SEC Seeks to Reduce Gobbledygook Disclosures By: Securities Lawyer 101
This month, the Securities and Exchange Commission (the “SEC”) provided guidance related to the enhanced mutual fund disclosure amendments it adopted in 2009. The SEC’s guidance is based on comments the staff of the Division of Investment Management provided to a number of funds and their securities lawyers. The SEC guidance is intended to focus funds on certain form and rule requirements to assist securities lawyers and provide investors with improved SEC disclosures in Form N-1A. This month, the SEC warned against “gobbledygook” disclosures in Form N-1A that include complex, technical and duplicative information.
The SEC’s Observations of Disclosures in Form N-1A
The SEC staff observed that funds often provide clear and concise disclosure in response to the specific Summary Section requirements of Form N-1A. There are a significant number of prospectuses, however, in which disclosure remains complex, technical and duplicative. Further, the staff continues to see what it believes are unnecessarily long Summary Sections. In the Adopting Release, the Commission explicitly noted that it shares the concerns of some commenters that, over time, Summary Sections could get longer, undermining the usefulness of the summary. While the SEC did not impose page limits on the Summary Section, stating that doing so could constrain appropriate disclosure, the Commission emphasized its intent that funds and their securities lawyers prepare a concise summary (on the order of three or four pages) that will provide key information.
Based on comments the staff has provided, the staff highlighted certain rule and form requirements that, while not exhaustive of the disclosure requirements, are intended to focus funds on providing investors clear and concise disclosure:
♦ Summarize the Principal Investment Strategies and Risks: Form N-1A provides that the principal investment strategies and risks, required by Item 4 in the Summary Section, should be based on the information given in response to Item 9 of the Form, and should be a summary of that information. The Form also provides that information included in response to Items 2 through 8 need not be repeated elsewhere in the prospectus. Instead of a concise summary, however, the staff often observes in Item 4 of the Summary Section long, complex and detailed descriptions of principal investment strategies and risks that are dense, are not user-friendly, and do not appear to be summaries of the information in Item 9 later in the prospectus. The staff also often reviews prospectuses that substantially repeat the same principal investment strategies and risks disclosure
♦ Plain English Requirements: Form N-1A provides that the Summary Section must be provided in plain English under Rule 421(d) under the Securities Act. In addition, the prospectus, in its entirety, is subject to the requirement that the information be presented in a clear, concise, and understandable manner. Similarly, Form N-1A also provides that the prospectus disclosure requirements “are intended to elicit information for an average or typical investor who may not be sophisticated in legal or financial matters.”
♦ Summary Section: The staff closely scrutinizes the disclosure in the Summary Section, and when information is included that is not required or permitted, comments that the information should be moved out of the Summary Section. For example, to streamline the disclosure and foster comparison between funds, the staff, in particular, assesses whether information in the footnotes to the Fee Table is permitted or required. As another example, the staff often comments about the inclusion of purchase and sale information that is neither permitted nor required by Item 6 of Form N-1A (“Purchase and Sale of Fund Shares”), which generally requires a fund to disclose its minimum initial or subsequent investment requirements, that the fund’s shares are redeemable, and briefly identify the procedures for redeeming shares. Funds are reminded to include only information in the Summary Section that is either permitted or required by Form N-1A.
♦ Inclusion of Non-Principal Strategies and Risks in the Prospectus: As noted above, Form N-1A requires a fund to disclose its principal investment strategies and risks in its prospectus. The Form provides that a fund should describe any investment strategies and risks that are not principal in the SAI. Form N-1A, however, also provides that a fund may include (except in the Summary Section) information in the prospectus that is not otherwise required. Many funds include in their prospectus additional information related to strategies and risks that are not principal. In the view of the staff, however, funds that include this additional information often do not clearly indicate which of the strategies and risks are principal and which are not principal. The staff believes that this can result in prospectus disclosure that does not clearly and concisely inform investors about how the fund principally intends to invest and the related risks. In such cases, the staff will comment that funds should distinguish which of the strategies and risks are principal and which are not principal.
♦ Avoid Cross-References: Form N-1A provides that, in responding to the required information in the prospectus, funds should avoid cross-references to the SAI or shareholder reports. The Form further provides that “[c]ross references within the prospectus are most useful when their use assists investors in understanding the information presented and does not add complexity to the prospectus.” The staff frequently observes funds with numerous cross-references in the Summary Section, which the staff believes can add complexity. When appropriate, the staff suggests that the cross-references be deleted to streamline the Summary Section.
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