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Summary of Comments:
Proposed Rules Regarding Shareholder Reports and Quarterly Portfolio Disclosure of Registered Management Investment Companies
January 30, 2004
S7-51-02

Prepared by:
Christopher Kaiser & John M. Faust
Division of Investment Management

Shareholder Reports and Quarterly Portfolio Disclosure of Registered Management Investment Companies

LIST OF COMMENTERS

Funds/Investment Advisers/Financial Advisers

1. AIM Advisors, Inc. AIM

2. American Century Investment Management, Inc. American Century

3. Capital Research & Management Co Capital Research

4. Charles Schwab Schwab

5. Fidelity Investments Fidelity

6. TIAA-CREF TIAA-CREF

7. The Vanguard Group Vanguard

Professional and Trade Associations

1. The Financial Planning Association FPA

2. Investment Company Institute I ICI-I

3. Investment Company Institute II ICI-II

4. Securities Industry Association SIA

5. American Institute of Certified Public Accountants AICPA

Bar Associations/Accounting Firms/Consultants/Academics

1. American Bar Association, Section of Business Law ABA

2. AMG Data Services AMG

3. Buyside Research Buyside

4. Computershare Analytics Computershare

5. KPMG KPMG

6. Morningstar Morningstar

7. PriceWaterhouseCoopers PWC

8. Shadow Financial Regulatory Committee Shadow

9. Stocksnfund.com Stocksnfund

Investor and Other Groups

1. AFL-CIO AFL-CIO

2. Council of Institutional Investors CII

3. Fund Democracy/Consumer Federation of America Fund Democracy

4. SIPA Advisory Committee SIPA

Individual Investors

1. Laurance Arnold Arnold

2. Susanne Bradford Bradford

3. Allen Chandler Chandler

4. Clifden1A Clifden1A

5. John Cochran Cochran

6. Rich Coyle Coyle

7. James G. Curtis Curtis

8. Tim Dillon Dillon

9. John E. Donaldson, Jr. Donaldson

10. Geoffrey F. Foisie Foisie

11. Thomas Fowler Fowler

12. Andy Freeman Freeman

13. Barbara Fritz Fritz

14. Daniel Hayhurst Hayhurst

15. Larry Herold Herold

16. Dan Jamieson Jamieson

17. Lewis D. Junior Junior

18. Ken Kessler Kessler

19. Anil Khubchandani Khubchandani

20. Jason Kreher Kreher

21. Hans Lange Lange

22. Martin N. Levine Levine

23. Harriett Magee Magee

24. William Malahy Malahy

25. John Pasqua Pasqua

26. Wendell G. Peart Peart

27. Erich Riesenberg Riesenberg

28. Thomas Rigo Rigo

29. Peter Ryan 1 Ryan 1

30. Peter Ryan 2 Ryan 2

31. William St. John St. John

32. Mike Savage Savage

33. Donald S. Schofield Schofield

34. David Singh Singh

35. Michael J. Stifter Stifter

36. RStone1 RStone 1

37. John Turner Turner

38. Joseph Welch Welch

39. Jim & Cecelia Woods Woods

40. Rachel Young Young

Table of Contents

Introduction
Discussion

Summary of Comments On Proposed Rules Regarding Shareholder Reports and Quarterly Portfolio Disclosure of Registered Management Investment Companies

I. Introduction

On December 18, 2002, the Securities and Exchange Commission (the "Commission") issued a release 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 management investment company registered under the Investment Company Act ("fund") to include a summary portfolio schedule in its reports to shareholders, provided that the complete portfolio schedule is filed with the Commission on Form N-CSR semi-annually and is provided to shareholders upon request, free of charge;
Exempt money market funds from including a portfolio schedule in reports to shareholders, provided that this information is filed with the Commission on Form N-CSR and is provided to shareholders upon request, free of charge;
Require reports to shareholders by funds to include a tabular or graphic presentation of a fund's portfolio holdings by identifiable categories;
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;
Require open-end management investment companies ("mutual funds") to disclose fund expenses borne by shareholders during the reporting period in reports to shareholders; and
Require a mutual fund to include Management's Discussion of Fund Performance in its annual report to shareholders.

The comment period closed on February 14, 2003. The Commission received 65 comment letters, including five from professional and trade associations; seven from members of the fund industry; nine from bar associations, accounting firms, consultants, and academics; 40 from individual investors; and four from investor and other groups. The following summarizes the commenters' views. The commenters generally supported the Commission's proposals to improve the periodic disclosure provided to investors, although some commenters expressed concerns regarding portions of the proposals or suggested changes.

II. Discussion

A. Summary Portfolio Schedule

Summary: The Commission proposed rule and form amendments that would permit a fund to include a summary schedule of investments in securities of unaffiliated issuers in its reports to shareholders. The summary portfolio schedule would include the fund's 50 largest holdings and each investment that exceeds one percent of net assets, in order of descending value. Any fund that uses a summary portfolio schedule would be required to file its complete portfolio schedule with the Commission on Form N-CSR, and to send its complete schedule to shareholders upon request within three business days of receipt of the request.

