Registration Form Used by Open-End Management Investment Companies
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 230, 232, 239, 240, 270, and 274
Release Nos. 33-7512; 34-39748; IC-23064; File No. S7-10-97
Registration Form Used by Open-End Management Investment Companies
AGENCY: Securities and Exchange Commission
ACTION: Final rules
SUMMARY: The Securities and Exchange Commission is adopting amendments to Form N-1A, the form used by mutual funds to register under the Investment Company Act of 1940 and to offer their shares under the Securities Act of 1933. The amendments are intended to improve fund prospectus disclosure and to promote more effective communication of information about funds to investors. The amendments focus the disclosure in a funds prospectus on essential information about the fund that will assist investors in deciding whether to invest in the fund. The amendments also minimize prospectus disclosure about technical, legal, and operational matters that generally are common to all funds.
Effective Date: June 1, 1998.
1. Initial Compliance Date: All new registration statements filed on or after December 1, 1998 must comply with the amendments to Form N-1A.
2. Final Compliance Date: All funds with effective registration statements must comply with the amendments to Form N-1A for post-effective amendments filed to update their registration statements on or after December 1, 1998, and no later than December 1, 1999.
FOR FURTHER INFORMATION CONTACT: Kathleen K. Clarke, Assistant Director, Markian M.W. Melnyk, Deputy Chief, George J. Zornada, Team Leader, Jonathan F. Cayne, Senior Counsel, John M. Ganley, Senior Counsel, Doretha M. VanSlyke, Attorney, (202) 942-0721, Office of Disclosure Regulation, or Anthony A. Vertuno, Senior Special Counsel, (202) 942-0591, Office of the Associate Director (Legal and Disclosure), Division of Investment Management, Securities and Exchange Commission, 450 5th Street, N.W., Mail Stop 5-6, Washington, D.C. 20549-6009. Contact the Office of Chief Counsel, Division of Investment Management, Securities and Exchange Commission, at (202) 942-0659, 450 5th Street, N.W., Mail Stop 5-6, Washington, D.C. 20549-6009 for additional information, including interpretive guidance, about this release or Form N-1A, as amended, and related rules.
SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission ("Commission") is adopting amendments to Form N-1A (17 CFR 274.11A), the registration form used by open-end management investment companies ("funds") to register under the Investment Company Act of 1940 (15 U.S.C. 80a-1, et seq.) ("Investment Company Act") and to offer their shares under the Securities Act of 1933 (15 U.S.C. 77a, et seq.) ("Securities Act"). The Commission also is adopting technical amendments to rules 483, 485, 495, and 497 under the Securities Act (17 CFR 230.483, 230.485, 230.495, and 230.497). In a companion release, the Commission is adopting new rule 498 (17 CFR 230.498) under the Securities Act and the Investment Company Act that permits a fund to provide investors with a new short-form document, called a "profile," which summarizes key information about the fund. If a fund makes a profile available, an investor would have the option of purchasing the funds shares after reviewing the information in the profile or after requesting and reviewing the funds prospectus (and other information about the fund) before making a decision about investing in the fund. An investor deciding to purchase a funds shares based on a profile will receive a copy of the fund's prospectus with the purchase confirmation. 1
TABLE OF CONTENTS
I. INTRODUCTION AND BACKGROUND
Over the last decade, the mutual fund industry has grown enormously both in total assets and in the number of funds. 2 Today, fund assets exceed the deposits of commercial banks. 3 Coincident with the explosive growth of fund investments, the business operations of many funds have become increasingly complex as funds offer new investment options and a wider variety of shareholder services. These factors, combined with new and more sophisticated fund investments, have resulted in fund prospectuses that often include long and complicated disclosure, as funds explain their operations, investments, and services to investors.
Many have criticized fund prospectuses, finding them unintelligible, tedious, and legalistic. 4 Although the prospectus remains the most complete source of information about a fund, technical and unnecessarily long prospectus disclosure often obscures important information about a fund investment and does not serve the informational needs of the majority of fund investors. 5 The millions of investors who turn to funds as their investment vehicle of choice 6 need clear and comprehensible information to help them evaluate and compare fund investments.
New Disclosure Initiatives
In seeking to improve the quality and usefulness of fund disclosure, the Commission proposed two major disclosure initiatives on February 27, 1997. 7 First, the Commission issued for public comment a release (the "Form N-1A Proposing Release") that proposed significant amendments to the prospectus disclosure requirements for funds (the "Proposed Amendments"). 8 Second, the Commission proposed, in a companion release, new rule 498 under the Securities Act and the Investment Company Act that would allow a fund to offer investors the option to purchase its shares after reviewing the information in the funds profile or after requesting and reviewing the funds prospectus (and other information about the fund) before making a decision about investing in the fund. 9 As proposed, the profile (the "Proposed Profile") would summarize key information about a fund, including the funds investment objectives, strategies, risks, performance, and fees. Under proposed rule 498, a fund would be required to send investors the funds prospectus and certain other information within 3 business days of a request, and any investor purchasing the funds shares on the basis of a profile would receive the prospectus with the purchase confirmation.
The Commissions disclosure initiatives were intended to: improve fund disclosure by requiring prospectuses to focus on information central to investment decisions; provide new disclosure options for investors; and enhance the comparability of information about funds. Taken together, these initiatives are designed to promote more effective communication of information about funds to investors without reducing the amount of information provided to investors. The Proposed Amendments reflected the Commissions strong belief that the primary purpose of the disclosure in a funds prospectus is to help an investor make a decision about investing in the fund. 10 Consistent with this belief, the objective of the Proposed Amendments was to provide investors with prospectus disclosure that presents clear, concise, and understandable information about an investment in a fund.
Commenters expressed overwhelming support for the Commissions disclosure initiatives. 11 Commenters believed that the Commissions disclosure initiatives would enhance the quality of disclosure that funds provide to investors. Some commenters emphasized that improved disclosure about funds was long overdue and would substantially benefit investors. In particular, commenters strongly supported the Proposed Amendments as effective steps toward improving fund prospectuses. Commenters also provided numerous additional suggestions to improve prospectus disclosure. The Commission is adopting the initiatives substantially as proposed.
Prior Commission Disclosure Initiatives
The amendments to the prospectus disclosure requirements adopted today are another important step in the Commissions ongoing efforts to improve disclosure about funds. In 1983, the Commission introduced an innovative approach to prospectus disclosure by adopting a two-part disclosure format that permitted a fund to provide investors with a simplified prospectus containing essential information about the fund and to place more detailed information in a companion document called the "Statement of Additional Information" ("SAI"), which investors could obtain upon request. 12 The Commission intended that, under this format, a funds prospectus would include essential information about the fund that would be most useful to typical or average investors in making an investment decision about the fund. The Commission contemplated that more detailed discussions of matters geared to the needs of more sophisticated investors would be available in the SAI, which all fund investors could obtain upon request. In adopting this new format, the Commissions goal was to provide investors with more useful information in "a prospectus that is substantially shorter and simpler, so that the prospectus clearly discloses the fundamental characteristics of the particular investment company . . . ." 13
Since 1983, the Commission has implemented a number of other initiatives to improve fund prospectus disclosure, including a uniform fee table 14 and a requirement that a funds management discuss the funds performance over the past year in its prospectus or annual report to shareholders (the managements discussion of fund performance ("MDFP")). 15 While these changes have provided investors with clear and helpful information about fund expenses and performance, they were not intended to address the overall effectiveness of Form N-1As prospectus disclosure requirements. The Proposed Amendments and Form N-1A, as amended, reflect the Commissions view that current prospectus disclosure must be considered on a comprehensive basis to ensure that the prospectus, as a whole, meets the information needs of investors.
Reassessment of Fund Disclosure
The Commissions recent efforts to improve disclosure began with an evaluation of the use of a standardized, summary disclosure document that highlights key information about a fund. The Commission, with the cooperation of the Investment Company Institute ("ICI") and several large fund groups, conducted a pilot program permitting funds to use profile-like summaries ("Pilot Profiles") together with their prospectuses. 16 The programs purpose was to determine whether investors found the Pilot Profiles, which summarize important information about a fund, helpful in making investment decisions. Focus groups conducted on the Commissions behalf, and fund investors participating in a survey sponsored by the ICI, responded very positively to the profile concept. 17
In considering fund disclosure issues, the Commission also has evaluated over 3,700 letters submitted in response to a release requesting comment on ways to improve risk disclosure in fund prospectuses, as well as the comparability of fund risk levels ("Risk Concept Release"). 18 The commenters, mostly individual investors, confirmed the importance of risk disclosure in evaluating and comparing funds and emphasized the need to improve prospectus disclosure of fund risks. In particular, commenters indicated that current risk disclosure is difficult to understand and does not fully convey to investors the risks associated with an investment in a fund.
Plain English Initiatives
The fund disclosure initiatives being adopted today are part of the Commissions broad undertaking to bring sweeping revisions to prospectus disclosure for all public companies. 19 As part of its commitment to make all prospectuses simpler, clearer, and more useful, and to eliminate jargon and boilerplate, the Commission recently adopted rule amendments to require the use of plain English principles in drafting prospectuses and to provide other guidance on improving the readability of prospectuses. 20 The Commissions plain English principles reflect fundamentals of clear communication and contemplate disclosure documents that:
- Present information in an easily readable format;
- Use everyday language that investors can easily understand; and
- Eliminate repetition of disclosure that lengthens a document and overwhelms the investor.
Improved Fund Disclosure
As one commenter on the disclosure initiatives pointed out, the Commissions proposals reflect an unprecedented number and variety of public comments and expert views, the results of Commission and other research, and broad investor input. The Commission agrees with the commenters further observation that the Commission has never had a more detailed, comprehensive, and compelling basis for a rulemaking than that developed for the fund disclosure initiatives. Through focus groups and written comments on the initiatives, investors have confirmed that they concur strongly with the Commissions view that fund disclosure documents will be useful only if they communicate information effectively. The Commission has designed both the fund prospectus and profile initiatives to meet this goal. The amendments to Form N-1A seek to make the prospectus, which will remain a funds primary disclosure document, a more effective tool by focusing its contents on information that is essential to an investment in the fund. The profile responds to investors strongly expressed desire for a new, concise disclosure document that summarizes key fund information and helps investors evaluate and compare funds more easily.
To encourage the use of disclosure that communicates effectively, the Commissions fund disclosure initiatives include a number of important innovations:
- The initiatives provide for a standardized risk/return summary at the beginning of every fund prospectus and in the profile that: 21
-- Concisely summarizes information in a specific sequence about a funds investment objectives, strategies, risks and performance, and fees;
-- Discusses the risks of a funds portfolio taken as a whole and minimizes detailed and technical descriptions of the risks associated with specific portfolio securities potentially held by the fund; and
-- Provides a graphic presentation of a funds annual returns over a 10-year period in a bar chart that illustrates the variability of the funds returns and gives investors some idea of the risks of an investment in the fund. To help investors evaluate a funds risks and returns relative to "the market," a table accompanying the bar chart compares the funds average annual returns for 1, 5, and 10 years with that of a broad-based securities market index.
- The initiatives require a fund to prepare disclosure documents using plain English disclosure, which is designed to give investors understandable disclosure documents.
- The initiatives eliminate prospectus clutter that obscures other information helpful to investors when making a decision about an investment in a fund. Specifically, the amendments to prospectus disclosure requirements:
-- Move certain disclosure about fund organization and legal requirements from the prospectus to the SAI;
-- Permit a fund that is offered as an investment alternative in a participant-directed defined contribution plan (or certain other tax-advantaged arrangements) to tailor its prospectus for the plan (or other arrangement);
-- Update and incorporate certain staff interpretive positions into Form N-1A; 22 and
-- Simplify current disclosure instructions to provide clearer guidance for preparing and filing fund registration statements.
The Commission believes that, in revising Form N-1A and in providing for the use of profiles, it has laid the foundation for the development of fund disclosure documents of a significantly higher quality than those often used today, which have drawn the consistent criticism of fund investors and others. If the initiatives are to have their intended effect, however, all those who participate in the preparation and review of those documents -- funds, their legal counsels and other advisors, the Commission and its staff, and other regulators and their staffs -- should act consistently with the basic disclosure principles that serve as the cornerstones of the initiatives. These principles, which are referred to throughout this release, include the following:
- Funds should design disclosure documents, particularly their prospectuses, first and foremost, to communicate information to investors effectively. Funds should present information in prospectuses following the principles of plain English, using language that is concise, straightforward, and easy to understand.
- A funds prospectus principally should include essential information about the fundamental characteristics of, and risks of investing in, the fund. Whenever possible, a fund should present this information in a manner that:
-- assists investors in comparing and contrasting the fund with other funds;
-- avoids simply restating legal or regulatory requirements to which funds generally are subject; and
-- avoids a disproportionate emphasis on possible investments or activities of the fund that are not a significant part of the funds investment operations.
- Funds should limit disclosure in prospectuses generally to information that is necessary for an average or typical investor to make an investment decision. Detailed or highly technical discussions, as well as information that may be helpful to more sophisticated investors, dilute the effect of necessary prospectus disclosure and should be placed in the SAI.
- Prospectus disclosure requirements should not lead to lengthy disclosure that discourages investors from reading the prospectus or obscures essential information about an investment in a fund.
The Commission has instructed its staff to use these principles consistently in administering the requirements of both amended Form N-1A and new rule 498 and strongly encourages all other participants in the development of fund disclosure documents to apply these principles in preparing their prospectuses and profiles. 23
A. Part A Information in the Prospectus
Form N-1A, as amended, retains the overall structure of current Form N-1A. The most significant changes to Form N-1A adopted today are the new risk/return summary at the beginning of the prospectus and improved disclosure about the risks of investing in a fund. This release first addresses these changes and then discusses other changes to substantive prospectus disclosure requirements in Part A of Form N-1A. 24 Following this discussion, the release describes revisions to requirements for information on the front and back cover pages of the prospectus, the General Instructions to Form N-1A, which have been updated and revised to make them easier to use, and other technical revisions to Form N-1As requirements. 25
1. Risk/Return Summary: Investments, Risks, and Performance (Item 2)
The Commission proposed to require a risk/return summary at the beginning of every prospectus that would provide key information about a fund's investment objectives, principal strategies, risks, performance, and fees. The risk/return summary, also included in the Proposed Profile, was intended to respond to investors' strong preference for summary information about the fund in a standardized format. 26 The proposed risk/return summary in a funds prospectus would provide investors with a type of "executive summary" of key information about the fund in a standardized, easily accessible place that investors could use to evaluate and compare the fund to others, regardless of whether the fund uses a profile.
