October 26, 2016
SEC Modifies Reporting Regime for Registered Investment Companies
New and Amended Disclosure Forms and Rule Amendments Implement Modified Reporting Requirements and Require Disclosure of Derivatives and Securities Lending Activities
On October 13, 2016, the Securities and Exchange Commission adopted new rules and reporting forms, as well as amendments to its rules and reporting forms, that modify the disclosure and reporting requirements applicable to registered investment companies under the Investment Company Act of 1940 (the "Investment Company Act").1 The new rules, which were approved by a 2-to-1 vote (with Commissioner Piwowar dissenting), are intended to modernize the investment company reporting regime and enhance the Commission's ability to oversee and monitor the activities of investment companies by (1) updating and standardizing the format in which funds report portfolio and census-type information and (2) providing for additional disclosure in certain areas, including securities lending activities and derivatives. Among other things, the new rules:
rescind Form N-Q and require registered management investment companies, other than money market funds and small business investment companies ("SBICs"), and unit investment trusts ("UITs") that operate as exchange-traded funds ("ETFs") to report portfolio information each month in a structured data format on a new form, Form N-PORT;
revise Regulation S-X to require new, standardized enhanced disclosures regarding fund holdings in derivative instruments; update the disclosures for other investments; and amend the rules regarding the general form and content of fund financial statements;
rescind Form N-SAR and replace it with Form N-CEN, which will require annual reporting of similar and additional census information in an updated, structured data format; and
amend Forms N-1A, N-3, and N-CSR to require certain disclosures regarding securities lending activities.
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Notably, the Commission declined to adopt proposed rule 30e-3, which would have permitted funds the to satisfy shareholder report transmission requirements by posting their reports online if they met certain conditions.
In December 2014, SEC Chair Mary Jo White outlined several initiatives to address potential risks associated with the increased size and complexity of the asset management industry, including the modernization and enhancement of the reporting regime for funds and their advisers.2 In furtherance of this initiative, on May 20, 2015, the SEC proposed new rules and reporting forms, as well as amendments to rules and reporting forms, that would result in significant modifications to the disclosure and reporting requirements applicable to most investment companies registered under the Investment Company Act and all investment advisers registered under the Investment Advisers Act of 1940 (the "Investment Advisers Act").3 In August 2016, the SEC adopted final rules to enhance reporting and disclosure of information provided by investment advisers, including new required reporting about separately managed accounts and an adviser's use of derivatives and borrowing.4
At the October 13, 2016 meeting during which the fund reporting rules were approved, Chair White stated that it was "essential that ... reporting requirements be modernized without delay" because the SEC and its staff "rely on information that funds report to monitor industry trends, identify risks, inform rulemaking, and assist in examination and enforcement efforts."5 Chair White noted that the final rules take into account concerns about the possible misuse of portfolio holdings information expressed in comments on the Proposing Release while providing the Commission and investors "powerful tools to understand the investment activities of funds." The key provisions of the SEC's adopting release are discussed below.6
A. FORM N-PORT AND RESCISSION OF FORM N-Q Under current rules, most management investment companies7 registered under the Investment Company Act are required to submit public reports to the SEC detailing their complete portfolio holdings on a quarterly basis. The content of these reports is filed on Form N-Q at the end of each first and third fiscal quarter (no later than 60 days after the period ends),8 and on Form N-CSR at the end of each second and fourth fiscal quarter (no later than 70 days after the period ends). Under the new rules, Form N-Q will be discontinued9 and replaced with the new Form N-PORT, to be filed electronically in a structured (XML) format on a monthly basis, within 30 days of the end of each month, by all registered management investment companies (other than money market funds10 and SBICs) and unit investment trusts that operate as ETFs.11 Consistent with current disclosure practice, portions of the reports for the third month of each fiscal quarter will be made publicly available, but only 60 days after the end of the
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fiscal quarter.12 Form N-PORTs filed for the first two months of each fiscal quarter will not be made
In addition to basic information on a fund's portfolio holdings,13 funds will be required to report on Form
N-PORT several items of information not required under current rules, including certain quantitative risk
metrics at the portfolio level (and, in the case of some types of investments, at the position level) that measure the fund's exposure and sensitivity to changing market conditions, such as fluctuations in asset prices, credit spreads, and interest rates. Funds will be required to provide the fund's Legal Entity Identifier ("LEI") number,14 and funds that have not yet obtained a LEI will be required to do so. Form
N-PORT also significantly expands reporting requirements regarding specific types of investment activity
for which current disclosure requirements are limited. Significant examples include:
Derivatives: Funds will be required to provide enhanced, standardized disclosure of each derivative contract, including, among other things, the category of derivative instrument that most closely represents the investment (e.g., forward, future, option, etc.), the full name and LEI (if any) of the counterparty (including a central counterparty), the terms and conditions of each derivative instrument that are important to understanding its payoff profile and a description of the derivative's relevant reference asset.15 The SEC has observed significant increases in the use of derivatives by funds, particularly "alternative" funds, and believes that a more "detailed, uniform and structured reporting regime" is needed to enable the SEC and investors to more easily analyze and compare the use of derivatives across funds.16
Securities Lending: The final rules require funds to disclose certain information regarding securities lending activities on Form N-PORT, including the full name and LEI (if any) of each counterparty, the aggregate value of securities on loan to each counterparty, which securities are on loan and the value thereof, the reinvestment of cash collateral securing the loans, and non-cash collateral treated as fund assets.