Fifteen comment letters addressed whether the Commission should permit use of a summary portfolio schedule.¹ All 15 generally supported the concept of allowing a fund to include a summary portfolio schedule in its report to shareholders. They argued, in general, that permitting use of a summary portfolio schedule would encourage investors to focus on a fund's most significant investments when evaluating its risk profile and investment strategy, and would reduce printing and mailing costs for shareholder reports. One commenter suggested that the summary schedule should be required even if the full schedule is disclosed, to promote consistency of reporting.² Another commenter recommended that the Commission allow funds to file a summary portfolio schedule, rather than a complete portfolio schedule, on Forms N-CSR and N-Q.³

1. Disclosure of 50 largest holdings and holdings accounting for one percent of net assets and disclosure of securities identified in order of descending value

Six commenters addressed whether a fund's 50 largest holdings and each holding that exceeds one percent or more of net assets were the appropriate thresholds to require in the summary portfolio schedule.⁴ Four commenters explicitly argued that 50 was the appropriate number of largest holdings to require in the summary portfolio schedule.⁵ One of these commenters also recommended, however, that the Commission permit a fund to disclose a larger number of holdings and use a lower threshold of investments in the summary schedule of investments, if applied consistently.⁶ By contrast, two commenters suggested requiring a number of holdings less than 50.⁷ One of these commenters recommended that the summary schedule include the fund's top ten holdings followed by the percentage of fund assets represented by that holding, and the principal category by which the holding is identified in the tabular or graphic presentation.⁸

Two commenters supported the proposed requirement that holdings in the summary portfolio schedule be listed in descending order.⁹ One of these commenters noted that shareholders are likely to be most interested in obtaining information about the fund's largest holdings upfront before seeing other information.¹⁰ Seven commenters, by contrast, objected to the requirement that holdings be presented in descending order, arguing that this requirement would conflict with the American Institute of Certified Public Accountant's Audit and Accounting Guide ("AICPA Audit Guide"), which requires investments to be categorized by the type of investment, and the related industry, country, or geographic region in the schedule of investments.¹¹

Alternatives suggested by these commenters included:

Allowing a fund the flexibility to select the most appropriate format of presentation, given the type and circumstances of the fund;¹²
Allowing a fund the flexibility to disclose holdings in identifiable categories, with holdings in each category listed in order of descending value; ¹³
Requiring investments to be categorized, consistent with the AICPA Audit Guide; ¹⁴ or
Presenting investments in descending order by value of category, with each investment that is either one of the fund's 50 largest holdings or greater than 1% of net assets presented within its respective category.¹⁵

2. Use of fund websites to provide full portfolio schedules

Six commenters addressed the issue of whether a fund that provides a summary portfolio schedule should be permitted to provide its full portfolio schedule to investors exclusively through posting on its Internet website.¹⁶

Five commenters stated that a fund should be permitted to provide its complete portfolio schedule exclusively through website posting or other electronic means.¹⁷ Some of these commenters argued that this approach would be consistent with the Commission's rules allowing a fund the flexibility to make its proxy voting record available to shareholders either upon request or by making available an electronic version on or through the fund's website.¹⁸ One of these commenters also recommended that the Commission permit funds to satisfy this requirement by providing a hyperlink to the Commission's EDGAR website.¹⁹ One commenter suggested that funds should be required to provide complete portfolio schedules to their shareholders upon request, free of charge, on a quarterly basis, but should also be required to disclose their complete schedules on their websites.²⁰

Finally, one commenter suggested that disclosure of the complete portfolio schedule to shareholders should not be subject to the specific requirements of Sections 12-12 through 12-14 of Regulation S-X, and in particular funds should not be required to provide the level of detail required by the notes to Sections 12-12 through 12-14.²¹

3. Minimum number of securities required for utilization of a summary portfolio schedule

Two commenters addressed whether a fund should have a minimum number of securities in order to utilize a summary portfolio schedule.²² The commenters stated that a minimum number of securities should not be required, arguing that the purpose of the schedule is both to eliminate unnecessary costs and to provide a consistent disclosure format that will be easily understood and recognized by shareholders.

4. Utilization of a summary portfolio schedule for multiple funds in a single shareholder report

Five commenters addressed whether a shareholder report covering more than one fund should be required to use the same type of portfolio schedule for all funds included in the report.²³ Four commenters recommended that a shareholder report for multiple funds should not be required to present the same type of portfolio schedule (summary or complete) for all funds presented, provided the information is not presented in a misleading manner.²⁴ These commenters argued that the rules should allow each fund the flexibility to use the most meaningful presentation for its individual type and characteristics, regardless of the presentation used by other funds in the shareholder report.²⁵ However, one commenter recommended that a fund's election to report a summary or complete portfolio schedule in shareholder reports should be conditioned on use of the same method of reporting for at least one complete fiscal year, arguing that continuous changes in reporting method would likely confuse investors.²⁶ Another commenter recommended that when two types of portfolio schedules are used in a multifund report, the fund's adviser should be required to provide an explanation for the difference.²⁷

In addition, one commenter recommended that a shareholder report covering more than one fund should be required to use the same schedule for all funds, in order to provide investors with a consistent format.²⁸

5. Utilization of a summary portfolio schedule with respect to other investments in addition to investments in securities of unaffiliated issuers

Six commenters argued that use of a summary portfolio schedule should be permitted with respect to investments in addition to investments in securities of unaffiliated issuers.²⁹ Two of these commenters suggested that use of a summary schedule should be permitted for all investments, including investments other than securities and investments in affiliated issuers.³⁰ Two commenters recommended that a summary portfolio schedule should be permitted to include any (1) investment other than securities or (2) investment in an affiliated security.³¹ These commenters argued that including these investments in a summary portfolio schedule would focus investors' attention on a fund's most significant investments, and would be consistent with the AICPA Audit Guide, which contemplates a summary schedule of investments that includes all types of investments.³² The fourth commenter argued that the Commission should allow investments in affiliated issuers to be included in the summary schedule.³³

Two commenters, however, argued that use of a summary portfolio schedule should not be permitted with respect to investments other than investments in securities of unaffiliated issuers.³⁴ One of these commenters stated that complete disclosure of derivatives and affiliates is important to investors because it will allow investors to appreciate how risks are being managed for the fund and any potential conflicts of interest in the management of the fund.³⁵ The other commenter noted that a complete presentation of investments in affiliates and derivative instruments normally involves an insignificant printing cost burden, and that the actual savings in printing costs would not outweigh the benefits of continuing to require the complete presentation of investments in affiliates and derivative instruments.³⁶

6. Aggregation of fully collateralized repurchase agreements and short-term debt instruments into a single issue

One commenter recommended that the Commission should not require aggregation of short-term debt instruments of the same issuer and fully collateralized repurchase agreements into a single issue.³⁷ The commenter reasoned that aggregation may not be appropriate in every case and could even be misleading because different types of short-term debt and different maturities of the same type of short-term debt of a single issuer may have different credit risk profiles, due to different types of credit enhancement and different credit ratings. Similarly, the commenter argued that aggregation of fully collateralized repurchase agreements would not provide investors with an accurate assessment of counterparty risk.

