23 February 2004
Jonathan G. Katz
Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, N.W., Stop 6-9
Washington, D.C. 20459
Re: Disclosure of Breakpoint Discounts by Mutual Funds (File No. S7-28-03); Disclosure Regarding Market Timing and Selective Disclosure of Portfolio Holdings (File No. S7-26-03)
Dear Mr. Katz:
The U.S. Advocacy Committee (USAC) of the Association for Investment Management and Research (AIMR)1 appreciates the opportunity to comment on the two proposed rules that would require mutual funds to provide additional disclosure to investors about any breakpoint discounts they offer and about risks involved in market timing practices, including whether the fund has policies in place to prevent such practices (collectively "disclosure proposals").
The USAC is a standing committee of AIMR charged with responding to new regulatory, legislative, and other developments in the United States affecting the investment profession, the practice of investment analysis and management, and the efficiency of financial markets.
We appreciate and support the approach taken by the SEC in these two disclosures proposals that would require funds to provide disclosures about breakpoint discounts and market timing and selective disclosure of mutual fund portfolio holdings. We also strongly support the specific types of disclosure that are called for in these proposals, because we believe this is the type of information that investors need to receive in order to make fully-informed investment decisions.
As an investor advocate group, we have long-supported regulatory initiatives to provide investors with meaningful disclosure that allows them to make informed investment decisions. As discussed more fully below, we believe that the goal to provide this meaningful disclosure is not always met by simply providing more disclosure, but that it is important to keep in mind the ultimate objective of raising the level of understanding among all investors.
Information is better understood when it is provided "in context". Therefore, as discussed more fully below, we encourage the SEC to consider more ways to providing investors a context in which they can better understand how the investment vehicle that they are considering works. With respect to mutual funds, we believe that this context may take the form of more basic discussion of how funds in general work (e.g., how different funds move with respect to general market movements, risks that might cause a fund to lose money, the difference between value versus growth, international versus global, etc.). We believe that such a general discussion of mutual funds will help investors understand the proposed disclosures for the fund(s) they are considering
Moreover, we believe that it is critical for investors to understand the relative costs of different fund offerings to effectively judge the investment return. Therefore, we encourage the SEC to require a one-sheet summary in the fund's prospectus that clearly sets out the fund's expenses and details the cost to investors of investing in that particular fund or class of shares. While much of this information is already required by Form N1-A, the ways in which the information is presented often obscures the plain meaning of the actual options and costs that the investor must consider when comparing fund alternatives.
While these two proposals raise substantively different issues, we believe that the general issue of disclosure of mutual fund practices raises a number of similar issues that should be addressed in the context of both proposals.
First, to be effective and achieve the desired objective, any additional disclosures to be made by mutual funds must be readable (i.e., written in plain English) and understandable. While we recognize that the issues addressed in these disclosure proposals are complex, we believe that the most effective disclosure for investors is the one that is most simply written. Well-intended, additional disclosures will be of little or no value to investors (while adding length to disclosure documents) if they are not easily read and understood. Thus, we encourage the SEC to provide examples and general guidance in the final rule of the types of statements that would be acceptable, as well as examples of those that would not.
Second, we believe that it is also important to provide investors with a context within which the required disclosures will have meaning. This objective may require additional discussions that further educate the investor and that go beyond the proposed disclosures. For example, we are concerned that a number of investors may not understand how to compare an investment in a no-load fund with a fund with a front-end sales charge. We believe that investors will need to be provided with general information about different fund characteristics and what the trade-offs in risk and return would be across these different characteristics. Thus, we believe that in some instances simply providing the proposed disclosure will not, in itself, provide the appropriate context to ensure the disclosure is meaningful to the investor. Accordingly, as discussed below, we urge the SEC to require in the final rule additional discussions that will help the average investor to better evaluate the investment vehicle under consideration.
Third, while there is little dispute that investor education must be a paramount component if the system is to work, we recognize that gauging the success of disclosure is often difficult to do. Quite often, the inadequacy of a certain disclosure is evident only after investors have lost money, or made inappropriate investment decisions. Thus, we encourage the SEC to consider some mechanism for allowing investors to respond to information that has been provided in a way that demonstrates their understanding (e.g., use of an acknowledgment form). While we recognize the potential difficulties in constructing a reasonable system, we urge the SEC to consider viable options. Accordingly, we would be pleased to work with SEC staff or others to further this effort.
It is against this backdrop that we offer further comments on the two proposals below.
