On October 26, 2022, the Securities and Exchange Commission (“SEC”) adopted rule and form amendments that modernize the disclosure framework for mutual funds and exchange-traded funds (“ETFs”) to create a new layered disclosure approach (the “Amendments”).[1]

Overview

The modernized disclosure framework under the Amendments includes the following:

• Receipt of a concise annual and semi-annual shareholder report that highlights key information of particular importance for retail investors to assess and monitor their fund investments, including, among other things, fund expenses, performance and portfolio holdings. There must be separate shareholder reports for each fund series and for each share class of a fund if it is a multi-class fund.
• Certain information currently included in shareholder reports which may be of more interest to financial intermediaries and investors who desire more in-depth information will no longer be included in these reports, but will be available online and delivered free of charge upon request, and be filed semi-annually with the SEC on Form N-CSR.
• Rescission of the ability for open-end funds and ETFs registered on Form N-1A to rely on Rule 30e-3 under the Investment Company Act of 1940, as amended (the “1940 Act”).

Additionally, the Amendments include amendments to the investment company and business development company (“BDC”) advertising rules to promote more transparent and balanced statements about investment costs.

Although proposed by the SEC, the Amendments do not include proposed rule 498B, which would have provided an alternative approach to satisfy prospectus delivery for existing shareholders, nor do they include the proposed amendments to funds’ prospectus fee and risk disclosure requirements.

Each of these Amendments is discussed below in more detail.

Compliance Dates

There will be a transition period of 18 months from the time that the Adopting Release is published in the Federal Register.

Annual Shareholder Reports

The Amendments add new Item 27A to Form N-1A, which specifies the design and content of fund annual and semi-annual reports. Current provisions in Item 27 of Form N-1A that relate to fund annual and semi-annual reports are being rescinded.

Scope of Annual Report Disclosure

A separate annual report will be required for each fund series, so that investors only receive information about the fund that they are invested in. Additionally, in a change from the proposal, the Amendments will require that a fund prepare and send to shareholders a shareholder report that covers the specific class that the shareholder has invested in if the fund is a multi-class fund.

While the content of a fund’s annual report will be limited to the information specifically required or permitted by Item 27A to Form N-1A, the instructions provide some flexibility so that a fund can tailor its presentation of information to match how the fund invests (including that in certain limited circumstances, additional information will be allowed to the extent needed to make the required disclosure items not misleading). A fund will also be allowed to omit an item if it is not applicable to that fund. Item 27A will not allow incorporation by reference of any information to an annual report for purposes of satisfying the annual report disclosure requirements.

There are also new instructions relating to the format and presentation of the shareholder reporting, and funds are encouraged to consider using, as appropriate, question and answer format, charts, graphs, tables, bullet point lists and other graphics.

Content of Annual Report

Below is a description of the information that will be required in a fund annual report under the Amendments. The design and content specifications required for funds’ semi-annual reports will be similar.[2] Under the Amendments, there is no limit of the length of the shareholder report.

The following information will be required to be on the cover page or at the beginning of the annual report:

• Fund Name and Class Name
• Ticker Symbol
• Principal U.S. Market – applicable for ETFs
• Statement Identifying Document as “Annual Shareholder Report”
• Legend
  • The following legend will be required:
    
    “This annual shareholder report contains important information about [the Fund] for the period of [beginning date] to [end date]. You can find additional information about the Fund at [Fund website address]. You can also request this information by contacting us at [toll-free telephone number and, as applicable, email address].”

• Although not in the proposal, the Amendments require that if the shareholder report discusses material changes to the Fund, then there will have to be a prominent statement: “This report describes changes to the Fund that occurred during the reporting period”.

The following are the items required in the content of the annual report, which do contain some variation from what was included in the proposal:

• Fund Expenses
  • The Amendments require a simplified expense presentation in the annual report that require a fund to provide expenses associated with a hypothetical $10,000 investment in the fund during the preceding reporting period in two different formats (1) as a percent of the shareholder’s investment in the fund (expense ratio) and (2) as a dollar amount.
  • The proposed expense example will appear as follows:
    
    What were the Fund costs for the last [year/six months]? (based on a hypothetical $10,000 investment)

    Fund or Class Name	Cost of a $10,000 investment	Costs paid as a percentage of a $10,000 investment
    	$	%