Another commenter, however, supported the aggregation of fully collateralized repurchase agreements and short-term debt instruments into a single issue.³⁸

7. Disclosure of fixed-income securities

One commenter argued that the requirement that each issue be listed separately in the summary schedule, whether or not issued by a single issuer, after aggregating securities by issuer to determine if the securities are over 1% of net asset value, would nullify the benefits of the summary portfolio schedule for U.S. government and corporate fixed income funds that invest in numerous issues of a single issuer.³⁹ The commenter recommended that the Commission revise the requirement, so that funds would not be required to list separately any individual fixed income holding that neither is among the fund's 50 largest issues nor exceeds 1% of net asset value.⁴⁰ Thus, fixed income securities of a single issuer that individually are not among a fund's 50 largest issues and do not exceed one percent of the fund's net assets, but that exceed one percent of net asset value when aggregated with other issues of the same issuer, would be listed in the aggregate by issuer.

8. "Miscellaneous securities" provision

Three commenters recommended that a parallel provision to the "miscellaneous securities" provision of the full portfolio schedule be added to the proposed summary portfolio schedule.⁴¹ This provision permits funds to list an amount of up to five percent of the value of investments in securities of unaffiliated issuers as "miscellaneous securities," provided that the securities so listed are not restricted, have been held for not more than one year prior to the date of the related balance sheet, and have not previously been reported by name to shareholders or to any exchange, or set forth in any registration statement, application, or annual report, or otherwise made available to the public.⁴² The commenters argued that funds rely on this provision to guard against the premature release of certain positions in securities of unaffiliated issuers that could lead to front running, and that funds should not be forced to choose between using the summary schedule and relying on the current exclusion.

9. Other format modifications

One commenter recommended that the Commission clarify that short-term investments made with cash collateral from securities lending be excluded from the summary portfolio schedule. The commenter argued that to the extent that the value of investments representing cash collateral from securities lending constituted a significant percentage of a fund's net asset value, it would not be appropriate to include such collateral in the summary portfolio schedule because this could create a distorted view of how the fund's portfolio is invested, and could cause certain of the fund's primary investments to fall out of the top 50 holdings.⁴³

Five commenters suggested other modifications to the format of the proposed summary portfolio schedule, as well as the complete portfolio schedule.⁴⁴ Two commenters recommended that no specific identification should be required in the summary or complete portfolio schedule of non-income producing securities, arguing that this disclosure provides an investor only limited information in evaluating a fund's risk profile or investment strategy.⁴⁵ Two other commenters recommended that specific identification of non-income producing equity securities (as opposed to fixed income securities) should not be required in the summary or the full portfolio schedule, because whether or not a stock pays a dividend is not particularly significant or helpful information to investors.⁴⁶

Two commenters recommended that the requirement to specifically identify restricted securities be eliminated with respect to both the summary and the complete portfolio schedule.⁴⁷ One of the commenters recommended that the Commission instead require aggregate disclosure of illiquid securities and securities valued in good faith by the board of directors, regardless of whether the security is legally restricted, in both the summary and complete portfolio schedule, arguing that this disclosure would alert investors to the level of subjectivity involved with a fund's valuation and would be more meaningful to shareholders than the current restricted securities disclosure requirements.⁴⁸ The second commenter recommended that both the summary and complete portfolio schedule instead require disclosure of the total investment value, and percentage of net assets, of (1) securities valued at fair value; (2) defaulted debt securities; and (3) securities of persons where a "control" relationship exists.⁴⁹ The commenter argued that this information would help investors understand a fund's risk profile more clearly.

One commenter recommended that the Commission eliminate the current requirement to disclose investments in affiliates for securities that are deemed to be issued by an "affiliate" solely because the fund owns more than 5% of the issuer's voting securities,⁵⁰ and another commenter recommended that this requirement not be applied in the summary portfolio schedule.⁵¹ These commenters argued that these holdings are typically purchased and held in compliance with the diversification and other requirements under the Investment Company Act, and therefore, providing historical data for these investments is of questionable benefit and might lead investors to make erroneous assumptions about this disclosure.

10. Disclosure of the complete portfolio schedule in Form N-CSR

One commenter recommended that the adopting release clarify that the full portfolio of investments should be reported on by the fund's independent accountants as a supplementary schedule to the audited financial statements filed with the Commission, as is currently the practice for reporting on additional schedules filed by operating companies with the Commission.⁵²

B. Exemption of Index Funds from Portfolio Schedule Disclosure in Shareholder Reports

Summary: The Commission had requested comment on whether to exempt index funds from the requirement to include their portfolio holdings in their reports to shareholders, so long as the holdings are filed with the Commission and made available to investors on request.

Six commenters opposed such an exemption for index funds.⁵³ In general, these commenters argued that portfolio holdings information is as useful to index fund shareholders as it is to shareholders in an actively managed fund, and that most index fund investors know few, if any, of the securities in the fund's target index.⁵⁴ By contrast, one commenter supported an exemption for index funds, arguing that given the tight portfolio restrictions applicable to index funds, it is difficult to see the value to investors of providing even the fund's top 50 holdings in shareholder reports.⁵⁵

C. Exemption of Money Market Funds from Portfolio Schedule Disclosure in Shareholder Reports

Summary: The Commission proposed rules that would exempt money market funds from including a portfolio schedule in reports to shareholders, provided that the information is filed with the Commission on Form N-CSR and provided to shareholders upon request, free of charge.

