Recently, the U.S. Securities and Exchange Commission (SEC) adopted rule and form amendments for registered open-end funds (Final Rules) that will substantially change the form and content of fund shareholder reports. The SEC also adopted related amendments to the fund advertising rules. Effective January 24, 2023, the Final Rules reflect the SEC’s ongoing effort to require funds to provide clear and concise disclosures to shareholders, particularly retail shareholders. Notably, a fund must prepare and deliver shareholder reports that are specific to each share class of a single fund. Such reports are expected to be as short as three or four pages. Expanding on the SEC’s approach to layered disclosures, the Final Rules also require that more detailed information must be available online or by request. The new streamlined and tailored reports are intended to help retail investors monitor their fund holdings more easily.

The Final Rules also exclude funds registered on Form N-1A from Rule 30e-3, meaning that all reports must be mailed to shareholders, unless the shareholders have consented to e-delivery, in a sharp departure from recent rulemaking.

As noted above, the Final Rules will become effective on January 24, 2023, and the compliance date is

July 24, 2024.

Tailored Shareholder Reports (Mutual Funds and Exchange-Traded Funds)

The Final Rules amend Item 27 of Form N-1A and fundamentally change the structure and presentation of fund shareholder reports. The SEC emphasized that the new reports should be “concise and visually engaging,” utilizing tables and graphical representations of certain fund characteristics such as fees, performance, and holdings. Under the new structure, the SEC expects each shareholder report to be as few as three pages. This is to be achieved by shifting many of the disclosures that are currently included in shareholder reports onto Form N-CSR and limiting each report to a single share class of a single fund.

Under the Final Rules, shareholder reports will generally have the following structure:

• Fund/Class Name and Ticker. Funds will be required to prepare and mail reports that are specific to a single share class of a single fund and are required to identify the applicable class/fund and ticker on the report’s cover page. Currently, many fund managers present information applicable to many funds, each with multiple share classes, in a single report.
• Principal U.S. Market(s) (Exchange-Traded Funds (ETFs) only). If the fund is an ETF, the ETF must disclose the principal U.S. market(s) where the ETF is traded.
• Identifying Statement and Legend. The cover page will be required to include a statement identifying the report as annual or semi-annual, as well as a standardized legend disclosing the time period of the report and contact information where shareholders can request additional information.
• Statement on Material Changes. If a shareholder report includes a discussion of material changes during a specific time period (discussed below), the report will be required to include a prominent statement noting that the report includes this information.
• Expense Example. Reports will be required to include a table reflecting the expenses associated with a hypothetical $10,000 investment during the reporting period, both as a percentage of a shareholder’s investment (expense ratio) and in dollars.
• Management’s Discussion of Fund Performance (MDFP). As is currently the case, the MDFP section will be optional for semi-annual reports and not required for money market funds. The Final Rules encourage the MDFP to “briefly summarize” the “key” factors that impacted a fund over the reporting period. Funds will not be permitted to include additional discussions, such as a letter to shareholders from the adviser, interviews with portfolio managers, or a discussion of the general market conditions that are not specific to the applicable fund. The MDFP section will continue to include performance line graphs and performance tables reflecting 1-, 5-, and 10-year returns, as applicable.
  Regarding the performance table and the presentation of performance information generally (including in prospectuses), the Final Rules will amend the definition of “appropriate broad-based securities market index” to be “an index that represents the overall applicable domestic or international equity or debt markets, as appropriate.” This reflects the SEC’s position that certain benchmarks are not sufficiently broad and will effectively require all funds to compare their performance, both in shareholder reports and prospectuses, to the overall securities market in which a fund invests. While the particular details of which benchmarks are sufficiently representative of an overall securities market remain unclear, the SEC explained, for example, “an appropriate benchmark for a fund that invests primarily in the equity securities of a subset of the U.S. market, such as healthcare companies, should show its performance against the overall U.S. equities market, rather than a benchmark consisting of only healthcare companies.” The SEC extended this logic to “indexes that include characteristics such as ‘growth,’ ‘value,’ ‘ESG,’ or ‘small- or mid-cap’ . . . and therefore these indexes would not be appropriate broad-based securities market indexes under the final rules.” Funds may continue to compare performance against more narrowly tailored benchmarks in addition to the applicable broader index.

