revised rule 498 to specify in greater detail the information about a fund's purchase and sale procedures that funds must include in a profile. Under rule 498, as adopted, a fund must disclose the minimum initial or subsequent investment requirements, the initial sales load (or other loads), and, if applicable, the initial sales load breakpoints or waivers.\99\ Rule 498 also requires a fund to state that its shares are redeemable, to identify the procedures for redeeming shares (e.g., on any business day by written request, telephone, or wire transfer), and to identify any charges or sales loads that may be assessed upon redemption (including, if applicable, the existence of waivers of these charges). \100\ --------------------------------------------------------------------------- \99\ Rule 498(c)(2)(vi). \100\ Rule 498(c)(2)(vii). --------------------------------------------------------------------------- --Fund Distributions and Tax Information The Commission is adopting the proposed requirement that a fund disclose information in its profile about the terms and conditions under which it makes distributions, as well as the expected tax treatment of those distributions.\101\ Rule 498, as adopted, requires a fund's profile to describe how frequently the fund intends to make distributions and what reinvestment options for distributions (if any) are available to investors in the fund. Rule 498 also requires a fund to disclose whether its distributions to shareholders may be taxed as ordinary income or capital gains and that the rates shareholders pay on capital gains will depend on the length of time that the fund holds its assets.\102\ Rule 498 requires a tax-exempt fund to state that it intends to distribute tax-exempt income and to disclose, as applicable, that a portion of its distributions may be taxable. --------------------------------------------------------------------------- \101\ Rule 498(c)(2)(viii). \102\ If a fund expects that its distributions, as a result of its investment objectives or strategies, primarily will consist of ordinary income or capital gains, the fund must provide disclosure to that effect in responding to rule 498(c)(2)(viii). Funds subject to this requirement would include, for example, those often described as ``tax-managed,'' ``tax-sensitive,'' or ``tax- advantaged,'' which have investment strategies to maximize long-term capital gains and minimize ordinary income. To the extent that a fund has a principal investment objective or strategy to achieve tax-managed results (e.g., to maximize long-term gains and minimize ordinary income), the fund would be required under rule 498 to provide disclosure to that effect in the discussion of its investment objectives. Rule 498(c)(2)(ii). --------------------------------------------------------------------------- --Other Services Provided by the Fund Recognizing that funds often seek to distinguish themselves by the services that they offer investors and that investors often select funds for the services that they provide, the Commission proposed to require a fund to summarize or list in its profile the services available to its investors, including, for example, any exchange privileges or automated information services. One commenter expressed concern about the open-ended nature of this item and suggested that the Commission clarify that a fund need not respond to the item by disclosing all of its services available to all investors. This clarification, according to the commenter, would ensure that the profile serves its intended purpose as a summary document that includes information of use to a typical fund investor. The Commission agrees, and as adopted, rule 498 requires only that a fund's profile provide a summary of services available to typical investors in the fund.\103\ --------------------------------------------------------------------------- \103\ Rule 498(c)(2)(ix). --------------------------------------------------------------------------- 4. Application to Purchase Shares The Commission proposed to permit a fund to include in its profile an application to purchase its shares.\104\ To ensure that investors are informed of the [[Page 13980]] availability of a fund's prospectus, which can be reviewed by an investor before investing in the fund, proposed rule 498 would require the application to note with equal prominence that an investor has the option of purchasing shares of the fund after reviewing the information in the profile or after requesting and reviewing the fund's prospectus (and other information). --------------------------------------------------------------------------- \104\ Proposed rule 498(c)(3). Rule 482 under the Securities Act prohibits a fund from including an application to purchase its shares in an advertisement. This prohibition was based on concerns that an application would be inconsistent with the purpose of rule 482, which was to provide a limited amount of information about a fund and a means of requesting a fund's prospectus. See Fund Performance Release, supra, note 5. In 1993, the Commission proposed to amend rule 482 to permit a fund to include in an advertisement a purchase application if the advertisement included certain information about a fund. Investment Company Act Release No. 19342 (Mar. 5, 1993) [58 FR 16141]. In lieu of adopting the proposed revisions to rule 482, the Commission is adopting rule 498. The Commission is amending rule 482 in a number of respects to reflect the adoption of rule 498. In addition, the Commission is adopting revisions to rule 482 to permit letters or other materials permitted under the rule to accompany a profile. See infra note 123 and accompanying text. --------------------------------------------------------------------------- Commenters generally supported permitting a fund to include an application in its profile, and the Commission is adopting rule 498 as proposed. One commenter questioned why an application needed to be included within a profile and suggested that it should be sufficient for an application to accompany the profile. The Commission recognizes that allowing funds to separate purchase applications from profiles may facilitate the printing and distribution of profiles and make it easier for funds to administer and process investors' applications. The Commission is concerned, however, that separating the application from the profile may cause investors to overlook the information provided in the profile. Balancing these concerns with a desire to ease the administrative burden on funds, the Commission has revised rule 498 to permit a fund to provide an application for purchase of fund shares either in the profile, or together with the profile in a manner reasonably designed to alert investors that the application is to be considered along with the information about the fund disclosed in the profile.\105\ --------------------------------------------------------------------------- \105\ Instruction to rule 498(c)(3). --------------------------------------------------------------------------- C. Filing Requirements The Commission proposed to require a fund to file its profile with the Commission at least 30 days before its first use.