Seven commenters supported the Commission's proposal to exempt money market funds from any requirement to include portfolio holdings in their reports to shareholders, as long as the holdings are filed with the Commission and made available to investors on request. These commenters argued, in general, that disclosure of the portfolio holdings of money market funds is not necessary because money market funds must meet rigid credit quality, maturity, and diversification requirements under Investment Company Act rule 2a-7, and that the short-term nature of money market securities makes disclosure of portfolio holdings almost obsolete upon delivery.⁵⁶ One of these commenters recommended that the exemption be expanded to apply to all required schedules, and not just the schedule of investments in securities in unaffiliated issuers.⁵⁷

However, three commenters opposed exempting money market funds from requirements to include portfolio holdings disclosure in their reports to shareholders, arguing that portfolio holdings disclosure is an important element of investment company financial statements, and that excluding money market funds from this requirement would send an implicit message to shareholders that they need not inform themselves about the fund's credit quality, maturity, and diversification characteristics.⁵⁸

D. Tabular or Graphic Presentation of Portfolio Holdings

Summary: The Commission proposed rules to require funds to include in their annual and semi-annual reports to shareholders a presentation using tables, charts, or graphs that would depict a fund's portfolio holdings by reasonably identifiable categories. This presentation would show the percentage of net asset value attributable to each category. 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 would be required to 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.

Eight commenters addressed this issue.⁵⁹ Seven of these commenters supported the Commission's proposal to require a tabular or graphic presentation in shareholder reports.⁶⁰ The remaining commenter stated that a tabular or graphic presentation of portfolio holdings can be useful to investors, but it should be optional.⁶¹

The seven commenters who supported the proposed tabular or graphic presentation requirement disagreed, however, on the degree of flexibility that should be allowed funds to design the format of such a presentation. Six of seven commenters supported the Commission's proposal that funds be given broad discretion about how to structure the tabular or graphic presentation of portfolio holdings, arguing that a one-size-fits-all approach could result in presentations that are not tailored to the fund that is the subject of the report.⁶² One of these commenters recommended that the proposed requirement that 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 should be modified to require only that funds must provide useful information to investors, because the usefulness of the information provided will be a subjective judgment. This commenter also recommended that: (i) funds should be permitted to base the categories in the presentation either on a fund's total investments or the fund's net asset value, consistent with the AICPA Audit Guide; and (ii) the Commission should clarify that securities purchased with cash collateral from securities lending should be excluded for purposes of the presentation.⁶³

The remaining commenter who supported the proposed tabular or graphic presentation requirement argued that the degree of flexibility proposed by the Commission would dilute the utility of the information in the tabular or graphic presentation. The commenter further suggested that the Commission: (i) require that all funds provide tabular or graphic information according to two specific categories, such as market capitalization and industry sector for stock funds, and maturity or government/non-government for fixed income funds; (ii) require that the tabular or graphic presentation in these categories be followed by presentations of up to four additional categories selected by the fund; (iii) identify special categories for certain types of funds, such as tracking error for index funds; and (iv) require the tabular or graphic presentation to precede the summary portfolio schedule.⁶⁴

Three commenters addressed whether the tabular or graphic presentation should be required of all funds.⁶⁵ One commenter stated that the presentation should be required for all non-money market funds, regardless of size or whether the fund provides a summary portfolio schedule or full portfolio schedule in its reports to shareholders. This commenter argued that the tabular or graphic presentation requirement would be of little, if any, value for shareholders of money market funds for the same reasons that money market funds should be exempt from the requirement to provide portfolio schedule disclosure.⁶⁶ The remaining two commenters recommended that the presentation should be required for all funds regardless of the number of portfolio holdings of a fund⁶⁷ and regardless of whether the fund has delivered a complete list of holdings to investors or whether it uses a summary portfolio schedule.⁶⁸

E. Quarterly Filing of Complete Portfolio Schedule

Summary: The proposal would require funds to file their complete portfolio holdings schedules with the Commission on a quarterly basis, rather than semi-annually as currently required. Funds would be required to file their complete portfolio schedules for the second and fourth fiscal quarters on proposed Form N-CSR. 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.

Thirty-two commenters addressed this specific issue including 14 individual investors;⁶⁹ six members of the fund industry;⁷⁰ two professional or trade associations;⁷¹ seven bar associations, consultants, or academics;⁷² and three investor and other groups.⁷³ A majority of the commenters supported the proposal.⁷⁴ Commenters argued generally that the proposed quarterly disclosure would substantially improve mutual fund investors' ability to make informed investment decisions, and would deter forms of portfolio manipulation such as window dressing and portfolio pumping.⁷⁵ Commenters also generally argued that the proposed 60-day reporting delay would appropriately address concerns that more frequent portfolio disclosure would allow front running of fund trades.⁷⁶ Some commenters also noted that by not requiring paper delivery of Form N-Q to shareholders, the proposal would keep fund costs down.⁷⁷

Commenters also suggested particular changes or requested clarification. These suggestions and clarifications were as follows:

Seven commenters recommended that funds be required to disclose portfolio holdings on a more frequent basis, such as monthly, in order to provide shareholders with more certainty that funds are investing consistent with their investment objectives and in order to further deter window dressing by funds.⁷⁸ As an alternative to monthly disclosure, one of these commenters recommended requiring funds to disclose their holdings on two or three random dates throughout the year.⁷⁹
Two commenters recommended allowing funds to keep confidential holdings that meet the standard for confidential treatment applicable to Form 13F under the Exchange Act, in order to protect against forms of manipulation such as free riding and front running.⁸⁰
One commenter supported exempting money market funds from the requirement to file portfolio schedules on Form N-Q, for the same reasons that the Commission proposed to exempt money market funds from portfolio schedule requirements in shareholder reports.⁸¹
Two commenters argued that Form N-Q should not be designated as a report filed under Section 13(a) and 15(d) of the Securities Exchange Act and subject to certification requirements under Section 302 of the Sarbanes-Oxley Act, because of additional administrative and cost burdens that this would impose.⁸²
One commenter supported the filing of the complete portfolio schedule in Form N-Q for all fiscal quarters, rather than in Form N-CSR for the second and fourth fiscal quarters. The commenter argued that this would allow the production and filing process for the complete portfolio schedule to occur with minimum burden and cost.⁸³
One commenter suggested that monthly portfolio disclosure should be required via Internet, with a 30 day delay period, in order to improve advisers' and shareholders' ability to rebalance their portfolios in a more timely fashion to avoid style drift.⁸⁴
One commenter suggested that the disclosure dates for all registered investment companies should be on a calendar year basis.⁸⁵
One commenter recommended that any officer of the fund be able to sign Form N-Q, noting the unique circumstances of fund complexes in complying with the SEC's rules related to the Sarbanes-Oxley Act as compared to those of operating companies.⁸⁶
One commenter recommended that funds be allowed to file a summary portfolio schedule on Form N-Q and then provide the complete portfolio holding schedule on their websites.⁸⁷
Two commenters suggested that quarterly disclosure by funds identify holdings by CUSIP number as well as name.⁸⁸

Three commenters did not support the proposed quarterly disclosure requirement. These commenters argued that: (i) there are potential harms and increased costs associated with front-running, free riding, liquidity, and tax-management strategies;⁸⁹ (ii) quarterly disclosure will be detrimental to fund managers' ability to acquire or sell positions in companies in a discreet manner over time;⁹⁰ and (iii) quarterly disclosure is more costly.⁹¹

In addition, one commenter suggested that the Commission undertake a more thorough analysis of the costs to shareholders imposed by portfolio holdings disclosure, in the form of sacrificed fund returns. The commenter also recommended that the Commission consider requiring funds to adopt a minimum disclosure lag policy, in order to protect the confidentiality of fund holdings against any potential conflicts of interest that an advisor may face, and requiring funds to disclose these policies to fund shareholders. In addition, the commenter suggested that the Commission address issues presented by disparate disclosure of fund holdings (e.g., where a fund advisor releases holdings to commercial fund tracking services monthly while making them available to shareholders quarterly), and provide guidance on how to achieve fair dissemination of fund portfolio holdings.⁹²

Four commenters addressed the issue of whether the proposed summary portfolio schedule and/or complete schedule should be required to identify securities acquired within a designated number of days before the end of the reporting period.⁹³ Two of the four commenters suggested that funds should be required to identify securities acquired within five trading days before the end of the reporting period, as an additional deterrent to window dressing and portfolio pumping by portfolio managers.⁹⁴ The two remaining commenters opposed a requirement to identify securities acquired within a designated number of days before the end of the reporting period, arguing that this could lead to misimpressions about the propriety of these acquisitions.⁹⁵ One of these commenters suggested that any such disclosure, if required, should be included in MDFP rather than in the fund's financial statements because the evaluation of the importance of this activity is more appropriately addressed by management as part of a substantive discussion rather than listing such transactions in financial statements.⁹⁶

F. Revisions to Form 13F Disclosure Requirements

The Commission requested comment on whether to make changes to the requirements for reports on Form 13F, including the required 45 day delay period. Two commenters suggested that the delay period for Form 13F should be changed from 45 days to 60 days to match the delay period for the proposed quarterly disclosure on Form N-Q.⁹⁷ One of the two commenters suggested that Form 13F be filed semi-annually, rather than quarterly, because the proposed rule will require quarterly disclosure on Form N-Q or Form N-CSR.⁹⁸ Another commenter suggested that it is unnecessary for the delay for Form 13F to be the same as that for Form N-Q, because predatory trading practices are less significant in the context of disclosure of aggregate holdings in equity securities management by an institutional investment manager and institutional investment managers are able to request confidential treatment of filings on Form 13F.⁹⁹

One commenter suggested that the threshold for Form 13F filings should be increased to $1 billion to reflect the effects of market inflation. The commenter argued that the $100 million threshold no longer accomplishes the stated purpose of Form 13F disclosure, and the review of confidentiality requests of managers with less than $100 million under management is a waste of SEC resources.¹⁰⁰

G. Disclosure of Fund Expenses

Summary: The Commission proposed to require mutual funds to disclose in their shareholder reports expenses borne by shareholders during the reporting period. 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% per year.

Twenty-four commenters addressed this issue.¹⁰¹ All of the individual investors who commented stated that they wanted funds to disclose the details of their fees more extensively and clearly.¹⁰²

The majority of the other commenters supported the proposal.¹⁰³ These commenters agreed with the Commission generally that the proposed shareholder report expense disclosure would provide shareholders with additional, useful information that should assist them both in understanding the impact of expenses on their investment return and in comparing expenses across different funds. In addition, several commenters emphasized that the Commission's proposed approach was preferable to an alternative approach, recommended by the U.S. General Accounting Office ("GAO") in a 2000 report, that would have required individualized disclosure in account statements of the exact dollar amount of mutual fund fees paid by each shareholder during the reporting period, based on actual amounts invested in the fund.¹⁰⁴ These commenters argued that this individualized disclosure could be costly, burdensome, and impractical, particularly for broker-dealers, financial advisers, and other third-party intermediaries. By contrast, these commenters argued, the Commission's proposed approach would appropriately place expense disclosure in the shareholder report along with other backward-looking information for the period covered.

Two commenters, on the other hand, argued that additional expense disclosure should be included in account statements, rather than shareholder reports, because this would make this information more readily accessible to investors who regularly review their account statements but not their shareholder reports.¹⁰⁵ One of these commenters supported the Commission's approach of showing the cost in dollars associated with a $10,000 investment, but suggested that this information be included in account statements.¹⁰⁶ The other commenter supported disclosure of the actual dollar amount of expenses incurred by individual shareholders if the costs of such disclosure do not outweigh the benefits.¹⁰⁷ This commenter argued that if the costs of individualized dollar disclosure are too high, dollar disclosure should be required, calculated by determining the hypothetical expenses during each quarter for a one dollar account and multiplying that by the shareholder's average account balance. The commenter also argued that if the Commission is opposed to hypothetical expenses, it should consider requiring a table showing the range of fees paid on different size accounts, so that investors would not have to take the extra step of extrapolating their own fees.

