On Jan. 13, 2009, the SEC issued a Release adopting amendments to Form N-1A that require specified items of "key information" to appear in "plain English" in a standardized order at the front of the mutual fund "statutory prospectus." The Release also adopts rule amendments that permit (but not require) a person to satisfy its mutual fund prospectus delivery obligations by providing essentially the same information directly to investors in the form of a "Summary Prospectus" and by making the statutory prospectus and other fund documents available, in a specified manner, on an Internet website, and sending copies on request. Release Nos. 33-8998; IC-28584; available at http://www.sec.gov/rules/final/2009/33-8998.pdf.
In major departures from its proposals on these matters, the SEC has determined not to require inclusion of "top 10" portfolio holdings information in either the statutory or Summary Prospectuses, and not to require quarterly updating of the Summary Prospectus.
Highlights of the lengthy Release (more than 190 pages) are reviewed below. Please note that the Release also adopts a number of changes to Form N-1A that affect only exchange-traded funds, which are not discussed below.
The effective date of the amendments is March 31, 2009.
Compliance Dates – All initial registration statements on Form N-1A, and all post-effective amendments, that are filed on or after Jan. 1, 2010, must comply with the amendments to Form N-1A. The final compliance date for filing amendments to effective registration statements to comply with the new Form N- 1A requirements is Jan. 1, 2011. A fund may, at its option, prepare documents in accordance with the amended requirements of Form N-1A at any time after the effective date. A person may not rely on the Summary Prospectus provisions to satisfy its obligations to deliver a mutual fund’s statutory prospectus unless the fund is also in compliance with the amendments to Form N-1A.
Note: The Release states that post-effective amendments filed to comply with the amendments to Form N-1A should be filed under Securities Act rule 485(a) (which generally provides for a 60-day review period). However, in "appropriate circumstances," the SEC staff will consider requests by existing funds to file these post-effective amendments pursuant to rule 485(b)(1)(vii), which allows the SEC staff to approve the filing of a post-effective amendment to a registration statement under rule 485(b) (which generally provides for immediate effectiveness) for a purpose other than those specifically enumerated in the rule. Appropriate circumstances may include, for example, situations where a fund complex has previously filed under rule 485(a) post-effective amendments for a number of funds that implement the new requirements, and the staff determines not to review additional such filings by the fund complex in light of the staff’s experience with the previously filed amendments.
Revisions to Form N-1A
The amendments to Form N-1A require the statutory prospectus of every mutual fund to include a summary section at the front of the prospectus consisting of "key information" presented in plain English in a standardized order. The starting point for the revisions is the risk/return summary that is currently required at the front of every mutual fund prospectus by what are now Items 2 and 3 of the Form. The SEC is making two significant modifications to this information. First, additional information is to be included in the summary section, which will now encompass Items 2 through 8 of revised Form N-1A. The information required in the expanded summary section of the statutory prospectus is essentially the same as will be required in the new Summary Prospectus.
Second, the SEC is imposing a new formatting requirement for statutory prospectuses that offer multiple funds under which (with limited exceptions) all summary information would have to be presented separately for each fund covered by the prospectus. That is, a multiple fund prospectus will be required to present all of the summary information for a particular fund together, followed by all of the summary information for each additional fund. However, a multiple fund prospectus will be permitted to integrate the information required by any of new Item 6 (purchase and sale of fund shares), Item 7 (tax information), and Item 8 (financial intermediary compensation), so long as the information is identical for all funds covered in the prospectus. If the information required by any of Items 6 through 8 is integrated, the integrated information will be required to immediately follow the separate individual fund summaries containing the other nonintegrated information. In addition, the following statement will be required in each individual fund summary section in the location where the information that is integrated, and presented later, would have appeared:
“For important information about [purchase and sale of fund shares,] [tax information,] and [financial intermediary compensation], please turn to [identify section heading and page number of prospectus].”
On the other hand, a prospectus offering multiple share classes will be able to present the summary information separately for each class, to integrate the information for multiple classes, or to use another presentation that is consistent with disclosing the summary information in a standard order at the beginning of the prospectus.