While most commenters supported the proposed risk/return summary, several questioned whether it was necessary in a prospectus. These commenters argued that the summary could repeat other information in the prospectus and that it would undermine the Commissions goal of making prospectus disclosure clear and concise.
The Commission is of the view that the prospectus risk/return summary will not undermine, but further, the goal of making prospectuses more useful for investors. The Commission believes that the disclosure in the risk/return summary need not generally repeat other information in the prospectus; much of the summary consists of information that Form N-1A would not require to be disclosed elsewhere in the prospectus, such as the bar chart, performance table, and fee table. The Commission has concluded that the possibility that the risk/return summary could repeat some information appearing elsewhere in the prospectus is outweighed by the benefits of providing investors with standardized and comparable fund information at the beginning of every prospectus and in the profile. Thus, the Commission is adopting the requirement that every prospectus and profile contain a risk/return summary. 27
The Commission proposed to require that the risk/return information in the prospectus, like that in the Proposed Profile, appear in a specific sequence and in a question-and-answer format. Many commenters objected to the question-and-answer format, stating, among other things, that rigid adherence to the format would not necessarily result in effective communication of information to investors. 28 To allow funds to design effective disclosure documents, the Commission has determined not to require this format in the prospectus or the profile. Any fund that chose to do so could use a question-and-answer format in its prospectus, profile, or in both documents.
a. Investment Objectives and Principal Strategies
The Proposed Amendments would require a fund to disclose its investment objectives in the risk/return summary and to summarize, based on the information provided in its prospectus, how the fund intends to achieve those objectives. The purpose of the proposed disclosure was to provide a summary of the fund's principal investment strategies, including the specific types of securities in which the fund principally invests or will invest, and any policy of the fund to concentrate its investments in an industry or group of industries. 29 The Commission is adopting this requirement as proposed. 30
The information contained in the risk/return summary about a funds investment objectives and principal strategies is intended to meet the needs of an average or typical fund investor. Recognizing that disclosure about a funds specific portfolio holdings may be important to some investors, the Proposed Amendments would require a fund to inform investors in its prospectus risk/return summary that additional information about the fund's investments is available in the funds shareholder reports. 31 While supporting the proposed disclosure, most commenters suggested placing statements about how investors can obtain a funds SAI, shareholder reports, and other information about the fund on the back cover page of the prospectus. According to these commenters, this disclosure would be easier for investors to find if it were located in one place rather than in different places in the prospectus. The Commission agrees with the commenters that typical fund investors may find a single reference to the availability of additional information helpful. Therefore, Form N-1A, as amended, requires all disclosure about the availability of additional information to appear on the back cover page of the prospectus. 32 The Commission is adopting the disclosure as proposed, with minor adjustments to the language to ensure that the disclosure clearly explains the availability of additional information about a fund to a typical investor. 33
Summary Risk Disclosure. The Proposed Amendments would require the risk/return summary to include a discussion of the principal risks of investing in a fund that summarizes information about those risks set out in the funds prospectus. Reflecting the Commissions proposed new approach to risk disclosure, this discussion was intended to summarize the risks of a fund's anticipated portfolio holdings as a whole, and the circumstances reasonably likely to affect adversely the fund's net asset value, yield, and total return. Commenters generally supported the summary risk disclosure contemplated by the Proposed Amendments, agreeing that it would be specific and brief and would assist investors in identifying the principal risks of investing in a particular fund. The Commission is adopting this disclosure requirement with modifications to reflect certain commenters suggestions. 34
Several commenters asked the Commission to clarify the scope of the proposed summary risk disclosure, arguing that the requirement would not serve its purpose if the risk disclosure simply repeated information from other sections of the prospectus. In the Commissions view, the purpose of the summary risk disclosure in a funds prospectus is to identify briefly the principal risks of investing in the particular fund and to emphasize those risks reasonably likely to affect the funds performance. In light of this purpose, the Commission expects a fund, in meeting this requirement, to present only a succinct summary of the principal risks of investing in the fund and not to repeat the fuller discussion of these risks required elsewhere in the prospectus. 35 On the other hand, the Commission believes that it generally would be inconsistent with the summary risk requirement for a fund to include a "laundry list" of generic risk factors that may apply to any fund and that does not identify the risks of investing in the fund.
The Commission proposed to require that the prospectus risk summary identify the types of investors for whom the fund may be an appropriate or inappropriate investment. 36 Commenters either opposed or raised significant concerns about this provision, arguing that it could be viewed as requiring a fund to determine whether its shares, among other things, are a suitable investment for a particular investor. 37 Commenters also stated that the disclosure would tend to be generic and not meaningful or useful for investors.
The Commission is persuaded by commenters that disclosure about the appropriateness of funds for particular investors should not be required in all fund prospectuses and has deleted this requirement from the prospectus risk summary. The Commission believes, however, that disclosure indicating whether a fund is appropriate for specific types of investors or is consistent with certain investment goals, even if generic in nature, may be useful for some investors and may provide a means for the fund to distinguish itself from other investment alternatives. 38 Therefore, Form N-1A, as amended, permits, but does not require, a fund to include disclosure in the narrative risk summary about the types of investors for whom the fund is intended or the types of investment goals that may be consistent with an investment in the fund. 39
Under the Proposed Amendments, a fund could choose to discuss the potential rewards of investing in the fund in the risk summary as long as the discussion provided a balanced presentation of the fund's risks and rewards. One commenter strongly questioned this provision of the proposal, asserting that it would detract from a clear presentation of risks in the risk summary. The Commission has reconsidered this disclosure in light of the intended standardized and summary nature of the risk summary and has concluded that the disclosure should focus solely on the risks of investing in a fund. Thus, the Commission has determined to eliminate the option to describe the rewards of investing in a fund in the risk summary. A fund desiring to add this disclosure elsewhere in its prospectus can do so subject to Form N-1As general rule with respect to information that is not required to be in a prospectus. Under this general rule, a fund can disclose this information, so long as it is not incomplete or misleading and would not obscure or impede understanding of the information that is required to be in the prospectus. 40
Special Risk Disclosure Requirements. The Proposed Amendments were intended to simplify the prospectus cover page and to avoid repeating information on the cover page and in the risk summary discussion. In seeking to meet this goal, the Commission proposed to move certain cover page disclosure requirements relating to the risks associated with specific types of funds to the risk summary where, the Commission believed, it would be more meaningful to investors.
Form N-1A currently requires that each money market fund 41 disclose on the cover page of its prospectus that an investment in the fund is neither insured nor guaranteed by the U.S. Government and that there can be no assurance that the fund will be able to maintain a stable net asset value of $1.00 per share. This required disclosure is intended to alert investors that investing in a money market fund is not without risk. 42 In addition to moving this disclosure to the risk summary, the Proposed Amendments would simplify the technical disclosure that a money market fund may not be able to maintain a stable net asset value. 43 Commenters supported the proposed disclosure for money market funds, and the Commission is adopting it as proposed. 44
Form N-1A currently requires specific prospectus cover page disclosure for a tax-exempt money market fund that concentrates its investments in a particular state (a "single state money market fund"). Each such fund is required to disclose that it may invest a significant percentage of its assets in a single issuer and that investing in the fund may be riskier than investing in other types of money market funds. This disclosure was intended to make investors aware of special risks that could be associated with an investment in a single state money market fund. 45 In the Form N-1A Proposing Release, the Commission asked whether it should continue to require this disclosure in prospectuses. The Commission noted that this disclosure may exaggerate the risk of investing in a single state money market fund. As the Form N-1A Proposing Release pointed out, although these funds are subject to less stringent issuer diversification provisions under Commission rules than other money market funds, they are subject to credit quality and maturity investment restrictions that are comparable to other money market funds. 46
In response to the Commissions question regarding single state money market funds, commenters indicated that the special disclosure now required on the cover page of fund prospectuses overstates the risks of investing in single state money market funds, particularly in view of the minimal risk that commenters asserted is associated with these funds. The Commission is persuaded by these comments and has determined not to require the disclosure in Form N-1A.
Form N-1A currently requires a fund that is advised by or sold through a bank to disclose on the cover page of its prospectus that the fund's shares are not deposits or obligations of, nor guaranteed or endorsed by, the bank, and that the shares are not insured by the Federal Deposit Insurance Corporation ("FDIC") or any other government agency. 47 This disclosure is intended to alert investors that funds advised by or sold through banks are not federally insured. 48 The Commission proposed to move this disclosure to the prospectus risk summary and to simplify the wording of the current disclosure required for funds advised by or sold through banks. 49 Commenters supported the revised disclosure requirements for bank-sold funds, and the Commission is adopting them substantially as proposed. 50
Risk/Return Bar Chart and Table. The Proposed Amendments would require a funds risk/return summary to include a bar chart showing the fund's annual returns for each of the last 10 calendar years and a table comparing the fund's average annual returns for the last 1-, 5-, and 10-fiscal years to those of a broad-based securities market index. Commenters generally supported the proposed bar chart and performance table, but had a number of suggestions about the content and presentation of the information in both. The Commission is adopting the proposed bar chart and table requirements with modifications to reflect suggestions of commenters. 51
The bar chart reflects the Commissions 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 funds returns (e.g., whether a fund's returns for a 10-year period have changed significantly from year to year or were relatively even over the period) and thus provide investors with some idea of the risk of an investment in the fund. 52 The average annual return information in the table should enable investors to evaluate a fund's performance and risks relative to "the market."
In the Form N-1A Proposing Release, the Commission requested comment about alternative presentations that could improve fund risk disclosure. 53 In particular, the Commission expressed interest in disclosure that would show a funds highest and lowest returns (or "range" of returns) for annual or other periods as an alternative, or in addition, to the bar chart. The Commission suggested that a fund could present the information in a separate table or could include it in the performance table.
In response to the Commissions request, some commenters suggested including in a funds 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 funds returns by comparisons to other measures of market performance or economic factors. 54 Most commenters, however, opposed requiring additional information in the bar chart, asserting that it could complicate and reduce the effectiveness of the bar chart.
Several commenters supported the inclusion of return information in the bar chart on a quarterly or semi-annual rather than an annual basis. They argued that this change to the bar chart would respond to concerns that investors may not sufficiently appreciate that an investment in a fund may be subject to the risk of a short-term decline in value. This risk, commenters asserted, may not be apparent from the annual returns proposed to be shown in the bar chart. One commenter recommended that the Commission require quarterly returns in the bar chart so that investors would have more information about returns over shorter periods to use in assessing the variability reflected in a funds past returns. The commenter argued that including returns on an annual basis in the bar chart may not show a significant amount of shorter-term price fluctuation.
The Commission acknowledges that a funds returns may vary significantly and could decrease in value over short periods and that the annual returns in the bar chart will not necessarily reflect this pattern. On the other hand, the Commission is concerned that requiring quarterly returns over a 10-year period would make the bar chart more complex and less useful in communicating information to investors. In balancing the desire to make typical fund investors aware that fund shares may experience fluctuations over shorter periods with its underlying goal that fund documents communicate information in as straightforward and uncomplicated a manner as possible, the Commission has determined to require a fund to disclose, in addition to the bar chart, its best and worst returns for a quarter during the 10-year (or other) period reflected in the bar chart. 55 The Commission believes that this information will assist investors in understanding the variability of a funds returns and the risks of investing in the fund by illustrating, without adding unwarranted complexity to the bar chart, that the funds shares may be subject to short-term price fluctuations.
Presentation of Return Information. The Proposed Amendments would require a fund to include the bar chart and table in the risk section of the prospectus risk/return summary under a separate sub-heading that referred to both risk and performance. Several commenters argued that the separate sub-heading requirement was unnecessary and suggested that a fund should be able to choose whether to include any sub-heading. Consistent with the objective of encouraging funds to develop disclosure formats that are most helpful to investors, Form N-1A, as amended, does not require the sub-heading included in the Proposed Amendments. 56 To help investors use the information in the bar chart and table, Form N-1A, as amended, however, does require a fund to provide a brief narrative explanation of how the information illustrates the variability of the fund's returns. 57
Bar Chart Return Information. The Proposed Amendments would require that a funds prospectus bar chart show the funds annual returns for the last 10 calendar years of the funds existence. The purpose of the calendar year requirement was to facilitate the comparison of annual returns among funds, which typically have fiscal periods that do not correspond to the calendar year. 58 Unlike the proposed bar chart, the proposed performance table required disclosure of a funds 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 funds prospectus.
Several commenters argued that using different time periods for the proposed bar chart and performance table would confuse investors and urged the Commission to minimize potential investor confusion by adopting consistent time periods for this information. The Commission is persuaded by these comments and believes that requiring both the bar chart and the performance table to be based on calendar year periods will promote understandable information in fund prospectuses. Therefore, Form N-1A, as amended, requires calendar year periods for both the bar chart and table. 59 Rule 498, as adopted, also requires the bar chart and table in the profile to show calendar year data so that both the profile and the prospectus of a fund will have virtually the same risk/return information. 60
The Commission is adopting, as proposed, the requirement that a fund calculate the annual returns in the bar chart using the same method required for calculating annual returns in the financial highlights information included in fund prospectuses. 61 The bar chart does not reflect sales loads assessed upon the sale of a funds shares, although the average annual return information for the fund in the table would reflect the payment of any sales loads. 62 Commenters generally supported this presentation of annual return information. The Commission believes that, in light of the different types of sales loads that may be charged on funds shares, it would be difficult for funds to compute annual returns for the purposes of the bar chart and to communicate the information effectively to investors. 63 In addition, the Commission has concluded that more precise return information is not necessary for the bar chart to serve the purpose of graphically showing fund annual returns and illustrating the variability of an investment in a fund over a 10-year period.
