On March 9, 2016, the staff of the SEC’s Division of Investment Management issued a Guidance Update titled, “Fund Disclosure Reflecting Risks Related to Current Market Conditions” (the “Guidance”). The Guidance reminds funds of the importance of reviewing risk disclosures on an ongoing basis and considering whether the risk disclosures remain adequate in light of current market conditions. Because risks may change over time, the Guidance states that a fund should consider whether disclosure that may have been adequate at one time may need to be reconsidered in light of new or changed market conditions. According to the Guidance, if a fund determines that its risk disclosure is not adequate, it should “consider the appropriate manner of communicating changed risks to existing and potential investors, for example, in the prospectus, shareholder reports, fund website, and/or marketing materials.” The Guidance outlines several steps fund advisers should take on an ongoing basis, including (i) monitoring market conditions and their impact on fund risks, (ii) assessing whether fund risks have been adequately communicated to investors in light of current market conditions, and (iii) communicating with investors when a fund determines that changes in current market conditions have resulted in material changes to the fund’s risks such that current disclosures do not adequately reflect those changes.
The Guidance provides two specific examples of the types of disclosure updates a fund may wish to consider, based on the SEC staff’s reviews of fund risk disclosures. The first concerns disclosures by fixed-income funds regarding interest rate risk, liquidity risk and duration risk during the current period of rising interest rates. The second example concerns investments by funds in debt securities issued by the Commonwealth of Puerto Rico and its agencies and instrumentalities (together, “Puerto Rico debt”) in light of recent failures of issuers of Puerto Rico debt to make scheduled payments to bondholders.
With respect to fixed-income investments disclosure, the Guidance states the staff has seen interest rate risk disclosure that includes references to historically low interest rates, or to potential government policy changes that may affect interest rates. These disclosures indicate that current conditions may result in a rise in interest rates, which in turn may result in a decline in the value of the fixed-income investments held by the fund. The Guidance also states that some funds in their discussion of fixed-income liquidity risk disclose that a potential rise in interest rates may result in periods of volatility and increased redemptions. Some funds also state that, as a result of increased redemptions, they may have to liquidate portfolio securities at disadvantageous prices, which could reduce the returns of the fund. With respect to fixed-income duration risk, the Guidance notes that some funds disclose that longer-term fixed-income securities may be more sensitive to interest rate changes, and also include numerical examples illustrating how interest rate changes may have a greater impact on such longer-term securities.
With respect to funds that invest in Puerto Rico debt, the Guidance notes that some funds with disclosure about the risks associated with Puerto Rico debt have updated that disclosure to communicate the existence of heightened risk under current conditions. Other disclosures refer to current factors that may be expected to have an impact on the value of the Puerto Rico debt held by the fund. Examples of such disclosure include information about the Puerto Rico debt issuer’s significant financial difficulties or budget deficits, as well as recent downgrades in the credit ratings of Puerto Rico debt.