Securities and Exchange Commission (“SEC”) Division of Investment Management (“Division”) staff (“Staff”) published on September 9, 2019 Accounting and Disclosure Information (“ADI”)1 2019-08 summarizing the Staff’s views regarding the disclosure of principal risks in registered investment company (“fund”) prospectuses.2 The ADI is in response to the Staff’s review of mutual fund disclosures that they deemed overly lengthy and technical, such that it would be difficult for investors to identify and understand the key risks of an investment in the fund.
The improvement of fund risk disclosures has been a topic of discussion for the SEC staff for some time. This issue was raised in a speech given by Division Director Dalia Blass in October 2018.3 The Division launched its Investor Experience Initiative in 2017 to refocus how funds approach their disclosures to investors, with an emphasis on clarity and understandability.
The ADI follows this trend of seeking to enhance the investor experience and provides a set of recommendations that may improve principal risk disclosures for investors:
- Ordering Risks by Importance. The Staff encourages funds to consider placing the most significant risks first and ordering them by importance. Funds that list risks alphabetically, for instance, could obscure the importance of some key risks.
- Tailoring Risk Disclosures. The Staff encourages funds to tailor risk disclosures for each fund in a fund group, rather than relying on generic, standardized risk disclosures across funds. In its recent review, the Staff observed principal risk disclosures that described risks for investments even though a fund did not hold or expect to hold such investments. This superfluous disclosure could decrease the utility of a fund’s risk disclosures for investors.
- Disclosing the Appropriateness of the Fund for Certain Investors. The Staff encourages funds to consider disclosing that a fund is not appropriate for certain investors given the fund’s characteristics. The Staff provides, by way of example, that a fund seeking to provide a defined return over a specific time period may not be appropriate for an investor that does not plan to hold the fund for that time period. Although not mentioned in the ADI, this mirrors the concern the Financial Industry Regulatory Authority (“FINRA”) has identified in the past regarding marketing communications to retail investors about leveraged and inverse ETFs that seek to achieve the returns of a positive or negative multiple of an index on a daily basis.4
The Staff also provides further recommendations to funds to improve their risk disclosures. These include: (1) presenting concise information about principal risks in the summary prospectus, and more detailed information about those risks elsewhere; (2) disclosing non-principal risks (and non-principal investment strategies) in the fund’s statement of additional information, rather than the prospectus; and (3) periodically reviewing risk disclosures, including the order in which they are presented, to consider whether the disclosures are adequate in light of a fund’s characteristics and market conditions.
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1 ADIs are recurring publications that summarize the SEC staff’s views regarding various requirements of securities laws.
2 The ADI is available here: https://www.sec.gov/investment/accounting-and-disclosure-information/principal-risks/adi-2019-08-improving-principal-risks-disclosure.
3 See Dalia Blass, Keynote Address, ICI Securities Law Developments Conference (Oct. 25, 2018), available at https://www.sec.gov/news/speech/speech-blass-102518.
4 See “FINRA Reminds Firms of Sales Practice Obligations Relating to Leveraged and Inverse Exchange-Traded Funds,” FINRA Regulatory Notice 09-31, available at https://www.finra.org/rules-guidance/notices/09-31.