Repurchase and Reverse Repurchase Agreements: Funds will have to provide information on each repurchase or reverse repurchase agreement, including the full name and LEI (if any) of the counterparty, the category of the transaction from the fund's standpoint (repurchase, reverse repurchase), whether the transaction is cleared by a central counterparty (and, if so, the name of the central counterparty, or, if not, the name and LEI (if any) of the over-the-counter counterparty), the repurchase rate, whether the agreement is tri-party, and the maturity date.
Funds will also be required to report certain flow information (the total net asset value of (1) shares sold
(including exchanges, but excluding reinvestment of dividends and distributions); (2) shares sold in
connection with reinvestments of dividends and distributions; and (3) shares redeemed or repurchased
(including exchanges)) in their reports on Form N-PORT, similar to what is currently reported
semiannually on Form N-SAR. The SEC believes that monthly reporting of flow information will better
enable it to monitor industry trends.
The SEC believes that the more detailed, structured information it collects on Form N-PORT will be
important to the Commission and its staff in analyzing and understanding the various risks in a particular
fund, as well as risks across specific types of funds and the fund industry as a whole. While the SEC
notes that Form N-PORT is designed primarily for use by the SEC and its staff, it also believes that
periodic public disclosure of the information filed on Form N-PORT will benefit investors, particularly
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institutional investors, as well as other potential users, such as investment advisers, broker-dealers, and
entities that provide information and analysis for fund investors.
The compliance date for Form N-PORT is June 1, 2018 for funds in complexes with net assets of $1
billion or greater. The compliance date for other funds is June 1, 2019.
B. AMENDMENTS TO REGULATION S-X
The SEC adopted amendments to Regulation S-X that modify the form and content of fund financial
statements that are included in shareholder reports and registration statements. The revisions require
fund financial statements filed by registered investment companies (management companies and UITs) and business development corporations ("BDCs")17 to include additional disclosure on certain subjects, with many of the new disclosures being similar to those that will be required in Form N-PORT. Significant
Derivatives: Fund financial statements will be required to include standardized and detailed disclosure regarding fund holdings in open futures contracts, open forward foreign currency contracts, and open swap contracts, as well as additional information on holdings of written and purchased options.18 The amendments require the "prominent placement of details regarding investments in derivatives in a fund's schedule of investments, rather than allowing such schedules to be placed in the notes to the financial statements."19
Investments in Securities of Unaffiliated Issuers: Additional disclosures will be required regarding funds' investments in securities of unaffiliated issuers, although the SEC decided not to adopt a proposal that would have required categorization by industry and country or geographic region.20 For variable rate securities and other specified debt instruments, funds will be required to disclose additional information regarding the relevant interest rate, including a description of the reference rate and spread, and, in a departure from the proposing release, funds will be also be required to provide the end of period interest rate for each investment, or include disclosure of each reference rate at the end of the period. Funds will also be required to identify, and to indicate, for each issue of securities held in connection with open put or call option contracts and loans for short sales, whether any portion of such issue is on loan.21
Investments in and Advances to Affiliates: The rules requiring disclosure of investments in and advances to affiliates in which the fund owns 5% or more of the outstanding voting securities have been expanded to require disclosure regarding net and total "realized gains and losses for the period" in addition to the net and total "increase or decrease in unrealized appreciation or depreciation for the period" for each affiliated investment.22
Notably, the SEC did not adopt amendments to Regulation S-X that would have required funds to make
additional disclosures regarding securities lending activities in the notes to their financial statements,
including the monthly average value of portfolio securities on loan; the income from, and fees paid in
connection with, securities lending; and information on compensation arrangements with securities
lending agents (including any revenue sharing split). Instead, it opted to require that these disclosures be made in a fund's Statement of Additional Information (or, for closed-end funds, reports on Form N-CSR)
or in Form N-CEN (see below). The rules, however, did include various revisions to the form of financial
statements designed to produce greater consistency and usability for investors, as well as numerous
technical and clarifying amendments.
