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SEC Adopts Amendments To Shareholder Reports And Advertising Rules – Shareholders & More News

INTRODUCTION

On October 26, 2022, the US Securities and Exchange Commission
(SEC) voted to adopt rule and form
amendments (the “final rules”) related to (1)
shareholder reports of mutual funds and exchange-traded funds
(ETFs) registered on Form N-1A and (2) fee and expense information
in advertisements of all registered investment companies and
business development companies (BDCs). The rules were proposed in
August 2020.

The final rules consist of the following principal elements:

  • The final rules change both the structure and the content of
    shareholder reports for open-end management investment companies
    and ETFs registered on Form N-1A (“open-end funds” or
    “funds”). Under the new framework, shareholders will
    receive “concise and visually engaging” shareholder
    reports emphasizing the information the SEC considers most valuable
    to retail investors, including fund expenses, performance, and
    portfolio holdings.
  • More in-depth information will be made available online,
    delivered free of charge upon request, and filed with the SEC on
    Form N-CSR.
  • The final rules further amend the scope of Rule 30e-3 to
    exclude open-end funds, requiring the mailing of the new tailored
    shareholder reports in paper unless the shareholder has
    affirmatively elected electronic delivery or (if elected by the
    shareholder) electronically.
  • The final rules make significant changes to advertising for all
    registered investment companies and BDCs, including changes to how
    fee and expense information is presented.

This client alert provides an overview of the final rules, and
describes certain changes from the proposal in August 2020.

Most aspects of the final rules become effective 60 days after
publication in the Federal Register and allow for an 18-month
transition period beginning from the effective date, meaning that
most aspects of the final rules must be implemented mid-2024
(assuming that the final rules are published relatively soon). As
discussed further in this client alert, certain aspects of the
final rules apply on the effective date.

CHANGES TO SHAREHOLDER REPORTS FOR OPEN-END MUTUAL FUNDS AND
ETFS

SHAREHOLDER REPORTS

The SEC adopted substantially as proposed Item 27A to Form N-1A,
which specifies the design and content of shareholder reports. This
change replaces provisions in Item 27 of current Form N-1A that
relate to shareholder reports. Funds are required to send
shareholders information only about the funds and share classes
they hold. A fund is not permitted to incorporate by reference any
information into its shareholder reports.

CONTENTS OF SHAREHOLDER REPORTS

As seen in the chart below, Item 27A to Form N-1A contains a
number of requirements for shareholder reports, some of which are
specific only to annual reports.

Description Item of Amended Form N-1A Item of Current Form N-1A Containing Similar
Requirements
Shareholder Report (Annual Report or Both Annual Report
and Semi-Annual Report)
Cover Page or Beginning of Report Fund/Class Name Item 27A(b) [None] Both
Ticker Symbol Item 27A(b) [None] Both
Principal US Market(s) for ETFs Item 27A(b) [None] Both
Statement Identifying as “Annual Shareholder
Report”
Item 27A(b) [None] Both
Legend Item 27A(b) [None] Both
Statement on Material Fund Changes in the Report Item 27A(b) [None] Both
Content Expense Example Item 27A(c) Item 27(d)(1) Both
Management’s Discussion of Fund Performance Item 27A(d) Item 27(b)(7) Annual Report
Fund Statistics Item 27A(e) [None] Both
Graphical Representation of Holdings Item 27A(f) Item 27(d)(2) Both
Material Fund Changes Item 27A(g) [None] Annual Report
Changes in and Disagreements With Accountants Item 27A(h) Item 27(b)(4) Both
Availability of Additional Information Item 27A(i) Item 27(d)(3) Through (5) Both
Householding Disclosure (Optional) Item 27A(j) [None] Optional

The below explanations apply to both annual and semi-annual
reports, unless otherwise stated.