• Fund Statistics and Graphical Representation of Holdings. Funds will be required to disclose net assets, total number of holdings, portfolio turnover rate (not applicable to money market funds), and the total advisory fee paid during the reporting period. Reports will continue to be required to present a graphical representation of fund holdings by category.
• Material Fund Changes. Funds will be required to disclose and briefly describe any material fund changes that occurred during the reporting period. “Material changes” in this context includes changes to a fund’s name, investment objectives, strategy, annual expenses (including termination or introduction of expense caps), principal risks, and investment adviser. 
• Changes in and Disagreements with Accountants. If applicable, annual reports will be required to include a statement of whether a fund’s former accountant resigned, declined to stand for re-election, or was dismissed and the date thereof, and a brief, plain English description of management’s disagreement(s) with the former accountant during the fund’s two most recent fiscal years.
• Availability of Additional Information. Shareholder reports will be required to note that additional information is available on a fund’s website.
• Householding Disclosure (Optional). Shareholder reports will continue to be permitted to explain how to revoke consent to householding.

As noted above, much of the information currently included in shareholder reports will be moved to Form N-CSR, and investors can access this more in-depth information using the SEC’s website or by request if they so choose. Below are the items currently included in shareholder reports that will transition to Form N-CSR:

• Financial Statements, including the Schedule of Investments and Notes to Financial Statements;
• Financial Highlights;
• Results of any shareholder vote;
• Trustee and Officer table; and
• Disclosures pursuant to the requirements of Section 15(c) of the 1940 Act (annual advisory contract approval).

Additionally, the statement regarding a fund’s liquidity risk management program will no longer be required to be provided in the report or on Form N-CSR.

E-Delivery Exclusion

In a disappointment to the open-end fund industry, the Final Rules exclude mutual funds and ETFs from Rule 30e-3 and rescind Rule 30e-1(d). Currently, Rule 30e-3 permits mutual funds and ETFs to satisfy shareholder report delivery obligations by posting their reports online and notifying shareholders of their availability online (i.e., access equals delivery). Rule 30e-1(d) currently permits mutual funds and ETFs to send a prospectus or statement of additional information in place of a shareholder report as long as all of the required information is included. Together, but particularly in Rule 30e-3, these delivery rules provided significant cost savings and logistical ease for mutual funds and ETFs with little impact on disclosures available to investors. Under the Final Rules, however, mutual funds and ETFs will be required to mail shareholder reports to investors on a single share class and single fund basis unless a shareholder affirmatively consents to e-delivery. In the release, the SEC argued that for any shareholders who have not opted into e-delivery, funds are still required to mail a notice of report availability. Since the new shareholder reports are intended to be very short, the SEC believes the mailing costs under the Final Rules would be low.

Advertising Rules (Including Closed-end Funds and Business Development Companies (BDCS))

The Final Rules also adopt amendments to the rules governing investment company advertisements (including closed-end funds and BDCs) that include fee and expense information. The amendments are similar in nature to the new Marketing Rule under the Investment Advisers Act of 1940 (Rule 206(4)-1) and will require advertisements that include fee and expense data to include both gross and net fees with equal prominence and clear explanations of any waivers, limitations, or caps. The amendments are intended to standardize how fees and expenses are presented across essentially all fund documents, from sales literature to prospectuses.

Next Steps

While the compliance date for the new Final Rules is not until July 2024, the operational changes to how shareholder reports are drafted and delivered will be dramatic for many open-end fund managers. In particular, advisers that manage a suite of mutual funds should be considering the ease or difficulty involved in adjusting to creating and reviewing, in most cases, many more reports than it currently produces. Advisers should be prepared for the coordinated efforts across multiple service providers (for example, financial printers) that will be required to implement the new report structures and filings on Form N-CSR. 

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