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The compliance date for the amendments made to Regulation S-X is August 1, 2017.
C. FORM N-CEN AND RESCISSION OF FORM N-SAR
The SEC currently collects a wide variety of census-type information on registered management investment companies and unit investment trusts through reports on Form N-SAR. However, in the Adopting Release, the SEC rescinded Form N-SAR and replaced it with new Form N-CEN, to be filed by all registered investment companies (except face-amount certificate companies). The new form includes many of the same data elements as Form N-SAR, but in a streamlined form to eliminate outdated or duplicative items, and has been updated to reflect the SEC's current information needs.23 Form N-CEN also requires new information addressing, among other things:
background information and other identifying information about the fund; information about the fund's directors;24 whether the fund has received financial support from an affiliated entity; whether the independent public accountant's report on internal control found any material
whether the certifying accountant issued an opinion other than an unqualified opinion with respect to its audit of the fund's financial statements;
for management companies, the monthly average of the value of securities on loan; the fees and net income associated with any securities lending activity by the fund and information about the fund's relationship with certain securities-lending-related service providers, including whether a securities lending agent is an affiliated person of the fund (or an affiliated person of such person); whether the securities lending agent or any other entity indemnifies the fund against borrower default on loans administered by the agent; and certain identifying information about the entity providing indemnification, if not the agent;25 and
for a fund that is an Exchange-Traded Fund or an Exchange-Traded Managed Fund (in each case as defined in Form N-CEN),26 the fund's (or its service provider's) interaction with authorized participants27 (including the authorized participant's name, SEC file number, CRD number, and LEI, if any; the dollar-value of the fund shares the authorized participant purchased or redeemed from the fund for the reporting period; and whether the fund required the authorized participant to post collateral in connection with the purchase or redemption of fund shares) and other characteristic information regarding the fund.
Like Form N-PORT, reports on Form N-CEN will be required to be filed in a structured (XML) data format. The reports will be filed annually, within 75 days after the end of the fiscal year for management companies (and calendar year-end for UITs), by all funds, unlike reports on Form N-SAR which are currently filed semiannually by most funds.
The compliance date for the new Form N-CEN is June 1, 2018 for all funds, regardless of asset size.
D. AMENDMENTS TO FORMS REGARDING SECURITIES LENDING ACTIVITIES
The SEC adopted new disclosure requirements for management investment companies relating to securities lending activities in order to allow investors to understand better the income generated from, and the expenses associated with, a fund's securities lending activities. To that end, the SEC
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determined that funds should include securities lending disclosures in their Statements of Additional Information on Forms N-1A and N-3 (or for closed-end funds, in their reports on Form N-CSR).28 The final rule requires funds to disclose gross and net income from securities lending activities, fees and compensation in total and broken out by enumerated types,29 and a description of the services provided to the fund by the securities lending agent. To avoid the disclosure of sensitive information and promote comparability, the SEC modified the rule as originally proposed by requiring disclosure of backwardlooking dollar-based disclosures rather than disclosure of the terms governing the compensation arrangements between funds and their securities lending agents. Funds will also not be required to disclose the monthly average of the value of portfolio securities on loan--as the proposed rule would have required--because the SEC has adopted a similar requirement in Form N-CEN, where such information will be made available in a structured data format.
The compliance date for amendments made to the Statement of Additional Information requirements of Form N1-A (and Form N-CSR for closed-end funds) is August 1, 2017.