In addition, the SEC has added a requirement that a fund include its exchange ticker symbol on the cover pages of the statutory prospectus, statement of additional information (SAI), and Summary Prospectus.
Requirements for the Expanded Summary. The summary section of the statutory prospectus must be provided in "plain English" under rule 421(d) under the Securities Act. Funds must disclose this information in numerical order at the front of the prospectus, and cannot precede this information with any additional information (other than the prospectus cover page and table of contents). Information included in the summary section need not be repeated elsewhere in the prospectus. While a fund could continue to include elsewhere in the prospectus information that is not required, a fund cannot include any such additional information in the summary section of the prospectus (unless an Item specifically permits it to do so).
As noted, the expanded summary section of the statutory prospectus would encompass Items 2 through 8 of revised Form N-1A, each of which is briefly discussed below. Although the SEC is not imposing page limits on either the summary section of the statutory prospectus or the Summary Prospectus, the Release notes, "We emphasize, however, that it is our intent that funds prepare a concise summary (on the order of three or four pages) that will provide key information."
Item 2. Risk/Return Summary: Investment Objectives/Goals. Like the current risk/return summary, the proposed summary section will begin with disclosure of a fund’s investment objectives or goals. A fund is also permitted (but not required) to identify its type or category (e.g., that it is a money market fund or balanced fund).
Item 3. Risk/Return Summary: Fee Table. The SEC is moving the fee table forward from its current location (which follows information about investment strategies, risks, and past performance), and making several amendments to the fee table. First, funds that offer discounts on front-end sales-charges for volume purchases (so-called “breakpoint discounts”) will have to include prescribed disclosure regarding those discounts, along with a cross reference to the section heading and page number of the fund's prospectus and SAI where more information can be found. Second, the SEC is revising the parenthetical following the heading “Annual Fund Operating Expenses” in the fee table to read “expenses that you pay each year as a percentage of the value of your investment” (in place of “expenses that are deducted from Fund assets”). Third, funds other than money market funds must add disclosure regarding portfolio turnover immediately following the fee table example. A fund would have to disclose its portfolio turnover rate for the most recent fiscal year as a percentage of the average value of its portfolio, along with a prescribed explanation of the effect of portfolio turnover on transaction costs and fund performance. (The portfolio turnover rate is already a required element of the "financial highlights" table, which often appears at the end of the prospectus.)
Lastly, the SEC is amending the requirement that a fund disclose in its fee table gross operating expenses that do not reflect expense reimbursement or fee waiver arrangements, to essentially incorporate staff disclosure positions. Specifically, a fund may place two additional captions directly below the “Total Annual Fund Operating Expenses” caption in cases where there are expense reimbursement or fee waiver arrangements that will reduce fund operating expenses for no less than one year from the effective date of the fund’s registration statement. One caption would show the amount of the expense reimbursement or fee waiver, and a second caption would show the fund’s net expenses after subtracting the reimbursement or waiver from the total fund operating expenses. Funds that disclose these arrangements must also disclose the period for which the arrangement is expected to continue, including the expected termination date of the arrangement, and briefly describe who can terminate the arrangement and under what circumstances. Further, in computing the fee table example, a fund would be permitted to reflect such arrangements, but only in the periods for which the expense reimbursement or fee waiver arrangement is expected to continue. The Release also specifies that a fund may not include the additional captions if the expense reimbursement or fee waiver arrangement may be terminated without agreement of the fund’s board of directors (e.g., unilaterally by the fund’s investment adviser) during the one-year period.
Item 4. Risk/Return Summary: Investments, Risks, and Performance. Following the fee table and example, the fund will disclose summary information regarding its principal investment strategies and risks, including the current risk/return bar chart and table, in much the same manner required in the current risk/return summary (i.e., current Items 2(b) and (c) of Form N-1A). However, the SEC has added a provision requiring a fund that makes updated performance information available on a website or at a toll-free (or collect) telephone number to include a statement explaining this, and providing the website address and/or telephone number.
Item 5. Management. The prospectus summary section generally must disclose the name of each investment adviser and sub-adviser of the fund, followed by the name, title, and length of service of the fund’s "portfolio managers." These items are similar to disclosures currently required in the fund’s prospectus.
