February 14, 2003
Mr. Jonathan G. Katz, Secretary
Re: File No. S7-51-02
Dear Mr. Katz:
PricewaterhouseCoopers LLP appreciates the opportunity to comment on the Commission's Proposed Rule: Shareholder Reports and Quarterly Portfolio Disclosure of Registered Management Investment Companies (the "proposal" or the "proposed rule").
We agree with the proposed rule's objectives that shareholder reports should be streamlined, useful and understandable to investors. Further, we agree that shareholder reports should provide investors with information to better evaluate a fund's risk profile and investment strategy. In particular, we support the Commission's efforts to improve the disclosures provided by registered management investment companies about their portfolio investments. The observations and suggestions that follow highlight several matters we bring to your attention for consideration to further the Commission's objectives. In these observations, we address certain of the matters upon which the Commission requested comment in its proposed rule. At a later date we would also encourage the Commission to consider a broader review of Regulation S-X, especially Article 6, to determine whether other aspects of the SEC's rules can be streamlined or enhanced, particularly where there is divergence from the AICPA Audit and Accounting Guide Audits of Investment Companies (the "AICPA Guide"), as revised in late 2000.
Summary Schedule for Investments
In general, we support the use of a summary schedule of investments in the financial statements of an investment company delivered to shareholders, and believe that the Commission has struck a reasonable balance by requiring the inclusion of a full portfolio schedule in Form N-CSR and requiring delivery of a full portfolio schedule to investors upon request should they desire this information. As discussed in more detail below, however, we believe that the summary schedule should permit greater flexibility in presentation by the fund and should be more consistent with the condensed portfolio of investments prescribed by the AICPA Guide. Inconsistencies between the Commission's requirements and those of the AICPA Guide could make preparation of financial statements more difficult by requiring preparers of financial statements to conform to multiple sets of rules. Since the AICPA Guide has been subjected recently to public comment, it reflects a current consensus as to preferable disclosure. In areas where existing literature can be conformed while still serving to protect the shareholders' interests, we support convergence of existing standards.
1. Are the proposals to require funds to disclose their 50 largest holdings and holdings accounting for one percent (and greater) of net assets appropriate?
Yes. We believe that the proposed requirements (i.e., fifty largest issuers and investments in issuers whose fair values aggregate more than one percent of net assets) are appropriate minimum standards. However, we believe there may be instances where an investment company may want to take advantage of using a summary schedule of portfolio investments and present information with respect to a greater number of issuers than is required by the proposed Rule 12-12C. Accordingly, we are suggesting that the requirements of the rule be clarified to allow an investment company to disclose a larger number of holdings (for example, 75 or 100 largest issuers) and/or use a lower threshold than one percent of investments by issuer in preparing the summary schedule of investments. The final rule should make clear, however, that an investment company must consistently apply a largest issuer/percent of net assets disclosure rule within any fund's summary portfolio, and may not selectively include only certain issuers that fall below that threshold.
2. As proposed, securities disclosed in the summary schedule would be identified in order of descending value (largest holding to smallest). Should we adopt a different approach?
Yes. We are concerned that a descending value approach would be inconsistent with the requirements of the AICPA Guide, which calls for a presentation organized by asset class, industry or other relevant classification. We also believe the presentation format should provide registrants with flexibility to present the information in the most meaningful manner given the type and circumstances of the individual fund, so investors can easily identify which are the largest issuers and how they are affecting the portfolio composition. We suggest the rule be modified to allow the summary portfolio to be organized in the manner that the investment company believes is most meaningful in the circumstances, so long as the minimum portfolio disclosure requirements are met. We believe that the financial statements, including the summary portfolio, should be sufficient to present the fund in a meaningful way to the reader, without any additional information that may be required or presented elsewhere in the shareholder report.
3. Should we allow the use of a summary portfolio schedule with respect to other investments in addition to investments in securities of unaffiliated issuers?
