SEC Overhauls Mutual Fund and ETF Shareholder Reports

Highlights

• Annual and semiannual shareholder reports will be condensed to as few as three pages. This is to be achieved primarily in two ways: first, by moving the financial statements and financial highlights out of the reports in favor of graphics and summary material, and second, by limiting each report to covering a single fund and a single share class. The changes apply to funds that register shares on Form N-1A (mutual funds and ETFs) and thus do not apply to closed-end funds or business development companies (BDCs). 
• Financial statements and most other content now in shareholder reports will move to Form N-CSR and fund firm websites. Most information to be cut from the shareholder reports still will be publicly available on Form N-CSR, which funds file with the SEC and now must provide at no cost to shareholders who request it. Funds also must publish this information on their websites.
• Funds must send the new, condensed shareholder reports to shareholders by mail (or by email, for shareholders electing electronic delivery). In a significant disappointment to industry stakeholders, the SEC eliminated the ability of mutual funds and ETFs to rely on the “access equals delivery” provisions of Rule 30e-3 with respect to shareholder reports.
• Fund advertising will require standardized treatment of expenses. The principal registered fund advertising rules (Rule 482 under the Securities Act of 1933 (the Securities Act) and Rule 34b-1 under the Investment Company Act of 1940 (the Investment Company Act) require standardized calculation and presentation of investment performance in advertising. Expanding on that principle, the SEC now will require that all registered investment companies (including closed-end funds) and BDCs conform with standardized presentation of expenses in sales materials. These rules do not require funds to disclose expenses in advertising, but advertisements that include expense information must follow the standardized format. The SEC also is adding a provision to Rule 156 under the Securities Act stating that representations about fees and expenses can be misleading if they omit necessary explanations or qualifications.
• The final rules did not include three significant changes from the original 2020 rule proposals. In 2020, the SEC had proposed (1) giving funds the option of no longer sending an annual prospectus update mailing to their existing shareholders if they instead followed certain ongoing notice requirements, (2) changing how fees and expenses are presented in fund prospectuses, and (3) adding new registration statement form instructions emphasizing, among other things, the “most significant risks” and tailoring the presentation of risks for each fund rather than using standardized presentations across multiple funds. Acknowledging mixed feedback, the SEC deferred action on these proposals.

Background

Most registered funds currently use a “layered disclosure approach.” That is, funds can satisfy their prospectus delivery obligations by sending a summary prospectus to prospective investors and make available (online and copies sent upon request) the fund’s longer statutory prospectus and statement of additional information. The new rules contemplate a similar approach for shareholder reports. A fund’s shareholder reports will highlight key information that the SEC considers most important to retail investors and move information that may be of more interest to financial professionals and other investors wanting more in-depth fund information to separate reports.

Condensed Shareholder Reports

The heart of the amendments is wholesale revision of the structure and content of shareholder reports, with a goal of condensing them to include the most salient and quickly absorbed information. The SEC observes that the average registered fund shareholder report today is more than 100 pages long and can run over 600 pages. By contrast, the new shareholder reports could be as short as three pages.

Two principal changes will, by themselves, trim many pages of content.

First, shareholder reports will be limited to a single fund and share class. As most funds are organized in “series,” with potentially many separate investment portfolios in a single trust or corporate entity, their financial results often are included in a single shareholder report covering all or many of the funds at once. Rejecting calls for flexibility, the SEC said that funds may no longer combine multiple funds (or even share classes) in a single shareholder report.  

Second, shareholder reports will no longer include financial statements. Rather, shareholders will find the financial statements in Form N-CSR, which funds will continue to file with the SEC. Form N-CSR also will include the financial highlights currently presented in the shareholder reports. Other information that will move to Form N-CSR includes (1) matters submitted to a shareholder vote, (2) the aggregate remuneration paid to directors, officers, and affiliates, (3) the fund board’s approval of the fund’s investment advisory contract, and (4) certain disagreements with and changes in accountants (replacing full disclosure of any such disagreements in the report with a high-level summary). To facilitate ready access to this information, funds also will post most of Form N-CSR on their websites.