Item 6. Purchase and Sale of Fund Shares. The summary section must next disclose the fund’s minimum initial or subsequent investment requirements, and the fact that the fund’s shares are redeemable, and identify the procedures for redeeming shares (e.g., on any business day by written request, telephone, or wire transfer).
Item 7. Tax Information. A fund will have to state, as applicable, that it intends to make distributions that may be taxed as ordinary income or capital gains, or that the fund intends to distribute tax-exempt income. A fund that holds itself out as investing in securities generating tax-exempt income must provide, as applicable, a general statement to the effect that a portion of the fund's distributions may be subject to federal income tax.
Item 8. Financial Intermediary Compensation. All funds will have to include the following statement (or a modified statement containing comparable information), unless neither the fund nor any of its related companies pays financial intermediaries for the sale of fund shares or related services. The Release notes in this regard that even "no-load" funds and "directly-sold" funds will be required to include the narrative disclosure in certain circumstances (e.g., where the fund pays servicing fees to a fund supermarket).
The disclosure in revised Item 8 reads as follows: "Payments to Broker-Dealers and Other Financial Intermediaries. If you purchase the Fund through a broker-dealer or other financial intermediary (such as a bank), the Fund and its related companies may pay the intermediary for the sale of Fund shares and related services. These payments may create a conflict of interest by influencing the broker-dealer or other intermediary and your salesperson to recommend the Fund over another investment. Ask your salesperson or visit your financial intermediary’s Web site for more information."
New Summary Prospectus Option - Revised Rule 498
The SEC is replacing rule 498, the current voluntary "profile" rule under the Securities Act, with a new rule that permits the obligation under the Securities Act to deliver a statutory prospectus with respect to mutual fund securities to be satisfied by sending or giving a Summary Prospectus, providing the statutory prospectus and other documents online in a specified manner, and meeting other specified requirements. In addition, the new rule requires a fund that opts to use a Summary Prospectus to send the specified documents in paper or by e-mail upon request. The Summary Prospectus will contain essentially the same information that is included in the new summary section of the statutory prospectus, and in the same order that is required in the statutory prospectus.
By way of background, Section 5(b)(2) of the Securities Act makes it unlawful to deliver a security for purposes of sale or for delivery after sale “unless accompanied or preceded” by a statutory prospectus. New rule 498(c) provides that any obligation under Section 5(b)(2) to have a statutory prospectus precede or accompany the carrying or delivery of a mutual fund security in an offering registered on Form N-1A is satisfied if:
- A Summary Prospectus is sent or given no later than the time of the carrying or delivery of the Fund security
- The Summary Prospectus is not bound together with any materials (except that a Summary Prospectus for a Fund that is available as an investment option in a variable annuity or variable life insurance contract may be bound together with the statutory prospectus for the contract and Summary Prospectuses and statutory prospectuses for other investment options available in the contract, if certain conditions are met)
- The Summary Prospectus that is sent or given satisfies the content and format requirements of rule 498(b) at the time of the carrying or delivery of the fund security
- The conditions pertaining to availability of the fund's statutory prospectus, Summary Prospectus, SAI, and most recent annual and semi-annual reports to shareholders set forth in rule 498(e), are satisfied
Moreover, communications that are preceded or accompanied by a Summary Prospectus would not be deemed to be "prospectuses," and thus would not be subject to the liability provisions of Section 12(a)(2) of the Securities Act, if all the conditions of the rule are met. These communications would, however, remain subject to the general antifraud provisions of the federal securities laws.
Regarding delivery of the Summary Prospectus by electronic means, the Release notes that a fund could rely upon existing SEC guidance, which typically requires affirmative consent from individual investors. In addition, if, prior to the March 31, 2009 effective-date of this rule, an investor had consented in accordance with existing SEC guidance to receive future versions of one or more funds’ statutory prospectuses by electronic means, the SEC would not object if a fund or financial intermediary relies on that consent to send or give the Summary Prospectuses of those funds by electronic means to that investor, provided that the consent is not otherwise revoked.
The Release also notes that a fund could choose to provide a Summary Prospectus to some investors, while providing a statutory prospectus to others. For example, it would be permissible to rely on rule 498 to provide the Summary Prospectus to existing investors who purchase additional shares, while providing the statutory prospectus to new investors.