• Management’s Discussion of Fund Performance
  • The Amendments generally keep the current requirements with respect to the management’s discussion of fund performance (“MDFP”) section of the annual report with a few changes.
    • Narrative MDFP
      • The narrative discussion of the factors that materially affected the fund’s performance during the most recently completed fiscal year will remain but the instructions require that it be a brief summary of the key factors.
      • The instructions also recommend the use of graphics, bullet point lists or tables. No additional information will be allowed in the shareholder report, such as president’s letter to shareholders, general market commentary or other similar information.
    • Performance Line Graph
      • The performance line graph currently required remains but a fund will no longer be allowed to show periods longer than the most recent 10 fiscal years.
      • The performance shown will have to be for the specific class covered by the shareholder report if it is a multi-class fund.
      • The definition of an “appropriate broad-based securities market index” is changed to be an index that represents the overall applicable domestic or international equity or debt markets, as appropriate[3]. Funds will be allowed to also include narrower, secondary indexes.
    • Performance Table
      • The performance table remains, however there are some amendments to what must be included:
        • the average annual returns of an appropriate broad-based securities market index;
        • the fund’s average annual total returns without sales charges (in addition to the current disclosure that must show returns that reflect any sales charges)
        • the average annual total returns must be for the class that the report covers.
      • The Amendments will replace the required statement accompanying the performance line graph and performance table with a simplified statement to the effect that the fund’s past performance is not a good predictor of how the fund will perform in the future. This statement must be prominent and noticeable.
      • If there was a material change to the fund during the reporting year, such as a change in adviser or investment strategies, the fund may include a brief legend or footnote to describe the change and when it occurred. The Adopting Release notes that funds have discretion about when to disclose information about a prior material change to a fund with its performance presentation, but that information must be disclosed if, absent that disclosure, the performance information would be misleading.
      • If the fund provides updated performance information through a website, or other widely accessible mechanism, there must be a statement directing shareholders to where they can find that information. The fund will also have to provide a hyperlink to where the information is located if the report is delivered electronically or a URL address or QR code if the report is delivered in paper format.
    • For funds that have a stable distribution policy but were not able to maintain that stated level of distribution, that fact must be disclosed.

• Fund Statistics
  • Funds will be required to disclose certain fund statistics, including:
    • Net assets
    • Total number of portfolio holdings
    • Portfolio turnover rates, except for money market funds; and
    • Total advisory fees paid during the reporting period.
  • The instructions provide requirements for multi-class funds related to calculating statistics in light of the requirements that a report only cover a single class.
  • Funds are also permitted to include additional statistics that they believe will help shareholders better understanding the fund’s activities and operation during the reporting period (such as tracking error, maturity, duration, average credit quality or yield). However, if these additional statistics are included, there are a number of additional instructions with which the fund must comply:
    • The required fund statistics must precede any additional statistics provided.
    • if a fund provides a statistic that is disclosed elsewhere on Form N-1A, the fund must follow any associated instructions describing the calculation method for the relevant statistic;
    • the instructions encourage a fund to use tables, bullet lists, or other graphics or text features to disclose the statistics;
    • if a statistic is included in, or could be derived from, a fund’s financial statements or financial highlights, the instructions require a fund to use or derive such statistic from the fund’s most recent financial statements or financial highlights;
    • the instructions allow a fund to briefly describe the significance or limitations of any disclosed statistics in a parenthetical or similar presentation; and
    • if a fund chooses to include additional statistics, the instructions require those additional statistics to be reasonably related to the fund’s investment strategy.

• Graphical Representation of Holdings
  • The current requirements for the graphical representation of holdings that funds currently include in their annual reports will be retained with certain changes.
    • While funds currently have the flexibility to base the tabular or graphic presentation of holdings on the fund’s net asset value or total investments, the Amendments will also allow holdings to be shown based on the fund’s total exposure to particular categories of investments. This change could be particularly useful for funds that execute their strategy primarily through derivatives or for long/short funds.
    • Currently if a fund depicts portfolio holdings based on credit quality, that fund must describe how the credit quality of its holdings was determined and, if credit ratings are used, the fund must explain why it selected a particular credit rating. The staff of the SEC has noted that there is a wide range of practices as to the level of detail provided for these descriptions and under the Amendments they will need to be brief and concise.
    • Although not in the proposal, along with the graphical presentation of holdings, a fund will explicitly be permitted to include a list of its ten largest holdings and the percentage of the fund’s net asset value, total investments, or total exposure attributable to each such holding.

• Material Fund Changes
  • Under the Amendments, a new section is added to annual reports to describe material changes in an enumerated list of items that have occurred since the beginning of the reporting period. Funds can also choose, but are not required to, disclose other material changes; changes that the fund believes might be helpful for investors to understand the fund’s operations and/or performance over the period; or any material planned changes to be updated in the prospectus for the current fiscal year. Material changes in any of the following items will be required to be disclosed even if they have previously been disclosed through a prospectus supplement:
    • Change in the fund name
    • Change in the fund’s investment objectives or goals
    • A change in the fund’s annual operating expenses, shareholder fees or maximum account fee, including the termination or introduction of an expense reimbursement or fee waiver arrangement;
    • A change in the fund’s principal investment strategies
    • A change in the fund’s principal risks
    • A change in the fund’s investment adviser(s), including sub-adviser(s)
  • The following legend will be required to accompany the disclosure of these material fund changes:
    
    “This is a summary of certain changes [and planned changes] to the Fund since [date]. For more complete information, you may review the Fund’s next prospectus, which we expect to be available by [date] at [website address] or upon request at [toll-free telephone number and, as applicable, email address].”