We fully support the proposal to require open-end funds to provide enhanced disclosure regarding breakpoint discounts on front-end sales loads, including a summary of shareholder eligibility requirements. We believe this is just the type of information that investors are entitled to receive. In particular, we believe that the summary of shareholder eligibility requirements will significantly help investors understand the ways they can best avail themselves of breakpoint opportunities.
As we have said before, we urge that this information be communicated to investors clearly and concisely so that it is meaningful to them and can easily be incorporated into their decision-making. We thus support the recommendation offered by the Joint NASD/Industry Task Force on Breakpoints that key data on pricing methods and breakpoint schedules be included in the mutual fund's prospectus in a "prominent and clear format." In making our case for clear and concise disclosure rather than the usual "boilerplate legalese", we share the SEC's concern that the investor not be overwhelmed with disclosure. We believe that the proposed scope is appropriate and that the information belongs in the fund's prospectus.
With respect to our call for a context in which investors can better understand the specific disclosures about a particular fund option, we also urge that the final rule require disclosure about sales loads in general. We believe that until investors understand the reasons for investing in a fund that carry certain sales loads, they cannot fully understand the applicability of breakpoints to their investment decision-making. A general discussion of sales loads will give investors a context within which they can understand and evaluate their options when choosing a particular fund or class of shares.
Unfortunately, we understand that relatively few shareholders actually read the entire prospectus. Therefore, our primary concern is that the disclosures will be buried in the prospectus and will not reach their intended audience. Therefore, we recommend that, if included in the prospectus, disclosure about breakpoints be provided in a prominent location. Rather than permitting this important disclosure to be scattered throughout the prospectus (and sometimes the Statement of Additional Information), we strongly encourage the SEC to revise current Form N1-A requirements to consolidate this information, especially the information about costs, in one place.
We suggest that a one-page summary at the front of the prospectus would accomplish this objectively and note that this approach is already used in some sectors (e.g., consumer credit industry). On this page investors would find all of the costs of investing in a particular fund or class of shares, including fund expenses, breakpoint discounts, management and advisory fees, front-end and back-end sales loads, and 12b-1 fees (which could, in plain English, simply be called "sales and marketing fees"). A mandated format would not only provide an investor with the most significant cost considerations of investing in the fund, but would also provide a basis of comparison across other funds, classes of shares, and even other investment vehicles. We believe that use of this one-page summary would in itself be a significant step toward educating investors so that they are better able to make informed decisions.
We believe that market timing, while not illegal under current regulations, is detrimental to long-term shareholders. The extra transaction costs and dilution of long-term investors' returns diminish the ultimate return to these investors. In some respects, allowing market timing creates a two-tiered system of mutual fund investors: a minority who enjoys privileges not available to the majority.
Thus, we strongly support proposed measures to require funds to disclose to investors the risks to shareholders of frequent purchases and redemptions and the fund's policies with respect to market timing. Consistent with our discussion above, however, we believe that information provided investors needs to go beyond the proposed disclosure. In the same way that they need a context in which to understand the relative costs of a particular investment option, investors need to understand what "market timing" is and how it can affect expected and actual returns.
Therefore, we suggest that mutual funds that permit investors to engage in market timing should first clearly explain how and why some investors engage in market timing strategies and under what circumstances such strategies are allowed. Funds with policies and procedures to prevent market timing should clearly explain why market timing is detrimental to long-term investors, and how their policies and procedures are effective in detecting and preventing use of market timing strategies. In this way, the survival of market timing strategies can be left to market forces, as investors decide for themselves how important this issue is to their choice of investment funds.
We fully support requiring mutual funds to provide the proposed disclosures, but we do not believe the proposals will be sufficient. Investors need this information to be educated consumers but we ask and encourage the SEC to expand the final rules to also require information that will provide investors with a context in which they can better understand the relevance and importance of the disclosure and compare the particular fund under consideration with other fund options.
If we can provide additional information, please do not hesitate to contact James W. Vitalone at 704.553.0455, jwvitalone@carolina.rr.com or Linda Rittenhouse at 434.951.5333, linda.rittenhouse@aimr.org.
Sincerely,
/s/ James W. Vitalone, CFA James W. Vitalone, CFA Chair, U.S. Advocacy Committee |
/s/ Linda L. Rittenhouse Linda L. Rittenhouse AIMR Advocacy |
| cc: | U.S. Advocacy Committee |
| Rebecca T. McEnally, Ph.D., CFA - Vice President, AIMR Advocacy |