COVER PAGE OR BEGINNING OF SHAREHOLDER REPORTS

The final rules require funds to provide certain key information
on a cover page or at the beginning of the shareholder report. This
includes the fund’s name, the class of shares to which the
shareholder report relates, the ticker symbol, and whether the
shareholder report is an annual report or a semi-annual report. If
the fund is an ETF, it must provide the principal US market(s) on
which the fund’s shares are traded. Further, the cover page
must include a specific legend about the shareholder report. In a
change from the proposing release, if a shareholder report is
disclosing material fund changes, the fund will be required to
include a prominent statement, in bold-face type, noting that the
shareholder report is disclosing material changes.

FUND EXPENSES

The final rules require shareholder reports to include a
simplified expense presentation, including a table showing the
expenses associated with a hypothetical $10,000 investment in the
fund during the most recent reporting period. The expenses must be
presented in two formats: (1) as a percentage of a
shareholder’s investment in the fund and (2) as a dollar
amount. In a notable difference from the proposed rules, the table
will not be required to include information about the fund’s
total return during the period. The simplified expense presentation
should look as follows:

What Were the Fund Costs for the Last [Year/Six
Months]?

(Based on a Hypothetical $10,000 Investment)
[Fund or Class Name] Costs of a $10,000 Investment Costs Paid as a Percentage of a $10,000 Investment

$ %

MANAGEMENT’S DISCUSSION OF FUND PERFORMANCE

Substantially as proposed, the final rules largely maintain the
current requirements for the Management’s Discussion of Fund
Performance (MDFP) section of annual reports, with several targeted
changes. The MDFP section is optional for semi-annual reports.

The final rules specify the narrative discussion must
“briefly summarize” the “key” factors that
materially affected a fund’s performance during the most recent
fiscal year, such as market conditions and the fund’s
investment strategies. Further, the final rules instruct funds to
utilize graphics or text features, including bullet lists and
tables, to present such factors. The final rules direct funds not
to include lengthy, generic, or overly broad disclosure and
prohibit funds from including additional information, such as a
fund president’s letter to shareholders, interviews with
portfolio managers, general market commentary, and other similar
information.

The final rules maintain the current requirements for a
performance line graph, but with certain amendments designed to
improve the current presentation and to reflect that annual reports
cover a single class. Annual reports must include a performance
line graph that depicts the performance of a $10,000 investment in
the fund (for the relevant class) and in an appropriate broad-based
securities market index over a ten-year period. Additionally, the
definition of an appropriate broad-based securities market index
was amended to ensure that funds compare their performance to the
overall applicable securities market, for purposes of both
shareholder reports and prospectuses. A “broad-based”
index is defined as one that “represents the overall
applicable domestic or international equity or debt markets, as
appropriate.” Funds may also compare their performance to
other indexes, including more narrowly based indexes that reflect
the market sectors in which the fund invests.

FUND STATISTICS

The final rules require funds to disclose in their shareholder
reports certain fund statistics, including, but not limited to, (1)
the fund’s net assets, (2) the total number of portfolio
holdings, (3) for funds other than money market funds, portfolio
turnover rate, and (4) the total advisory fees paid by the fund
during the reporting period. A fund may disclose any additional
statistics that it believes would help shareholders better
understand the fund’s activities and operations during the
reporting period, but the required statistics must precede any
additional statistics the fund chooses to include.

GRAPHICAL REPRESENTATIONS OF HOLDINGS

The final rules retain current requirements related to the
graphical representation of holdings in shareholder reports. Funds
will continue to be required to include one or more tables, charts,
or graphs depicting the fund’s portfolio holdings by category,
as of the end of the holding period. Funds may present such
information using one of the currently available methods, including
showing holdings based on the percentage of net asset value or
total investments attributable to each category. The final rules,
however, also permit funds to show its holdings based on total
exposure to particular categories of investments in addition to one
of the currently available methods. In a change from the proposed
rules, the final rules permit funds to include, along with the
graphical representation of holdings, a list of its ten largest
portfolio holdings and the percentage of the fund’s net asset
value, total investments, or total exposure attributable to each
such holding.