Bar Chart Presentation. The Proposed Amendments would allow a single bar chart to include return information for more than one fund. Most commenters supported the proposal, agreeing that it would give funds the appropriate amount of flexibility to present the information in the bar chart in a manner designed to assist investors in making investment decisions. Under Form N-1A, as amended, the bar chart may include returns for more than one fund, subject to the general requirement that the information presented in the bar chart appear in a clear and understandable manner. 64
Multiple Class Funds. Although the Commission proposed to permit return information for more than one fund to be included in a single bar chart, the Proposed Amendments would require a fund offering more than one class of its shares in a prospectus to limit the information in the funds bar chart to one class. Commenters uniformly supported this approach, and the Commission is adopting it as proposed. 65 Unlike individual funds, classes of a fund represent interests in the same portfolio of securities, and the returns of each class differ only to the extent the classes do not have the same expenses. The Commission believes that including return information for all classes offered through a funds prospectus is not necessary to provide some indication of the risks of investing in the fund. In addition, the table accompanying such a funds bar chart would provide return information for each class offered in the prospectus so that investors would be able to identify and compare the performance of each class. 66
The Proposed Amendments would require the bar chart of a fund offering more than one class of shares through a prospectus to reflect annual return information for the class offered in the prospectus that had the longest performance history over the last 10 years. When two or more classes have returns for at least 10 years, or returns for the same period but fewer than 10 years, the Proposed Amendments would require annual returns for the class with the greatest net assets as of the end of the most recent calendar year. Most commenters addressing the issue opposed this approach. They argued that, if all classes had existed for the same amount of time, the largest class could change from year to year, thus requiring a fund to change the class reflected in the bar chart. According to the commenters, changes in the information each year could be confusing for investors and result in unwarranted administrative burdens for funds. Commenters suggested that the Commission permit a fund having classes with performance histories extending over the same period of time to include the performance of any existing class in the bar chart, maintaining that the effect of expenses on the returns for different classes of shares is not significant. 67 The Commission is persuaded that allowing a multiple class fund in such a case to choose the class reflected in the funds bar chart will simplify compliance with Form N-1As requirements and provide investors with sufficient information to evaluate the variability of returns for any class of the fund. Therefore, Form N-1A, as amended, permits a fund to choose the class to be reflected in the bar chart, subject to certain limitations. 68 Under Form N-1A, as amended, the bar chart must reflect the performance of any class that has returns for at least 10 years (e.g., a fund could not present a class in the bar chart with 2 years of returns when another class has returns for at least 10 years). In addition, if two or more classes offered in the prospectus have returns for different periods shorter than 10 years, the bar chart must reflect returns for the class that has returns for the longest period.
Tabular Presentation of Fund and Index Returns. The Proposed Amendments would require a table accompanying a funds bar chart to present the fund's average annual returns for the last 1-, 5-, and 10-fiscal years (or for the life of the fund, if shorter) and to compare that information to the returns of a broad-based securities market index for the same periods. The purpose of including return information for a broad-based securities market index was to provide investors with a basis for evaluating a fund's performance and risks relative to the market. The proposed approach also was consistent with the line graph presentation of fund performance required in MDFP disclosure. 69
Commenters generally supported the proposed performance table, but had several technical suggestions. The Commission is adopting the performance table with revisions to clarify the disclosure requirements for the table. 70
One commenter suggested that the Commission allow funds that have existed for more than 10 years to include average annual returns for the life of the fund in the performance table. The Commission agrees that this information could be helpful for typical investors in such a fund. Form N-1A, as amended, permits, but does not require, a fund to include performance information in the table for the life of the fund if it exceeds 10 years. 71
The Proposed Amendments would require a money market fund, in meeting the proposed performance table requirement, to provide its 7-day yield as of the end of its most recent fiscal year. One commenter questioned this requirement, arguing that it would result in money market funds giving outdated information to investors and suggested that disclosure describing how an investor can obtain the funds current 7-day yield would be preferable. As amended, Form N-1A gives a money market fund the option of providing in its performance table its 7-day yield ending on the date of its most recent calendar year or disclosing a toll-free (or collect) telephone number that an investor can use to contact the fund to obtain its current 7-day yield. 72
2. Risk/Return Summary: Fee Table (Item 3)
The Proposed Amendments would continue to require a fee table in the prospectus that summarizes the sales charges and fund operating expenses associated with an investment in a fund. Proposed rule 498 also incorporates the fee table requirement in the risk/return summary included in the profile. Including the fee table in both the prospectus and the profile reflects the Commissions strongly held belief in the importance of fees and expenses in a typical investors decision to invest in a fund. The fee table is designed to help investors understand the costs of investing in a fund and to compare those costs with the costs of other funds. Commenters generally supported the fee table disclosure, and the Commission is adopting it substantially as proposed.
The Commission proposed certain amendments designed to improve communication of the information in the fee table. The Commission proposed to require a narrative explanation of the purpose of the "Example" that accompanies the fee table. 73 Recognizing the trend that the typical fund investment is increasing in size, 74 the Proposed Amendments would increase the initial hypothetical investment included in the Example from $1,000 to $10,000.
Several commenters criticized the Example, arguing that, because it is an arbitrary approximation of a funds actual expenses, the Example is not helpful to investors. These commenters recommended that the Commission eliminate the Example from the fee table disclosure.
The Commission recognizes that any example necessarily has limitations. On balance, however, the Commission believes that the Example provides useful information that helps a typical investor understand and compare the expenses of different funds. 75 The Example is a relatively straightforward means of illustrating the effect of costs in investing in a fund over time. Expressing expense amounts solely as a percentage amount, as is done in the fee table, may not give the average investor enough information to assess the likely effect of a funds expenses on a dollar amount of an investment in the fund. The addition of a clear narrative explanation of the purpose of the Example should increase its effectiveness in assisting investors understanding of the Example, and the Commission is adopting this disclosure requirement as proposed. 76
To ensure that all account fees (e.g., administrative fees charged to maintain an account) paid directly by shareholders are disclosed, the Proposed Amendments would require a new line item in the shareholder transaction section of the fee table describing account fees charged by a fund. The Commission is adopting this requirement as proposed. 77 In response to comments on the Proposed Amendments, Form N-1A, as amended, clarifies that the table should include account fees that affect a typical investor in a fund and not miscellaneous fees that apply to only a limited number of shareholders based on their particular circumstances. 78
The Commission proposed to modify some of the captions in the fee table relating to fees and expenses. The revisions were intended to result in fee tables referring consistently to different types of expenses as "fees." In particular, the Proposed Amendments would change the captions for "sales loads" to "sales fees (loads)." The Proposed Amendments also would revise the caption "12b-1 Fees" to read "Marketing (12b-1) Fees." Commenters generally criticized these changes. They maintained that the caption sales fees (loads) was not typically used by the industry or industry commentators and could be confusing to investors. The commenters recommended that the caption in the fee table refer to "sales charges." Commenters also recommended that the caption "Distribution (and/or Service) (12b-1) Fees" would better describe these fees than the term "Marketing (12b-1) Fees." Commenters said that the types of fees that can be paid in accordance with rule 12b-1 under the Investment Company Act extend beyond marketing fees so that referring to rule 12b-1 fees as marketing fees would be inaccurate.
The Commission believes that the terms suggested by commenters are commonly used by the industry and by the press in covering the industry and may be more easily understood by investors than those proposed. Form N-1A, as amended, modifies the caption for sales fees (loads) to refer to sales charges (loads). 79 The Commission is retaining the reference to loads because many investors are familiar with this term. Form N-1A, as amended, also requires funds to use the captions suggested by the commenters in referring to distribution fees in the fee table.
The Commission proposed to continue to require a fund to reflect in the fee table its operating expenses for the most recent fiscal year, taking into account expense reimbursements and fee waiver arrangements. 80 As required by current Form N-1A, a footnote to the fee table would disclose the amount of expenses that would have been incurred had there been no waiver or reimbursement. One commenter expressed strong opposition to showing expenses in the fee table that are reduced by reimbursements or fee waivers. The commenter asserted that investors would interpret the disclosure to mean that the net fee disclosed in the table is what they can expect for the life of their investment in the fund, which may not be the case.
The Commission believes that typical investors need clear disclosure of information about fees charged by funds. 81 Reflecting its continuing concern about the quality of disclosure about fees, the Commission has reconsidered the disclosure of expense reimbursement and fee waiver arrangements. The Commission believes that typical investors may tend to overlook or disregard information about a funds fee structure if it is included in a footnote. Moreover, requiring the fee table to show fees that a fund will charge under its contractual arrangement with its investment adviser, without regard to temporary arrangements that may decrease these fees, is consistent with other Form N-1A requirements. 82
In view of its desire to improve the quality of fee disclosure, the Commission has revised Form N-1A to require a fund to disclose in the fee table its operating expenses, not taking into account expense reimbursements and fee waiver arrangements. 83 To ensure that investors have current information about a funds expenses, however, Form N-1A, as amended, permits a fund to disclose its operating expenses net of reimbursements and waivers in a footnote to the fee table. 84 The Commission believes that the fee table disclosure of fund expenses, as amended, will give an investor clearer information about the long-term costs of an investment in a fund, while at the same time allowing the fund to provide current information about its operating expenses.
3. Investment Strategies and Risk Disclosure (Item 4)
In the Form N-1A Proposing Release, the Commission discussed its concerns about disclosure of fund investments and risks typically found in many fund prospectuses. 85 This disclosure generally consists of descriptions of the types of securities in which a fund may invest and the risks associated with each of those securities. 86 In the Commissions view, disclosing information about all of the securities in which a fund might invest does not help a typical fund investor evaluate how the fund's portfolio will be managed or the overall risks of investing in the fund. The disclosure also adds substantial length and complexity to fund prospectuses, which discourages investors from reading them.
The Commission has concluded that prospectus disclosure would be more useful to a typical fund investor if it emphasized the principal investment strategies of a fund and the principal risks of investing in the fund, rather than the characteristics and risks of each type of instrument in which the fund may invest. 87 The Commission believes that funds are appropriately viewed as a means through which a professional money manager provides its services to investors 88 and that, for that reason, the focus of disclosure about a funds prospective investments should center on the funds investment objectives and the principal means used by the fund's adviser to achieve those objectives. Consistent with this view, the Proposed Amendments would require prospectus disclosure that is designed to help investors understand how a particular fund's portfolio will be managed. The purpose of the Proposed Amendments was to implement more effectively the Commission's original goal in adopting Form N-1A that the prospectus should describe a fund's "fundamental characteristics." 89 Commenters generally supported the proposed approach to disclosure of the funds investment operations and attendant risks, and the Commission is adopting it substantially as proposed.
a. Principal Investment Strategies, Investment Objectives, and Implementation of Investment Objectives
To assist investors in determining whether a fund meets their investment needs, Form N-1A, as amended, continues to require prospectus disclosure of a fund's investment objectives. 90 The Commission proposed to shift the focus of disclosure about how a fund intends to achieve its investment objectives away from the current practice of listing all types of securities in which a fund may invest to a discussion of the funds overall portfolio management. 91 The Commission proposed to require a fund to disclose in its prospectus the principal strategies that it used to achieve its investment objectives, which would include the particular type or types of securities in which the fund will invest principally. This approach was designed to focus disclosure on a fund's anticipated investment operations rather than on investments that the fund might make.
The Commission continues to believe that a clear, concise, and straightforward discussion of investment objectives and strategies is central to effective prospectus disclosure. Therefore, the Commission is adopting the requirement for a fund to disclose how it intends to achieve its investment goals as proposed. 92
Under Form N-1A, as amended, whether a particular investment strategy (including a strategy to invest in a particular type of security) is a principal investment strategy depends upon the strategy's anticipated importance in achieving the fund's investment objectives and how the strategy affects the fund's potential risks and returns. 93 The Commission believes that a fund should disclose those strategies that are expected to be the most important means of achieving the funds objectives and that the fund anticipates will have a significant effect on its performance. Form N-1A, as amended, requires a fund, when determining whether a strategy is a principal investment strategy, to consider, among other things, the portion of assets that it expects to commit to the strategy, the portion of assets that it expects to place at risk by the strategy, and the likelihood that it will lose some or all of those assets in implementing the strategy. 94
The Commission intends that focusing disclosure on a fund's principal investment strategies 95 will improve the funds prospectus by eliminating discussions of securities and strategies that do not have a significant role in achieving the fund's investment objectives. Under Form N-1A, as amended, for example, it generally will be unnecessary for a fund (other than, for example, a money market fund) to disclose in its prospectus its cash management practices (e.g., entering into overnight repurchase agreements), because these practices are not typically among the principal investment strategies that a fund uses to achieve its investment objectives. 96
The Proposed Amendments would require a fund, in discussing its principal investment strategies in its prospectus, to explain in general terms how the fund's adviser decides what securities to buy and sell. This requirement sought to provide investors with essential information about the fund's investment approach and how the fund's portfolio would be managed. One commenter questioned this requirement, arguing that it could place undue emphasis on a funds decisions to invest in or sell particular securities and result in boilerplate disclosure. The Commission continues to believe that a general discussion of the methods of analysis and investment strategies that a funds adviser will use in managing the fund will provide typical investors with information that will help them in deciding whether to invest in a fund. Therefore, the Commission is adopting the proposed disclosure requirement regarding the manner in which the investment adviser determines to buy and sell securities. 97
Concentration. The Commission proposed to continue to require a fund to disclose in its prospectus any policy to concentrate its investments in any industry or group of industries. This requirement reflects the view that such a policy is likely to be central to a funds ability to achieve its investment objectives, 98 and that a fund that concentrates its investments will be subject to greater risks than funds that do not follow the policy. The Commissions staff has taken the position for purposes of the concentration disclosure requirement that a fund investing more than 25% of its assets in an industry is concentrating in that industry. 99 The Proposed Amendments incorporated this percentage test into Form N-1A.