Content of Summary Prospectus. The rule generally requires the Summary Prospectus to include a specified legend and other information on the cover page, followed by the same information as the summary section of the statutory prospectus, in the same order as required in the statutory prospectus. The legend must provide an Internet address, toll free (or collect) telephone number, and e-mail address that investors can use to obtain the statutory prospectus and other information. The Internet address must be "specific enough to lead investors directly" to the statutory prospectus and other required information, rather than to the home page or other section of the website on which the materials are posted, although the website could be "a central site with prominent links to each required document."
The Summary Prospectus cannot omit any of the required information, or include additional information, except as specified in the rule. A document that omits required information or includes additional information not permitted by the rule would not be a Summary Prospectus under the rule, and could not be used under the rule for any purpose, including meeting the obligation to deliver a fund’s statutory prospectus. In addition, a Summary Prospectus can describe only one fund, but could describe multiple classes of a single fund.
Provision of Statutory Prospectus, SAI, and Shareholder Reports. In addition to sending or giving a Summary Prospectus, a person that decides to rely on the rule to meet its statutory prospectus delivery obligations would be required to provide the statutory prospectus itself on the Internet, together with other fund documents, in the manner specified by rule 498(e). Compliance with all of the conditions in the proposed rule regarding Internet posting would be required in order to meet prospectus delivery obligations under Section 5(b)(2) of the Securities Act.
The required documents must be provided through the Internet as follows: The fund’s "current" Summary Prospectus, statutory prospectus, SAI, and most recent annual and semi-annual reports to shareholders must be accessible, free of charge, at the website address specified in the Summary Prospectus. These documents must be accessible on or before the time that the Summary Prospectus is sent or given and current versions of the documents must remain on the website through the date that is at least 90 days after (i) in the case of reliance on the proposed rule to satisfy the obligation to have a statutory prospectus precede or accompany the carrying or delivery of a mutual fund security, the date that the mutual fund security is carried or delivered, and (ii) in the case of reliance on the proposed rule to deem a communication with respect to a mutual fund security not to be a "prospectus" under Section 2(a)(10) of the Securities Act, the date that the communication is sent or given.
The Release clarifies that the “current” standard does not require a fund to maintain online an outdated version of a document that was current at the time the Summary Prospectus was sent or given, but that has subsequently been updated. Rather, the “current” standard requires a fund to maintain updated versions of the required documents online.
Under the rule, the information on the Internet must be presented in a format (or formats) that:
(1) Are "human-readable" and capable of being printed on paper in human-readable format
(2) Permit persons accessing the statutory prospectus or SAI to move directly back and forth between each section-heading in a table of contents of such document, and the section of the document referenced in that section-heading
(3) Permit persons accessing the Summary Prospectus to move directly back and forth between:
(A) Each section of the Summary Prospectus and any section of the statutory prospectus and SAI that provides additional detail concerning that section of the Summary Prospectus; or
(B) Links located at both the beginning and end of the Summary Prospectus (or that remain continuously visible to persons accessing the Summary Prospectus), and tables of contents of both the statutory prospectus and the SAI that meet the requirements of (2) above.
Persons accessing the downloaded version of the statutory prospectus or SAI must be able to move directly back and forth between the table of contents in that document and each section of that document referenced in the table of contents. However, an electronic version that is retained by an investor would not be required to incorporate links between the Summary Prospectus, statutory prospectus, and SAI.
Incorporation by Reference and Liability. The rule permits a fund to incorporate by reference into the Summary Prospectus information contained in its statutory prospectus and SAI, as well as any information from its most recent shareholder reports, that the fund has incorporated by reference into its statutory prospectus, subject to specified conditions. A fund is not permitted to incorporate by reference into the Summary Prospectus information from any other source, and could not incorporate by reference any information that is required to be included in the Summary Prospectus. Information can be incorporated by reference into the Summary Prospectus only by reference to the specific document that contains the information, and not by reference to another document that incorporates the information by reference. (Thus, if a fund’s statutory prospectus incorporates the fund’s SAI by reference, the Summary Prospectus could not incorporate information in the SAI simply by referencing the statutory prospectus, but would be required to reference the SAI directly.)
