SEC Clarifies New Final Rule on Tailored Shareholder Reports

The SEC’s Division of Investment Management (the “Commission”) issued new guidance on fund reporting rules adopted in 2022, enhancing transparency for open-end funds and updating advertisement regulations for investment companies. On Jan 19, 2024, the Commission responded to FAQs on the SEC’s rule and form amendments from Oct 2022. The amendments require open-end funds to transmit concise and visually engaging annual and semi-annual reports and amend the advertisement rules for all regulated investment companies to ensure fee comparability in fund advertisement.

A summary of the Commission’s responses to the FAQs is included below:

Appropriate broad-based securities market index

1. The Commission stated that an index that represents the equity or fixed income market of a group of countries in Europe or Asia, a group of countries that excludes a specific country or countries (such as Asia excluding Japan), or groups of countries with shared characteristics such as emerging market or developed markets, could qualify as an appropriate broad-based security market index, provided that the index represents the overall applicable international equity or debt market relative to the fund’s investment.
2. The Commission has observed that funds that mainly invest in tax-exempt municipal securities, including a fund that invests mostly in the municipal income securities of a single state, can use an index that reflects the national municipal securities market as its appropriate broad-based securities market index. This can be used instead of an index that reflects the national aggregate fixed-income securities market. The Commission has stated that, in their view, the national municipal securities market is distinct in itself, as tax-exempt municipal bonds are different from other securities. Therefore, it can be regarded as a standalone overall market rather than just a subset of the fixed-income market.
   
   The Commission also stated that it does not believe that indexes that include characteristics such as “growth,” “value,” “ESG,” or “small- or mid-cap” represent the overall market.

Form N-CSR and website availability requirements

1. Concerning each shareholder report, the final rules (rule 30e-1) require a fund to make certain disclosures required by Form N-CSR (Items 7 through 11) publicly available, free of charge, on the fund’s website. Conversely, the fund may post the complete Form N-CSR.
2. The Commission stated that, in its view, a variable annuity or variable life insurance company issuer (collectively, “variable contract issuer”) may satisfy their requirements to make fund materials available under Rule 30e-1 by making the materials available either on the variable contract issuer’s website or the underlying fund’s website. The Commission observed that if multiple variable contract issuers allow contract value to be allocated to the same underlying fund, it may be more efficient for the required fund materials to appear on the underlying fund’s website as opposed to the variable contract issuers’ websites to avoid listing the websites of each of the variable contract issuers in the fund’s shareholder report.
3. The Commission clarifies that compliance with the requirement to post Form N-CSR information online under amended rule 30e-1 would not be a violation of rule 502(c) of Regulation D as long as the fund limits its website content solely the information stipulated by the rule, and refrains from using its website as a platform to offer or sell securities, or in a way that constitutes a general solicitation or advertising of its securities.

Binding individual shareholder reports of multiple funds

1. According to Instruction 4 of the new Item 27A(a) of Form N-1A, a fund has to prepare a separate shareholder report for each series of the fund. If a series has multiple classes, the fund should prepare a separate shareholder report for each class. The SEC clarified that if an investor has invested in multiple funds or multiple share classes of funds, the individual shareholder reports of such funds or share classes may be bound, stapled, or stitched together for transmission to the investor. The SEC noted that this practice does not raise the same concerns about multi-series shareholder reports discussed in the adopting release. The Commission suggests that funds should consider adding a table of contents to any collective transmission of shareholder reports, thereby enhancing navigability and facilitating user access for investors.

Electronically provided shareholder reports

1. As per Instruction 4 of new Item 27A(a) of Form N-1A, funds are required to deliver specific shareholder reports to investors based on the fund and share class. The Commission has provided clarification on this instruction. In case of delivering shareholder reports to investors who have opted to receive their reports electronically, a fund can comply with instruction 4 by delivering an email or an electronic notification that includes direct hyperlinks to the shareholder report(s) of the fund (s) and share class(es) in which the investor has holdings. Alternatively, the notification can specify the investor’s fund(s) and share class(es) and include a link directing the investor to a website landing page that comprises direct hyperlinks to the shareholder report(s) for the fund (s) and share class(es) owned by the investor.

Compliance date and Inline XBRL issues

1. The Commission clarifies that funds should include the shareholder report transmitted to shareholders in the respective Form N-CSR, regardless of whether the Form N-CSR is filed before or after the compliance date, July 24, 2024.

As the compliance deadline of July 24, 2024, approaches, the intricacies of these rule changes will necessitate meticulous attention from fund managers and legal teams to adhere to the enhanced standards. If you have any questions, Ask Marcum today.

References

• https://www.sec.gov/investment/tailored-shareholder-reports-faqs