Commenters supported requiring a fund to disclose in its prospectus its policies on industry concentration, 100 and the Commission continues to believe that 25% is an appropriate benchmark to gauge the level of investment concentration that could expose investors to additional risk. Therefore, the Commission is adopting this disclosure requirement as proposed. 101
Temporary Defensive Positions. The Proposed Amendments would require disclosure about a funds policy that permits the fund to take "temporary defensive positions" to respond to adverse market, economic, political, or other conditions. The purpose of the requirement was to make investors aware of potential changes in a fund's investments that are not generally contemplated by, or are otherwise inconsistent with, a funds principal investment objectives and policies. In particular, the Proposed Amendments would require a fund to disclose the percentage of its assets that may be committed to temporary defensive positions (e.g., up to 100% of the fund's assets), the risks, if any, associated with the positions, and the likely effect of these positions on the fund's performance. Although commenters generally supported disclosure that a fund may take temporary defensive positions, they found problematic disclosure of the percentage of assets that may be committed to temporary defensive positions and the likely effect of these positions on the funds performance. Commenters argued that, to maintain flexibility, a fund typically would disclose that all of its assets could be committed to temporary positions. The commenters maintained that such disclosure was boilerplate and would not be meaningful to investors. In addition, commenters asserted that funds would find it difficult to predict the likely effect of temporary defensive positions on their performance.
The Commission believes that a typical fund investor would want to know about investment positions that a fund can take from time to time that are inconsistent with the funds central investment focus. On the other hand, the Commission is aware that, in practice, the disclosure about temporary investment positions currently appearing in some fund prospectuses is so lengthy and detailed as to suggest incorrectly that a funds temporary investment policies are more important than the funds investment objectives and the principal investment strategies used to achieve them. The Commission believes that disclosure of this sort, which discusses possible but not probable investments of funds, is inconsistent with the fundamental disclosure principles underlying Form N-1A. In the Commissions view, however, disclosure that a fund may take temporary defensive positions to respond to market conditions will alert investors to the possibility that a fund may vary its investments on a temporary basis. Therefore, Form N-1A, as amended, requires a fund to disclose, if applicable, that in response to unfavorable market conditions it may make temporary investments that are not consistent with its principal investment objectives and policies. 102
Portfolio Turnover. Form N-1A currently requires all funds to state their portfolio turnover rates in their financial highlights tables included in their prospectuses. 103 Under the Proposed Amendments, a fund would be required to supplement the information in its financial highlights table by disclosing certain information about its portfolio turnover rate if it anticipated having a turnover rate of 100% or more in the coming year. 104 The disclosure would be required to include an explanation of the tax consequences and effect of increased trading costs on the funds performance. 105 Most commenters questioned or opposed the proposed disclosure about portfolio turnover rate. Some commenters suggested that the Commission move this disclosure to the SAI or require it in the MDFP in fund shareholder reports. Other commenters argued that a funds portfolio turnover rate may reflect the funds response to particular market events, or special circumstances affecting the funds investments, that are difficult to predict. These commenters argued further that the unpredictable nature of fund portfolio turnover rates would lead to generic or boilerplate disclosure that would not be meaningful to investors in assessing various funds. The commenters suggested that Form N-1A should instead require disclosure about portfolio turnover rates as part of a discussion of a funds principal investment strategies when a funds investment approach is expected to include active and frequent trading (as opposed to, e.g., a "buy and hold" strategy).
The Commission continues to believe that a discussion about a funds portfolio turnover in some cases is relevant to typical fund investors. The Commission notes, for instance, that increased portfolio turnover can on some occasions result in tax consequences that can be significant to investors and that can be viewed as a cost to an investor of holding fund shares. Moreover, investors may find information about portfolio turnover particularly relevant in light of recent changes to the tax laws that reduce the tax rate on capital gains. 106 The Commission agrees with commenters, however, that disclosure about portfolio turnover and its consequences should be made only if an increased portfolio turnover rate is likely to result from the funds investment objectives and principal investment strategies and would have a significant effect on a funds returns. Therefore, Form N-1A, as amended, requires a fund to discuss the consequences of its portfolio turnover rate if the fund anticipates that active and frequent trading of portfolio securities will be a likely result of implementing its principal investment strategies. 107
Classification and Policies. The Commission proposed to move to the SAI disclosure about a fund's legal status as an open-end management company, 108 as well as disclosure relating to certain policies identified under the Investment Company Act, such as borrowing money, issuing senior securities, underwriting securities issued by other persons, investing in real estate or commodities, and making loans. 109 Commenters supported moving this disclosure, agreeing that it is not likely to be significant to a typical fund investor. Form N-1A, as amended, requires the disclosure to appear in the SAI. 110
b. Risk Disclosure
Risk disclosure in fund prospectuses typically consists of detailed, and often technical, descriptions of the risks associated with particular securities in which a fund may invest. Just as disclosure about each type of security in which a fund may invest does not appear to communicate effectively to investors how the fund's portfolio will be managed, disclosure about the risks associated with each type of security in which the fund may invest does not effectively communicate to them the overall risks of investing in the fund. In the Commissions view, disclosing the risks of each possible portfolio investment, rather than the overall risks of investing in a fund, does not help investors evaluate a particular fund or compare the risks of the fund with those of other funds.
The Commission proposed, consistent with its conclusion that mere inventories of potential portfolio securities do not assist typical investors in selecting among funds, to modify prospectus disclosure requirements in Form N-1A about the risks associated with specific securities. The Proposed Amendments would require a fund to disclose the risks to which the fund's particular portfolio as a whole is expected to be subject and to discuss the circumstances that are reasonably likely to affect adversely the fund's net asset value, yield, or total return. Commenters generally supported the proposed approach to the disclosure of risk, and the Commission is adopting it as proposed. 111
The Commission notes that a fund could meet the risk disclosure requirements of Form N-1A, as amended, by including in its prospectus a discussion of the risks of the asset class or classes that the fund expects to hold principally, together with a discussion of the risks to the fund of holding specific types of securities within the asset class or classes. Under such an approach, a fund investing in the equity securities of companies with small market capitalizations, for example, would discuss market risk as a general risk of holding equity securities, as well as the specific risks associated with investing in small capitalization companies (e.g., that these stocks may be more volatile and have returns that vary, sometimes significantly, from the overall stock market). 112
The Commission did not propose to require a fund to disclose information designed to quantify its expected risk levels, citing, among other things, the lack of a broad consensus as to what measure of risk would best serve fund investors. 113 Comments submitted in response to the Commissions Risk Concept Release asserted that investors have too wide a range of investment goals and ideas of what "risk" means to be well served by a single quantitative risk measure. In addition, commenters argued that, if the Commission mandated a risk measure, investors might rely on it as a definitive standard despite the lack of general agreement on how to measure risk.
As adopted, the prospectus risk/return summary and amendments to the general risk disclosure requirements of Form N-1A are designed to improve fund risk disclosure without raising the concerns associated with Commission-mandated quantitative information. While it is not adopting specific quantitative risk disclosure requirements, the Commission believes that new approaches to measuring risk are emerging and that quantitative risk information may be useful to some investors. 114 The Commission notes that a fund may include quantitative risk disclosure in its prospectus if the information is presented in a manner consistent with the guidelines on the inclusion of information not required by Form N-1A. 115
4. Management's Discussion of Fund Performance (Item 5)
The Proposed Amendments would continue to require a fund to provide its MDFP and the related line graph comparing the fund's returns to a broad-based securities market index in either its prospectus or its annual report. The Commission is adopting the MDFP as proposed with minor changes. 116 The Commission notes in support of this decision that a review of MDFP disclosure by the Commissions Division of Investment Management ("Division") indicates that the discussion of fund performance and the line graph have generally provided fund shareholders with useful, comparative information about a fund's performance.
As discussed in the Proposed Amendments, funds typically choose to include the MDFP in their annual reports, rather than in their prospectuses. This choice may be explained, in part, by the relevance of the MDFP to other current financial information appearing in annual reports. 117 As a result of recent amendments to the Investment Company Act, the Commission has the authority to require additional disclosure in annual and semi-annual reports as necessary or appropriate in the public interest or for the protection of investors. 118 Several commenters recommended that the Commission exercise this authority and require the MDFP to appear in fund annual reports, asserting, among other things, that shareholders read these reports more frequently than prospectuses. Commenters also suggested that, like other information contained in an annual report, the MDFP analyzes a funds past performance rather than the funds anticipated future course of action, which is the central focus of a funds prospectus.
Although it acknowledges that a funds annual report may be the preferred location for the MDFP disclosure, the Commission is deferring consideration of its requirements as to the placement of the MDFP discussion. The Commission has concluded that MDFP disclosure should be considered as part of a comprehensive reassessment of the Commissions existing rules specifying the disclosure to be included in fund reports to shareholders. The Commission believes that such an initiative would be an important future step in improving the quality of fund disclosure documents and has directed the Division to begin work on proposed amendments to fund periodic reporting requirements. The Commission has asked that, in connection with such a proposal, the Division consider whether certain disclosure required by Form N-1A would be more useful to investors in shareholder reports. In this regard, the Commission notes its preliminary view that an "integrated" approach to registration and reporting requirements could improve the overall information about a fund available to investors. 119
5. Management, Organization, and Capital Structure (Item 6)
a. Management and Organization
The Commission proposed to abbreviate disclosure in the prospectus about a funds management and organization and move certain of this information to the SAI. Commenters generally supported the Proposed Amendments, and the Commission is adopting them as proposed with modifications to reflect suggestions of commenters.
Management Disclosure. Under existing Form N-1A, all funds must disclose the rate of fees that they pay their investment advisers in their fee tables. As stated above, the Commission has retained this requirement, which the Commission believes is among the core requirements of the Form. The Proposed Amendments would continue to require, in addition to the disclosure contained in the fee table, prospectus disclosure about investment advisory services provided to, and investment advisory fees paid by, a fund. Some commenters recommended eliminating disclosure about the investment advisory fees, which they argued is merely duplicative of the information in the fee table. The Commission disagrees with this argument. The Commission believes that a concise and straightforward description of the services that an investment adviser provides to a fund along with disclosure of the investment advisory fee rate for a recent fiscal year, as well as providing this information in a single place in a prospectus, can help a typical investor understand the management of the fund. Therefore, the Commission is adopting the disclosure requirements as proposed. 120
In the Form N-1A Proposing Release, the Commission requested comment whether information about the amount of fees paid to a sub-adviser or sub-advisers of a fund helps investors evaluate and compare the fund to other funds. The Commission also asked whether this type of disclosure obscures the aggregate investment advisory fee paid by a particular fund. 121 Most commenters supported disclosure of the aggregate fee only, maintaining that information about individual sub-advisory fees is not relevant to investors because it does not help them compare the fees charged by different funds. The Commission is persuaded that information about sub-advisory fees is not necessary for a typical fund investor, but may be of interest to some investors. Therefore, Form N-1A, as amended, requires prospectus disclosure of the aggregate advisory fees paid by a fund and disclosure in the SAI of the amount of sub-advisory fees paid by the fund. 122
Portfolio Manager. The Proposed Amendments would continue to require prospectus disclosure indicating the person or persons responsible for the day-to-day management of a funds portfolio. Under the Proposed Amendments, and as currently permitted by instructions to Form N-1A, a fund could, in meeting this requirement, indicate that a committee was responsible for a funds portfolio management if, under the organizational arrangements of the fund (or its investment adviser), no one person was responsible for making recommendations to the committee.
One commenter criticized the proposed portfolio manager disclosure requirement, arguing that it may have the effect of creating the false impression that the identity of the individual portfolio manager of a fund is paramount to the funds performance. According to the commenter, the collective experience, resources, personnel, and reputation of a funds investment adviser often are of greater importance to the funds performance than the funds portfolio manager. The commenter recommended that, to enable funds to describe their management structures more accurately than they can under Form N-1As existing provisions, the Commission require disclosure of the identity of a funds portfolio manager only when a change in the identity of the manager would be material to investors (e.g., when a fund group promotes the identity of individual portfolio managers). The commenter suggested that the Commission, in the alternative, clarify the disclosure obligations of a fund for which the day-to-day responsibilities for the funds portfolio investments are shared by a committee and certain individuals.
The Commission is not persuaded that it should adopt the commenters recommendation that the Commission tie portfolio manager disclosure to a fund groups marketing efforts. Such a recommendation is substantially similar to proposals considered and rejected by the Commission when it adopted Form N-1As existing portfolio manager disclosure requirement. 123 The Commission believes that typical investors in a fund should have clear and succinct information about the individuals who significantly affect the funds investment operations. In the Commissions experience, Form N-1As existing requirement appropriately serves this purpose and should not be changed significantly. To the Commissions knowledge, the requirement has not generally resulted in funds inaccurately describing the individuals responsible for their management.
Although the Commission believes that Form N-1As portfolio manager disclosure requirements should not be changed significantly, the Commission has concluded that it is appropriate to provide additional guidance in Form N-1A as to the disclosure obligations of a fund for which day-to-day management responsibilities are shared. New instructions to Form N-1As portfolio manager disclosure requirements have been added for this purpose. 124
Legal Proceedings. The Proposed Amendments would continue to require prospectus disclosure of any material pending legal proceedings involving a fund, its investment adviser, or principal underwriter. The Commission also proposed to expand Form N-1As legal proceedings disclosure requirement to cover those proceedings contemplated by a governmental authority. In proposing this change, the Commission sought to conform Form N-1As requirements to those included in other Commission forms applying to other types of issuers. 125
Some commenters questioned the requirement that a fund disclose contemplated proceedings, arguing that a fund would find it difficult to assess whether proceedings of a governmental entity are in fact contemplated. The Commission is not persuaded by this argument and has adopted the legal proceedings requirement as proposed. 126 In support of its decision, the Commission notes that issuers that have been subject to the requirement appear not to have experienced significant difficulty in complying with it.