Incorporation by reference is permitted only if the fund satisfies the conditions described above regarding the means by which the incorporated information is available to investors. In addition, if a fund incorporates information by reference, the Summary Prospectus legend must clearly identify the document from which the information is incorporated, including the date of the document, and explain that any information that is incorporated from the SAI or shareholder reports may be obtained, free of charge, in the same manner as the statutory prospectus.
The Release also includes a discussion of the effect of incorporating information into a Summary Prospectus, particularly with respect to the liability provisions of the Securities Act. In an apparent attempt to address concerns that a Summary Prospectus might be found to have omitted material information contained, for example, in the full statutory prospectus, rule 498 provides that information is conveyed to a person not later than the time that a Summary Prospectus is received by the person if the information is incorporated by reference into the Summary Prospectus in accordance with the rule. Moreover, the Release notes that "the Commission believes that a person that provides investors with a mutual fund Summary Prospectus in good faith compliance with rule 498 would be able to rely on Section 19(a) of the Securities Act against a claim that the Summary Prospectus did not include information that is disclosed in the fund’s statutory prospectus, whether or not the fund incorporates the statutory prospectus by reference into the Summary Prospectus." Section 19(a) protects a defendant from liability for actions taken in good faith in conformity with any rule of the Commission.
Further on the subject of liability, the SEC is requiring that a Summary Prospectus be filed with the Commission no later than the date that it is first used. Although the Summary Prospectus would be filed as part of the registration statement pursuant to rule 497(k), it would not be deemed a part of the registration statement for purposes of the disclosure liability provisions of Section 11 of the Securities Act.
Other Requirements. Rule 498(f) contains additional requirements relating to use of a Summary Prospectus. However, compliance with paragraph (f) is not a condition to a fund's ability to rely on rule 498(c) (relating to the obligation under Section 5(b)(2) to have a statutory prospectus precede or accompany the carrying or delivery of a mutual fund security) or rule 498(d) (relating to communications that are preceded or accompanied by a Summary Prospectus not being deemed to be "prospectuses"). Thus, while a failure to comply with a requirement of paragraph (f) would constitute a violation of an SEC rule, such failure does not negate the ability to rely on paragraph (c) or (d). These additional requirements are summarized below.
(1) Delivery upon request. The rule requires that a fund (or financial intermediary through which shares of the fund may be purchased or sold) send, at no cost to the requestor and by U.S. first class mail or other reasonably prompt means, a paper copy of the fund’s statutory prospectus, SAI, and most recent annual and semi-annual shareholder report, to any person requesting such a copy within three business days after receiving a request for a paper copy. Requests for electronic copies of these documents must also be responded to within three business days. The requirement to send an electronic copy of a document by email may be satisfied by sending a direct link to the document on the Internet, provided certain conditions are met.
(2) Greater prominence. The fund’s Summary Prospectus shall be given greater prominence than any materials that accompany the Summary Prospectus, with the exception of other Summary Prospectuses or statutory prospectuses. The Release notes generally that the “greater prominence” requirement would be satisfied if the placement of the Summary Prospectus is more prominent than accompanying materials, e.g., the Summary Prospectus is on top of a group of paper documents that are provided together.
(3) Convenient for reading and printing. (i) The materials that are accessible in accordance with rule 498(e)(1) must be presented on the website in a format, or formats, that are convenient for both reading online and printing on paper; and (ii) persons accessing such materials must be able to permanently retain, free of charge, an electronic version of such materials in a format, or formats, that are convenient for both reading online and printing on paper.
(4) Information in Summary Prospectus must be the same as information in Statutory Prospectus. The information provided in response to Items 2 through 8 of Form N-1A in the fund’s Summary Prospectus must be the same as the information provided in response to Items 2 through 8 of Form N-1A in the fund’s statutory prospectus, except as expressly permitted by rule 498(b)(2). Thus, if a fund files a supplement (or “sticker”) to its statutory prospectus that changes any information in the summary section, the Summary Prospectus should also be “stickered” or amended to reflect the information in the statutory prospectus sticker.