One commenter recommended an alternative to these approaches.¹⁰⁸ The commenter suggested retaining the current disclosure of fund expenses as a percentage of net asset value because it is a simpler way for investors to understand individual shareholder costs than the Commission's proposal. However, the commenter recommended that actual brokerage and related soft dollar expenses be added to a fund's overall expense ratio, or broken out in a separate category in percentage terms.

A number of commenters supported the first expense example in the Commission's proposal, but opposed the second expense example, which would be based on the fund's actual expenses and an assumed return of 5% per year.¹⁰⁹ These commenters argued that this second example would be unnecessary and would confuse investors, because it would be similar, but not identical, to the expense example found in the fund prospectus. Further, the commenters argued that the second example would diverge from the goal of providing investors with information in the shareholder reports about actual expenses paid. Finally, the commenters noted that the use of the second example could make the fee disclosure cumbersome, particularly in reports for multiple class funds.

Two commenters objected to the proposed requirement that 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 must 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.¹¹⁰ The commenters argued that the expense example in shareholder reports should be based on actual costs that were incurred during the reporting period, and that the proposed footnote disclosure of restated expenses would be more appropriately disclosed in the prospectus fee table.

H. Management's Discussion of Fund Performance ("MDFP")

Summary: The proposal would require that MDFP, which is currently required for all mutual funds other than money market funds, be included in annual reports to shareholders.

Seven commenters supported the proposal to require MDFP in mutual fund annual reports.¹¹¹ They argued that requiring MDFP in the annual report is the common industry practice, provides useful information to investors, and is a better fit with the "backward looking" information in shareholder reports than the "forward looking" information in prospectuses. In addition, one of these commenters suggested that the Commission consider extending the MDFP requirement to closed-end funds.¹¹² This commenter also recommended that the Commission, to increase transparency of fund performance, undertake a separate study to identify the information that should be included in the MDFP to make it more consistently useful to the reader. The result of the study, according to the commenter, should be a comprehensive statement (preferably through a rulemaking proposal) of the Commission's expectations for the contents of MDFP.

One commenter opposed the proposal to require MDFP to be included in annual reports to shareholders. The commenter noted that requiring MDFP to be included in annual reports to shareholders will require it to be certified by a fund's principal executive and principal financial officers. The commenter argued that this would have a negative impact on the quality of MDFP, as funds may be reluctant to include subjective, albeit useful, information (such as the portfolio manager's opinion about why the fund performed as it did during the period covered), because it does not readily lend itself to meaningful certification. The commenter also argued that the content of MDFP should not be changed because no change is needed.¹¹³

Two commenters offered suggestions for additional changes to the substantive requirements for MDFP.¹¹⁴ One of these commenters suggested that the use of disaggregated performance results (showing the fund's realized and unrealized gains and losses in individual securities that it invested in over the course of a chosen fixed period) would better serve investors than MDFP.¹¹⁵ Another commenter argued that index fund tracking error provides information as to whether a fund is meeting its investment objective and, therefore, may be useful to investors in MDFP. The commenter suggested that if the Commission determines that disclosure of index fund tracking error is appropriate, the Commission should seek further comment on a uniform standard.¹¹⁶

I. Compliance Date

Summary: The Commission proposed 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, the Commission proposed to require funds to file quarterly reports on Form N-Q with respect to any fiscal quarter ending on or after the effective date.

Three commenters suggested that a transition period be provided, so that compliance would be required 120 days after adoption of the final rule.¹¹⁷

J. Cost/Benefit Analysis

Seven commenters commented directly on aspects of the Cost/Benefit Analysis. These commenters addressed two specific issues: individualized cost disclosure and the costs of front-running resulting from more frequent disclosure.¹¹⁸

Four commenters opposed a requirement to provide fund shareholders with individualized cost information as to the fees and expenses that they paid in quarterly account statements. These commenters argued that implementation of individualized cost information would involve significant costs and logistical challenges because it would require not only funds and their servicing agents, but also the multitude of financial intermediaries through which fund shares are distributed, to develop and maintain coordinated systems capable of producing account statements containing the required disclosure.¹¹⁹ By contrast, one commenter supported requiring individualized cost disclosure, but appreciates, however, that this will impose much larger costs on funds than providing hypothetical dollar disclosure. The commenter recommended that the Commission consider whether the additional costs of this disclosure would outweigh the potential benefits, including lower expenses for shareholders, that improved fee disclosure and the attendant increase in price competition would provide.¹²⁰

Three commenters specifically addressed the issue of the costs of front-running resulting from more frequent portfolio disclosure.¹²¹ One commenter supported the Commission's analysis of the set of conditions that must be present for even the possibility of harmful trading to exist. The commenter argued that this analysis thoroughly rebuts any arguments that front-running will occur with more frequent portfolio disclosure.¹²² The remaining two commenters argued that there would be significant costs imposed on funds and ultimately on shareholders from more frequent portfolio disclosure, because of increased front-running and free-riding.¹²³ The two commenters argued that the Commission's analysis ignores the basic fact that any additional information about fund portfolio holdings will facilitate front running that is already occurring. In addition, the commenters argued that there is research contrary to the Commission's analysis indicating that free riding can be achieved, is profitable, and will be facilitated by more frequent portfolio disclosure.

Several commenters that did not comment directly on the Cost/Benefit Analysis did raise cost issues with respect to specific substantive provisions. For example, three commenters argued that including the summary portfolio schedule instead of the complete portfolio schedule in the reports to shareholders would reduce printing, mailing and postage costs.¹²⁴

K. Paperwork Reduction Act Summary

There were no comments specifically related to the Paperwork Reduction Act summary. However, one commenter did urge the Commission to minimize compliance burdens and minimize paper filings.¹²⁵

L. Regulatory Flexibility Act Analysis

There were no comments related to the Regulatory Flexibility Act Analysis.

