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SECURITIES AND EXCHANGE COMMISSION17 CFR Parts 210, 239, 249, 270, and 2747 [Release Nos. 33-8164; 34-47023; IC-25870; File No. S7-51-02] RIN 3235-AG64 Shareholder Reports and Quarterly Portfolio Disclosure of Registered Management Investment Companies Agency: Securities and Exchange Commission Action: Proposed rule Summary: The Securities and Exchange Commission is proposing rule and form amendments under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Company Act of 1940 to improve the periodic disclosure provided by registered management investment companies about their portfolio investments, costs, and past performance. The proposed amendments would permit a registered management investment company to include a summary portfolio schedule of investments in its reports to shareholders, provided that the complete schedule is filed with the Commission and is provided to shareholders upon request, free of charge. The proposals also would require a registered management investment company to include a tabular or graphic presentation of its portfolio holdings in its reports to shareholders. In addition, the proposed amendments would require a registered management investment company to disclose its complete portfolio schedule on a quarterly basis in filings with the Commission that would be available on the Commission's Electronic Data Gathering, Analysis, and Retrieval System. The proposed amendments also would require a registered open-end management investment company to include in its shareholder reports disclosure of fund expenses borne by shareholders during the reporting period. Finally, the proposals would require a registered open-end management investment company to include Management's Discussion of Fund Performance in its annual report to shareholders. Dates: Comments must be received on or before February 14, 2003. Addresses: To help us process and review your comments more efficiently, comments should be sent by hard copy or electronic mail, but not by both methods. Comments sent by hard copy should be submitted in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. Comments also may be submitted electronically at the following E-mail address: rule-comments@sec.gov. All comment letters should refer to File No. S7-51-02; this file number should be included in the subject line if electronic mail is used. Comment letters will be available for public inspection and copying in the Commission's Public Reference Room, 450 Fifth Street, NW, Washington, DC 20549. Electronically submitted comment letters also will be posted on the Commission's Internet website (http://www.sec.gov).1 For Further Information Contact: David S. Schwartz, Senior Counsel, or Paul G. Cellupica, Assistant Director, Office of Disclosure Regulation, Division of Investment Management, (202) 942-0721, at the Securities and Exchange Commission, 450 Fifth Street NW, Washington, DC 20549-0506. Supplementary Information: The Securities and Exchange Commission (the "Commission") is proposing for comment new rule 30b1-4 [17 CFR 270.30b1-4] and new Form N-Q [17 CFR 274.129] under the Investment Company Act of 1940 [15 U.S.C. 80a-1 et seq .] ("Investment Company Act"); amendments to Forms N-1A [17 CFR 239.15A; 17 CFR 274.11A], N-2 [17 CFR 239.14; 17 CFR 274.11a-1], and N-3 [17 CFR 239.17; 17 CFR 274.11b] under the Investment Company Act and the Securities Act of 1933 [15 U.S.C. 77a et seq.] ("Securities Act"); amendments to proposed Form N-CSR [17 CFR 249.33; 17 CFR 274.128] under the Investment Company Act and the Securities Exchange Act of 1934 [15 U.S.C. 78a et seq. ] ("Exchange Act"); and amendments to Article 6 [17 CFR 210.6] and Article 12 [17 CFR 210.12] of Regulation S-X [17 CFR 210]. Executive SummaryWe are proposing rule and form amendments that would:
These proposed amendments are intended to provide better information to investors about fund investments, costs, and performance. I. BackgroundThe Investment Company Act and rules thereunder require each fund to transmit a report to its shareholders semi-annually, within 60 days of the end of the period for which the shareholder report is made, and to file the report with the Commission no later than 10 days after it is transmitted to shareholders.4 Reports to shareholders currently are required to contain financial statements and other financial information,5 as well as information about the fund's officers and directors.6 Annual reports to shareholders of mutual funds typically also contain Management's Discussion of Fund Performance ("MDFP"), although they are not required to do so.7 MDFP includes narrative disclosure of the factors that materially affected the fund's performance during the fiscal year, a line graph comparing the fund's performance over 10 years to that of an appropriate broad-based market index, and a table of the fund's average annual total returns for 1-, 5-, and 10-year periods. Shareholder reports are one of the principal means by which funds provide periodic information to their investors. Fund shareholder reports historically have served primarily as a vehicle to provide financial statements and other financial information to shareholders.8 We believe that, with some modifications, fund shareholder reports could become a more effective vehicle for communicating information to investors. Today's proposals principally address disclosure of fund portfolio holdings and expenses, two significant areas for improvement that have been identified by investor groups, members of the fund industry, and others. A. Disclosure of Fund Portfolio HoldingsCurrently, funds are required to include their complete portfolio holdings in the reports that are delivered to all shareholders twice a year.9 Investor groups, members of the fund industry, and others have suggested ways in which this current disclosure regime could be improved, both by making the portfolio schedule that is required to be delivered to investors more streamlined, useful, and understandable and by increasing the frequency with which funds disclose their entire portfolio holdings. First, some have argued that permitting funds to include a summary portfolio schedule in lieu of a complete portfolio schedule in their shareholder reports would simplify those reports, enable investors to focus on a fund's principal holdings, and thereby better evaluate the fund's risk profile and investment strategy.10 At the same time, the fund's full portfolio schedule could remain available, upon request, to those investors who find this information useful. Because of its size or investment strategy, a fund may hold securities in hundreds, or even thousands, of portfolio companies, which may require as many as 35 or 40 pages to list. For many funds, such as index funds, providing a lengthy portfolio schedule may not contribute significantly to investor understanding regarding the fund's primary investment focus. It may, however, result in significant printing and mailing costs, which are ultimately borne by investors. Similarly, because of the high turnover of portfolio holdings by money market funds, and the fact that money market funds' portfolios are circumscribed by the credit quality, maturity, and portfolio diversification requirements of rule 2a-7 under the Investment Company Act, some have also argued that such funds should be exempt from the requirement to list portfolio holdings in their reports to shareholders.11 Advocates of this position have asserted that investors would be better served if fund shareholder reports contained a summary portfolio schedule listing a fund's most significant holdings, coupled with a chart, table, graph, or other graphical presentation breaking down a fund's investments by category. For example, a domestic equity fund might provide a graphical presentation that shows its portfolio investments broken down by industry sector, while a corporate or municipal bond fund might present its holdings broken down by credit quality or maturity. Second, others have argued that investors would benefit if funds were required to disclose their complete portfolio schedules more frequently than semi-annually. The Commission has received six rulemaking petitions in the past several years that advocate more frequent disclosure of funds' portfolio holdings.12 The petitioners argue that increasing the frequency of portfolio disclosure by funds will allow investors to better monitor the extent to which their funds' portfolios overlap, and hence will enable investors to make more informed asset allocation decisions. In addition, the petitioners argue that more frequent disclosure would expose "style drift" (when the actual portfolio holdings of a fund deviate from its stated investment objective) and provide investors with greater information about how a fund is complying with its stated investment objective. The petitioners also argue that more frequent disclosure would help to shed light on and prevent several potential forms of portfolio manipulation. These include "window dressing" (buying or selling portfolio securities shortly before the date as of which a fund's holdings are publicly disclosed, in order to convey an impression that the manager has been investing in companies that have had exceptional performance during the reporting period) and "portfolio pumping" (buying shares of stocks the fund already owns on the last day of the reporting period, in order to drive up the price of the stocks and inflate the fund's performance results). Those who seek more frequent portfolio disclosure advocate that this information be made readily available to shareholders, not that the information be separately delivered to each fund shareholder. B. Disclosure of Fund ExpensesPotential mutual fund investors receive significant disclosure about fund fees and expenses. Since 1988, the Commission has required the mutual fund prospectus to include a fee table that shows all fees and charges associated with a mutual fund investment as a percentage of net assets.13 In addition, the Commission has undertaken efforts to educate investors about the significance of the costs that they pay in connection with mutual fund investments. In 1999, for example, the Commission introduced the Mutual Fund Cost Calculator, an Internet-based tool available on the Commission's website that enables investors to compare the costs of owning different funds.14 In addition, the fund industry has undertaken efforts to educate investors and increase their awareness and understanding of mutual fund fees.15 Despite existing disclosure requirements and educational efforts, the degree to which investors understand mutual fund fees and expenses remains a significant source of concern. Mutual fund fees are of two types, transactional (e.g., sales loads, redemption fees) and ongoing (e.g., asset-based charges such as management fees and 12b-1 fees).16 While transactional fees are relatively transparent, ongoing fees are less evident because they are deducted from fund assets and are reflected in reduced account balances rather than being separately stated. Significant concerns have been raised regarding the degree to which investors understand the nature and effect of these ongoing fees.17 A joint report of the Commission and the Office of the Comptroller of the Currency, for example, found that fewer than one in five fund investors could give any estimate of expenses for their largest mutual fund and fewer than one in six fund investors understood that higher expenses can lead to lower returns.18 These ongoing fees can have a dramatic effect on an investor's return. A 1% annual fee, for example, will reduce an ending account balance by 18% on an investment held for 20 years. In an important contribution to the public dialogue on fund fees, the United States General Accounting Office ("GAO") issued a report in 2000, prepared pursuant to a request by Representative Michael G. Oxley, then Chairman of the Subcommittee on Finance and Hazardous Materials, House Committee on Commerce, and Representative John D. Dingell, Ranking Member of the Committee on Commerce, that analyzed mutual fund fees and the market forces that influence those fees.19 The report's principal conclusion was that additional disclosure could help to increase investor awareness and understanding of mutual fund fees