To permit comparability across funds, the content of the new reports will be similar for all funds and must appear in a specific order. Select content in the new reports include the following:

• Fees. At the top of every report will be a section showing expenses that shareholders bear during the period based on a $10,000 investment, in both dollars and basis points. Special instructions apply for feeder funds, stub periods, and extraordinary expenses.
• Emphasis on Graphics and Key Statistics. Reports must provide, as they do today, graphics showing the fund’s holdings by certain categories (e.g., type of security, industry sector, geographic region, credit quality, or maturity). The reports also will prominently show (1) net assets, (2) total number of portfolio holdings, (3) total advisory fees paid, and (4) for non-money-market funds, portfolio turnover. A report also may include optional statistics that a fund believes will help shareholders better understand the fund’s operations. The SEC emphasizes that any nonrequired statistics should be brief, quantitative measures that address significant factors relevant to a fund. There is no page or word limit for the shareholder reports, but the SEC encourages funds to focus on brevity. The rules specifically limit discretionary (i.e., permitted but not required) content.
• Management Discussion of Fund Performance (MDFP). The SEC believes that shareholders want to read a qualitative discussion of fund performance, so the rules continue to require this discussion in annual reports and permit it in semiannual reports. Concerned that the discussions often are too long, the SEC’s form instructions now encourage brevity, focused (as opposed to generic) discussion, and the use of white space, sidebars, Q&A style, and similar techniques. Funds can include nonmandatory information, such as a “president’s letter” or portfolio manager interviews or profiles, in a mailing with the required report so long as the report itself is kept more prominent than any supplemental material. MDFP is optional for money market funds.
• Performance Line Graph and Performance Table. These components of the current shareholder report are largely unchanged. However, the instructions now require that the “broad-based index” selected for comparisons of fund performance must be “one that represents the overall applicable domestic or international equity or debt markets, as appropriate.” The instructions encourage funds to compare performance to more narrowly based indexes in addition to the broad-based index.
• Discussion of Material Changes. As a new requirement, a fund must “briefly describe” in its annual report (and optionally in the semiannual report) any material changes with respect to its (1) name, (2) investment objective, (3) fees and expenses (including termination or changes to any expense limitation terms), (4) principal investment strategies, (5) principal investment risks, or (6) investment adviser. Funds that disclose material changes must include a legend on the cover of the report clearly stating that the report describes a change that occurred during the period. (The SEC dropped a proposed requirement to also cover anticipated events.)

New Mailing Requirements; Changes to Rule 30e-3

As the SEC proposed, funds that register their shares on Form N-1A must mail their annual and semiannual reports to shareholders. Thus, Rule 30e-3 will no longer allow mutual funds and ETFs to satisfy their delivery requirements using the “access equals delivery” framework.

The industry objected strongly to this change. The SEC notes, for example, that multiple commenters submitted data showing that that when paper mailings of the current shareholder reports were phased out in recent years, less than one-half of 1% of shareholders opted back into the paper mailings. Nonetheless, the SEC believes funds should send the newly formatted shareholder reports directly to shareholders by mail (or electronically if the shareholder opts in).

Advertising Rule Amendments

At present, investment company advertising rules limit how a fund presents its performance in advertisements but do not address how a fund presents its fees and expenses in advertisements. The advertising rule amendments — which will apply to Securities Act Rules 156, 433, and 482 and Investment Company Act Rule 34b-1 — generally will apply to all investment companies, including mutual funds, ETFs, registered closed-end funds, and BDCs.

The amendments will require advertisements that reference fees and expenses to include timely and complete standardized fee and expense information. The amendments address in some detail how advertising should address temporary fee waivers or expense caps, with the general effect that both gross and net expense information must be shown with equal prominence, together with the expected end date for the waivers or caps. The SEC also is adding language to Rule 156, stating that representations about fees and expenses can be misleading if they omit necessary explanations or qualifications.

Compliance Dates

The compliance dates for the new rules generally will be 18 months after their effective date, which will be 60 days after publication in the Federal Register. The new provision in Rule 156 (addressing representations about fees and expenses) is the only element of the amendments for which no transition period is provided.

Our Take

The SEC’s overhaul of how registered mutual funds and ETFs use their shareholder reports to communicate with shareholders is both striking and ambitious. To be sure, however, funds will incur significant costs in redesigning the reports and resuming paper mailings.

Some elements of the original proposals — such as the prospectus redesign and the option to use the annual reports in lieu of annual prospectus mailings — did not make it into the final rules. Certain of those changes were controversial, and we expect many industry stakeholders will welcome their absence from the final rules. That said, many firms expressed an interest in versions of the SEC’s proposal to eliminate annual prospectus mailings. Some constituents, especially BDCs, also will be disappointed that the SEC deferred consideration of a proposed change in the presentation of so-called “acquired fund fees and expenses” in fund expense ratios.