MATERIAL FUND CHANGES

Only applicable to annual reports, the final rules require funds
to disclose and describe the following material changes:

Changes Requiring Description Corresponding Item in Form N-1A
A change to the fund’s name Item 1(a)(1)
A change to the investment objectives or goals Item 2
A change to the annual operating expenses, shareholder fees, or
maximum account fee, including the termination or introduction of
an expense reimbursement or fee waiver arrangements
Item 3
A change to the principal investment strategies Item 4(a)
A change to the principal risks of investing in the fund Item 4(b)
A change to the investment adviser(s), including
subadvisor(s)
Item 5(a)

Funds may elect to disclose other material changes or changes
that may assist in a shareholder’s understanding of the
fund’s operations or performance. Any descriptions about
changes must be concise while still providing enough detail to
inform shareholders of how the change may affect them.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS

As proposed, the final rules require funds to include a concise
disclosure of certain disagreements with accountants in their
shareholder reports. If a fund has a material disagreement with an
accountant that has resigned or been dismissed, the fund is
required to include: (1) a statement of whether the former
accountant resigned, declined to stand for re-election, or was
dismissed and the date thereof, and (2) a brief, plain English
description of any disagreement(s) with a former accountant during
the fund’s two most recent fiscal years and any subsequent
period that the fund disclosed on Form N-CSR. There is no
requirement for funds to disclose the absence of disagreements.

AVAILABILITY OF ADDITIONAL INFORMATION

The final rules require funds to include in their shareholder
reports a brief, plain English statement notifying shareholders
that certain additional information is on the fund’s website.
Such statement must reference, as applicable, the fund’s
prospectus, financial information, holdings, and proxy voting
information. Funds may also elect to refer to additional
information on the website, so long as such information would
likely be found important to shareholders. Any such information
would be treated the same as other electronic content produced or
circulated by a fund for federal securities laws purposes. If
shareholder reports are presented electronically, they must include
a tool, such as a hyperlink or QR code, to immediately access the
additional information.

HOUSEHOLDING

The final rules maintain current Rule 30e-1, which permits
householding of fund shareholder reports if a shareholder has
written or implied consent to such householding. Funds relying on
written or implied consent must further explain to shareholders, at
least once a year, how to revoke their consent. Such a statement
may be included in annual reports.

FORMAT AND PRESENTATION OF SHAREHOLDER REPORTS

The final rules were designed to simplify the presentation of
shareholder reports and encourage the use of plain English;
graphics, lists, and tables; and investor-friendly principles. The
information must be presented in the order the requirements appear
in Item 27A. Additionally, the final rules provide legibility
requirements for hard copy shareholder reports.

The final rules, in a change from the proposed rules, require
funds to tag the information in shareholder reports in a
structured, machine-readable data language (i.e., using
Inline XBRL structured data language) in accordance with rule 405
of Regulation S-T and the EDGAR Filer Manual.

ELECTRONIC ANNUAL REPORTS

FORM N-CSR AND WEBSITE AVAILABILITY REQUIREMENT

As part of the transition to a layered disclosure framework for
shareholder reports, the SEC also adopted amendments to Form N-CSR
and Rule 30e-1. Funds will continue to be required to file certain
information, which is currently included in fund shareholder
reports, on Form N-CSR. The amendments to Rule 30e-1 will require
funds to make available on a website the information that they file
on Form N-CSR, and to deliver such information upon request to
shareholders, free of charge.

Certain information currently required in shareholder reports
will now no longer be required in shareholder reports or by Form
N-CSR. This change applies to (1) certain information about
management and the statement about the availability of additional
information about a fund’s directors and (2) the brief
discussion/statement regarding the operation and effectiveness of a
fund’s liquidity risk management program over the past year.
This disclosure will remain available in other fund disclosure
documents such as a fund’s statement of additional information
or its prospectus.

NEW FORM N-CSR FILING REQUIREMENTS

The SEC adopted as proposed the requirement for funds to file
their most recent complete annual or semi-annual financial
statements on Form N-CSR, and provide certain data points from the
financial statements in their shareholder reports, in lieu of
including the fund’s complete financial statements in their
shareholder reports. Unlike the changes to shareholder reports, the
amendments to Form N-CSR do not prohibit funds from preparing and
submitting multicolumn financial statements that include multiple
series or portfolios, or that address multiple share classes of a
fund, provided such financial statement presentation is consistent
with Regulation S-X. The annual financial statements will continue
to be required to be audited and accompanied by any associated
accountant’s reports. The semi-annual financial statements need
not be audited.