Yes. Consistent with the AICPA Audit Guide, we believe that the summary schedule tests (i.e., fifty largest issuers and investments in issuers whose fair values aggregate more than one percent of net assets) should be applied to the fund's entire portfolio of investments, including short sales, investments in affiliated issuers, written options, futures, forwards and other investment-related liabilities. The rule should explicitly state that long and short positions in any one issuer should be considered separately in applying the one percent issuer test.
We believe that the definition of an "affiliated" investment is too broad to provide meaningful information to investors and to segregate such securities in a separate schedule in the financial statements is not useful to investors. Presentation of a summary of investments in securities of unaffiliated issuers with a separate full listing of investments in affiliated issuers or other types of investments will complicate the presentation and make it more difficult for an investor to assess the portfolio risks and characteristics. In many cases an "affiliated" investment simply represents a statutory definition of ownership of more than five percent of the shares of another company, but the fund and the issuer are neither "related parties" under Statement of Financial Accounting Standards No. 57, nor affiliated under a more common understanding of the word.
We believe that a summary schedule of investments that treats each investment in the portfolio consistently will better serve investors in understanding a fund's overall risk profile and investment strategy.
4. Are there any modifications in the format of the proposed summary portfolio schedule that would be appropriate, such as eliminating or revising the requirements to indicate by appropriate symbols non-income producing securities and restricted securities?
We believe the current disclosure requirements for non-income producing securities and restricted securities provide the investor only limited information in evaluating a fund's risk profile or investment strategy. For example, a non-income producing security can be either a stock that has not paid a dividend in the past year, or a bond that has ceased accrual because the collection of principal and interest is in doubt. Each of these examples has very different implications to an investor. We are recommending that the proposed rule and Regulation S-X Rule 12-12, footnotes 5 and 6 be modified to eliminate the current requirements regarding non-income producing securities and restricted securities, for both the summary schedule of investments and the full portfolio presentation.
We do believe that certain information about securities held will help investors understand a fund's risk profile more clearly. Information about (1) securities valued at fair value by or at the direction of the Board, (2) defaulted debt securities, and (3) securities of persons where a "control" (as opposed to an "affiliate") relationship exists (as defined by the 1940 Act) is useful information to investors. We recommend the proposed and current rules be modified to require disclosure in the summary and complete portfolio of the (a) total investment value and (b) percentage of net assets of the securities that conform to each such category. We do not believe that disclosure of individual securities that meet these criteria is necessary. Further, omitting the requirement for disclosure at an individual security level is most appropriate when an issuer presents a summary schedule of investments.
5. Should we require a shareholder report covering more than one fund to use the same type of portfolio schedule (summary or complete) for all funds included in the report?
No. We believe inclusion of multiple funds in one shareholder report should not restrict the issuer's choices of presentation of the portfolio for any fund. Many series funds that prepare a common annual report have portfolios of widely varying numbers of securities. We believe that requiring all funds included in a shareholder report to use the same format (i.e. summary schedule or full portfolio) may result in investment companies including the full portfolio of investments for each fund in the report in circumstances where one fund is considered best presented using the full portfolio disclosure. We believe that the rules should allow each fund the flexibility to use the most meaningful presentation for its individual type and characteristics, regardless of the presentation used by other funds in the shareholder report.
6. Is the information with respect to a money market fund in either a complete or the proposed summary portfolio schedule sufficiently important that it should be delivered to all investors in the fund?
Yes. We believe that all funds should be required to present a separate schedule of investments. An exemption for money market funds, or any other type of fund, would imply that portfolio information for that fund, or type of fund, is less important. We believe portfolio holdings are an important element of all investment company financial statements. Additionally, an exception would result in financial statement disclosure requirements for registered investment companies that are less comprehensive than the requirements under generally accepted accounting principles as outlined in the AICPA Guide.
Further, we believe it is particularly important to provide regular disclosure of money market fund portfolios directly to fund investors so they can consider the information routinely. Eliminating the requirement to report portfolio holdings in shareholder reports of money market funds could send an implicit message to shareholders that they need not inform themselves about the fund's credit quality, maturity and diversification characteristics. In fact, there is no assurance that securities will continually maintain their ratings, and history has shown that investment-grade securities held by money market funds have, on occasion, suddenly and unexpectedly become impaired or defaulted. We are concerned that, without routine disclosure, investors may only consider portfolio disclosure upon media reports that an issuer of securities held by money market funds is experiencing financial difficulty - a time when the disclosure is likely to be evaluated neither completely nor objectively.