M. Miscellaneous Comments

One commenter recommended that the Commission require fund advisers to include only required performance data, MDFP, the new proposed expense disclosure, the summary portfolio schedule, and the financial highlights table in reports to shareholders, thereby eliminating financial statements, notes to financial statements, and other detailed data, which would continue to be available to shareholders upon request. The commenter also recommended that the Commission eliminate required mailing of semi-annual reports, while retaining mandatory mailing of the annual report.¹²⁶

One individual investor commented that disclosure of disaggregated performance results (showing the fund's realized and unrealized gains and losses in individual securities that it invested in over the course of a chosen fixed period) would be an improvement over a portfolio schedule.¹²⁷

Six commenters suggested that reports to shareholders should be written in plain English that an average investor can understand.¹²⁸

Two commenters suggested that the Commission require disclosure in the area of undisclosed fund costs, namely, so-called "revenue sharing" fees that funds give to broker-dealers and other vendors.¹²⁹

One commenter suggested that reports to shareholders should disclose financial statements, compensation of officers and directors, pension plans, incentive plans, or any other proxy type information.¹³⁰

One commenter suggested that reports to shareholders should be done away with if funds publish the complete portfolio schedule quarterly because most of the information in the shareholder reports can be found elsewhere such as media reports and press releases.¹³¹

One commenter encouraged the Commission to consider a broad review of Regulation S-X, especially Article 6, to determine whether other aspects of the SEC's rules can be streamlined or enhanced, particularly where there is divergence from the AICPA Audit and Accounting Guide.¹³²

One commenter submitted a list of general disclosure problems with US and Canadian mutual fund reporting.¹³³

One commenter suggested the disclosure of letters of protest sent by the fund to object to a company's practices; how fund managers are paid; the top 20 fund managers, their compensation, and the number of shares they own in the fund; if the fund managers are required to own shares; the top 20 paid research houses used; and how were the shares voted at each company.¹³⁴

One commenter urged the Commission to require disclosure of out of index holdings, a time series presentation of the quintile distribution of market capitalization and market/book, and return attribution (sector weighting, security selection, foreign exchange, country weighting, credit quality, and duration).¹³⁵