E. OPTION FOR WEBSITE TRANSMISSION OF SHAREHOLDER REPORTS The SEC considered but did not adopt proposed rule 30e-3, which would have permitted a fund to satisfy shareholder report delivery requirements by making reports and certain other materials publicly available on the fund's website free of charge. Reliance on the rule would have been subject to certain conditions aimed at ensuring accessibility of the reports, including the mailing of notice to shareholders. Moreover, a fund seeking to rely on the proposed rule would have needed to obtain consent from each affected shareholder, though consent would be implied if the fund provided proper notice to a shareholder and the shareholder did not notify the fund that he or she wished to continue receiving print copies of reports.
The SEC observed in the Adopting Release that it received mixed comments regarding proposed rule 30e-3. Some commenters welcomed the rule, citing increased internet access and use, the preferences of many investors, reduction in printing and mailing expenses for funds and their shareholders, and intraand inter-agency regulatory consistency benefits. Others, however, expressed concern that the proposed rule could have adverse effects on investor readership of shareholder reports, especially within certain demographic subgroups, and disputed the amount of printing and mailing expense savings anticipated by the rule's proponents. As a result, the SEC declined to adopt the rule and will consider the proposal further.
Copyright Sullivan & Cromwell LLP 2016
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1 The new reporting requirements are generally applicable to registered management investment companies, other than money market funds and small business investment companies, and to unit investment trusts operating as exchange-traded funds. Registrants offering multiple series must file a report for each series separately, even if some information is the same for two or more series.
2 Enhancing Risk Monitoring and Regulatory Safeguards for the Asset Management Industry, Chair Mary Jo White (Dec. 11, 2014), available at https://www.sec.gov/News/Speech/Detail/ Speech/1370543677722.
3 For the proposed changes to reporting by registered investment companies, see Investment Company Reporting Modernization, Securities Act Release No. 9776 (May 20, 2015), available at https://www.sec.gov/rules/proposed/2015/33-9776.pdf (the "Proposing Release"). For the proposed changes to reporting by registered investment advisers, see Amendments to Form ADV and Investment Advisers Act Rules, Investment Advisers Act Release No. 4091 (May 20, 2015), available at https://www.sec.gov/rules/proposed/2015/ia-4091.pdf (the "Advisers Proposing Release"). For a summary of the Proposing Release and Advisers Proposing Release, see our firm memorandum "SEC Proposes Rules to Modify Reporting Regime for Registered Investment Companies and Investment Advisers" (May 26, 2015), available at https://www.sullcrom.com/siteFiles/Publications/SC_Publication_SEC_Proposes_Rules_to_Modif y_Reporting_Regime_for_Registered_Investment_Companies_and_Investment_Advisers.pdf.
4 For the final changes to reporting by registered investment advisers, see Form ADV and Investment Advisers Act Rules, Investment Advisers Act Release No. 4509 (Aug. 25, 2016), available at https://www.sec.gov/rules/final/2016/ia-4509.pdf (the "Advisers Adopting Release").
5 Modernizing and Enhancing Investment Company and Investment Adviser Reporting, Chair Mary Jo White (Oct. 13, 2016), available at https://www.sec.gov/news/statement/white-statement-openmeeting-101316.html.
6 Investment Company Reporting Modernization, Securities Act Release No. 10231 (Oct. 13, 2016), available at https://www.sec.gov/rules/final/2016/33-10231.pdf (the "Adopting Release").
7 The Investment Company Act defines a "management company" as any investment company other than a face-amount certificate company or a unit investment trust. 15 U.S.C. 80a-4.
8 SBICs do not file reports on Form N-Q.
9 In rescinding Form N-Q, the SEC is amending the certification requirements of Form N-CSR. Form N-Q, filed by management investment companies (other than SBICs) at the end of a fund's first and third fiscal quarter, requires each principal executive officer and principal financial officer of the registrant to make certifications regarding (i) the accuracy of the fund's portfolio schedules for the most recent fiscal quarter and (ii) disclosures of changes in the registrant's internal control over financial reporting during the most recent fiscal quarter. Form N-CSR required similar disclosures, but for the second and fourth fiscal quarters. Therefore, rescission of Form N-Q eliminates those two certification requirements for the first and third fiscal quarters. To address this gap in certification coverage, Form N-CSR, as amended, requires each certifying officer to state that he or she has disclosed in the report any change in the registrant's internal control over financial reporting that occurred during the most recent fiscal half-year. Nevertheless, the amendment to Form N-CSR does not address certification as to the accuracy of portfolio schedules, which, under the amended requirements, will be made only for the second and fourth fiscal quarters. The compliance date for the amendments to the certification requirements of Form N-CSR will be June 1, 2018 for funds in complexes with net assets of $1 billion or more and June 1, 2019 for other funds. Form N-Q will be rescinded two months later on August 1, 2019.