Board of Directors. Form N-1A currently requires a fund to include in its prospectus a brief description of the responsibilities of the fund's board of directors under the applicable laws of the jurisdiction in which the fund is organized. Recognizing that the disclosure provided by a fund in response to this item typically recites the substance of specific legal requirements, the Commission proposed to move this disclosure to the SAI. Commenters supported disclosing the director information in the SAI, arguing that the information does not help a typical investor make a decision to invest in a fund. Form N-1A, as amended, requires a fund to disclose this information in the SAI. 127
The Commission requested comment in the Form N-1A Proposing Release whether a funds prospectus should include the names, experience, and compensation of a fund's directors, as well as information, such as addresses and telephone numbers, indicating how a shareholder could contact the directors. 128 The Commission also requested comment whether this information, if required, should be given only for a fund's independent directors, accompanied by disclosure of the number of independent directors in comparison to the number of directors on the fund's board. 129
Most commenters strongly opposed additional disclosure about directors in the prospectus. While a few commenters supported identifying the directors in the prospectus, most argued that this information is not essential to a typical investor in making a decision about investing in a fund and would only serve to lengthen the prospectus. The commenters recommended that the SAI or annual report to shareholders would be a better place for disclosing the identity of directors.
Commenters addressing the issue uniformly opposed requiring a fund to disclose directors compensation in the prospectus, arguing that these fees are only a small part of total fund expenses and are not relevant to a typical investor in a making a decision to invest in a fund. The commenters also noted that director compensation is disclosed in a funds SAI, where it can be used by those investors interested in the information, and in a funds proxy statement, where it can be assessed by all shareholders of the fund in the context of an election of directors. 130
All commenters addressing the issue emphatically opposed the disclosure of information in either the prospectus or the SAI indicating how shareholders can contact directors. Commenters, particularly independent directors of funds, argued that this information would result in an unwarranted loss of privacy for board members and numerous calls to directors to which they would be ill-equipped to respond. Commenters also argued that disclosure of this information would serve as a disincentive for qualified individuals to serve as directors and that all investor comments regarding a fund should be directed to representatives of the funds management, and not to its directors.
The Commission believes that mandating more information about fund directors than is available under its existing disclosure rules may be appropriate in light of independent directors role as "watchdogs" of fund shareholders as contemplated by the Investment Company Act. 131 The Commission, however, is not convinced, particularly in light of the overwhelmingly negative comment on this issue, that the prospectus is the appropriate document for this disclosure. Therefore, Form N-1A, as amended, does not require additional information of the sort described in the Proposed Amendments to be provided about a funds directors. The Commission, however, has directed the Division to consider director disclosure issues as part of an initiative to improve shareholder reports. 132
Management and Organization. The Commission proposed to move to the SAI two items of disclosure about a funds management and organization that the Commission believes are only of minimal importance to typical fund investors. The Proposed Amendments would no longer require a fund to disclose in its prospectus the name of any person that controls the funds investment adviser and the name of any person that controls the fund. 133 The Proposed Amendments also would no longer require a fund to state in its prospectus, if applicable, that the fund engages in brokerage transactions with affiliated persons and allocates brokerage transactions based on the sale of fund shares. 134 The information called for in response to these two items typically results in generic disclosure that restates applicable legal requirements and does not appear to assist investors in deciding whether to invest in a particular fund. Commenters generally supported placing this information in the SAI. Form N-1A, as amended, requires a fund to disclose information in the SAI regarding controlling persons of the investment adviser and brokerage transactions with affiliated persons. 135
The Commission proposed to move to the SAI disclosure about a funds form of organization along with the date and state of the funds incorporation. Because most funds are organized in one of a few states as corporations or business trusts, disclosure about a funds organization does not appear to help investors evaluate a particular fund or compare the fund to other funds. For that reason, the Commission is adopting its proposal to move information about a funds organization to the SAI. 136
The Proposed Amendments would not include the disclosure about a funds expenses currently required by Form N-1A in the discussion of the funds management. This information is included in the fee table and the financial highlights table. Additional information about fund expenses also is available in a funds SAI. Eliminating repetitive information is one of the basic objectives of the Commissions efforts to improve fund disclosure documents. Consistent with this goal, Form N-1A, as amended, does not require this additional information about fund expenses in disclosure about a funds management.
b. Capital Structure
The Proposed Amendments would continue to require prospectus disclosure about any limits on the transferability of, and material obligations or potential liabilities associated with, a fund's shares. One commenter suggested that disclosure should appear in the SAI rather than in the prospectus, asserting that the information is technical and generally does not vary among funds. The commenter recommended that the Commission instead limit disclosure in a funds prospectus to unusual provisions that may pose special risks to the funds shareholders. The Commission agrees that descriptions of all potential restrictions and possible consequences of holding fund shares are of only marginal significance to typical investors in selecting among funds. Form N-1A, as amended, thus requires prospectus disclosure of only unique or unusual restrictions or potential liabilities associated with holding a funds shares (other than investment risks) that may expose an investor in the fund to significant risks. 137 Under Form N-1A, as amended, a fund would be required to discuss in its SAI generally applicable legal provisions relating to holding fund shares. 138
The Proposed Amendments would move disclosure about shareholder voting rights to the SAI. In explaining this decision, the Commission stated that the Investment Company Act sets out specific rights of fund shareholders, 139 which typically results in this disclosure being generic in nature and of little consequence to investors in evaluating and comparing funds. Commenters generally supported including this information in the SAI, agreeing that it is not essential to an investment decision. Form N-1A, as amended, requires this disclosure in the SAI. 140
Form N-1A currently requires a fund to describe in its prospectus any class of senior securities issued by the fund, and any "other class" of its shares that is outstanding. In the Commissions experience, disclosure in fund prospectuses made in response to this requirement merely restates legal requirements in the Investment Company Act and its rules, which limit a funds ability to issue certain classes of shares or senior securities. 141 The Commission concluded that disclosure of this sort is only of minimal significance to a typical investor in deciding whether to invest in a fund, and proposed to delete it from fund prospectuses. 142 Commenters agreed with the Commissions conclusion, and Form N-1A, as amended, does not require prospectus disclosure of information about other classes of fund shares (including senior securities). 143 The SAI would continue to require a fund to disclose the rights of any authorized securities of the fund other than capital stock. 144
6. Shareholder Information (Item 7)
a. General Purchase and Sale Information
The Proposed Amendments would retain most of the disclosure requirements concerning a funds purchase and redemption procedures, dividends, and distributions currently required by Form N-1A. The Commission believes that the required information is relevant to a typical investor contemplating an investment in a fund. In the Form N-1A Proposing Release, the Commission acknowledged that disclosure about purchase and redemption procedures is often quite lengthy and may contribute to the perception that prospectuses are too long and complicated and not worth reading. 145 The Commission also observed, however, that much of the purchase and redemption disclosure typically contained in fund prospectuses is not required by Form N-1A, but is included by funds for marketing or other business purposes. The Commission believes that it is appropriate for a fund to have the option to add disclosure to its prospectus for these purposes, and thus the Commission did not propose to limit prospectus disclosure of funds purchase and sale procedures to that expressly required by Form N-1A. The Commission is adopting the requirements to disclose purchase, redemption, and other shareholder information substantially as proposed with modifications to reflect commenters suggestions. 146
Several commenters on the Form N-1A Proposing Release suggested that the Commission specifically acknowledge as consistent with its rules the ability of a fund at its option to place certain information about purchase and redemption procedures in a separate document that would be delivered to an investor no later than with the confirmation of the investors purchase of the funds shares. According to the commenters, this separate document, or "owners manual," can help streamline prospectus disclosure and provide an efficient means for a fund group to provide disclosure about purchase and redemption procedures that is common to all funds in the group. The Commission believes that this sort of disclosure document is consistent with the disclosure principles underlying the revisions to Form N-1A and that investors may find it easier and less confusing to consult and retain a separate document describing certain procedures relating to purchasing and redeeming fund shares, which are typically mechanical in nature. In the Commissions view, as long as the purchase and sale information in a funds prospectus is not reduced below the minimum required by Form N-1A, the fund would be able to create and use a separate purchase and sale disclosure document as supplemental sales literature.
A second way in which a fund could create a separate purchase and sale disclosure document would be for the fund to include in its SAI the information to be contained in the document. A fund could set out this information in a separate section of the SAI and make it available, as a separate document, to investors upon request. To accommodate this option, the Commission is revising Form N-1A to include an instruction in the SAI that permits a fund to provide a separate document with additional purchase and sale information that can be made available to fund investors, along with the SAI or as a stand-alone document, in response to investor requests. 147
Form N-1A, as amended, provides a third means for developing a purchase and sale manual. As amended, the Form permits a fund to remove all information regarding its purchase and sale procedures from its prospectus and place the information in a separate document. The use of the separate document in this manner, however, would mean that required prospectus disclosure would appear only in the owners manual. Therefore, the use of this kind of separate document is conditioned on incorporating it by reference into the funds prospectus and providing it to investors with the prospectus. 148
b. Valuation of Fund Shares and Net Asset Value
Valuation. The Commission proposed to eliminate an existing requirement of Form N-1A that a fund disclose in its prospectus that the price at which investors purchase and redemption requests are effected is calculated on the basis of the funds current net asset value and that the fund identify the methods used to value its portfolio securities (e.g., market price or fair value). 149 The Commission proposed to take this action principally because, in meeting the requirement, funds typically go beyond the required identification of the methods used and repeat the substance of rules under the Investment Company Act specifying the way in which the net asset value of a fund must be calculated. In addition, the information presented by a fund usually repeats information required to be included in the SAI. This disclosure has tended to be lengthy and technical and, as discussed below, appears not to have been very informative for investors.
The Commission has re-evaluated the disclosure of information in fund prospectuses about the calculation of net asset value in light of numerous complaints from investors that the Commission received recently regarding the manner in which some funds determined their net asset value. In response to volatility in various markets, some funds recently valued certain of their securities on the basis of fair value rather than on the basis of the last market quotations for the securities. 150 In taking this action, the funds appear to have relied on a long-standing position of the Commissions staff that a fund may (but is not required to) value portfolio securities traded on a foreign exchange using fair value, rather than the closing price of the securities on the exchange, when an event occurs after the close of the exchange that is likely to have changed the value of the securities. 151 Many investors complained that they were unaware that their funds could use fair value pricing in such a situation. In response to these complaints, the Division undertook a review of the disclosure documents of funds using such fair value pricing and found that, although the funds disclosed the practice in their prospectuses, the funds discussions of their pricing procedures would have been enhanced if they had followed the principles of plain English. 152 Investors recent questions about fund pricing procedures confirm the general importance of this information to at least some investors. Thus, the Commission has determined to continue to require that funds identify the methods used to value their assets in their prospectuses. 153 The Commission is, however, adding an instruction in Form N-1A that will encourage funds to discontinue the use of boilerplate disclosure of the technical aspects of valuation and require them to include a statement about the effect of the funds use of fair value net asset calculation.
Time and Frequency of Calculation of Net Asset Value. As proposed, Form N-1A would continue to require a fund to state in its prospectus when calculations of its net asset value are made and to indicate that the fund uses a forward pricing procedure contemplating that the price at which a purchase or redemption order is effected is based on the next calculation of net asset value after the order is placed. 154 In addition, the Proposed Amendments would continue to require a fund to disclose those days on which the fund prices its shares and the holidays on which shares would not be priced. Commenters supported these disclosure requirements, and the Commission is adopting them as proposed. 155
Meaning of Net Asset Value. In the Form N-1A Proposing Release, the Commission noted that many funds now define the term "net asset value" in their prospectuses (e.g., net asset value means fund assets minus liabilities divided by the number of outstanding shares). 156 The Commission requested comment whether this disclosure should be required in all fund prospectuses. Commenters on this issue were evenly divided between those who believed that the information would be helpful to investors and those who believed the definition of net asset value would not assist investors in making a decision about investing in a fund. While some investors may find information about the meaning of the term net asset value helpful, the Commission is not persuaded that the information is necessary for most investors. Therefore, the Commission is not adopting a requirement that a fund explain the meaning of net asset value in its prospectus. A fund would continue to have the option of including this information in its prospectus or SAI if the fund concluded that such information would be useful to potential investors in the fund.
c. Restrictions on Portability
At the time that the Commission issued the Form N-1A Proposing Release, the Commissions staff was considering a number of complaints received from fund investors about restrictions on the "portability" of their fund shares. To better understand the issues raised by these investors, the staff consulted with, among others, a number of industry trade groups and other industry participants. 157 On the basis of the information compiled by the staff, the Commission understands that, in certain cases, an investor who purchases shares of a fund through a broker-dealer or other financial intermediary may be unable to transfer fund shares held in a brokerage account to an account established at another broker-dealer. 158 In their responses to the staff, industry representatives indicated that the lack of portability of an investors shares in a fund may be attributed to several factors, including limitations on the transfer of shares sold by broker-dealers affiliated with the investment adviser of the fund, the lack of participation by the fund in a computerized transfer system, and the absence of reciprocal agreements between the fund and broker-dealers. The industry participants, however, supported efforts to increase the portability of fund shares.
The Commission understands that some progress has occurred in eliminating portability restrictions. To the extent that restrictions continue to exist, however, the Commission believes that disclosure of the limits on portability of a funds shares may be of importance to a typical investor. The Commission notes that this type of disclosure would seem to address the relationship between a broker-dealer or other intermediary and a fund shareholder, rather than the relationship between the fund and the shareholder. For that reason, the Commission is not convinced that the disclosure should be required in fund prospectuses. 159 The Commission has asked its staff to continue discussions with the staff of the National Association of Securities Dealers, Inc. ("NASD") to consider means other than the prospectus to alert investors who purchase shares of funds through broker-dealers of restrictions on portability. 160
d. Tax Consequences
The Proposed Amendments would revise the tax disclosure required in a funds prospectus to focus that disclosure on the likely tax consequences to the fund and its shareholders if the fund operates as described in the prospectus. In general, the Proposed Amendments were designed to elicit tax disclosure that is far less complicated than that typically included in fund prospectuses today. 161 Commenters strongly agreed with the goal of the proposed provisions relating to prospectus tax disclosure, which the Commission has determined to adopt substantially as proposed. The Commission notes its strong desire that, in revising their documents to comply with Form N-1A, as amended, all funds pay particular attention to simplifying their existing tax disclosures, which the Commission believes are too complicated and discourage the use of fund prospectuses.