____________________________

¹ ABA, AFL-CIO, AIM, American Century, Capital Research, Fidelity, FPA, Fund Democracy, ICI-I, Jamieson, KPMG, PWC, Schwab, TIAA-CREF, Vanguard.
² Fund Democracy.
³ AIM.
⁴ ABA, American Century, Fidelity, FPA, Fund Democracy, PWC.
⁵ ABA, American Century, FPA, PWC.
⁶ PWC.
⁷ Fidelity, Fund Democracy.
⁸ Fund Democracy.
⁹ FPA, Fund Democracy.
¹⁰ FPA.
¹¹ AICPA, AIM, Capital Research, ICI-I, KPMG, PWC, Vanguard.
¹² AIM, Capital Research, ICI-I, PWC.
¹³ Vanguard.
¹⁴ KPMG.
¹⁵ KPMG.
¹⁶ AFL-CIO, AIM, American Century, Cochran, ICI-I, Schwab.
¹⁷ AIM, American Century, Cochran , ICI-I, Schwab.
¹⁸ See Release No. IC-25922 (Jan. 31, 2003) [68 FR 6564 (Feb. 7, 2003].
¹⁹ ICI-I.
²⁰ AFL-CIO.
²¹ AIM.
²² AIM, Fund Democracy.
²³ American Century, Fund Democracy, ICI-I, KPMG, PWC.
²⁴ American Century, ICI-I, KPMG, PWC.
²⁵ See, e.g., PWC.
²⁶ KPMG.
²⁷ American Century.
²⁸ Fund Democracy.
²⁹ AICPA, Capital Research, FPA, Fund Democracy, ICI-I, PWC.
³⁰ FPA, PWC.
³¹ AICPA, ICI-I. The ICI noted that the Commission could require funds to identify investments in affiliated issuers by an appropriate symbol or footnote, and require other information about the affiliate in a footnote to the summary schedule or the financial statements, but recommended that identification and related information not be required with respect to investments that are deemed to be issued by an affiliate solely because the fund owns 5% or more of the issuer's outstanding voting securities. The ICI also recommended that if the summary portfolio schedule is extended to investments other than securities, funds continue to provide separate schedules reflecting any securities sold short and any open option contracts written.
³² FPA, ICI-I, PWC.
³³ Capital Research.
³⁴ AIM, KPMG.
³⁵ AIM.
³⁶ KPMG.
³⁷ Schwab.
³⁸ ICI-I.
³⁹ ICI-I.
⁴⁰ ICI-II.
⁴¹ Capital Research, ICI-I, Vanguard.
⁴² Note 1 to Rule 12-12 of Regulation S-X [17 CFR 210.12-12].
⁴³ ICI-I. The ICI recommended that the Commission work with the AICPA to achieve consistency in GAAP requirements with the ICI's recommendation to exclude investments made with cash collateral from securities lending from the summary portfolio schedule.
⁴⁴ Capital Research, ICI-I, KPMG, PWC, Vanguard.
⁴⁵ PWC, KPMG.
⁴⁶ Capital Research, Vanguard.
⁴⁷ KPMG, PWC.
⁴⁸ KPMG.
⁴⁹ PWC.
⁵⁰ Vanguard.
⁵¹ ICI-I.
⁵² PWC.
⁵³ American Century, Fund Democracy, ICI-I, KPMG, PWC, Vanguard.
⁵⁴ See, e.g., ICI-I and Vanguard.
⁵⁵ ABA.
⁵⁶ ABA, AIM, American Century, Capital Research, Fund Democracy, ICI-I, Vanguard.
⁵⁷ ICI-I. In addition, ICI recommended that the Commission coordinate with the AICPA to resolve discrepancies with the AICPA Audit Guide, which makes no special provision for portfolio disclosure by money market funds.
⁵⁸ AICPA, KPMG, PWC.
⁵⁹ ABA, AIM, American Century, FPA, Fund Democracy, ICI-I, TIAA-CREF, Vanguard.
⁶⁰ ABA, AIM, American Century, Fund Democracy, ICI-I, TIAA-CREF, Vanguard.
⁶¹ FPA.
⁶² ABA, AIM, American Century, ICI-I, TIAA-CREF, Vanguard.
⁶³ ICI-I.
⁶⁴ Fund Democracy.
⁶⁵ ABA, AIM, Fund Democracy.
⁶⁶ AIM.
⁶⁷ ABA, Fund Democracy.
⁶⁸ Fund Democracy.
⁶⁹ Cochran, Curtis, Dillon, Jamieson, Lange, Levine, Rigo, Ryan 1, St. John, Savage, Singh, Stifter, Turner, Welch.
⁷⁰ AIM, American Century, Capital Research, Fidelity, TIAA-CREF, Vanguard.
⁷¹ FPA, ICI-I.
⁷² ABA, AMG, Buyside, Computershare, Morningstar, Shadow, Stocksnfund.
⁷³ AFL-CIO, CII, Fund Democracy.
⁷⁴ AFL-CIO, AIM, American Century, AMG, Buyside, Capital Research, CII, Computershare, Dillon, Fidelity, FPA, Fund Democracy, Jamieson, Lange, Levine, Morningstar, Rigo, Ryan 1, St. John, Savage, Shadow, Stifter, Stocksnfund, TIAA-CREF, Turner, Vanguard.
⁷⁵ See, e.g., AFL-CIO, Capital Research, FPA, Fund Democracy, TIAA-CREF.
⁷⁶ See, e.g., AFL-CIO, AIM, American Century, Morningstar, Shadow, TIAA-CREF, Vanguard.
⁷⁷ See, e.g., FPA, Vanguard.
⁷⁸ AFL-CIO, Dillon, FPA, Fund Democracy, St. John, Shadow, Stocksnfund.
⁷⁹ Fund Democracy.
⁸⁰ Capital Research, ICI-I.
⁸¹ Vanguard.
⁸² AIM, ICI-I.
⁸³ American Century.
⁸⁴ FPA.
⁸⁵ Shadow.
⁸⁶ AIM.
⁸⁷ AIM.
⁸⁸ Buyside, Computershare.
⁸⁹ ABA. This commenter stated that if the Commission does adopt quarterly portfolio disclosure, it should allow a fund to provide this information solely by posting it on its website, as the Commission permitted in its rules requiring funds to disclose their proxy votes.
⁹⁰ Curtis.
⁹¹ Welch.
⁹² Fidelity.
⁹³ AFL-CIO, Fund Democracy, ICI-I, PWC.
⁹⁴ AFL-CIO, Fund Democracy.
⁹⁵ ICI-I, PWC.
⁹⁶ PWC.
⁹⁷ Fidelity, ICI-I.
⁹⁸ ICI-I.
⁹⁹ AIM.
¹⁰⁰ Fund Democracy.
¹⁰¹ ABA, AFL-CIO, AIM, American Century, Capital Research, CII, Clifden1A, Coyle, FPA, Freeman, Fund Democracy, Hayhurst, Herold, ICI-I, Khubchandani, KPMG, Peart, Riesenberg, Rstone1, Ryan1, Schwab, TIAA-CREF, Vanguard, Young.
¹⁰² Clifden1A, Coyle, Freeman, Hayhurst, Herold, Khubchandani, Peart, Riesenberg, Rstone1, Ryan1, Young.
¹⁰³ ABA, AFL-CIO, AIM, American Century, Capital Research, CII, ICI-I, Schwab, TIAA-CREF, Vanguard.
¹⁰⁴ AIM, ICI-I, Schwab, SIA, TIAA-CREF.
¹⁰⁵ AFL-CIO, Fund Democracy.
¹⁰⁶ AFL-CIO.
¹⁰⁷ Fund Democracy.
¹⁰⁸ FPA.
¹⁰⁹ AIM, American Century, Capital Research, FPA, ICI-I, Schwab, Vanguard.
¹¹⁰ AIM, KPMG.
¹¹¹ ABA, AFL-CIO, AIM, American Century, CII, PWC, Vanguard.
¹¹² PWC.
¹¹³ ICI-I.
¹¹⁴ Foisie, KPMG.
¹¹⁵ Foisie.
¹¹⁶ KPMG.
¹¹⁷ ICI-I, Schwab, Vanguard.

¹¹⁸ ABA, Fidelity, Fund Democracy, ICI-I, SAI, Schwab, TIAA-CREF.
¹¹⁹ ABA, SAI, Schwab, TIAA-CREF.
¹²⁰ Fund Democracy.
¹²¹ Fidelity, Fund Democracy, ICI-I.
¹²² Fund Democracy.
¹²³ Fidelity, ICI-I.
¹²⁴ AIM, ICI-I, Vanguard.
¹²⁵ Jamieson.
¹²⁶ Fidelity.
¹²⁷ Foise.
¹²⁸ Bradford, CII, Kesler, Kreher, Magee, Ryan 1.
¹²⁹ Jamieson, Young.
¹³⁰ Schofield.
¹³¹ Shadow.
¹³² PWC.
¹³³ SIPA.
¹³⁴ Ryan 1.
¹³⁵ Donaldson.

http://www.sec.gov/rules/extra/s75102comsum.htm

Summary of Comments: Proposed Rules Regarding Shareholder Reports and Quarterly Portfolio Disclosure of Registered Management Investment Companies January 30, 2004 S7-51-02

Prepared by: Christopher Kaiser & John M. Faust Division of Investment Management