• Changes in and Disagreements with Accountants
  • Current shareholder report disclosures relating to changes in and disagreements with accountants will be moved to Form N-CSR. However, when a fund has a material disagreement with an accountant that has resigned or been dismissed, the fund has to include in its annual report:
    • A statement of whether the former accountant resigned, declined to stand for re-election, or was dismissed and the date thereof
    • A brief, plain English description of disagreement(s) with the former accountant during the fund’s two most recent fiscal years and any subsequent interim period that the fund discloses on Form N-CSR.

• Availability of Additional Information
  • Funds will be required to include a statement in the annual report that informs investors about additional information that is available on the fund’s website. Specifically, the statement will have to include plain English references, as applicable, to the fund’s prospectus, financial information, holdings and proxy voting information. If the shareholder report is available on a fund’s website or is otherwise provided electronically, the fund must provide a means of immediately accessing this additional information, such as through a hyperlink or QR code.

• Householding Disclosure (optional)
  • The Amendments retain the provision that permits funds to explain how to revoke consent to the householding of the annual report as part of the annual notice requirement.

• Electronic Annual Reports
  • The Amendments include instructions designed to clarify requirements for electronic annual reports and to promote the use of interactive, user-friendly electronic design features.

New Form N-CSR and Website Availability Requirements

The Amendments amend Form N-CSR and Rule 30e-1 under the 1940 Act. Certain information currently included in shareholder reports will now be filed on Form N-CSR. Funds will have to make available on their website the information that will now be filed on Form N-CSR and will be required to provide such to shareholders free of charge upon request. The information being moved from shareholder reports to Form N-CSR include:

• Financial statements for funds, including schedule of portfolio holdings;
• Financial highlights;
• Renumeration paid to directors, officers and others;
• Changes in and disagreements with accountants;
• Matters submitted for shareholder vote;
• Statement regarding the basis for the board’s approval of investment advisory agreements;
• Complete portfolio holdings as of the close of the most recent first and third fiscal quarters (this item will not be required for Form N-CSR as it is filed on Form N-PORT but it will have to be available on the fund’s website).

Under the Amendments, the required information will have to be on the fund’s website within 60 days after the end of the fiscal period until 60 days after the end of the next fiscal period, at which time it would be updated.

Disclosure Items Proposed to be Removed from Shareholder Report and Not Filed on Form N-CSR

The Amendments result in the following items being removed from a fund’s annual report and additionally, they will not have to be included in Form N-CSR:

• The management information table;
• The statement regarding the liquidity risk management program.

With respect to the management information table, the Adopting Release notes that this information is also included in a fund’s SAI and that it is not necessary to include it in multiple locations. With respect to the statement regarding the liquidity risk management program, the Adopting Release notes that information relevant to the program will still be available on Form N-PORT, on Form N-CEN and in prospectuses.

Amendments Narrowing the Scope of Rule 30e-3

Rule 30e-3 currently permits investment companies to satisfy shareholder report delivery requirements by making those reports and other materials available online and sending a notice of that availability instead of having to directly mail the shareholder report. The Amendments are changing Rule 30e-3 to exclude investment companies registered on Form N-1A from being allowed to rely on the Rule as those funds will now be delivering tailored shareholder reports to shareholders.

Investment Company and Business Development Company Advertising Rule Amendments

The Amendments also include changes to the SEC’s investment company advertising rules (which include Rules 482, 156 and 433 under the Securities Act and Rule 34b-1 under the 1940 Act) to promote transparent and balanced presentations of fees and expenses in investment company advertisements. These amendments apply to all investment companies, including mutual funds, ETFs, registered closed-end funds and BDCs. The amendments require that investment company advertisements providing fee and expense figures include: (1) the maximum amount of any sales load, or any other nonrecurring fee; and (2) the total annual expenses without any fee waiver or expense reimbursement arrangements based on the method of computation for a prospectus. Additionally, the Amendments will allow investment companies to include other figures regarding its fees and expenses, such as net expenses after fee waivers, so long as they are not any more prominent than the figures that are required. The Amendments also provide that representations about fees or expenses associated with an investment in a fund could be misleading because of statements or omissions involving a material fact, including situations where portrayals of the fees and expenses associated with an investment in the fund omit explanations, qualifications, limitations, or other statements necessary or appropriate to make the portrayals not misleading.

[1] Release IC-334731, Tailored Shareholder Reports for Mutual Funds and Exchange-Traded Funds; Fee Information in Investment Company Advertisements (October 26, 2022) at https://www.sec.gov/rules/final/2022/33-11125.pdf (“Adopting Release”).

[2] The MDFP and Material Fund Changes sections will be optional for semi-annual reports. If a fund does determine to include the MDFP in the semi-annual report, it will have to comply with the content requirements for MFDP. Additionally, the cover page statement and legend will be tailored for a semi-annual report rather than annual report.

[3] This change in definition also applies to the performance table in fund prospectuses.