Statement on Form N-PORT and Form N-CEN Reporting Amendments; Guidance on Open-End Fund Liquidity Risk Management Programs

Thank you, Chair Gensler. The recommendation before the Commission is to adopt certain changes to Form N-PORT and Form N-CEN[1] and to provide guidance to funds on certain aspects of their liquidity risk management programs.[2]

Form N-PORT was adopted in 2016 and made important changes to the information collected by the Commission about funds.[3] Form N-PORT requires funds to report individual portfolio holdings, risk metric calculations, and other information.[4] Currently, funds file Form N-PORT for each month in a fiscal quarter within 60 days of the end of that quarter. The third month of each fiscal quarter is made available to the public, while the first and second months remain confidential.

In response to financial stability concerns, there has been an increased demand by prudential regulators to know market-wide positions held across funds in recent years. Today’s amendments would require this information to be reported to the Commission within 30 days after the end of each calendar month, providing faster regulatory transparency into fund holdings and information based on timing that is not dependent on a fund’s fiscal quarter. Had these amendments been limited to such regulatory transparency, I could have supported them.

However, the amendments also require that monthly Form N-PORT’s information be made available to the public 60 days after month end. This means detailed fund holdings will be made publicly available twelve times per year.

Why does the difference between regulatory transparency and public transparency matter? Why does the difference between twelve public data points versus four public data points matter? It is because fund portfolios represent the intellectual work product of investment advisers. Thus, the idea that fund advisers need to provide their investment ideas to the general public for free is highly concerning. If fund investment advisers are not compensated for their skill in conducting fundamental investment research and effective trading strategies, then such efforts will be less likely to occur at all – and the public good of price discovery will be significantly harmed.

The Commission has not adequately justified the decision to substantially increase the frequency of public disclosure of Form N-PORT data and makes only cursory efforts to reverse a policy considered less than eight years ago.[5] Commenters, including asset managers that pursue an active management investment style, raised substantial concerns about the harmful effects that such public disclosure could have on fund investors.[6] For example, asset managers that follow a value style may take months to build a position as their decisions are based on narrow predetermined price ranges.

Similarly, some funds may have a focused portfolio consisting of a handful of companies, in which each investment decision is highly impactful. As such, public disclosure of Form N-PORT data raises the risk of predatory trading, where the manager’s careful investment decisions can be easily and cheaply copied.[7] Further, I am concerned that more frequent disclosure of portfolio holdings can put the fund at a disadvantage relative to other investment pools that compete in the same markets, such as hedge funds, family offices, and collective investment trusts, that are not subject to these requirements, not to mention separately managed accounts. This may be particularly acute for funds that invest in high yield bonds, where counterparties and other market participants may seek to benefit from the information that a fund is building or selling a position, thus exposing the fund to wider bid-ask spreads and lowered performance.

The Commission’s decision to minimize these concerns is puzzling. Form N-PORT, as the Commission has repeatedly observed, is primarily designed to assist the Commission and its staff.[8] It is not retail investor friendly. Instead, the Commission believes that individual investors will benefit from third-party service providers that aggregate and analyze the data for a fee, as well as the efforts of academics.

The Commission summarily dismisses the concern that a fund’s portfolio could be copied – merely because of the 60-day lag – and points to the fact that some funds voluntarily disclose portfolio holdings on their websites in support of more frequent public disclosure. However, the information that funds publish on their websites is not the same as required on Form N-PORT; it may consist solely of top ten holdings, or exposures to different sectors. Form N-PORT information includes not only all of the fund’s portfolio holdings but also information on risk metrics and other data. But more importantly, just because some funds have decided that the benefits of public disclosure outweigh the harm does not mean that we should mandate more frequent disclosure for all funds.

These concerns are heightened given advances in artificial intelligence, the availability of fractional shares and the ability to buy and sell them through electronic trading platforms with no commissions, and the increased use of structured data, including as required by the Financial Data Transparency Act.[9] This means that it might be even easier in the future to copy the investment strategy of a successful fund manager. Artificial intelligence could peruse the monthly holdings of all funds using structured data and automatically follow the fund adviser with the best performance at the moment. Mobile apps from brokerage platforms can offer the ability to hold a portfolio that mimics one’s favorite investment manager using fractional shares and zero commissions, avoiding the payment of any fund fees to do so.

Similarly, the Commission assumes that public disclosure of monthly portfolio holdings may benefit fund investors. I do not think that is true. What is my basis for this belief? It stems from my involvement as the Assistant Director for Disclosure Regulation in the Division of Investment Management, when I participated in extensive investor testing of information contained in fund shareholder reports. The results were not surprising. Fund investors were most interested in performance and they were far less interested in a complete listing of portfolio holdings. Many fund investors were more interested in understanding portfolio holdings by category, which is information that is not even disclosed in Form N-PORT. I highly doubt those investor views have changed since then. But if the Commission wanted to know, it could have conducted a new round of investor testing before charging ahead today.

In fact, fund investors could be harmed by increased trading costs, as managers may try to concentrate their trading activity within a shorter time frame or otherwise change their strategies to protect fund shareholders from the effects of predatory trading or less favorable bid-ask spreads. This may result in decreased fund performance which could cause these fund investors to redeem from these funds and could lead to the fund’s eventual liquidation. When an investor can obtain the same portfolio exposures as a fund manager for free, what is the incentive for the investor to invest in the fund?

The Commission’s decision to require more frequent public disclosure of certain Form N-PORT information may have broader, unwelcome implications for investor choice and the diversity of our markets. Index funds and index-based investing have grown in popularity, and actively-managed fund assets may be declining.[10] Some of this decline may be to market forces. It can be difficult to compete with index funds with enormous economies of scale that can be managed at low cost.

In this regard, I have repeatedly voiced my concerns that the rules imposed over the past three years can have a disproportionate effect on smaller asset managers, which include many active managers.[11] Whether intended or not, the Commission should not be implementing a regulatory regime that favors passive investment strategies over active management strategies.

Lastly, I reject the premise that frequent public disclosure of consistent information made available for all funds is a “public good.” The capital markets function efficiently because there are financial incentives to conduct value-adding fundamental research for securities and their prices, which is one reason for the very existence of fund investment managers. The results are the intellectual work product of the fund manager and its skill; that information is not a public good to which everyone may have access for free, while the active management itself is a public good given that it contributes to price discovery. Thus, with this rulemaking we run the danger of undermining the public good at issue here.

Although I cannot support this rulemaking, I appreciate the efforts of the staff of the Divisions of Investment Management, and Economic and Risk Analysis, as well as the Office of the General Counsel. I also recognize the efforts of other offices that have contributed to this rulemaking.

Thank you.