10 Money market funds already file their monthly portfolio investments with the SEC. See Form N-MFP.
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11 Under the new rules, all ETFs will be required to file reports on Form N-PORT, regardless of their form of organization. The SEC noted that while most ETFs today are structured as open-end management investment companies, the eight extant ETFs organized as UITs that have registered with the Commission nevertheless represent a sizeable share of the ETF market by assets invested (the SEC estimates this share to be 12%), and have a significant number of investors whom the SEC believes could benefit from the disclosures required in Form N-PORT.
The SEC rejected the request of a commenter stating that funds should not be required to report information directly to the SEC on their own behalf, but that the SEC should instead require other entities such as transfer agents and custodians to report information on behalf of funds.
12 Information about "miscellaneous securities" (investment securities totaling 5% or less of the total value of the fund's portfolio, provided the securities are not restricted, have been held for not more than one year prior to the end of the reporting period covered by the report, and have not previously been reported by name to the shareholders of the fund or otherwise been made available to the public), country of risk and economic exposure determinations, and position level risk for individual options, warrants, and convertible securities will be kept non-public, even in the third month of a fiscal quarter.
13 Though Form N-PORT as proposed failed to specify whether funds should report their portfolio holdings as of the trade date ("T+0") or the trade date plus one day ("T+1"), the form as adopted instructs funds to report portfolio information on the same basis they use to calculate NAV, which is generally T+1.
14 The LEI is a unique identifier associated with a corporate entity and is intended to provide a uniform international standard for identifying counterparties to a transaction. The SEC and other regulators, including the CFTC and FSOC, have already begun to require disclosure of LEIs in other contexts, and the inclusion of the LEI on Form N-PORT is expected to "facilitate the linkage of data reported on Form N-PORT with data from other filings and sources that [are] or will be reported elsewhere as LEIs become more widely used by regulators and the financial industry."
15 For example, in the case of an option or warrant, Form N-PORT requires disclosure of the type (put, call), payoff profile (written, purchased), a description of the reference instrument, number of shares or principal amount of underlying reference instrument per contract, exercise price or rate, expiration date, delta (i.e., the ratio of the change in value of the option to the change in value of the reference instrument), and the unrealized appreciation or depreciation of the instrument.
The SEC has adopted a tiered reporting structure for derivatives with reference assets that are non-public indices or "custom baskets" of assets. When the notional value of investments in a non-public index or custom basket is below a de minimis threshold of 1% of NAV, the fund need only provide a narrative description of the index. When the notional amount of the derivative represents more than 1%, but less than 5%, of a fund's net assets, funds must report the top 50 components of the basket plus those components that exceed 1% of the notional value of the index. Finally, when the notional amount of the derivative with a non-public index or custom basket reference asset exceeds 5% of the fund's net assets, the fund must report every component of the index.
16 The Adopting Release states that "while there is no clear definition of `alternative' in the fund industry, an alternative fund is generally understood to be a fund whose primary investment strategy falls into one or more of the three following categories: (1) non-traditional asset classes (for example, currencies); (2) non-traditional strategies (such as long/short equity positions); and/or (3) less liquid assets (such as private debt)."
17 A BDC is a closed-end fund that is operated for the purpose of making investments in small and developing businesses and financially troubled businesses and that elects to be regulated as a BDC. See section 2(a)(48) of the Investment Company Act. BDCs are not subject to periodic reporting requirements under the Investment Company Act, although they must comply with periodic reporting requirements under the Exchange Act.