In connection with these changes, the SEC also adopted
amendments to Form N-1A that will eliminate funds’ ability to
provide a summary schedule in lieu of providing a complete schedule
of portfolio investments as part of the financial statements.

The final rules will require funds to file their financial
highlights information on Form N-CSR. The final rules also require
that funds must file on Form N-CSR the disclosures that Item 304 of
Regulation S-K currently requires concerning changes in and
disagreements with accountants. The requirements in Form N-CSR
provide additional, more nuanced and technical disclosure than the
similar requirement in shareholder reports. The final rules require
that funds must include information about (1) matters submitted for
a shareholder vote and (2) the aggregate remuneration the fund paid
to its directors, officers, and certain affiliated persons on Form
N-CSR, rather than in their shareholder reports. This information
requirement is identical to the information requirement currently
included in shareholder reports. Lastly, instead of requiring funds
provide a statement regarding the basis for the board’s
approval of the fund’s investment advisory contract in
shareholder reports, the final rules instead require funds to
provide this information on Form N-CSR.

WEBSITE AVAILABILITY REQUIREMENTS

As proposed, the final rules will require funds to make
available on a website all of the information that will be newly
required on Form N-CSR (Items 7-11 of amended Form N-CSR). This
information is required to be publicly accessible and free of
charge. Funds will also be required to make this information
available from 60 days after the end of the relevant fiscal period
until 60 days following the end of the next respective fiscal
period, mirroring the required period of transmission of
shareholder reports. This represents a change from the proposal,
which would have required funds to make that same information
available from 70 days after the end of the fiscal period until 70
days following the next fiscal period. Funds will continue to have
70 days to file the complete Form N-CSR with the SEC, as they do
today.

In addition, as proposed, the SEC will also require funds (other
than money market funds) to make their complete portfolio holdings,
as of the close of the fund’s most recent first and third
fiscal quarters, available on a website. The final rules also
ensure that investors can easily reach and navigate the information
that appears online:

  • First, the website address where the required information
    appears must be specified on the cover page or in the beginning of
    the shareholder reports and cannot be the SEC’s EDGAR address.
    The website address must be specific enough to provide the
    requisite information, but can be a general website with clear
    links to the relevant information. It may not be the fund’s
    home page.
  • Second, the required online materials must be presented in a
    format convenient for both reading online and printing on paper,
    and persons accessing the materials must be able to retain
    permanently (free of charge) an electronic copy of the materials in
    this format. Funds may elect to post their most recent Form N-CSR
    report in its entirety, thereby satisfying the website availability
    requirement. The SEC noted in the adopting release that funds will
    have flexibility in how online information is presented so long as
    the information is consistent with the requirements described
    above.

The final rules also will include a safe harbor providing that
funds shall have satisfied their obligations to transmit
shareholder reports even if they did not meet the posting
requirements of the rule for a temporary period of time. To rely on
this safe harbor, funds must have reasonable procedures in place to
help ensure that the required materials appear online in the manner
required by the rule, and also must take prompt action to correct
noncompliance with the final rules’ website availability
requirements.

DELIVERY UPON REQUEST REQUIREMENTS

As proposed, the final rules will require funds to send, at no
cost by US first class mail or other reasonably prompt means, a
paper copy of any of the materials that will have to appear online
within three business days after receiving a request for a paper
copy. Funds must also send, at no cost by email or other reasonably
prompt means, an electronic copy of any materials discussed above
within three business days after receiving a request for an
electronic copy. These requirements will also apply to any
applicable financial intermediary.