and, thereby, promote additional competition among funds on the basis of fees.20 The GAO Report asserted that although mutual funds do not provide individual shareholders with information on the specific dollar amount of fees paid on their account statements, most other financial products and services (e.g., bank deposit accounts, stock or bond transactions through a securities broker) are required to make such disclosures, and that these disclosures may be one reason for the apparently vigorous price competition among firms offering these other products and services.21 The GAO Report therefore recommended that the Commission require funds to provide each investor with an exact dollar figure for fees paid in each quarterly account statement. However, the GAO Report acknowledged the potential costs associated with accounting for, and reporting, costs on an individual basis and encouraged the Commission to consider the cost and burden that various alternative means of making such disclosures would impose on the industry and investors. The GAO specifically discussed less costly alternatives, including providing the dollar amount of fees paid for preset investment amounts, such as $1,000, which investors could use to estimate the amount that they paid on their own accounts. In December 2000, the Commission staff issued a report on mutual fund fees and expenses ("Commission Staff Report"), which considered, among other issues, the recommendations in the GAO Report, and concluded that disclosure of the dollar amount of fees paid for a preset investment amount would likely have the most favorable trade-off between costs and benefits.22 The Commission Staff Report recommended requiring mutual funds to include in shareholder reports the cost in dollars associated with an investment of $10,000 that earned the fund's actual return for the period and incurred the fund's actual expenses for the period. Coupled with an investor's average account balance over the period, this would permit an individual investor to estimate the dollar costs that he or she incurred during the period. The staff also recommended that mutual funds disclose the cost in dollars, based on the fund's actual expenses, associated with an investment of $10,000 that earned a standardized return (e.g., 5%) for the period. This would permit investors to compare the relative magnitudes of the ongoing costs of different funds. * * * Today's proposals address these important issues. They are intended to improve the information disclosed to investors about a fund's investments, by enhancing and streamlining the information provided in reports to shareholders about a fund's portfolio holdings and by requiring funds to disclose their portfolio holdings quarterly rather than semi-annually. In addition, our proposals are targeted at heightening investors' understanding of ongoing fund fees and expenses. II. DiscussionA. Disclosure of Portfolio HoldingsThe Commission is proposing rule and form amendments that would: (1) permit a fund to include a summary portfolio schedule in its reports to shareholders, provided that the complete portfolio schedule is filed with the Commission semi-annually on proposed Form N-CSR and is provided to shareholders upon request, free of charge; (2) exempt money market funds from including a portfolio schedule in reports to shareholders, provided that this information is filed with the Commission on proposed Form N-CSR and is provided to shareholders upon request, free of charge; (3) require reports to shareholders to include a tabular or graphic presentation of a fund's portfolio holdings by identifiable category; and (4) require a fund to file its complete portfolio schedule as of the end of its first and third fiscal quarters with the Commission on new proposed Form N-Q. Together, these proposals would replace a one-size-fits-all approach to portfolio holdings disclosure, where all funds deliver their full portfolio schedules to all their shareholders twice a year, with a "layered" approach that would make more information available while permitting funds to tailor their shareholder reports to their particular circumstances and investors to tailor the amount of information they receive to meet their particular needs.23 This "layered" approach is intended to result in the availability of enhanced portfolio information at reduced cost. 1. Summary Portfolio ScheduleWe are proposing to permit funds to include in their reports to shareholders a summary portfolio schedule, in lieu of a complete portfolio schedule. The complete portfolio schedule would, however, continue to be available, free of charge, to those investors who are interested in this more detailed information. Our proposal is intended to address concerns that the current requirement for a fund to include in its shareholder reports a schedule that lists all investments held by the fund results, in many cases, in long lists of securities that do not provide meaningful information to most investors, and in substantial printing and mailing costs that are borne by fund investors.24 Permitting funds to provide a summary portfolio schedule in lieu of a complete portfolio schedule in required reports to shareholders could streamline these reports and help investors to focus on a fund's principal holdings, and thereby better evaluate the fund's risk profile and investment strategy. Our proposed amendments to Regulation S-X would permit a fund to include in its reports to shareholders a summary portfolio schedule, Schedule VI - Summary schedule of investments in securities of unaffiliated issuers, in lieu of the full schedule contained in Schedule I - Investments in securities of unaffiliated issuers .25 The proposed summary portfolio schedule would include - in order of descending value - each of the fund's 50 largest holdings in unaffiliated issuers and each investment that exceeds one percent of the fund's net asset value. For purposes of determining whether the value of a security exceeds one percent of net asset value, a fund would be required to aggregate and treat as a single issue all securities of any one issuer. However, each issue would be required to be listed separately in the schedule, whether or not issued by a single issuer. Restricted securities could not be combined with unrestricted securities of the same issuer.26 All securities not separately listed in the summary schedule would be required to be listed in a category labeled "Other Securities."27 Funds would continue to be required to include in their reports to shareholders the other schedules currently required by Regulation S-X.28 We are recommending that the summary portfolio schedule include the fund's 50 largest holdings and each investment that exceeds one percent of net assets, because we believe that this would result in inclusion of the most significant portfolio holdings information in shareholder reports.29 However, we note that if funds were required to disclose a somewhat higher number of securities, such as 150, this could result in a significant majority of funds including their complete schedules in their shareholder reports, while still allowing the minority of funds with lengthy portfolio schedules to limit their portfolio disclosure to two or three printed pages. We estimate that as of October 2002, almost 75% of all funds had portfolio holdings exceeding 50 securities, but only 25% of all funds had portfolio holdings exceeding 150 securities, and fewer than 10% of all funds had portfolio holdings exceeding 350 securities.30 The format of our proposed summary portfolio schedule would be similar to that of the complete schedule of investments in unaffiliated issuers currently contained in reports to shareholders. Thus, with respect to each issue required to be listed, the schedule would show (1) the name of the issuer and title of the issue; (2) the balance held at the close of the period (i.e., the number of shares or the principal amount of bonds and notes); and (3) the value of each item at the close of the period.31 Unlike the complete schedule, however, the summary schedule would also show the percentage value of the issue compared to net assets.32 The summary schedule would also show the total value of all investments in securities of unaffiliated issuers.33 Because the proposed summary portfolio schedule would require investments to be listed in order of descending value, the requirement in the complete portfolio schedule that investments be listed separately by type (e.g., common shares, preferred shares, bonds and notes, time deposits, and put and call options purchased) would be inapplicable.34 However, the proposals would require each type of instrument to be identified by an appropriate symbol or footnote.35 As with the current requirements for disclosure of the complete portfolio schedule, the summary schedule would require funds to identify by appropriate symbols each issue of securities that is non-income producing, each issue of securities held in connection with open put or call option contracts or loans for short sales, and each issue of restricted securities.36 Short-term debt instruments of the same issuer (with disclosure indicating the range of interest rates and maturity dates), and fully collateralized repurchase agreements (with footnote disclosure indicating the range of dates of the repurchase agreements, the total purchase price of the securities, the total amount to be received upon repurchase, the range of repurchase dates, and a description of the securities subject to the repurchase agreements) would be required to be aggregated and treated as a single issue.37 As in the current complete schedule, a fund also would be required to state in a footnote to the summary schedule the following amounts based on cost for Federal income tax purposes: (i) aggregate gross unrealized appreciation for all securities in which there is an excess of value over tax cost; (ii) aggregate gross unrealized depreciation for all securities in which there is an excess of tax cost over value; (iii) net unrealized appreciation and depreciation; and (iv) the aggregate cost of securities for Federal income tax purposes.38 To ensure that shareholders have continued access to a complete schedule of the fund's portfolio holdings, any fund that uses a summary portfolio schedule would be required to file its complete portfolio schedule with the Commission on proposed Form N-CSR, which would be available on the Commission's Electronic Data Gathering, Analysis, and Retrieval System ("EDGAR").39 In addition, any fund that uses a summary portfolio schedule would be required to send its complete schedule of investments in securities of unaffiliated issuers to shareholders upon request within three business days of receipt of the request, by first-class mail or other means designed to ensure equally prompt delivery, and to disclose in its reports to shareholders that this complete portfolio schedule is available (i) without charge, upon request, by calling a specified toll-free (or collect) telephone number; (ii) on the fund's website, if applicable; and (iii) on the Commission's website.40 We believe that permitting the use of a summary portfolio holdings schedule potentially could enable funds to provide more meaningful information in their annual and semi-annual reports to shareholders, and encourage investors to focus on a fund's most significant holdings in evaluating its risk profile and investment strategy. In addition, the costs of printing and mailing of shareholder reports should be reduced. At the same time, the proposals would require that the fund's complete portfolio schedule continue to be readily available, without charge, to shareholders who are interested in this information, and that the fund provide disclosure in its reports to shareholders of how this information may be obtained. This "layered" disclosure approach is intended to enable investors with varying degrees of interest in a fund's portfolio holdings to easily obtain the desired level of information about the fund. Thus, the proposals attempt to strike a balance that would result in maximum availability of information in a useful format and at minimum cost. We request comment on our proposal to permit funds to deliver a summary portfolio schedule in their reports to shareholders and specifically on the following issues.