The Commission proposed to move disclosure about a funds qualification under Subchapter M of the Internal Revenue Code 162 to the SAI, unless the fund does not expect to qualify for Subchapter M treatment. Commenters supported moving this disclosure to the SAI, agreeing that it does not help investors decide whether to invest in a fund. The Commission is adopting this disclosure requirement as proposed. 163
The Commission proposed to require a description of the tax consequences to shareholders of buying, holding, exchanging, and selling a fund's shares designed to highlight the tax consequences of investing in the fund. The Proposed Amendments would require a fund to state, as applicable, that the fund intends to make distributions to shareholders that may be taxed as ordinary income or capital gains. Under the Proposed Amendments, a fund that expects that its investment objectives or strategies will result in its distributions primarily consisting of ordinary income (or certain short-term capital gains) or long-term capital gains would be required to provide disclosure to that effect.
Commenters generally supported the proposed tax disclosure, and the Commission is adopting it as proposed with one modification to reflect recent changes to the tax laws. 164 In light of these changes, Form N-1A, as amended, requires a fund to disclose that capital gains may be taxable at different rates depending upon the length of time that the fund holds its assets. 165
The Proposed Amendments would require a fund to state that it will provide each shareholder by a specified date (typically, January 31 of each year) with information about the amount of ordinary income and capital gains, if any, distributed to the shareholder during the prior calendar year. One commenter questioned the need for this requirement, citing that a fund must send this information to investors by a particular date under Internal Revenue Service regulations. 166 The Commission agrees that, in light of these regulations, indicating in a prospectus the date by which a fund will deliver certain tax information is unnecessary. Therefore, Form N-1A, as amended, does not adopt this provision of the Proposed Amendments.
The Proposed Amendments would require a tax-exempt fund to inform investors of the special tax consequences associated with the fund. Commenters supported the proposed disclosure, and the Commission is adopting it substantially as proposed. 167
7. Distribution Arrangements (Item 8)
The Commission proposed changes to Form N-1A to require that all information about a funds distribution arrangements appear in one section of the funds prospectus. The Proposed Amendments would require that section to discuss, among other things, sales loads, fees paid under rule 12b-1 plans, and the details of multiple class and master-feeder fund arrangements. The Commission also proposed changes designed to make fund discussions of distribution arrangements less legalistic and more helpful to investors in evaluating and comparing funds. 168 Commenters generally supported the Commissions conclusion that information about distribution arrangements is particularly important to fund investors, and the Commission is adopting the disclosure requirements relating to those arrangements substantially as proposed.
Rule 12b-1 Plans. The Commission proposed to modify Form N-1As requirements pertaining to plans designed to meet the requirements of rule 12b-1 under the Investment Company Act to focus prospectus disclosure on the amount of fees paid under the plans and to move detailed, technical disclosure about these plans to the SAI. The Commission proposed to require a fund with a rule 12b-1 plan to state the amount of the fee and to disclose that the plan allows the fund to pay fees for the sale and distribution of its shares. The Commission also proposed an additional requirement designed to result in prospectuses that explain more effectively to shareholders that distribution fees are continuous in nature and that these fees, over time, cumulatively may exceed other types of sales loads. 169 The Proposed Amendments would require a fund to add to its prospectus disclosure to the effect that, because distribution fees are paid out of the funds assets on an ongoing basis, the fees may, over time, increase the cost of an investment in a fund and cost investors more than other types of sales loads.
Most commenters supported the proposed disclosure concerning rule 12b-1 plans, although some commenters maintained that disclosure of the amount of rule 12b-1 fees merely duplicated information appearing in the prospectus fee table. The Commission believes that disclosing the amount of the rule 12b-1 fee in connection with other disclosure about the nature of the fees will provide a typical investor with a complete and useful picture of the amounts paid by the fund for distribution. Therefore, the Commission is adopting the disclosure concerning rule 12b-1 fees as proposed. 170
Sales Loads. The Proposed Amendments would continue to require disclosure of the amount of any sales load charged on an investment in a fund and disclosure indicating when a sales load may be reduced or eliminated (e.g., for larger investments). The Commission proposed to move other technical disclosure about sales loads to the SAI, including disclosure about dealer reallowances, sales load waivers, and breakpoints applicable to the sale of a funds shares. The Commission believes that this detailed and technical information tends to obscure information about the amount of sales loads charged by a fund and does not help investors evaluate and compare funds. The Commission also proposed to eliminate disclosure about fees charged by third parties (i.e., banks, broker-dealers, or other persons) in connection with the purchase of a funds shares. 171 Commenters generally supported the proposed approach to disclosure about sales loads, and the Commission is adopting the amendments as proposed. 172
Multiple Class and Master-Feeder Fund Arrangements. The Commission proposed to combine, in one place in the prospectus, disclosure about the distribution and service arrangements of multiple class and master-feeder funds. Commenters generally supported this treatment of these arrangements, which the Commission is adopting substantially as proposed, with modifications to reflect commenters suggestions.
The Commission proposed to eliminate the requirement that a feeder fund discuss the possibility and consequences of its no longer investing in the master fund. It is the Commissions understanding that distribution arrangements currently used by many funds contemplate feeder funds having the authority to change the master funds in which they are invested. In recognition of this development, the Commission is modifying Form N-1A to require such a feeder fund to describe briefly the circumstances under which it may change its investment in a master fund. 173
One commenter suggested additional changes to streamline prospectus disclosure about multiple class funds and master-feeder funds. The commenter recommended that the Commission eliminate existing requirements for a fund to disclose information in its prospectus about additional classes or feeders that are not offered in the same prospectus. The commenter also recommended that the Commission modify the proposed disclosure about conversions or exchanges from one class to another to require disclosure only if the conversion or exchange is mandatory or automatic. The Commission agrees that the disclosure about multiple class funds or master-feeder funds in a prospectus should focus on the class or fund offered in that prospectus. Form N-1A, as amended, reflects this position. 174
8. Financial Highlights Information (Item 9)
Condensed Financial Information. The Proposed Amendments would continue to require a fund to include in its prospectus a summary of certain financial information. To provide funds with greater ability to present prospectus disclosure in a format that conveys information effectively to investors, the Proposed Amendments would permit this information to be disclosed anywhere in the prospectus, rather than on a particular page of the prospectus, as currently required. The Commission also proposed changes to the financial highlights table to assist investors in understanding the information contained in it. Commenters supported the Proposed Amendments and endorsed in particular the proposal to permit a fund to choose the location in its prospectus for the financial highlights table. The Commission is adopting revisions to the financial highlights table requirement substantially as proposed.
In the Form N-1A Proposing Release, the Commission acknowledged that additional changes could improve the financial highlights information and stated that it intended to revisit fund financial disclosure in a separate future rulemaking initiative addressing financial statement requirements generally. 175 For the purposes of its evaluation of the financial highlights information, the Commission requested comment on simplifying and updating this information. This request elicited a number of suggestions ranging from support for the table to recommendations that it be moved to the SAI or eliminated. The Commission will consider these comments as part of its financial statement initiative.
The Commission is, however, adopting some of the commenters recommendations that would simplify the financial highlights table. One commenter recommended that the Commission change the period covered by the financial highlights table from 10 to 5 years to parallel the period covered by financial information currently required to be in fund annual reports. The Commission has adopted this recommendation 176 because it believes that financial information for a 5-year period will help investors evaluate a fund and, at the same time, respond to concerns that the current table complicates the prospectus and is confusing to investors. Investors interested in historical return information about a fund beyond that contained in the amended financial highlights table can look to the bar chart that the Commission is requiring to be included in prospectuses, which shows the funds returns over a 10-year period. 177
One commenter urged the Commission to eliminate the requirement that a fund disclose its average commission rates in the financial highlights table, arguing that these rates are technical information that typical investors are unable to understand. Industry analysts support this view and have informed the Commission staff of their conclusion that the average commission rate information in the table is only of marginal benefit to them and typical fund investors.
At this time, the Commission believes that there continues to be some merit in ensuring that information about the average commission rates paid by funds is publicly available. The Commission believes, however, that a fund prospectus appears not to be the most appropriate document through which to make this information public. Therefore, Form N-1A, as amended, does not require disclosure of average commission rates in the financial highlights table. The Commission will consider adding such a requirement to Form N-SAR, which funds file with the Commission semi-annually to report information on their current operations. 178
Calculation of Performance Data. The Commission proposed to eliminate the Form N-1A requirement that a fund that includes performance information in certain of its advertisements include a brief explanation in its prospectus of how it calculates its performance. This disclosure requirement is intended to facilitate funds using advertisements in accordance with rule 482 under the Securities Act; such an advertisement is an omitting prospectus under section 10(b) of the Securities Act and, as an omitting prospectus, is required to contain information "the substance of which" is contained in the prospectus. Recent legislation added section 24(g) to the Investment Company Act, which authorizes the Commission to adopt rules permitting a fund to use a summary or omitting prospectus that includes information the substance of which is not required to be included in the prospectus. 179 With this new authority, the Commission intends to re-evaluate fund advertising rules with the goal of, among other things, proposing to amend rule 482 to eliminate the "substance of which" requirement.
Consistent with the Proposed Amendments, Form N-1A, as amended, does not require a fund to duplicate in its prospectus the explanation of how it calculates its performance required to appear in the funds SAI. 180 So long as the SAI is incorporated by reference in the prospectus, the rule 482 "substance of which" requirement will be satisfied for this information or any other information that a fund may wish to include in a rule 482 advertisement.
9. Front and Back Cover Pages (Item 1)
The Commission proposed to simplify the disclosure currently required on the front cover page of the prospectus. The Proposed Amendments would require only three items of cover-page disclosure: a funds name; the date of the prospectus; and the standard Commission disclaimer about the securities offered in the prospectus. 181 To unclutter the front cover page and avoid repeating information contained in the proposed risk/return summary at the beginning of the prospectus, the Proposed Amendments would no longer continue to require a fund to include on the front cover a brief statement of the funds investment objectives, a statement that the prospectus sets forth concise information that the investor should know before investing, and a statement that the prospectus should be retained for future reference. 182 Commenters generally supported the proposed front cover page disclosure requirements, and the Commission is adopting them with revisions reflecting the suggestions of commenters.
Several commenters maintained that the Commission should allow a fund to include certain information on the front cover page of its prospectus, such as its investment objectives or a brief (e.g., one sentence) description of its operations. The Commission agrees, and Form N-1A, as amended, permits, but does not require, a fund to include additional information on the front cover page, subject to the Forms general rule covering the presentation of information not otherwise required to be included in the prospectus. 183
Several commenters criticized the Commissions standard disclaimer regarding the securities offered by a prospectus and questioned other disclosure that is required on the front cover page of a fund prospectus. 184 The commenters recommended that the Commission eliminate the legend, maintaining that it is not meaningful to a typical investor and is not essential to such an investors decision to invest in a fund.
The Commission has not adopted this recommendation because it believes that every prospectus should clearly alert investors that a registration statement filed with and made effective by the Commission does not represent approval by the Commission of the securities described in the prospectus. This view is reflected in the requirement that all issuers filing registration statements under the Securities Act include the disclaimer legend on their prospectuses. 185 The Commission recognizes that the disclaimer used to date is technical in nature and may be difficult to understand. In its recent plain English initiatives, the Commission adopted amendments to simplify the legend, which apply to fund prospectuses. 186
The Commission proposed to consolidate disclosure regarding the availability of additional information about a fund on the back cover page of its prospectus. 187 The Proposed Amendments would require the back cover page to state that the SAI includes additional information about the fund that is available without charge upon request, and to explain how shareholder inquiries regarding the fund can be made. Under the proposal, the back cover page would also include a statement whether and from where information is incorporated by reference into the prospectus. Commenters generally supported these amendments, and the Commission is adopting the back cover page requirements as proposed, with modifications to reflect commenters suggestions. 188
To ensure prompt delivery of a requested SAI, the Proposed Amendments would require a fund to send its SAI to requesting investors within 3 business days of a request. Those commenters addressing this requirement generally supported it, although one commenter argued that, to provide funds some leeway in responding to unforeseen circumstances, funds should be subject to a "reasonably prompt" mailing standard, which would be deemed normally to be within 3 days of request. The Commission believes that prompt mailing of the SAI is essential to the disclosure format contemplated by Form N-1A and is adopting the 3-business day mailing requirement as proposed. 189
Several commenters raised concerns about requests for additional information about a fund when the funds shares are sold through financial intermediaries, such as broker-dealers or banks. Commenters recommended that Form N-1A permit funds to indicate in their prospectuses that investors may contact an intermediary to obtain the SAI and other additional information. 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, the Commission has revised Form N-1A to permit a fund to state on the back cover of its prospectus that additional information about the fund is available from a financial intermediary. 190 The Commission notes, however, that such a fund retains the obligation to ensure that information is sent to investors within 3 business days of an investor request. The Commission expects that funds will fulfill this obligation through contractual arrangements with broker-dealers, banks, or other financial intermediaries.
Some commenters had suggestions about certain technical disclosure information that the Commission proposed to include on the back cover page of the prospectus. The Proposed Amendments, for example, would move the requirement to disclose the date of the SAI to the back cover page of the prospectus. Several commenters criticized this requirement, asserting that the date of the SAI is not essential to an investors decision to invest in a fund and that requiring the SAI date on the back cover of a prospectus would necessitate the reprinting of prospectuses of funds that share a common SAI whenever a new fund is added to the group covered by the SAI. In light of these comments and the obligation imposed on funds to send investors who request an SAI the most current version of the document, the Commission has deleted from Form N-1A, as amended, the requirement to show the date of a funds SAI on the back cover of the funds prospectus. 191
B. Part B Statement of Additional Information
The Commission proposed a number of technical and conforming revisions to the SAI disclosure requirements to reflect the proposed changes in the prospectus disclosure requirements. The Commission is adopting these revisions as proposed. As discussed in the Form N-1A Proposing Release, the Commission intends to consider the SAI requirements as part of a future initiative and propose amendments to simplify and update SAI disclosure following the same disclosure principles underlying the revisions to Form N-1A being adopted today.