TRANSMISSION OF SHAREHOLDER REPORTS

Current Rule 30e-3 generally permits certain registered
investment companies to satisfy shareholder report transmission
requirements by making shareholder reports available online and
providing a notice of the shareholders reports’ online
availability, instead of mailing the shareholder reports to
shareholders. The final rules amend Rule 30e-3 to exclude open-end
funds from the scope of Rule 30e-3. Now, unless a shareholder
affirmatively opts into e-delivery, open-end funds will be required
to mail a paper copy of the new tailored shareholder reports to
shareholders. The final rules also clarify that variable contract
unit investment trusts may no longer rely on Rule 30e-3 to satisfy
their shareholder report transmission requirements with respect to
underlying funds registered on Form N-1A.

In a change from the proposing release, the SEC decided against
adopting proposed Rule 498B, which would have provided an
alternative approach to delivering annual prospectus updates. This
proposed layered disclosure framework would have used shareholder
reports and other notifications to inform shareholders about their
investments.

CHANGES TO INVESTMENT COMPANY ADVERTISING RULE AMENDMENTS

In addition to the changes to shareholder reports discussed
above, the SEC adopted amendments to certain advertising rules to
require that fee and expense presentations in advertisements and
sales literature be consistent with relevant prospectus fee table
presentations and be reasonably current. The amendments also
address representations of fees and expenses that could be
materially misleading. These amendments apply to all investment
companies that are subject to the SEC’s advertising rules,
including mutual funds, ETFs, registered closed-end funds, and BDCs
(each, an “investment company”).

REQUIREMENTS FOR STANDARDIZED FEE AND EXPENSE FIGURES

The SEC amended Rules 482 and 433 under the Securities Act of
1933 (the “Securities Act”) and Rule 34b-1 under the
Investment Company Act of 1940 to require that investment company
advertisements providing fee or expense figures for the investment
company include certain standardized fee and expense figures, and
that these figures must adhere to certain prominence and timeliness
requirements.

The amendments to Rule 482 will 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) total annual expenses without any fee waiver or expense
reimbursement arrangement. An advertisement need not include
required fee and expense figures if it only included general,
narrative info about fee/expense considerations and did not include
any numerical fee or expense amounts. Similarly, if an investment
company does not present total annual expense figures in its
prospectus, the amendments addressing the required fee and expense
figures would be inapplicable. This is relevant to variable
insurance contract separate accounts, which do not present the
total annual expense figures, and therefore, those annual expense
figures are not presented in variable insurance contract
prospectuses.

The amendments to Rules 34b-1 and 433 incorporate Rule 482’s
requirements for required fee and expense figures. As a result,
advertisements and supplemental sales literature covered by those
rules will be subject to the same requirements regarding fee and
expense information.

The SEC proposed several rules related to prospectus disclosure,
which they ultimately did not adopt, including amendments to
prospectus fee disclosure and amendments to prospectus risk
disclosure. The SEC chose not to adopt proposed rules that would
have removed the current fee table out of the summary prospectus
and replaced it with a fee summary that would have disclosed
“bottom line” costs of an investment using new
terminology. The SEC also did not adopt a proposed rule
establishing a 10% of assets standard for principal risk
disclosure.

MATERIALLY MISLEADING STATEMENTS ABOUT FEES AND EXPENSES IN
INVESTMENT COMPANY SALES LITERATURE

As noted above, the amendments also address representation of
fees and expenses that could be materially misleading. The SEC
amended Rule 156 under the Securities Act to specify the following
practice as one that could lead to materially misleading
representations: representations about the fees or expenses
associated with an investment in an investment company could be
misleading because of statements or omissions made involving a
material fact, including situations where portrayals of the fees
and expenses associated with an investment in the investment
company omit explanations, qualifications, limitations, or other
statements necessary or appropriate to make the portrayals not
misleading.

The SEC referenced investment companies that market themselves
as “zero expense” or “no expense funds” without
mentioning other costs investors would incur when investing in the
investment company. Consistent with the current framework in Rule
156, whether a particular description, representation,
illustration, or other statement involving an investment
company’s fees and expenses is materially misleading depends on
evaluation of the context in which it is made. Although the SEC
provided an 18-month transition period for other aspects of the
adopting release, these amendments to Rule 156 apply on the
effective date noted above.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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