We believe that the proposed rules to permit funds to include a summary portfolio schedule provide a means by which money market funds, and indeed all funds, could provide information to investors regarding the fund's significant investments and overall risks while still allowing the benefits of streamlining disclosures and reducing costs.
1. Is Form N-CSR the appropriate location for funds that include a summary portfolio schedule in their shareholder reports to disclose their complete portfolio schedules.
We recommend that the rules provide additional guidance clarifying required auditor reporting on the full portfolio of investments to be filed with the Commission and available to investors. The proposal indicates that the full portfolio of investments related to a fund's annual report must be audited when a summary portfolio of investments is included in the financial statements in the annual shareholder report; however, it does not address the manner of auditor reporting on such schedule. We believe that the full portfolio of investments should be reported on by the fund's independent accountants as a supplementary schedule to the audited financial statements filed with the Commission, as is currently the practice for reporting on additional schedules filed by operating companies with the Commission (e.g., schedules required by Form 10-K).
2. Should we require the proposed summary portfolio schedule and/or the complete portfolio schedule to identify securities acquired within a designated number of days before the end of the reporting period?
No. The Commission requested comment as to whether disclosure of security acquisitions within a set number of days (e.g., 20 days, 10 days, etc) would inhibit portfolio manipulation practices such as "window dressing" or "portfolio pumping". While we cannot comment on the prevalence of such practices nor have we considered the means of reducing this practice, we note that the proposed disclosure on which the Commission seeks comment implies that all trading activity before a reporting date should be presumed to represent portfolio manipulation. In addition, the proposed rule currently suggests disclosure would only be required for securities acquired prior to the reporting date. We believe limiting disclosure to security acquisitions that occur during an arbitrarily determined time frame prior to the reporting date may be too narrow a view of the ways in which manipulation might occur; for example, allegations of "window dressing" often involve the disposal of poorly-performing or otherwise "undesirable" positions close to period-end.
We also believe that any such disclosure, if required, should be included in management's discussion of fund performance rather than in the fund's financial statements (i.e., in the full or summary schedule of investments). The evaluation of the importance of such activity and a discussion of the related investment transactions in the context of a portfolio strategy is more appropriately addressed by management as part of a substantive discussion of factors affecting fund performance rather than a listing of such transactions in financial statements.
3. Should we require management discussion of fund performance ("MDFP") in annual reports to shareholders?
Yes. Including the MDFP in the annual report is the prevalent industry practice and aids investors in evaluating a fund's performance over the prior year. We agree with the Commission's conclusion that the MDFP need not be a part of a fund's prospectus as it is more appropriately a report on past stewardship. We have seen wide variability in the nature and depth of information that is included in the MDFP. We would support an initiative by the Commission to increase transparency around fund performance by undertaking a separate study to identify the information that should be included in the MDFP to make it more consistently useful to the reader. That study should include input from the key constituents, including shareholders, analysts, advisers, preparers and other users of fund annual reports. The result of that study should be a comprehensive statement (preferably a through rulemaking proposal) of the Commission's expectations for the contents of MDFP. As the proposal release itself demonstrates, currently those expectations appear in fragmentary form, through enforcement actions and published staff views. A formal statement of MDFP expectations would give preparers comprehensive guidance that would promote greater consistency and transparency of disclosure.
Also, as proposed, MDFP continues only to be required for open-end investment companies. Under the Commission's stated rationale MDFP should equally be required for shareholder reports of closed-end investment companies. This, too, should be considered for future rulemaking.
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We appreciate the opportunity to express our views and would be pleased to discuss our comments or answer any questions that the staff may have. Please do not hesitate to contact Chip Voneiff (312-298-4815) or Richard Grueter (617-439-7414) regarding our submission.