2. Exemption of Money Market Funds from Portfolio Schedule Requirements in Shareholder ReportsWe are proposing to permit money market funds to omit Schedule I, the schedule of investments in securities of unaffiliated issuers, from their reports to shareholders, provided that they make this schedule available to shareholders upon request and free of charge, and disclose the availability of the schedule in their reports to shareholders.43 Currently, money market funds, like other funds, are required to include their portfolio schedules in the shareholder reports that are delivered to all investors. The investments of money market funds are, however, circumscribed by the credit quality, maturity, and portfolio diversification requirements of rule 2a-7 under the Investment Company Act.44 Portfolio holdings schedules of money market funds typically contain a list of short-term government and corporate debt securities that may not assist the average investor in evaluating the money market fund, or in distinguishing one money market fund from another. Moreover, investors generally treat money market funds as cash investments, and therefore may be less interested in the composition of money market fund portfolios than other types of funds. Our proposals would require money market funds to file their complete portfolio holdings schedules semi-annually with the Commission on proposed Form N-CSR, however, so that complete information about their portfolios would remain available to interested investors.45 We also are proposing to require any money market fund that does not include its complete portfolio schedule in its reports to shareholders to disclose in its shareholder reports that its complete schedule of investments in unaffiliated issuers is available (i) without charge, upon request, by calling a specified toll-free (or collect) telephone number; (ii) on the fund's website, if applicable; and (iii) on the Commission's website at http://www.sec.gov.46 The proposals also would require a money market fund to send its complete schedule of investments in securities of unaffiliated issuers within three business days of receipt of the request, by first-class mail or other means designed to ensure equally prompt delivery.47 We request comment generally on whether money market funds should be permitted to omit their portfolio schedules from reports to shareholders and specifically on the following issues.
3. Tabular or Graphic Presentation of Portfolio HoldingsWe also are proposing to require funds to include in their annual and semi-annual reports to shareholders a presentation using tables, charts, or graphs that depicts a fund's portfolio holdings by reasonably identifiable categories (e.g., industry sector, geographic region, credit quality, or maturity).49 This presentation would show the percentage of net asset value attributable to each category. We believe that such a presentation could illustrate, in a concise and user-friendly format, the allocation of a fund's investments across asset classes. We believe that this presentation, coupled with a summary portfolio schedule, has the potential to effectively convey to investors key information about a fund's investments. Particularly in the case of a fund with a large number of holdings, the combination of a summary portfolio schedule and a tabular or graphic asset allocation presentation could be significantly more useful to many investors than the fund's complete portfolio schedule standing alone. Under our proposals, a fund would have the flexibility to determine both the categories to be used (e.g., industry sector, geographic region, credit quality, maturity, etc.) and the format (e.g., tables, charts, graphs, etc.) of the presentation. The categories should be selected, and the format of the presentation designed, to provide the most useful information to investors about the types of investments made by the fund, given its investment objectives. For example, a domestic equity fund could choose to categorize its investments by attributes such as industry sector, market capitalization, or price-earnings ratio. A bond fund could choose to categorize its investments by attributes such as credit quality or maturity or government versus non-government securities.50 Permitting a fund to determine the most useful means of presenting this portfolio information would allow each fund to tailor the presentation in a manner that is appropriate to its holdings. Further, over time, this flexible approach could enable both funds and the Commission to determine whether certain types of presentations are more effective for different types of funds. We request comment generally on the appropriateness of the proposed tabular or graphic presentation of fund holdings.
4. Quarterly Filing of Complete Portfolio ScheduleWe propose to require funds to file their complete portfolio holdings schedules with the Commission on a quarterly basis, rather than semi-annually as currently required. As described above, funds would be required to file their complete portfolio schedules for the second and fourth fiscal quarters on proposed Form N-CSR.52 In addition, funds would be required to file their portfolio schedules for the first and third fiscal quarters on new Form N-Q under the Investment Company Act, within 60 days of the end of the quarter.53 Form N-Q would require funds to file the same schedules of investments that are currently required in annual and semi-annual reports to shareholders. These schedules could be unaudited.54 Form N-Q would be a reporting form required under the Investment Company Act only, unlike proposed Form N-CSR, which is a combined Exchange Act and Investment Company Act form.55 Form N-Q would be required to be signed by the fund, and on behalf of the fund by its principal financial officer or officers.56 Our proposals are intended to provide greater transparency of fund portfolio holdings, without imposing significant costs on funds and, ultimately, their shareholders. The proposals would enable interested investors, through more frequent access to portfolio information, to monitor whether, and how, a fund is complying with its stated investment objective. Given the significant interest in more frequent portfolio information that has been expressed in rulemaking petitions to the Commission by investors groups and others,57 we believe that it is appropriate to propose more frequent portfolio reporting by funds for public comment at this time. We note, however, that the proposals would only require the filing of a fund's portfolio schedule on Form N-Q with the Commission on EDGAR and not actual delivery of that information to shareholders. A fund would be required to include in its annual and semi-annual reports to shareholders a statement that: (i) the fund files its complete schedule of portfolio holdings with the Commission for the first and third quarters of each fiscal year on Form N-Q; (ii) the fund's Forms N-Q are available on the Commission's website at http://www.sec.gov; (iii) the fund's Forms N-Q may be reviewed and copied at the Commission's Public Reference Room, and how information on the operation of the Public Reference Room may be obtained; and (iv) if the fund makes the information on Form N-Q available to shareholders on its website or upon request, a description of how the information may be obtained from the fund.58 This proposal is intended to strike an appropriate balance between investors' interest in more frequent portfolio information and the costs associated with disclosing and making that information available to investors, which are ultimately borne by investors. We are cognizant of concerns raised by some members of the fund industry that mandating more frequent portfolio disclosure would harm fund shareholders by expanding the opportunities for professional traders to exploit this information by engaging in predatory trading practices, such as trading ahead of funds, often called "front-running."59 They assert that more frequent portfolio disclosure would facilitate the ability of outside investors to "free ride" on a mutual fund's investment strategies, by obtaining for free the benefits of fund research and investment strategies that are paid for by fund shareholders.60 At this time, we are not persuaded that these concerns are significant enough to prevent our proposal from being put forward for public comment. We have endeavored to address those concerns by proposing a 60-day delay for the filing of the required additional quarterly disclosure. We believe that a 60-day filing delay would limit the ability of professional traders to engage in these harmful trading practices. In this regard, we note that a significant majority of funds already make their full portfolio schedules publicly available at least quarterly, apparently without concern about predatory trading practices.61 We also note that currently, fund managers and other institutional investment managers exercising investment discretion over $100 million or more in certain equity securities must disclose information about portfolios that they manage on Form 13F within 45 days of the end of each quarter.62 Reports on Form 13F disclose a fund manager's aggregate holdings in each security required to be reported; the holdings of each individual mutual fund or other account over which an investment manager has discretion are not broken out separately.63 To the extent that required quarterly disclosure about a fund's portfolio investments raises concerns about predatory trading practices, these concerns are not new, since fund portfolio holdings have been disclosed on Form 13F, aggregated by investment manager, since 1979.64 We request comment generally on whether more frequent portfolio holdings disclosure should be required and specifically on the following issues.