\106\ Proposed rule 498 would require a fund to file any profile containing substantive changes to a previously filed profile 30 days before use. The proposed rule would not require a fund to re-file a previously filed profile that has been revised only to update return information about the fund's past performance included in the risk/return summary. Commenters generally supported the proposed filing requirement, although some commenters suggested that it was unnecessary to require the subsequent re-filing of a profile with substantive changes 30 days before use. Commenters recommended that, if the Commission believes that such a filing requirement is necessary, the period before an amended profile can be used should be shortened to 5 days. Other commenters requested clarification about the kinds of changes made to a profile in use that would trigger a second filing requirement. --------------------------------------------------------------------------- \106\ Proposed rule 498 would require a fund to file the profile under rule 497, which sets out general filing requirements for fund prospectuses. The Commission proposed to include the profile requirement in new paragraph (k) to rule 497. --------------------------------------------------------------------------- The Commission has determined to adopt the proposed filing requirements with modifications to address commenters' concerns.\107\ As discussed in the Profile Proposing Release, requiring profiles to be filed prior to their first use will allow the Commission's staff to monitor the document's compliance with the provisions of rule 498 and other provisions under the federal securities laws.\108\ The Commission believes that the 30-day filing requirement for a new profile will provide the staff with sufficient time to review the profile.\109\ The subsequent filing of an amended profile was intended to enable the Commission to continue to monitor and assess the use of profiles by funds. Because substantive changes to the profile, particularly the risk/return summary, will be reflected in amended prospectus filed with the Commission that can be reviewed by the Division, the Commission believes that a subsequent filing of amendments to a profile before its use is not necessary. Therefore, the Commission has revised the procedures under which profiles are filed to require that a fund file its amended profile within 5-business days after its use.\110\ --------------------------------------------------------------------------- \107\ The Commission has determined that it is not necessary or appropriate in the public interest or for the protection of investors to require that a fund's profile be filed as part of the fund's registration statement on Form N-1A. Filing the profile as part of a registration statement would not add to the Commission's ability to monitor the disclosure in the profile, would provide no additional protection to investors, and would impose unnecessary administrative burdens on funds. \108\ See Profile Proposing Release, supra note 6, at 10950. Under rule 498, as adopted, a profile can be used by a fund only with an effective registration statement and a current prospectus. \109\ Rule 497, as amended, requires a fund to file a definitive form of any profile required to be filed with the Commission within 5 days after it is used. \110\ Rule 497(k)(1)(ii). Rule 497(k) separates filings of amended profiles into those that contain a material change to the investment objectives/goals, strategies, or risks of investing in the fund (changes to the information in, respectively, paragraphs (c)(2)(i)-(iii) of rule 498) and those that do not. Rule 497(k)(1)(iii) (A) and (B). As with any profile filing, rule 497 requires that a fund filing an amended profile designate under which paragraph and sub-paragraph of rule 497 the fund is filing the amended profile. Rule 497(k)(2)(i). This requirement will assist the staff of the Division in determining whether an amended profile contains substantive changes to the information in the risk/return summary. --------------------------------------------------------------------------- Funds would be required to submit profiles electronically on the Commission's electronic data gathering analysis and retrieval (``EDGAR'') system.\111\ Because filings on the EDGAR system currently are text-only, do not reflect formatting, and do not reproduce graphic images (such as the bar chart required to be in the profile), the Commission proposed to require a fund to submit 2 copies of the profile in the primary form intended to be distributed to investors (e.g., paper or electronic media) with its electronically-filed profile. The purpose of this requirement was to allow the Commission to assess how funds present information in the profile.\112\ Pointing out that all funds are now required to file their disclosure documents required under the federal securities laws electronically and are no longer permitted to file paper copies, one commenter argued that it would be burdensome to require an additional paper submission of a profile and that the paper filing was not necessary to review the content of the profile. The commenter suggested that, if the Commission determines that a paper (or other distributed form of) filing is necessary, the Commission should require that the first filing of the profile be in its primary format and allow subsequent filings to be made electronically on EDGAR only. The Commission believes that review of profiles in the form in which they will be distributed to investors will allow its staff to evaluate the effectiveness of the profile and will be helpful in assessing whether the Commission should permit other types of investment companies to use a form of profile.\113\ To avoid unnecessary administrative burdens on funds, which file most forms required by the Commission electronically, however, the Commission is revising the additional profile filing requirement. Under these revisions, the first profile filing must be accompanied by the submission of a profile in the format in which it will be distributed to investors.\114\ Subsequent filings will not require the additional formatted profile. --------------------------------------------------------------------------- \111\ The Commission requires most other filings to be made in the same manner. Rule 101(a)(1)(i) of Regulation S-T [17 CFR 232.101(a)(1)(i)], for example requires prospectuses filed pursuant to the Securities Act to be submitted in electronic format. \112\ See Profile Proposing Release, supra note 6, at 10951 nn. 86-88 and accompanying text. \113\ See supra Section II.A.4 (discussion of use of profile by other investment companies). \114\ Rule 497(k)(2)(ii). If a fund intends to disseminate its profile electronically, the supplemental submission need only include the Internet web site electronic address (``URL''). --------------------------------------------------------------------------- D. Dissemination of Profiles The Commission believes, on the basis of its own research and studies [[Page 13981]] undertaken by others, that the profile has the potential to be used by a significant number of fund investors. To facilitate use of the profile, the Commission proposed to permit profiles to be distributed to investors through any form of media.\115\ Commenters generally supported this approach, although one commenter urged the Commission to limit distribution of the profile to mass print media, arguing that the use of electronic media or direct mail to distribute a profile could promote fraud. The Commission believes that the profile's filing requirements and its staff's periodic regular review of fund operations through its inspections program provide important safeguards against the fraudulent use of the profile. In addition, the Commission has determined that it is in the interest of fund investors to provide them with different means to access sources of information about funds. Therefore, the Commissio [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A98-7071. Public record. Not legal advice.