Statement on Adoption of Amendments to Investment Company Liquidity Disclosure
June 28, 2018
I would like to join Chairman Clayton in thanking the staff for their work on this release—in particular, Zeena Abdul-Rahman, Thoreau Bartmann and Sarah ten Siethoff.
Liquidity—or how long it takes to sell an investment and turn it into cash without affecting its price—can be an important piece of information for mutual fund and exchange-traded fund—or “ETF”—investors. This is because the law requires that investors in these funds be able to get their money within seven days of making a request to redeem their fund shares. And, if a fund is forced to sell an investment at an unfavorable price to comply with this requirement, the return on the investor’s capital can be impacted. This effect can be exacerbated during times of market stress, when investors en masse try to redeem their shares. As a result, the liquidity of the investments in a mutual fund or ETF might be something an investor finds important when making investment decisions.
The Commission’s current rule requires that certain funds categorize their portfolio investments into four categories or buckets, from easy-to-sell to hard-to-sell. The rule also requires quarterly public disclosure of the total percentage of investments the fund has in each bucket. Investors would have seen four numbers every quarter from their funds that could have helped them make their investment decisions. Today’s amendments would eliminate the public reporting of these numbers.
Reflecting on the proposal, I compared this disclosure to the ingredient list on a food label, which the Food and Drug Administration requires to be listed in descending order of predominance. Consumers can use this ingredient information to decide if they want to purchase the food product. The product might contain an allergen or some other ingredient a consumer may want to avoid. But how do they know, if the information is never made public?
Liquidity information is no different. It would give investors some indication of the liquidity of the investments in their fund’s portfolio. Investors could therefore make a better determination as to whether a particular fund is appropriate for them to purchase. Why shouldn’t investors be able to get very basic liquidity information about a fund in which they are investing or about to invest? I was critical of the proposal just a few months ago for this very reason.
As if an amendment to eliminate public disclosure of basic liquidity information is not problematic enough, today’s release appears to be opening the door to something much worse. Specifically, the release suggests that the Commission could “propose amendments to [the liquidity rule] to move to a more principles-based approach” and solicits feedback “[o]n what principles [we should] base such an approach”?
Some might ask: What’s wrong with a principles-based approach? Aren’t many of the Commission’s rules principles-based? I recognize that principles-based approaches can work well in certain circumstances, and I also appreciate the value of retrospectively reviewing our rules. But this rule hasn’t even taken effect yet. It’s too early to embark on a retrospective review. We are merely creating business uncertainty for all of the funds working to comply with the rule. And this is after a robust, years-long rulemaking process that thoroughly weighed the pros and cons of a principles-based approach, and ultimately decided against such an approach. Instead, after much public comment, the Commission decided to set up minimum standards that should be included in every fund’s liquidity risk management program.
What’s more, sometimes principles-based rules are code for letting registrants use their own discretion in complying with the rule. In this case, I suspect investment companies will say “leave it to us, we’ve got this” in response to our requests for feedback. As we’ve seen—like with the multi-billion-dollar junk bond mutual fund that ran into a liquidity crunch and spiraled out of existence in 2015—sometimes funds don’t “have it”.
Liquidity crunches that affect one or a small number of funds are never good, but what about market-wide or systemic events? Those kinds of events can disrupt entire swaths of the economy and leave investors stranded without a nest egg or a safety net. That’s why I very much struggle with the timing of these amendments and the request for feedback on a principles-based approach. As I consider this rollback of public disclosure, I have to ask: why now? Shouldn’t we first see how the disclosures, and more broadly the full liquidity risk management paradigm, which the Commission unanimously voted for just a short while ago, are used by investors, and then assess their impact? At a minimum, shouldn’t the Commission at least assess the liquidity information it receives non-publicly first, before deciding on whether to remove the public disclosure? In fact, these disclosures and the liquidity rule may actually prove helpful to market participants and investors during upcoming market cycles.
I still have the same concerns that I expressed when this amendment was proposed. It is important for investors and the capital markets to understand the liquidity of various investment products’ underlying investments. Hiding information from investors and the marketplace is not good for anyone. While I appreciate the staff’s efforts, I simply cannot support today’s recommendation to eliminate the Commission’s requirement to provide investors with basic liquidity information about the funds in which they may choose to invest.
 The Investment Company Act of 1940, in Section 22(e), requires that shares of open-end investment companies be redeemed within seven days.
 See 21 C.F.R. § 101.4(a).
 My statement on the proposal is posted at the following location: https://www.sec.gov/news/public-statement/statement-stein-open-meeting-fund-liquidity-2018-03-14.
 See Adopting Release at Section II.C. The release asks several other questions about the costs and benefits of certain aspects of the liquidity rule. While it solicits feedback on whether public disclosure of liquidity information may be appropriate, I believe that if we are asking for feedback from the public, we should also consider requesting feedback on what additional forms of liquidity disclosure could help investors understand the liquidity risks in the funds in which they invest. For example, would a graphic disclosure of liquidity over time or a pie chart showing the distribution of the liquidity profile of the fund be helpful? I would invite commenters to weigh in.
 See Third Avenue Trust and Third Avenue Management LLC, Investment Company Act Release No. 31943 (Dec. 16, 2015), available at https://www.sec.gov/rules/ic/2015/ic-31943.pdf; Tim McLaughlin, Ross Kerber & Svea Herbst-Bayliss, Hidden in Plain Sight: Big Risks at Failed Third Avenue Fund Were Clear to Some, Reuters (Dec. 23, 2015), available at https://www.reuters.com/article/us-funds-thirdavenue-junk-insight/hidden-in-plain-sight-big-risks-at-failed-third-avenue-fund-were-clear-to-some-idUSKBN0U627V20151223.
 This more measured approach was what at least one commenter originally suggested. See e.g., Comment Letter of Securities Industry and Financial Markets Association (Jan. 13, 2016), available at https://www.sec.gov/comments/s7-16-15/s71615-64.pdf (“At the very least, we urge the Commission to study the information it receives for a reasonable period of time before reaching a determination as to whether making some or all of it publicly available will, in fact, benefit the investing public.”).
 In fact, some have noted that “‘[n]ow that managers will be required to measure [liquidity] and have tools to manage it and report to the SEC… it’s only natural to expect that [the] investor base will be looking for more transparency around that.’” See Beagan Wilcox Volz, Liquidity Rule Countdown: Next Up, 'Highly Liquid' Minimums, Ignites (Feb. 20, 2018), available at http://ignites.com/c/1889814/220884?referrer_module=SearchSubFromFF&highlight=next%20up%2C%20%27highly%20liquid%27%20minimums.