B. Disclosure of Fund ExpensesWe are proposing to require mutual funds to disclose in their reports to shareholders fund expenses borne by shareholders during the reporting period. Fund shareholder reports would be required to include: (1) the cost in dollars associated with an investment of $10,000, based on the fund's actual expenses and return for the period; and (2) the cost in dollars, associated with an investment of $10,000, based on the fund's actual expenses for the period and an assumed return of 5 percent per year.65 The first figure is intended to permit investors to estimate the actual costs, in dollars, that they bore over the reporting period. The second figure is intended to provide investors with a basis for comparing the level of current period expenses at different funds. Together, the two expense figures in the proposed example are designed to increase investor understanding of the fees that they pay on an ongoing basis for investing in a fund. The proposed disclosure in shareholder reports would supplement the fee disclosure required in the mutual fund prospectus. Funds are currently required to include in their prospectuses a fee table that includes, as a percentage of fund assets, all fees and charges associated with a mutual fund investment.66 The fee table reflects both (1) charges paid directly by a shareholder out of his or her investment, such as front- and back-end sales loads, and (2) recurring charges deducted from fund assets, such as management and 12b-1 fees.67 The fee table is accompanied by a numerical example that illustrates the aggregate expenses that an investor could expect to pay over time on a $10,000 investment if he or she received a 5 percent annual return and remained in the fund for 1-, 3-, 5-, and 10-year periods. The numbers that we are proposing be disclosed in mutual fund shareholder reports are intended to provide information to investors about actual current period expenses. This disclosure would respond to concerns that have been raised regarding the degree to which investors understand the nature and effect of these ongoing fees.68 While some have advocated that this information should be provided on an individualized basis in shareholder account statements, our proposals are intended to strike an appropriate balance between investors' need for this information and the costs and burdens that would be associated with providing this information on an individualized basis. The methodology for calculation of the proposed fee disclosure would be similar to that required for the expense example in the fee table of the mutual fund prospectus, with modifications to reflect the fact that the example in shareholder reports is intended to reflect actual historical expenses borne by an investor, rather than hypothetical future expenses. In determining its actual operating expenses during the reporting period, a fund would be required to include all expenses that are deducted from its assets or charged to all shareholder accounts, including management fees, distribution (12b-1) fees, and other expenses.69 The example would not reflect any exchange fees, redemption fees, or sales charges (loads).70 Our proposal would require a fund to use its actual operating expenses (after expense reimbursement or fee waiver arrangements that reduced expenses) for the reporting period in calculating the example.71 Expenses that would be deducted from the fund's assets for the purposes of the required example would be the amounts shown as expenses in the fund's statement of operations.72 If there were any increases or decreases in fund operating expenses that occurred during the reporting period (or that occurred or would be expected to occur during the current fiscal year) that would have materially affected the information in the example had those changes been in place throughout the reporting period, the fund would be required to restate in a footnote to the example the expense information using the current fees as if they had been in effect throughout the entire reporting period.73 Account fees that are collected by more than one fund would be required to be allocated among the funds in proportion to the relative average net assets.74 The example would assume the reinvestment of all dividends and distributions.75 The proposed numerical expense disclosure would be accompanied by a prescribed narrative explanation.76 The narrative would explain that mutual funds charge both transaction costs and ongoing costs and that the example is intended to help a shareholder understand his or her ongoing costs and to compare these costs with the ongoing costs of investing in other mutual funds. The narrative also would explain the assumptions used in the example, note that the example does not reflect any transactional costs, and caution that the example is useful in comparing ongoing costs but not total costs of different funds. A fund would be permitted to modify the narrative explanation if the narrative contained comparable information to that prescribed, and a fund could eliminate any part of the narrative that is inapplicable.77 For example, a fund that did not charge loads could omit the statement that the example does not reflect loads. As an alternative to our proposed approach, we considered the recommendation of the GAO Report that the Commission require mutual funds to provide each investor with an exact dollar figure for expenses paid in each quarterly account statement that the investor receives.78 The GAO Report's alternative would have the benefit of providing cost disclosure tailored to each investor. However, we have concerns about the cost and logistical complexity that this requirement might entail.79 Mutual fund expenses are charged against fund assets and are not currently accounted for on an individual account basis. Moreover, in many cases fund shares are held by broker-dealers, financial advisers, and other third-party financial intermediaries, which must prepare accurate and timely customer account statements by integrating data supplied by many unrelated fund groups. In addition to the systems changes necessary for the fund itself, these financial intermediaries would need to implement new systems in order to calculate and report personalized expense information for each fund held in an account each quarter. Because we believe that the costs of requiring this expense disclosure in quarterly account statements may outweigh the benefits, we determined that it would be more appropriate to propose including additional expense information in shareholder reports.80 We request comment generally on our proposal to require mutual funds to include in reports to shareholders the dollar cost associated with a $10,000 investment and specifically on the following issues.
C. Management's Discussion of Fund Performance ("MDFP")We are proposing to require that MDFP, which is currently required for all mutual funds other than money market funds, be included in annual reports to shareholders.82 Currently, a mutual fund is required to include MDFP in its prospectus unless the information is included in the fund's latest annual report to shareholders.83 At the time we adopted MDFP, our authority to directly require information in annual reports was circumscribed.84 Mutual funds, however, typically include MDFP in their annual reports, and we believe that requiring MDFP to be included in the annual report would aid investors in assessing the fund's performance over the prior year, and would fit naturally with other "backward looking" information contained in the annual report, such as the fund's financial statements. We now have broad authority to prescribe the content of shareholder reports, and we propose to require MDFP in annual reports to shareholders.85 We wish to remind funds of their obligation to use MDFP to provide a complete and accurate discussion of the factors that affected fund performance over the past year. In its integrated reviews of mutual fund prospectuses and shareholder reports, the staff has identified instances where MDFP has provided insufficient substantive discussion of the factors that affected the fund's performance during the most recent fiscal year.86 The Commission has asked the staff, in its review of a fund's disclosure documents, to continue to focus on areas where funds' MDFP disclosure has been deficient. We expect that our proposed revisions to shareholder reports, coupled with improved MDFP disclosure by funds, should enhance the usefulness of shareholder reports and result in improved disclosure by funds about their operations. We request comment generally on our proposal to require mutual funds to include MDFP in their annual reports to shareholders.
D. Compliance DateIf we adopt the proposed amendments, we would expect to require all fund reports to shareholders filed for periods ending on or after the effective date of the amendments to comply with the proposed amendments. In addition, we would expect to require funds to file quarterly reports on Form N-Q with respect to any fiscal quarter ending on or after the effective date. The Commission requests comment on these proposed compliance dates. III. General Request For CommentsThe Commission requests comment on the amendments proposed in this release, whether any further changes to our rules or forms are necessary or appropriate to implement the objectives of our proposed amendments, and on other matters that might have an effect on the proposals contained in this release. IV. Paperwork Reduction ActCertain provisions of the proposed amendments contain "collection of information" requirements within the meaning of the Paperwork Reduction Act of 1995 [44 U.S.C. 3501, et seq.], and the Commission is submitting the proposed collections of information to the Office of Management and Budget ("OMB") for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The titles for the collections of information are: (1) "Form N-1A under the Investment Company Act of 1940 and Securities Act of 1933, Registration Statement of Open-End Management Investment Companies"; (2) "Form N-2 - Registration Statement of Closed-End Management Investment Companies"; (3) "Form N-3 - Registration Statement of Separate Accounts Organized as Management Investment Companies"; (4) "Form N-CSR - Certified Shareholder Report of Registered Management Investment Companies"; (5) "Rule 30e-1 under the Investment Company Act of 1940, Reports to Stockholders of Management Companies"; and (6) "Form N-Q - Quarterly Schedule of Portfolio Holdings of Registered Management Investment Company." An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid OMB control number. Form N-1A (OMB Control No. 3235-0307), Form N-2 (OMB Control No. 3235-0026), and Form N-3 (OMB Control No. 3235-0316) were adopted pursuant to Section 8(a) of the Investment Company Act [15 U.S.C. 80a-8] and Section 5 of the Securities Act [15 U.S.C. 77e]. We issued a release proposing Form N-CSR on August 30, 2002 [67 FR 57298 (Sept. 9, 2002)], pursuant to Section 30 of the Investment Company Act [15 U.S.C. 80a-8] and Sections 13 and 15(d) of the Exchange Act [15 U.S.C. 78m and 78o(d)]. We proposed amendments to Form N-CSR on September 20, 2002 (Investment Company Act Release No. 25739 [67 FR 60828 (Sept. 26, 2002)]; October 22, 2002 (Investment Company Act Release No. 25775 [67 FR 66208 (Oct. 30, 2002)]; December 2, 2002 (Investment Company Act Release No. 25838); and December 10, 2002 (Investment Company Act Release No. 25845). Rule 30e-1 (OMB Control No. 3235-0025) was promulgated under section 30(e) of the Investment Company Act [15 U.S.C. 80a-29(e)]. New Form N-Q is being proposed under Section 30 of the Investment Company Act [15 U.S.C. 80a-29(e)]. We are proposing a new rule and form, and rule and form amendments, that are intended to improve the periodic disclosure provided by registered management investment companies ("funds") to their investors about fund investments, costs, and performance. The proposed amendments would:
These proposed amendments are intended to significantly improve the periodic disclosure that fund investors receive, particularly with respect to portfolio holdings and expenses, while reducing the costs of producing and delivering funds' annual and semi-annual reports to shareholders. Form N-1AForm N-1A contains collection of information requirements. The likely respondents to this information collection are open-end funds registering with the Commission on Form N-1A. Compliance with the disclosure requirements of Form N-1A is mandatory. Responses to the disclosure requirements are not confidential. We estimate that the proposed amendments to Form N-1A would have no impact on the hour burden for filing registration statements on Form N-1A. The amendments to Form N-1A relate solely to the contents of shareholder reports for funds registered on Form N-1A, and the additional burden hours imposed by these amendments are reflected in the collection of information requirements for shareholder reports required by rule 30e-1 under the Investment Company Act. Form N-2Form N-2 contains collection of information requirements. The likely respondents to this information collection are closed-end funds registering with the Commission on Form N-2. Compliance with the disclosure requirements of Form N-2 is mandatory. Responses to the disclosure requirements are not confidential. We estimate that the proposed amendments to Form N-2 would have no impact on the hour burden for filing registration statements on Form N-2. The amendments to Form N-2 relate solely to the contents of shareholder reports for funds registered on Form N-2, and the additional burden hours imposed by these amendments are reflected in the collection of information requirements for shareholder reports required by rule 30e-1 under the Investment Company Act. Form N-3Form N-3, including the proposed amendments, contains collection of information requirements. The likely respondents to this information collection are separate accounts, organized as management investment companies and offering variable annuities, registering with the Commission on Form N-3. Compliance with the disclosure requirements of Form N-3 is mandatory. Responses to the disclosure requirements are not confidential. We estimate that the proposed amendments to Form N-3 would have no impact on the hour burden for filing registration statements on Form N-3. The amendments to Form N-3 relate solely to the contents of shareholder reports for funds registered on Form N-3, and the additional burden hours imposed by these amendments are reflected in the collection of information requirements for shareholder reports required by rule 30e-1 under the Investment Company Act. Form N-CSRProposed Form N-CSR, including the proposed amendments, contains collection of information requirements. The respondents to this information collection would be management investment companies subject to rule 30e-1 under the Investment Company Act of 1940 registering with the Commission on Form N-1A, N-2, or N-3. Compliance with the disclosure requirements of Form N-CSR is proposed to be mandatory. Responses to the disclosure requirements are not confidential. We previously estimated that the weighted average hour burden for preparing a proposed Form N-CSR would be 16.38 hours per filing. We also estimated that 3,700 funds would file Form N-CSR on a semi-annual basis for a total of 7,400 filings. Thus, we estimated that the total annual hour burden for the preparation and filing of Form N-CSR would be 121,195 hours.87 We estimate that the 3,700 funds filing reports on Form N-CSR include 9,850 portfolios, including 9,100 portfolios of mutual funds registered on Form N-1A, 630 closed-end funds registered on Form N-2, and 120 sub-accounts of managed separate accounts registered on Form N-3.88 The proposed amendments would require a fund that has used a summary portfolio schedule in its reports to shareholders in lieu of including a complete schedule of investments in securities of unaffiliated issuers, or a money market fund that has omitted its schedule of investments in securities of unaffiliated issuers from its reports to shareholders, to file its complete schedule of investments in securities of unaffiliated issuers pursuant to Item 7 of Form N-CSR. We estimate that 7,195 fund portfolios, including 1,000 money market fund portfolios that would be exempt from including a portfolio schedule in their shareholder reports, and 6,195 portfolios (or 70% of the fund portfolios remaining) would take advantage of one of these provisions, and hence would be required to file a complete portfolio schedule on Item 7 of Form N-CSR.89 We estimate that the requirements of Item 7 of Form N-CSR would increase the hour burden for filing Form N-CSR by 5 hours per portfolio per filing, or 71,950 hours (7,195 portfolios × 5 hours per portfolio × 2 filings per year). Thus, if the proposed amendments to Form N-CSR are adopted, the total annual hour burden for all funds for preparation and filing of Form N-CSR would be 193,145 hours (121,195 hours + 71,950 hours). The weighted average burden per filing on Form N-CSR would be 26.1 hours. Shareholder ReportsRule 30e-1, including the proposed amendments to Forms N-1A, N-2, and N-3, contains collection of information requirements.90 The respondents to this collection of information requirement are funds registered on Forms N-1A, N-2, and N-3. Compliance with the disclosure requirements of rule 30e-1 is mandatory. Responses to the disclosure requirements will not be kept confidential. There are approximately 3,700 funds subject to rule 30e-1. We estimate that the current hour burden for preparing and filing semi-annual and annual shareholder reports in compliance with rule 30e-1 is 212.5 hours per fund, for a total annual burden to the industry of 786,250 hours. We estimate that the 3,700 funds filing annual and semi-annual shareholder reports pursuant to rule 30e-1 include 9,850 portfolios, including 9,100 portfolios of mutual funds registered on Form N-1A, 630 closed-end funds registered on Form N-2, and 120 sub-accounts of managed separate accounts registered on Form N-3.91 We estimate that there are 1,000 money market fund portfolios that would take advantage of the provision permitting a money market fund to omit its schedule of investments in securities of unaffiliated issuers from its shareholder reports. This would decrease the hour burden of complying with rule 30e-1 for these funds by 5 hours per portfolio per filing, or 10,000 hours (1,000 portfolios × 5 hours × 2 filings per year). We estimate that of the remaining 8,850 portfolios of funds filing shareholder reports, 70%, or 7,095 portfolios, would choose to take advantage of the provisions permitting use of a summary portfolio schedule. However, we estimate that use of the summary portfolio schedule provisions would have no net effect on the burden hours of complying with rule 30e-1. The estimated time necessary to prepare a summary portfolio schedule will be equivalent to the time currently required to prepare a complete portfolio schedule, because a fund will still need to evaluate the size of each of its investments in securities of unaffiliated issuers in order to prepare the summary portfolio schedule. Further, we estimate that the proposed requirement to include a tabular or graphic presentation in shareholder reports, which would apply to all funds, will increase the estimated burden hours for complying with rule 30e-1 by 3 hours per portfolio per filing, or 59,100 hours (9,850 portfolios × 3 hours × 2 filings per year). We estimate that the requirement to disclose in shareholder reports the dollar cost of investing in the fund over the reporting period, which would apply only to mutual funds, will increase the estimated burden hours for complying with rule 30e-1 by 5 hours per portfolio per filing, or 91,000 hours (9,100 mutual fund portfolios × 5 hours × 2 filings per year).92 Finally, we estimate that the requirement for mutual funds to include MDFP in annual reports to shareholders would have a negligible effect on the estimated burden hours for complying with rule 30e-1, because over 90% of mutual funds, in the staff's experience, already include MDFP in annual reports to shareholders. Thus, the proposed amendments would have a net increase on the burden hours of complying with rule 30e-1 of 140,100 hours (-10,000 hours + 59,100 hours + 91,000 hours), for a new total burden of 926,350 hours. Rule 30b1-4The purpose of proposed Rule 30b1-4 is to improve transparency of information about funds' portfolio holdings. Proposed Rule 30b1-4 would require funds to file a quarterly report via the Commission's EDGAR system on proposed Form N-Q, not more than sixty calendar days after the close of each first and third fiscal quarter, containing their complete portfolio holdings. The likely respondents to Rule 30b1-4 would be registered management investment companies, other than small business investment companies registered with the Commission on Form N-5. We estimate that there are approximately 3,700 funds that would be affected by the proposed rule. Each of those 3,700 funds would be required by proposed Rule 30b1-4 to file a complete portfolio holdings schedule via EDGAR on proposed Form N-Q. For purposes of this Paperwork Reduction Act analysis, the burden associated with the requirements of proposed Rule 30b1-4 has been included in the collection of information requirements of proposed Form N-Q, rather than the proposed Rule. Compliance with rule 30b1-4 is mandatory for every registered fund. Responses to the disclosure requirements will not be kept confidential. Form N-QProposed Form N-Q contains collection of information requirements. The respondents to this information collection would be management investment companies subject to rule 30e-1 under the Investment Company Act of 1940 registering with the Commission on Forms N-1A, N-2, or N-3. Compliance with the disclosure requirements of Form N-Q would be mandatory. Responses to the disclosure requirements would not be kept confidential. Every registered management investment company, other than a small business investment company registered on Form N-5, would be required to file a quarterly report on Form N-Q disclosing the information required therein, not more than sixty calendar days after the close of the first and third quarters of each fiscal year. We estimate that there are approximately 3,700 funds that would be affected by the proposal, which include 9,850 fund portfolios. We therefore estimate that for each of those funds the disclosure of their portfolio holdings schedules in filings on Form N-Q as of the end of each first and third fiscal quarter would require, on average, 10 hours per portfolio per filing,93 for a total annual hour burden of 197,000 hours (10 hours per filing × 2 filings per year × 9,850 fund portfolios). Request for CommentsWe request your comments on the accuracy of our estimates. Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments to: (1) evaluate whether the proposed collection of information is necessary for the proper performance of the functions of the agency, including whether the information will have practical utility; (2) evaluate the accuracy of the Commission's estimate of burden of the proposed collection of information; (3) determine whether there are ways to enhance the quality, utility, and clarity of the information to be collected; and (4) evaluate whether there are ways to minimize the burden of the collection of information on those who are to respond, including through the use of automated collection techniques or other forms of information technology. Persons submitting comments on the collection of information requirements should direct the comments to the Office of Management and Budget, Attention: Desk Officer for the Securities and Exchange Commission, Office of Information and Regulatory Affairs, Room 3208, New Executive Office Building, Washington, DC 20503, and should send a copy to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 5th Street, NW, Washington, DC 20549-0609, with reference to File No. S7-51-02. Requests for materials submitted to OMB by the Commission with regard to this collection of information should be in writing, refer to File No. S7-51-02, and be submitted to the Securities and Exchange Commission, Records Management, Office of Filing and Information Services, 450 Fifth Street NW, Washington, DC 20549. OMB is required to make a decision concerning the collection of information between 30 and 60 days after publication of this release. Consequently, a comment to OMB is best assured of having its full effect if OMB receives it within 30 days after publication of this Release. V. Cost/Benefit AnalysisThe Commission is sensitive to the costs and benefits imposed by its rules. Our proposed amendments are intended to improve the periodic disclosure provided by registered management investment companies ("funds") about their portfolio investments, costs, and past performance. The proposed amendments would:
These proposed amendments are intended to significantly improve the periodic disclosure that fund investors receive, particularly with respect to portfolio holdings and expenses, while reducing the costs of producing and delivering funds' annual and semi-annual reports to shareholders. A. BenefitsUse of Summary Portfolio Schedule and Exemption of Money Market Funds from Portfolio Schedule Requirements in Shareholder Reports. The Commission estimates that more than 70% of all funds may realize at least some cost savings, through reduced printing and mailing expenses, by use of a summary portfolio holdings schedule in their shareholder reports.94 Money market funds would realize similar benefits with respect to the proposed exemption from the requirement to include the schedule of investments in unaffiliated issuers in their reports to shareholders. In addition, for purposes of the Paperwork Reduction Act, we have estimated that this exemption for money market funds would reduce the burden hours for compliance with shareholder reports requirements by 10,000 hours, translating into a cost savings of $689,400 annually.95 For funds with large numbers of holdings, such as index funds, the cost savings in printing and mailing could be substantial. As of year-end 2001, there were approximately 248 million shareholder accounts invested in funds.96 For each account, funds are required to provide an annual and semi-annual shareholder report, although our rules allow the delivery of a single shareholder report to investors who share an address ("householding") under certain conditions. We estimate that, as a result, funds may print and deliver approximately 347.2 million and 446.4 million shareholder reports annually.97 Annually, use of a summary portfolio schedule could therefore impact approximately 243.0 million to 312.5 million shareholder reports.98 Although we are unable to precisely quantify the overall cost savings, at a minimum, if funds could reduce their printing and distribution expenses by one page per shareholder report, at a cost of 2¢ per page, shareholders could save approximately $4.9 million to $6.3 million per year.99 The Commission believes, however, that some funds may be able to reduce the length of their shareholder reports by more than a single printed page and we therefore expect the cost savings to funds may exceed these estimates.100 These potential savings may be passed on to fund shareholders.101 Apart from savings in printing and distribution costs, use of a summary portfolio schedule may benefit investors by helping them focus on a fund's principal holdings, and thereby better evaluate a fund's risk profile and investment strategy. These benefits to investors are difficult to quantify, however. We request comment on the extent and magnitude of the benefits to funds and investors that would result from permitting use of a summary portfolio schedule in shareholder reports, and permitting money market funds to omit a schedule of investments in securities of unaffiliated issuers from shareholder reports. Tabular or Graphic Presentation of Portfolio Holdings. The proposed requirements for funds to provide a tabular or graphic presentation of their portfolio holdings in their annual and semi-annual reports to shareholders should benefit fund investors by illustrating, in a concise and user-friendly format, the allocation of a fund's investments across asset classes. This presentation, coupled with a summary portfolio schedule, may more effectively convey key information about a fund's investments than would the fund's complete portfolio schedule standing alone, particularly in the case of funds with large numbers of holdings. These benefits to investors resulting from the use of a tabular or graphic presentation are difficult to quantify, however. We request comment on the extent and magnitude of the benefits to funds and investors that would result from use of a summary portfolio schedule in shareholder reports. Quarterly Filing of Complete Portfolio Schedule. The proposal to require the quarterly filing of a fund's complete portfolio schedule via EDGAR, within 60 days after the end of the first and third fiscal quarters, should benefit investors by providing them with greater information about whether, and how, a fund is complying with its stated investment objective. The proposal would allow investors, and their advisers or other investment professionals, to better monitor the extent to which the portfolios of the funds that investors hold overlap, and hence should promote more informed asset allocation decisions. In addition, quarterly disclosure of a fund's portfolio holdings may expose instances of "style drift," when the actual portfolio holdings of a fund deviate from its stated investment objective. The increased transparency resulting from quarterly disclosure may also deter several forms of portfolio manipulation by portfolio managers, including "window dressing" (buying or selling portfolio securities shortly before the date as of which a fund's holdings are publicly disclosed, in order to convey an impression that the manager has been investing in companies that have had exceptional performance during the reporting period) and "portfolio pumping" (buying shares of stocks the fund already owns on the last day of the reporting period, in order to drive up the price of the stocks and inflate the fund's performance results).102 Any of these forms of portfolio manipulation enhance the apparent composition of the portfolio at the expense of portfolio returns. By increasing the frequency of reporting, engaging in these activities becomes more expensive in terms of returns. Therefore, we would expect fewer funds to engage in these activities. To the extent that portfolio managers currently engage in these activities, shareholders would be better off as a result of the proposed amendments. More broadly, the increased frequency of disclosure will permit investors to better link the composition of a fund portfolio to fund performance. We request comment on the benefits to investors of quarterly portfolio disclosure, and in particular on whether, and to what extent, quarterly portfolio disclosure might deter forms of portfolio manipulation. Disclosure of Fund Expenses in Shareholder Reports. The proposed requirement for mutual funds to disclose in their reports to shareholders fund expenses borne by shareholders during the reporting period should benefit investors by increasing their awareness and understanding of the fees that they pay on an ongoing basis for investing in a mutual fund. The benefits of the improved transparency of funds' ongoing fees and expenses are difficult to quantify, however. We request comment on the extent and magnitude of these benefits, as well as the benefits of alternative means of disclosure of the ongoing costs of funds. Inclusion of MDFP in Annual Reports to Shareholders by Mutual Funds. The proposals to require funds to include MDFP in their annual reports to shareholders should assist investors in assessing the fund's performance over the prior year. Requiring MDFP in the annual report, as opposed to the fund's prospectus, may benefit shareholders by enabling them to assess information provided in the MDFP together with other "backward looking" information contained in the annual report. We note, however, that to the extent that, based on the staff's experience, over 90% of mutual funds already include this information in their annual reports to shareholders, these benefits are already being realized. B. CostsThe proposed amendments may lead to some additional costs for funds, which could be passed on to fund shareholders. In the case of the additional disclosure requirements being proposed, these costs would include both internal costs (for attorneys and other non-legal staff of a fund, such as computer programmers, to prepare and review the required disclosure) and external costs (for printing and typesetting of the disclosure). Use of Summary Portfolio Schedule and Exemption of Money Market Funds from Portfolio Schedule Requirements in Shareholder Reports. Our proposals to allow funds to include summary portfolio schedules in reports to shareholders, and to exempt money market funds from the requirement to include a portfolio schedule of investments in securities of unaffiliated issuers in their reports to shareholders, may result in some costs to funds. For purposes of the Paperwork Reduction Act, we estimate that these proposals would not increase the hour burden for completing a shareholder report in compliance with rule 30e-1 under the Investment Company Act. However, we estimate that use of either the provision permitting use of a summary portfolio schedule or the provision permitting a money market fund to omit its schedule of investments in securities of unaffiliated issuers would increase the hour burden for filing Form N-CSR by 5 hours per portfolio per filing, or 71,950 hours (7,195 portfolios × 5 hours per portfolio × 2 filings per year), resulting in an additional cost of filing Form N-CSR of $4,960,233.103 Further, under our proposals, to the extent that investors want to see a complete portfolio schedule, investors would incur search costs to gather this information (i.e., requesting the information from the fund). However, since funds will be required to deliver the complete portfolio schedule within three days and free of charge to all investors who request it, we expect these costs to be very small. We request comment on these estimates. Tabular or Graphic Presentation of Portfolio Holdings. The proposals would require funds to provide one or more tables, charts, or graphs depicting the securities holdings of the fund by reasonably identifiable categories (e.g., type of security, industry sector, geographic region, credit quality, or maturity) showing the percentage of net asset value attributable to each. We estimate that these costs would be limited, however, because a fund could select the most appropriate means by which it would convey information to investors about the types of investments made by the fund, given its investment objectives, and because a majority of funds, according to the staff's estimate, already provide some type of tabular or graphic depiction of their holdings in shareholder reports. For purposes of the Paperwork Reduction Act, we have estimated that the disclosure requirements would add 3 hours per portfolio to the burden of completing each annual and semi-annual report to shareholders, or 59,100 hours total (3 hours per portfolio × 2 reports per year × 9,850 portfolios of funds required to provide reports to shareholders). We estimate that this additional burden would equal total internal costs of $4,074,354 annually.104 Further, because most funds already include a similar type of presentation voluntarily in shareholder reports, we estimate that this new disclosure requirement will not increase printing and mailing costs of shareholder reports for most funds, and hence the external costs to funds of the tabular and graphic disclosure requirement would be minimal. We request comment on these estimates. Quarterly Filing of Complete Portfolio Schedule. Our proposals to require funds to file with the Commission for the first and third fiscal quarters of each fiscal year their complete portfolio holdings schedule on proposed Form N-Q, and to disclose the availability of the filing on the Commission's website, would impose certain costs on funds. We estimate that for purposes of the Paperwork Reduction Act, these disclosure requirements would impose 10 burden hours per portfolio per filing on Form N-Q. We estimate that the total burden would therefore be 197,000 hours, or $13,581,180 in total internal costs annually, based on an estimate of 3,700 funds filing reports on Form N-Q for 9,850 fund portfolios.105 Because this quarterly disclosure would only be required to be filed on EDGAR, and not actually delivered to shareholders, we estimate that the external costs per fund, for typesetting, printing, and mailing, of this additional disclosure would be negligible. Mandating quarterly portfolio disclosure may impose other costs on funds and their shareholders. Arguments have been made that more frequent disclosure of portfolio holdings may expand the opportunities for professional traders to exploit this information by engaging in predatory trading practices, such as trading ahead of funds, often called "front-running."106 However, in order for "front-running" to significantly decrease investment returns under the proposed quarterly reporting requirements, it appears that the following conditions may have to be present:
It appears that front running may be a profitable strategy if all of these conditions hold simultaneously. It also appears that these conditions may rarely be met. If this is correct, the resulting costs of front-running under our proposals should be minimal.107 Furthermore, there are two additional potential costs that may be associated with these proposals. First, it has been argued that, given public data about aggregate flows of new cash to funds, more frequent disclosure of portfolio holdings would allow traders to effectively identify the securities in which the fund(s) will transact to accommodate this flow. This may, in turn, provide a potentially profitable front-running strategy to these traders.108 Second, a requirement for more frequent disclosure may disrupt trades that are made for potential tax-timing advantages.109 These potential costs are particular cases of front-running, and it appears that they may require the same conditions to hold as those described above, along with additional conditions specific to these strategies. We request comment on the analysis above, and on the nature and magnitude of any potential costs of front-running resulting from more frequent disclosure of portfolio holdings. Arguments have also been made that more frequent portfolio disclosure may facilitate the ability of outside investors to "free ride" on a mutual fund's investment strategies, by obtaining for free the benefits of fund research and investment strategies that are paid for by fund shareholders.110 The extent to which our proposed quarterly disclosure requirement, with a 60 day lag, would result in these types of costs is difficult to quantify, and may depend on a number of assumptions. In general, it appears that the following conditions must be satisfied for free-riding to be a profitable strategy: 1. The market is able to consistently identify skilled fund managers.111 2. The trading information of skilled fund managers remains valuable from 2 to 5 months after the trade is initiated. It appears that a fund may be damaged by free-riding if its trading positions are incomplete when the fund's portfolio is disclosed and the front-running conditions discussed above are met. In addition, it appears that the market for the securities being traded pursuant to the strategy must be sufficiently illiquid to generate price impacts such that completion of the trading strategy is more costly to the fund manager. It appears that these conditions may not often simultaneously hold, although when they do, funds may be adversely impacted. We also note, however, that once the fund adviser has completed its trading strategy, it may hope that other traders will follow it because the price impacts of their trading will make the fund's trades profitable. The net effect of "free riding" therefore is not necessarily negative. We request comment on this analysis and on the nature and magnitude of any potential costs of free-riding that may result from more frequent disclosure of portfolio holdings. We request comment generally on whether, and to what extent, our proposals would impose costs resulting from predatory trading practices, and on any other costs that would be imposed by our proposed quarterly portfolio disclosure requirement. Disclosure of Fund Expenses in Shareholder Reports. We estimate that in order for mutual funds to comply with the proposed requirement to include in annual and semi-annual reports disclosure of the dollar cost associated with investing a standardized amount in a fund, a typical mutual fund would need to add two additional pages to its annual and semi-annual reports, at a cost of $0.02 per page.112 We estimate that a typical fund may have, on average, 30,000 shareholder accounts, and will send out between 42,000 and 54,000 reports to shareholders annually.113 Therefore, this additional disclosure in shareholder reports would cost approximately $2,400 (($0.04 × 30,000 shareholder accounts) × 2 reports per year) in external costs per fund annually. Based on an estimate of 3,100 mutual funds filing annual and semi-annual reports with the Commission pursuant to rule 30e-1, we estimate these external costs would be $7,440,000 for the industry as a whole. In addition, we estimate for purposes of the Paperwork Reduction Act that these disclosure requirements would add 91,000 burden hours for mutual funds required to transmit shareholder reports, or 10 hours per mutual fund portfolio, equal to internal costs of $6,273,540 for the industry annually.114 We request comment on these estimates. As the Commission considered how to best disclose to investors the fees and expenses that they incur with investment in a fund, it considered the costs and benefits of various alternatives, including providing fund shareholders with individualized cost information (in dollars) as to the fees and expenses that they paid in quarterly account statements. We estimate that the cost of providing this individualized cost disclosure would greatly exceed the cost of our proposal. According to the GAO Report which recommended requiring individualized cost disclosure in account statements, one broker-dealer with approximately 6.5 million customer accounts estimated that for it to develop the systems necessary to produce such statements might cost as much as $4 million, with additional annual costs of $5 million.115 Given that as of year-end 2001, there were approximately 248 million shareholder accounts invested in funds, estimated industry-wide costs could easily exceed $100 million annually.116 We request comment on the costs of alternative methods of increasing investors' awareness of fund fees and expenses. Inclusion of MDFP in Annual Reports to Shareholders by Mutual Funds. We estimate that the proposed requirement that mutual funds include MDFP in their annual reports to shareholders would not impose any costs on funds or shareholders. The staff estimates that over 90% of mutual funds already include MDFP in their annual reports to shareholders. Further, a fund that does not include MDFP in its annual reports must include MDFP in its prospectus. Thus, this proposed amendment would not impose any new disclosure requirement on funds, but rather would only mandate a change in the location of the required disclosure, for the minority of funds that do not already include MDFP in their annual reports. To the extent, however, that a fund does not already include MDFP in its annual report to shareholders, the fund may incur additional printing and mailing costs. We request comment on this estimate.
C. Request for CommentsWe request comments on all aspects of this cost-benefit analysis, including identification of any additional costs or benefits of, or suggested alternatives to, the proposed amendments. Commenters are requested to provide empirical data and other factual support for their views to the extent possible. VI. Consideration of Burden on Competition; Promotion of Efficiency, Competition, and Capital FormationSection 23(a)(2) of the Exchange Act requires us, when adopting rules under the Exchange Act, to consider the impact that any new rule would have on competition. Section 23(a)(2) also prohibits us from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act.117 In addition, Section 2(c) of the Investment Company Act, Section 2(b) of the Securities Act, and Section 3(f) of the Exchange Act require the Commission, when engaging in rulemaking that requires it to consider or determine whether an action is necessary or appropriate in the public interest, to consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation.118 The proposed amendments are intended to provide greater transparency for fund shareholders regarding their investments in funds. These proposed amendments may improve efficiency. The enhanced disclosure requirements may provide shareholders with more frequent access to portfolio holdings of the funds in which they invest, which may promote more efficient allocation of investments by investors and more efficient allocation of assets among competing funds. The proposed amendments may also improve competition, as enhanced disclosure may lead to better-informed investors and may prompt funds to seek to provide better-informed investors with improved products and services. In addition, permitting funds to deliver summary portfolio schedules in shareholder reports may provide a significant reduction in printing and delivery costs ultimately borne by shareholders. Finally, the effects of the proposed amendments on capital formation are unclear. Although, as noted above, we believe that the proposed amendments would benefit investors, the magnitude of the effect of the proposed amendments on efficiency, competition, and capital formation is difficult to quantify, particularly given that many funds do not currently provide the type of disclosure contemplated by the proposed amendments. We request comment on whether the proposed amendments, if adopted, would impose a burden on competition. We also request comment on whether the proposed amendments, if adopted, would promote efficiency, competition, and capital formation. Commenters are requested to provide empirical data and other factual support for their views if possible. VII. Initial Regulatory Flexibility AnalysisThis Initial Regulatory Flexibility Analysis ("Analysis") has been prepared in accordance with 5 U.S.C. 603, and relates to the Commission's proposed rule and form amendments under the Securities Act, the Exchange Act, and the Investment Company Act to improve the quality of periodic disclosure provided by registered management investment companies ("funds") about their portfolio investments, costs, and past performance. These proposed amendments are intended to enable funds to provide more meaningful information to shareholders while reducing the costs of producing and delivering annual and semi-annual reports to shareholders. A. Reasons for, and Objectives of, Proposed AmendmentsShareholder reports are one of the principal means by which funds provide periodic information to their investors. Fund shareholder reports historically have served primarily as a vehicle to provide financial statements and other financial information to shareholders.119 The Commission believes that, with some modifications, fund shareholder reports could become a more effective vehicle for communicating information to investors. The proposed amendments principally address disclosure of fund portfolio holdings and expenses, two significant areas for improvement that have been identified by investor groups, members of the fund industry, and others. B. Legal BasisThe Commission is proposing amendments to Regulation S-X pursuant to authority set forth in sections 5, 6, 7, 8, and 19(a) of the Securities Act [15 U.S.C. 77e, 77f, 77g, 77h, and 77s(a)], sections 12, 13, 15(d) and 23(a) of the Exchange Act [15 U.S.C. 78l, 78m, 78o(d), and 78w(a)] and sections 8, 24(a), 30, 31, and 38 of the Investment Company Act [15 U.S.C. 80a-8, 80a-24(a), 80a-29, 80a-30, and 80a-37]. The Commission is proposing new rule 30b1-4 and new Form N-Q pursuant to authority set forth in sections 8, 30, 31, and 38 of the Investment Company Act [15 U.S.C. 80a-8, 80a-29, 80a-30, and 80a-37]. The Commission is proposing amendments to Forms N-1A, N-2, and N-3 pursuant to authority set forth in sections 5, 6, 7, 10, 19(a), and 28 of the Securities Act [15 U.S.C. 77e, 77f, 77g, 77j, 77s(a), and 77z-3] and sections 6(c), 8, 24(a), 30, and 38 of the Investment Company Act [15 U.S.C. 80a-6(c), 80a-8, 80a-24(a), 80a-29, and 80a-37]. The Commission is proposing amendments to proposed Form N-CSR pursuant to authority set forth in sections 10(b), 13, 15(d), 23(a), and 36 of the Exchange Act [15 U.S.C. 78j(b), 78m, 78o(d), 78w(a), and 78mm] and sections 6(c), 8, 24(a), 30, and 38 of the Investment Company Act [15 U.S.C. 80a-6(c), 80a-8, 80a-24(a), 80a-29, and 80a-37]. C. Small Entities Subject to the RuleFor purposes of the Regulatory Flexibility Act, an investment company is a small entity if it, together with other investment companies in the same group of related investment companies, has net assets of $50 million or less as of the end of its most recent fiscal year.120 Approximately 205 out of 3700 investment companies that would be affected by this rule meet this definition.121 D. Reporting, Recordkeeping, and Other Compliance RequirementsThe proposed amendments would:
The proposed amendments would apply equally to funds that are small entities and to other funds. The Commission estimates that the proposed amendments may result in some one-time formatting and ongoing costs and burdens that would be imposed on all funds, but which may have a relatively greater impact on smaller firms. These include the costs related to disclosing the dollar cost associated with investing a standardized amount in a fund; and the requirement that funds file their complete portfolio schedules with the Commission on a quarterly basis. These costs also could include expenses for computer time, legal and accounting fees, information technology staff, and additional computer and telephone equipment. However, we believe the benefits that will result to shareholders through better information about their funds' investments, costs, and past performance justify these potential costs. The Commission solicits comment on the effect the proposed amendments would have on small entities. E. Duplicative, Overlapping or Conflicting Federal RulesThere are no rules that duplicate, overlap, or conflict with the proposed amendments. F. Significant AlternativesThe Regulatory Flexibility Act directs us to consider significant alternatives that would accomplish our stated objective, while minimizing any significant adverse impact on small issuers. In connection with the proposed amendments, the Commission considered the following alternatives: (i) the establishment of differing compliance or reporting requirements or timetables that take into account the resources available to small entities; (ii) the clarification, consolidation, or simplification of compliance and reporting requirements under the proposed amendments for small entities; (iii) the use of performance rather than design standards; and (iv) an exemption from coverage of the proposed amendments, or any part thereof, for small entities. The Commission believes at the present time that special compliance or reporting requirements for small entities, or an exemption from coverage for small entities, would not be appropriate or consistent with investor protection. The proposed disclosure amendments would provide shareholders with greater transparency regarding a fund's investments, costs, and performance. Different disclosure requirements for small entities, such as reducing the frequency of portfolio holdings reports that small entities would have to file with the Commission, may create the risk that shareholders of those small entities would not have access to sufficient information to make an informed evaluation as to whether the fund is complying with its stated investment objective. We believe it is important that the disclosure that would be required by the proposed amendments be provided to shareholders by all funds, not just funds that are not considered small entities. We have endeavored throughout these proposed amendments to minimize the regulatory burden on all funds, including small entities, while meeting our regulatory objectives. Small entities should benefit from the Commission's reasoned approach to the proposed amendments to the same degree as other investment companies. Further clarification, consolidation, or simplification of the proposals for funds that are small entities would be inconsistent with the Commission's concern for investor protection. Finally, we do not consider using performance rather than design standards to be consistent with our statutory mandate of investor protection in the present context. G. Solicitation of CommentsThe Commission encourages the submission of written comments with respect to any aspect of this analysis. Comment is specifically requested on the number of small entities that would be affected by the proposed amendments and the likely impact of the proposals on small entities. Commenters are asked to describe the nature of any impact and provide empirical data supporting the extent of the impact. These comments will be considered in the preparation of the Final Regulatory Flexibility Analysis, if the proposed amendments are adopted, and will be placed in the same public file as comments on the proposed amendments themselves. Comments should be submitted in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. Comments also may be submitted electronically at the following E-mail address: rule-comments@sec.gov. To help us process and review your comments more efficiently, comments should be sent by hard copy or electronically, but not by both methods. All comment letters should refer to File No. S7-51-02; this file number should be included on the subject line if E-mail is used. Comment letters will be available for public inspection and copying in the Commission's Public Reference Room, 450 Fifth Street, NW, Washington, DC 20549-0102. Electronically submitted comment letters also will be posted on the Commission's Internet website (http://www.sec.gov).122
VIII. Consideration of Impact on the EconomyFor purposes of the Small Business Enforcement Fairness Act of 1996,123 a rule is "major" if it results or is likely to result in:
The Commission requests comment on the potential impact of the proposed amendments on the U.S. economy on an annual basis. Commenters are requested to provide empirical data to support their views. IX. Statutory AuthorityThe Commission is proposing amendments to Regulation S-X pursuant to authority set forth in sections 5, 6, 7, 8, and 19(a) of the Securities Act [15 U.S.C. 77e, 77f, 77g, 77h, and 77s(a)]; sections 12, 13, 15(d), and 23(a) of the Exchange Act [15 U.S.C. 78l, 78m, 78o(d), and 78w(a)]; and sections 8, 24(a), 30, 31, and 38 of the Investment Company Act [15 U.S.C. 80a-8, 80a-24(a), 80a-29, 80a-30, and 80a-37]. The Commission is proposing new rule 30b1-4 and new Form N-Q pursuant to authority set forth in sections 8, 30, 31, and 38 of the Investment Company Act [15 U.S.C. 80a-8, 80a-29, 80a-30, and 80a-37]. The Commission is proposing amendments to Forms N-1A, N-2, and N-3 pursuant to authority set forth in sections 5, 6, 7, 10, 19(a), and 28 of the Securities Act [15 U.S.C. 77e, 77f, 77g, 77j, 77s(a), and 77z-3] and sections 6(c), 8, 24(a), 30, and 38 of the Investment Company Act [15 U.S.C. 80a-6(c), 80a-8, 80a-24(a), 80a-29, and 80a-37]. The Commission is proposing amendments to proposed Form N-CSR pursuant to authority set forth in sections 10(b), 13, 15(d), 23(a), and 36 of the Exchange Act [15 U.S.C. 78j(b), 78m, 78o(d), 78w(a), and 78mm] and sections 6(c), 8, 24(a), 30, and 38 of the Investment Company Act [15 U.S.C. 80a-6(c), 80a-8, 80a-24(a), 80a-29, and 80a-37]. List of Subjects 17 CFR Parts 210, 270, and 274 Investment companies, Reporting and recordkeeping requirements, Securities. 17 CFR Parts 239 and 249 Reporting and recordkeeping requirements, Securities. TEXT OF PROPOSED RULE AND FORM AMENDMENTS For the reasons set out in the preamble, Title 17, Chapter II of the Code of Federal Regulations is proposed to be amended as follows: PART 210 - FORM AND CONTENT OF AND REQUIREMENTS FOR FINANCIAL STATEMENTS, SECURITIES ACT OF 1933, SECURITIES EXCHANGE ACT OF 1934, PUBLIC UTILITY HOLDING COMPANY ACT OF 1935, INVESTMENT COMPANY ACT OF 1940, INVESTMENT ADVISERS ACT OF 1940, AND ENERGY POLICY AND CONSERVATION ACT OF 1975 1. The authority citation for part 210 continues to read as follows:Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3, 77aa(25), 77aa(26), 78c, 78j-1, 78l, 78m, 78n, 78o(d), 78q, 78u-5, 78w(a), 78ll, 78mm, 79e(b), 79j(a), 79n, 79t(a), 80a-8, 80a-20, 80a-29, 80a-30, 80a-37(a), 80b-3, 80b-11 unless otherwise noted. 2. Paragraph (c) of § 210.6-10 is revised to read as follows: § 210.6-10 What schedules are to be filed. * * * * * (c) Management investment companies. (1) Except as otherwise provided in the applicable form, the schedules specified in this paragraph shall be filed for management investment companies as of the dates of the most recent audited balance sheet and any subsequent unaudited statement being filed for each person or group. Schedule I - Investments in securities of unaffiliated issuers. The schedule prescribed by § 210.12-12 shall be filed in support of caption 1 of each balance sheet. Schedule II - Investments - other than securities. The schedule prescribed by § 210.12-13 shall be filed in support of caption 3 of each balance sheet. This schedule may be omitted if the investments, other than securities, at both the beginning and end of the period amount to less than one percent of the value of total investments (§ 210.6-04.4). Schedule III - Investments in and advances to affiliates. The schedule prescribed by § 210.12-14 shall be filed in support of caption 2 of each balance sheet. Schedule IV - Investments - securities sold short. The schedule prescribed by § 210.12-12A shall be filed in support of caption 10(a) of each balance sheet. Schedule V - Open option contracts written. The schedule prescribed by § 210.12-12B shall be filed in support of caption 10(b) of each balance sheet. (2) When permitted by the applicable form, the schedule specified in this paragraph may be filed for management investment companies as of the dates of the most recent audited balance sheet and any subsequent unaudited statement being filed for each person or group. Schedule VI - Summary schedule of investments in securities of unaffiliated issuers. The schedule prescribed by § 210.12-12C may be filed in support of caption 1 of each balance sheet. * * * * * 3. Add § 210.12-12C to read as follows: § 210.12-12C Summary schedule of investments in securities of unaffiliated issuers.
1List the 50 largest issues and any other securities the value of which exceeded one percent of net asset value of the registrant as of the close of the period in order of descending value. For purposes of determining whether the value of a security exceeds one percent of net asset value, aggregate and treat as a single issue all securities of any one issuer. List each issue separately, whether or not issued by a single issuer, except as provided in note 2. Restricted securities shall not be combined with unrestricted securities of the same issuer. 2Identify by an appropriate symbol or footnote the type of instrument. For purposes of the list, aggregate and treat as a single issue, respectively, (a) short-term debt instruments of the same issuer (indicating the range of interest rates and maturity dates), and (b) fully collateralized repurchase agreements (indicate in a footnote the range of dates of the repurchase agreements, the total purchase price of the securities, the total amount to be received upon repurchase, the range of repurchase dat |