C. Part C Other Information
The Commission proposed amendments to Part C of Form N-1A to eliminate certain filing requirements no longer deemed necessary. Commenters supported the proposed amendments, and the Commission is adopting them as proposed with certain modifications to reflect the suggestions of commenters. 192
The Proposed Amendments would continue to require newly organized funds to file updated financial statements within 4 to 6 months of the effective date of the registration statement. The Commission asked for comment whether the requirement should be retained. All commenters responding to the request said that the Commission should eliminate this requirement. Commenters argued that the information is of little value to investors in a new fund because it covers a funds operations for a short start-up period that does not usually reflect the funds expected operations. Commenters also argued that the cost of providing this information places a heavy burden on new funds, which typically have smaller amounts of assets under management than larger funds. According to the commenters, these costs can have a significant and disproportionate effect on a small funds expense ratio.
The Commission believes that financial statements for the initial operations of a fund may not provide information that is significant to a typical fund investor. In addition, an investor interested in financial information about a funds initial operations can obtain the information by requesting the funds most recent shareholder report, which is generally available 6 to 8 months after the fund commences operations and begins selling shares to investors. For these reasons, the Commission has concluded that the costs associated with the 4 to 6 month update are not outweighed by the benefits that the information may provide to some investors. Therefore, Form N-1A, as amended, does not require the filing of updated financial statements for a newly organized fund.
D. General Instructions
1. Reorganizing and Simplifying the Instructions
The General Instructions to Form N-1A currently provide guidance on the use and content of the Form. The Proposed Amendments were intended to update and reorganize the General Instructions to make the Instructions easier to use. Commenters generally supported these revisions, which the Commission is adopting substantially as proposed. As adopted, the General Instructions consist of the following topics: (A) Definitions; (B) Filing and Use of Form N-1A; (C) Preparation of the Registration Statement; and (D) Incorporation by Reference.
The Proposed Amendments added several definitions to standardize certain terms as used in Form N-1A. Under the proposal, the term "Fund" would be defined as a registrant or a series of the registrant. The Proposed Amendments also included definitions of the terms "Registrant" and "Series" as used in Form N-1A. The Commission is adopting all three definitions as proposed. 193
Proposed General Instruction B incorporated a more user-friendly, question-and-answer format regarding the filing and use of Form N-1A and replaced current Instructions A through D and F. The Commission is adopting General Instruction B as proposed.
General Instruction C to Form N-1A, as proposed, would set out the requirements for preparing the registration statement in an understandable format and would replace existing Instruction G to the Form. As proposed, the new Instruction emphasized the need to provide clear and concise prospectus disclosure and permitted a fund to include in its prospectus or SAI information not otherwise required by Form N-1A, so long as the information is not misleading and does not, because of its nature, quantity, or manner of presentation, obscure the information required to be included. 194 The Commission is adopting Instruction C substantially as proposed. 195
2. Plain English Disclosure
The Commission is adopting amendments to General Instruction C clarifying that funds must comply with rule 421 under the Securities Act, which sets out the Commissions recently adopted plain English requirements. 196 Rule 421(b) sets out general requirements that the entire prospectus be clear, concise, and understandable and provides guidance on how to draft prospectuses that meet this standard.
Under Form N-1A, as amended, a fund would need to draft the front and back cover pages and the risk/return summary of a fund prospectus in accordance with the provisions of rule 421(d). 197 In meeting these requirements, a fund will need to use plain English principles in the organization, language, and design of these sections of their prospectuses. Funds also will comply substantially with the following six principles of clear writing:
- short sentences;
- definite, concrete, everyday language;
- active voice;
- tabular presentation or bullet lists for complex material, wherever possible;
- no legal jargon or highly technical business terms; and
- no multiple negatives.
The compliance dates for rule 421(d) and Form N-1A, as amended, will be the same. Therefore, when a fund files a new or amended registration statement in order to comply with Form N-1A, as amended, it must also comply with the plain English rule. 198
3. Disclosure Guidelines
The Commission has revised General Instruction C to reflect clearly the basic disclosure principles underlying the Commissions initiatives being adopted today. The Commission believes that applying these principles consistently in developing fund disclosure documents will result in high quality documents that effectively communicate information to investors.
General Instruction C, as amended, includes a set of drafting guidelines that are designed to improve prospectus disclosure. The Instruction encourages funds to avoid cross-references in their prospectuses to their SAIs or shareholder reports. Repeated cross-references to the SAI and shareholder reports can add unnecessary length and complexity to fund prospectuses and often preclude prospectuses from disclosing information effectively to investors.
General Instruction C provides guidance on the use of Form N-1A by more than one fund and by a multiple class fund. Fund prospectuses frequently contain information for multiple series and classes that offer investors different investment alternatives and distribution arrangements. When information in them is presented clearly, prospectuses offering more than one fund may make it easier for investors to compare funds and may be more efficient for funds and investors by eliminating the need to provide investors with multiple prospectuses containing repetitive information. Instruction C generally enables a fund to organize information about multiple funds and classes in a format of its choice that is consistent with the goal of communicating information to investors effectively. 199
4. Modified Prospectuses for Certain Funds
Proposed Instruction C would permit a fund that is offered as an investment alternative in a participant-directed defined contribution plan to modify its prospectus for use by participants in the plan. Under the Proposed Amendments, a prospectus used to offer fund shares to plan participants could omit certain information required by proposed Items 7 (shareholder information) and 8 (distribution arrangements). This prospectus disclosure would largely be irrelevant to plan participants; investments that can be made by participants, and the distributions participants receive (including the tax consequences of distributions), are governed by statutory requirements and by the terms of individual plans. 200 Commenters generally supported permitting prospectuses to be modified for plan participants, asserting that it would allow funds to provide meaningful disclosure specifically designed for plan participants who invest in funds. The Commission is adopting the provisions in Instruction C relating to prospectuses for plan participants with modifications to reflect suggestions of commenters.
Instruction C, as proposed, would permit funds to tailor disclosure for prospectuses to be used for investments in defined contribution plans qualified under the Internal Revenue Code. One commenter suggested that the Commission permit funds that serve as investment options for variable insurance contracts to use modified prospectuses that set out purchase and sale procedures, distributions, and tax consequences applicable to these funds. In response to the commenters suggestions, the Commission is permitting prospectuses to be tailored for funds offered through variable insurance contracts in furthering its goal of providing investors with more useful disclosure documents. 201
5. Incorporation By Reference
Proposed General Instruction D would replace an existing instruction to Form N-1A that addresses incorporation by reference in a funds prospectus of information in the funds SAI. When the Commission adopted the two-part disclosure format for Form N-1A, the Commission intended that Part A of the registration statement provide investors with a simplified prospectus that, standing alone, would meet the requirements of section 10(a) of the Securities Act. 202 Part B, the SAI (which is available to investors upon request), includes additional information that the Commission has determined may be useful to some investors and should be available to all investors, but is not necessary in the public interest or for the protection of investors to be in the prospectus. 203 Form N-1A currently permits, but does not require, a fund to incorporate the SAI by reference into the prospectus. The two-part disclosure format has been widely used by funds, and the Commission has found that the current approach to incorporation by reference is consistent with the intended purpose of Form N-1A and should be retained. 204
Proposed Instruction D would continue to permit, but not require, a fund to incorporate the SAI by reference into the prospectus. Commenters supported this approach to incorporation by reference, and the Commission is adopting Instruction D substantially as proposed. 205 The revised Instruction clarifies that incorporating information by reference from the SAI is not permitted as a response to an item of Form N-1A requiring information to be included in the prospectus. Permitting the SAI to be incorporated by reference into the prospectus was meant to allow funds to add material that the Commission determined not to require in the prospectus, not to permit funds to delete required information from the prospectus and place it in the SAI. Form N-1A, as amended, provides funds with clearer directions for allocating disclosure between the prospectus and the SAI. Funds can discuss items of information required to appear in the prospectus in greater detail in the SAI, which may be incorporated by reference into the prospectus.
The Commission notes that section 19(a) of the Securities Act 206 and section 38(c) of the Investment Company Act 207 protect a fund from liability under these Acts for actions taken in good faith in conformity with any rule of the Commission. The amendments to Form N-1A are designed to provide better guidance to funds as to what information should be in the prospectus and the SAI to assist funds seeking to act in good faith in conformity with Form N-1A. 208
6. Form N-1A Guidelines and Related Staff Positions
The Guidelines to current Form N-1A (the "Guides") were prepared by the Division and published by the Commission when it adopted the Form in 1983. 209 The Guides, which generally restate Division positions that may affect fund disclosure, were intended to assist funds in preparing and filing their registration statements. Additional Division positions on disclosure matters have been included from time to time in Generic Comment Letters prepared by the Division ("GCLs"). 210
Although certain Guides have been revised and new ones added in connection with the adoption of various rules, the Guides collectively have not been reviewed since 1983. Certain Division positions in the Guides and GCLs have become outdated. 211 Other Guides and GCLs explain or restate legal requirements and may encourage generic disclosure about fund operations that does not appear to help investors evaluate and compare funds. 212 In addition, the presentation of information in 35 Guides and 7 GCLs is not organized in the most useful or effective manner.
To address these issues, Form N-1A, as amended, incorporates certain disclosure requirements from the Guides and GCLs. Other disclosure requirements in the Guides and the GCLs have not been incorporated in Form N-1A because, among other things, they are outdated or result in disclosure about technical, legal, and operational matters generally common to all funds. In addition, Form N-1A does not incorporate certain requirements calling for specific disclosure about certain types of fund investments because these requirements have tended to standardize disclosure about certain securities without regard to how a particular fund intends to use the securities in achieving its investment objectives. Generalized disclosure of this sort is inconsistent with the goal of the amendments to prospectus disclosure being adopted today to provide investors with information about how a particular fund's portfolio will be managed and elicit disclosure tailored to a fund's particular investment objectives and strategies. 213
Information in the Guides and GCLs about legal requirements (including information about fund organization and operations), interpretive positions, and descriptions of filing procedures will be updated and reorganized in a new Investment Company Registration Guide ("Registration Guide"). 214 The Commission has instructed the Division to make the Registration Guide available as soon as practicable. While the Commission believes that the Registration Guide will be a useful tool for funds in preparing their filings, FormN-1A, as amended, includes all of the requirements necessary for funds to prepare new or amend existing registration statements. 215
E. Technical Rule Amendments
When it proposed to amend FormN-1A, the Commission proposed several technical rule amendments. These rule amendments generally were intended to implement the recommendations of the Commissions Task Force on Disclosure Simplification that apply to funds. 216 The Commission is adopting these amendments substantially as proposed. 217 The Commission also is adopting conforming amendments to several rules and a form to correct references to items in Form N-1A that have been redesignated or reorganized in Form N-1A, as amended. 218
F. Administration of Form N-1A
While generally praising the Proposed Amendments and their goals, some commenters voiced concern that, unless administered appropriately, Form N-1A, as amended, would not lead to more useful and understandable disclosure documents for fund investors. Some commenters argued that, over time, the Commissions staff has interpreted Form N-1As existing requirements so narrowly as to prevent funds from adopting formats in which information could be effectively communicated to investors. Other commenters asserted that the Commissions staff, in interpreting the provisions of existing Form N-1A, has consistently required lengthy and complex disclosure that may discourage investors from reading fund prospectuses. 219
The Commission acknowledges that some interpretations relating to Form N-1A disclosure taken by the staff in the past have contributed to fund prospectuses becoming dense and less inviting to read by shareholders. 220 The Commission believes, however, that funds, their counsels and other advisors also have contributed to this result. In seeking to minimize potential liabilities under the federal securities laws, many funds appear to have made the use of clear formats and concise and understandable language in fund prospectuses only a secondary concern, at best. Funds also appear to have added material to their prospectuses not otherwise required by Form N-1A to facilitate marketing or other business objectives.
The Commission firmly believes that achieving the goals underlying the amendments to Form N-1A being adopted today necessitates discipline on the part of the Commission and its staff, as well as on the part of funds and their advisors. In exercising discipline, all parties involved in the disclosure process should look not only to the Form N-1A disclosure requirements, as amended, but also to the disclosure principles reflected in the Form. The Commission has instructed its staff to adhere to those principles closely when providing comments on registration statements filed on Form N-1A and in interpreting provisions of the Form. 221 The Commission strongly encourages funds and their advisors to follow closely the principles in drafting language and designing formats for use in fund prospectuses.
Throughout the period during which the Form N-1A and profile initiatives were developed, the Commission staff worked with numerous fund groups to create innovative disclosure materials and new and improved prospectuses. 222 The results of these efforts have been commended by many as achieving a significant improvement over existing disclosure documents. 223 Many of the efforts were furthered by the willingness of the staff to interpret Commission disclosure requirements in a manner consistent with the goal of enabling funds to communicate more effectively to investors information essential in considering an investment in a fund. 224 The Commissions staff will continue to exercise this approach in interpreting the provisions of Form N-1A, as amended, and in reviewing fund filings under the revised disclosure requirements. 225
G. Coordination with the NASD
As discussed in the Form N-1A Proposing Release, some rules of the NASD restrict the ability of NASD members to engage in various activities relating to funds unless certain disclosures are made in fund prospectuses. 226 NASD Conduct Rule 2830, for example, generally does not allow underwriters to pay compensation to broker-dealers for selling shares of a fund, unless the compensation arrangements are disclosed in the funds prospectus. 227 Certain commenters expressed concern that these and other NASD prospectus disclosure requirements appear to be inconsistent with the Commissions broad initiatives to improve fund disclosure, and encouraged the Commission to coordinate its regulatory efforts with the NASD.