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18 For open options contracts and open swaps contracts, funds need not disclose the counterparty to exchange-traded or centrally cleared options and swaps. Moreover, in the case of open option and swap contracts with an underlying reference asset that is an index or basket of investments for which components are publicly available on a website as of the fund's balance sheet date, or if the notional amount of the investment does not exceed 1% of the fund's NAV as of the close of the period, the fund need only provide information sufficient to identify the reference asset. However, where the reference asset is an index or custom basket the components of which are not publicly available on a website as of the balance sheet date and the notional amount of the derivative represents more than 1% of the NAV of the fund as of the close of the period, the fund will be required to provide a description of the index or custom basket and list separately (i) the fifty largest components in the index or custom basket and (ii) any other components where the notional value for that component is over 1% of the notional value of the index or custom basket. This approach stands in contrast to the tiered reporting structure adopted for derivatives on Form N-PORT.
19 See page 162 of the Adopting Release.
20 Currently, funds must categorize investments in securities of unaffiliated issuers by (i) type and (ii) related industry, related country, or geographic region.
21 As proposed, the amendments to Regulation S-X would have required funds to identify each issue of illiquid securities as well. However, given the portfolio-level liquidity reporting required on Form N-PORT, the SEC chose not to adopt the amendment as proposed, and funds will not be required to identify illiquid securities pursuant to Regulation S-X.
22 See rule 12-14, Columns C and D of Regulation S-X; see also section 2(a)(3)(A) of the Investment Company Act (defining an "affiliated person" as "any person directly or indirectly owning, controlling, or holding with power to vote, 5 per centum or more of the outstanding voting securities of such other person.").
23 The Adopting Release includes a chart, beginning at page 299, summarizing which items in the current Form N-SAR are included, without change or in modified form, or removed from Form NCEN.
24 Item B.8 of Form N-CEN requires that management companies report each director's name, whether he or she is an "interested person" (as defined by section 2(a)(19) of the Investment Company Act), and the Investment Company Act file number of any other registered investment company for which he or she serves as a director. In addition, the SEC will also require, in a modification from the proposal, that the fund report the CRD number, a central licensing and registration system number issued by the Financial Industry Regulatory Authority (if any) for each director.
25 Management companies will be required to report annually whether any borrower of securities failed to return the loaned securities by the contractual deadline with the result that the fund (or its securities lending agent) liquidated collateral pledged to secure the loaned securities or that the fund was otherwise adversely impacted during the reporting period (including, sustaining (1) a loss to the fund if collateral and indemnification were not sufficient to replace the loaned securities or their value, (2) the fund's ineligibility to vote shares in a proxy, or (3) the fund's ineligibility to receive a direct distribution from the issuer). In addition, management companies will be required to report whether they exercised their indemnification rights during the reporting period.
26 As defined by Form N-CEN, Exchange-Traded Funds and Exchange-Traded Managed Funds are similar, except that the shares of Exchange-Traded Funds are listed and traded on a national securities exchange at market prices, whereas the shares of Exchange-Traded Managed Funds are listed and traded on a national securities exchange at NAV-based prices.
27 For purposes of Form N-CEN, "authorized participant" is defined as "a broker-dealer that is also a member of a clearing agency registered with the Commission or a [Depository Trust Company] Participant, and which has a written agreement with the Exchange-Traded Fund or Exchange-
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ENDNOTES (CONTINUED) Traded Managed Fund or one of its designated service providers that allows the authorized participant to place orders to purchase or redeem creation units of the Exchange-Traded Fund or Exchange-Traded Managed Fund." 28 The SEC adopted these disclosure requirements as amendments to the fund registration forms (N-1A and N-3) and reports on Form N-CSR (for closed-end funds only), rather than as amendments to Regulation S-X, as initially proposed, in response to commenters who raised concerns about costs and asserted that lengthy disclosure of securities lending activity in a fund's financial statements could detract from other financial statement disclosures. 29 In an effort to enhance comparability, the new rules enumerate specifically which fees should be disclosed and what those fees should include rather than requiring, as proposed, disclosure of all fees and/or compensation paid for securities lending and related services without specifying which fees should be disclosed. Fees to be disclosed include (i) fees paid to securities lending agents from a revenue split; (ii) fees paid for any cash collateral management service (including fees deducted from a pooled cash collateral reinvestment vehicle) that are not included in the revenue split; (iii) administrative fees not included in the revenue split; (iv) indemnification fees not included in the revenue split; (v) borrower rebates; and (vi) other fees not included in the revenue split. The list of specific fees enumerated is adopted from the list of payments required to be reported by Form N-CEN.
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