The Commission believes that it is of the utmost importance that all disclosure contained in fund prospectuses conforms to the principles of effective communication reflected in Form N-1A, as amended. The Commission has discussed these principles with the NASD staff, which has agreed to evaluate all of the NASDs existing requirements for consistency with these principles and to propose to the Commission that those rules be changed as necessary to achieve greater consistency. In addition, to the extent that it imposes prospectus disclosure requirements in the future, the NASD will seek to do so in accordance with the Commissions disclosure principles. 228
H. Effective Dates and Transition Period
As discussed in the Form N-1A Proposing Release, 229 the Commission is providing for a transition period after the effective date of the amendments to Form N-1A that gives funds sufficient time to update their prospectuses or to prepare new registration statements under the revised Form N-1A requirements. All new registration statements or post-effective amendments that are annual updates to effective registration statements filed on or after December 1, 1998 must comply with the amendments to Form N-1A. 230 The final compliance date for filing amendments to effective registration statements to conform with the new Form N-1A requirements is December 1, 1999. The same compliance dates apply to the new plain English disclosure requirements for fund prospectuses. A fund may, at its option, prepare documents in accordance with the requirements of Form N-1A, as amended, at any time after the effective date of the amendments.
III. COST/BENEFIT ANALYSIS AND EFFECTS ON COMPETITION, EFFICIENCY, AND CAPITAL FORMATION
Section 2(c) of the Investment Company Act provides that whenever the Commission engages in rulemaking requiring the Commission to consider whether its action is in the public interest, the Commission also must consider whether the action will promote efficiency, competition, and capital formation. 231 For the reasons stated in the cost/benefit analysis below, as well as the reasons discussed elsewhere in this release, the Commission has concluded that the amendments to Form N-1A protect investors and promote efficiency, competition, and capital formation.
The central goal of the amendments to Form N-1A is to promote fund disclosure documents that effectively communicate essential information to investors. The amendments seek to meet this goal by focusing prospectus disclosure on information that will help investors decide whether to invest in a fund. The amendments seek to organize the prospectus in a more efficient manner, which increases the effectiveness of the information in the prospectus. For example, the amendments minimize required disclosure in a funds prospectus about matters that generally are common to all funds and focus the disclosure on matters about the fund. Changes such as the addition to Form N-1A of a standardized risk/return summary also allow investors to use prospectus information efficiently to compare one fund to others before investing. Well-informed investors may invest more of their resources and allocate their investments carefully, which in turn would tend to promote competition among funds.
The Commission did not receive any comments addressing the costs associated with the amendments to Form N-1A. While it is difficult to quantify costs and benefits related to Form N-1A, the Commission notes that commenters strongly favored the amendments. As discussed in the Commissions Paperwork Reduction Act submission in conjunction with the Form N-1A Proposing Release, the Commission estimated that there are approximately 7,500 registrants on Form N-1A. The total annual cost to the industry of preparing, filing, and updating current Form N-1A is approximately $175 million. 232 The Commission does not believe that these amendments will result in a significant cost increase over time because the amendments do not require that funds disclose a significant amount of new information. Rather than increase the reporting burden, the amendments primarily clarify instructions, reorganize the prospectus, and require new formats for certain information.
The Commissions estimate of the total annual cost to the industry identified above reflects the burden of initial Form N-1A filings, which the Commission has sought to minimize. It is likely that an initial expense from the revisions would be offset by future savings such as lower printing and distribution costs from a shorter prospectus. For example, the amendments eliminate the requirement that newly organized funds file updated financial statements within 4 to 6 months after the effective date of the registration statement. The costs of filing these updated financial statements may have a disproportionate effect on small funds and the Commission estimates that the elimination of the requirement will produce an approximate savings of $1.8 million annually based on an estimate of 180 filings of Form N-1A per year by newly organized funds. The elimination of this requirement also promotes competition and capital formation by decreasing cost-related barriers to entry. On balance, the Commission believes that the amendments to Form N-1A benefit investors, foster efficiency, and tend to promote competition and capital formation.
IV. PAPERWORK REDUCTION ACT
As explained in the Form N-1A Proposing Release, the amendments to Form N-1A contain "collection of information" requirements within the meaning of the Paperwork Reduction Act of 1995 ("PRA"). 233 The collection of information requirements in this release were submitted to the Office of Management and Budget ("OMB") for review under section 3507(d) of the PRA. OMB approved the collection of information under the title "Form N-1A Under the Investment Company Act of 1940 and the Securities Act of 1933, Registration Statement of Open-End Management Investment Companies" and assigned it a control number of 3235-0307. The collection of information contained in the release is in accordance with the clearance requirements of 44 U.S.C. 3507. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information, unless the agency displays a valid OMB control number.
Funds use Form N-1A to register under the Investment Company Act and to register the offer for sale of their shares under the Securities Act. The amendments to Form N-1A seek to minimize prospectus disclosure about technical, legal, and operational matters that generally are common to all funds and focus disclosure on essential information about a particular fund that would assist an investor in deciding whether to invest in that fund. The filing of Form N-1A is mandatory. Responses to the disclosure requirements of Form N-1A will not be kept confidential.
The Commission solicited public comment on the collection of information requirements contained in the Form N-1A Proposing Release and received no comments on the PRA portion of the release. The estimated total burden, purpose, use and necessity of the collection of information will be the same as detailed in the Form N-1A Proposing Release.
V. SUMMARY OF FINAL REGULATORY FLEXIBILITY ANALYSIS
The Commission has prepared a Final Regulatory Flexibility Analysis ("FRFA") in accordance with 5 U.S.C. 604 regarding the amendments to Form N-1A. The FRFA explains that the amendments will revise disclosure requirements for fund prospectuses to minimize prospectus disclosure about technical, legal, and operational matters that generally are common to all funds and focus prospectus disclosure on essential information about a particular fund that will assist investors in deciding whether to invest in that fund. The FRFA also explains that the amendments are intended to improve fund prospectuses and to promote more effective communication of information about funds.
The Commission requested comment with respect to the Initial Regulatory Flexibility Analysis ("IRFA") contained in Form N-1A Proposing Release. The Commission did not receive any comments with respect to the IRFA.
The Commission estimates that approximately 2,700 registered open-end management investment companies are subject to the requirements of Form N-1A. Of these, approximately 620 (23%) are funds that meet the Commissions definition of small entity for the purposes of the Securities Act and the Investment Company Act -- an investment company with net assets of $50 million or less as of the end of its most recent fiscal year (17 CFR 230.157(b) and 270.0-10).
The FRFA explains that Form N-1A, as amended, will not impose any substantial additional burdens for small entities because most of the changes do not require the development of new information. Initially, however, the changes will require funds to amend the format in which they present information in their prospectuses. The amendments primarily will clarify and simplify the instructions for completing Form N-1A, shift information from the prospectus to the SAI, and require new formats for certain information. A funds initial update under Form N-1A, as amended, may take longer than preparing a current prospectus due to a lack of familiarity with the new format. On balance, however, the Commission believes that preparing and updating the revised Form should take the same amount of time (or possibly less time) as preparing and updating the current Form.
As stated in the FRFA, the Commission considered several alternatives to the amendments, including, among others, establishing different compliance or reporting requirements for small entities or exempting them from all or part of the rule. Because the amendments to Form N-1A are intended to improve prospectus disclosure for all investors, whether they invest in funds that are small entities or others, the Commission believes that separate treatment for small entities is inconsistent with the protection of investors. A copy of the FRFA may be obtained by contacting Markian M.W. Melnyk, Deputy Chief, Office of Disclosure Regulation, Securities and Exchange Commission, 450 5th Street, N.W., Mail Stop 5-6, Washington, D.C. 20549-6009.
VI. STATUTORY AUTHORITY
The Commission is amending rules and forms pursuant to sections 5, 7, 8, 10 and 19(a) of the Securities Act (15 U.S.C. 77e, 77g, 77h, 77j, and 77s(a)), and sections 8, 22, 24(g), 30 and 38 of the Investment Company Act (15 U.S.C. 80a-8, 80a-22, 80a-24(g), 80a-29, and 80a-37). The authority citations for the amendments to the rules and forms precede the text of the amendments.
TEXT OF RULE AND FORM AMENDMENTS
List of Subjects in 17 CFR Parts 230, 232, 239, 240, 270 and 274
Investment companies, Reporting and recordkeeping requirements, Securities.
For the reasons set out in the preamble, the Commission amends Chapter II, Title 17 of the Code of Federal Regulations as follows:
PART 230 GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933
1. The general authority citation for Part 230 is revised to read as follows:
Authority: 15 U.S.C. 77b, 77f, 77g, 77h, 77j, 77r, 77s, 77sss, 78c, 78d, 78l, 78m, 78n, 78o, 78w, 78ll(d), 79t, 80a-8, 80a-24, 80a-29, 80a-30, and 80a-37, unless otherwise noted.
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2. Revise the note immediately preceding § 230.480 to read as follows:
Note: The rules in this section of Regulation C (§§ 230.480 to 230.488 and §§ 230.495 to 230.498) apply only to investment companies and business development companies. Section 230.489 applies to certain entities excepted from the definition of investment company by rules under the Investment Company Act of 1940. The rules in the rest of Regulation C (§§ 230.400 to 230.479 and §§ 230.490 to 230.494), unless the context specifically indicates otherwise, also apply to investment companies and business development companies. See § 230.400.
3. Amend § 230.483 to remove all references to "3(a)" under the heading "Form N-1A" in the table following paragraph (e)(4) and add, in their place, "9", and to remove the references to "3(b)" and the corresponding item descriptions under the heading "Form N-1A" in the table following paragraph (e)(4).
4. Amend § 230.485 to correct the reference "paragraph (b)(1)(v)" in the introductory text of paragraph (b) to read "paragraph (b)(1)(iii)", and to revise the reference "Items 5(c) or 5A" in paragraph (b)(iv) to read "Items 5 or 6(a)(2)".
5. Amend § 230.495 to remove the words "cross-reference sheet;" from paragraph (a).
6. Amend § 230.497 to remove the words ", together with 5 copies of a cross reference sheet similar to that previously filed, if changed" from paragraph (d) and ", together with five copies of a cross-reference sheet similar to that previously filed, if changed" from paragraph (e).
PART 232 REGULATION S-T GENERAL RULES AND REGULATIONS FOR ELECTRONIC FILINGS
7. The authority citation for Part 232 continues to read as follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s(a), 77sss(a), 78c(b), 78l, 78m, 78n, 78o(d), 78w(a), 78ll(d), 79t(a), 80a-8, 80a-29, 80a-30 and 80a-37.
8. Amend § 232.304 to revise the reference to "Item 5A" in paragraph (d) to read "Item 5".
PART 239 FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933
9. The general authority citation for Part 239 is revised to read as follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77sss, 78c, 78l, 78m, 78n, 78o(d), 78u-5, 78w(a), 78ll(d), 79e, 79f, 79g, 79j, 79l, 79m, 79n, 79q, 79t, 80a-8, 80a-24, 80a-29, 80a-30 and 80a-37, unless otherwise noted.
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10. Amend Form N-14 (referenced in § 239.23) to revise the reference "Item 2 of Form N-1A" in Item 3(a) to read "Item 3 of Form N-1A", to revise the reference "Items 10 through 23 of Form N-1A" in Item 12(a) to read "Items 10 through 22 of Form N-1A", and to revise the reference "Items 10 through 14 and 16 through 23 of Form N-1A" in Item 13(a) to read "Items 10 through 13 and 15 through 22 of Form N-1A," and revise paragraph (a) of Item 5 to read as follows:
Note: Form N-14 does not and these amendments will not appear in the Code of Federal Regulations.
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(a) if the registrant is an open-end management investment company, furnish the information required by Items 2, 3, 4(a) and (b), and 5 - 9 of Form N-1A under the 1940 Act; provided, however, that the information required by Item 5 may be omitted if the prospectus is accompanied by an annual report to shareholders containing the information otherwise required by Item 5;
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PART 240 GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934
11. The general authority citation for Part 240 is revised to read, in part, as follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78f, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w, 78x, 78ll(d), 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4 and 80b-11, unless otherwise noted.
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12. Amend § 240.14a-101 to revise the reference "Item 5" in paragraph (a)(1)(i) of Item 22 to read "Item 15(h)", the reference "Item 2" in paragraph (a)(3)(iv) of Item 22 to read "Item 3", and the reference "Item 2(a)(ii)" in Instruction 4 to paragraph (a)(3)(iv) of Item 22 to read "Item 3".
PART 270 RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940
13. The authority citation for part 270 continues to read as follows:
Authority: 15 U.S.C. 80a-1, et seq., 80a-34(b)(1), 80a-37, 80a-39 unless otherwise noted;
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14. Amend § 270.8b-11 to remove the word "manually" from paragraph (c) and to revise paragraph (e) to read as follows:
§ 270.8b-11 Number of copies; signatures; binding.
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(e) Signatures. Where the Act or the rules thereunder, including paragraph (c) of this section, require a document filed with or furnished to the Commission to be signed, the document should be manually signed, or signed using either typed signatures or duplicated or facsimile versions of manual signatures. When typed, duplicated or facsimile signatures are used, each signatory to the filing shall manually sign a signature page or other document authenticating, acknowledging, or otherwise adopting his or her signature that appears in the filing. Execute each such document before or at the time the filing is made and retain for a period of five years. Upon request, the registrant shall furnish to the Commission or its staff a copy of any or all documents retained pursuant to this section.
PART 274 FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940
15. The authority citation for Part 274 continues to read as follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m, 78n, 78o(d), 80a-8, 80a-24, and 80a-29, unless otherwise noted.
16. Revise Form N-1A (referenced in §§ 239.15A and 274.11A) (including the Guidelines to the Form) to read as follows:
Note: The text of Form N-1A does not and this amendment will not appear in the Code of Federal Regulations.