SEC Adopts Rule Bringing Fund Report Delivery into the 21st Century
The Commission, perhaps realizing that what looked like the future is already here, on June 5 made a quantum leap: It adopted a Rule allowing mutual funds, exchange-traded funds and other investment funds to offer investors the ability to give up paper shareholder reports and instead opt to view those reports online.
Under new Rule 30e-3, there is now an optional "notice and access" method for funds to deliver their shareholder reports. The Rule allows funds to deliver the reports by making them publicly available on a web site, free of charge, and mailing investors a paper notice to let them know when the reports are available. Those investors wishing to continue receiving paper reports may continue to do so. The new ability to provide electronic versions of shareholder reports will begin on January 1, 2021.
The SEC also passed two related measures tied to the electronic delivery Rule. One of those measures authorizes the agency to seek public comment on further ways by which the SEC can modernize fund information. The second allows the Commission to seek comment on the framework for certain processing fees that broker-dealers and other intermediaries charge funds for delivering fund shareholder reports and other materials to investors. In both cases, the SEC wants feedback by October 31 of this year.
"These actions are an important part of the Commission’s effort to better serve Main Street investors in our ever-changing marketplace," said SEC chairman Jay Clayton. "The new Rule significantly modernizes delivery options for fund information while preserving the right of fund investors to receive information in paper form as they do today." He said that he also looks forward to receiving input from the public on "next steps" the Commission might take, and encouraged "everyone with an interest in fund disclosure – especially Main Street investors – to give us their ideas on how to improve the design, delivery and content of fund disclosures."
The SEC branded all three actions as part of its larger initiative to "improve and modernize the design, delivery and content of information provided to fund investors."
"The SEC is trying to accommodate the reality that paper-based delivery is not for everyone," said Stradley Ronon partner Lawrence Stadulis. "Most people are simply not using paper anymore."
"The Rule was widely expected, but slow in coming," said Shearman & Sterling partner Jay Baris, who said that funds that offer electronic views "are likely to experience great cost savings. Some existing disclosure and prospectus delivery rules were written pre-Internet, pre-email. Your average millennial is not likely to wade through a 200-page paper report."
Some concerns, some support
Commissioner Robert Jackson voted against adopting Rule 30e-3, saying that the Commission, adopting it, "reverse[d] the default rule for delivery of information to mutual fund investors, a choice contrary to everything we know about how individual investors and funds actually behave." Specifically, he criticized the final rule for not requiring that summary information about performance and fees be provided in the notice investors will receive. "The decision raises the risk that funds with weak performance or high expenses will actively select a less transparent delivery method – to the detriment of their investors."
Commissioner Kara Stein, who also expressed concerns about the new Rule, nonetheless voted in favor of its adoption, in part because it can be seen as a "pilot program" and reviewed later, raised some concerns about whether it might create new problems.
"If you own shares of a fund that uses Rule 30e-3, instead of getting a paper report every six months, you will [now] get a paper notice sitting in your mailbox," she said. "The notice will inform you that your shareholder report has been posted online and is ready for viewing. If you want the paper version of the full shareholder report, you will now have to take an active step to request paper delivery. The notice will provide you with instructions on how to make that election, either on a one-time or a permanent basis through a required toll-free (or collect) telephone number. Or, if the fund chooses, it may also provide you with other methods of allowing your preference to be known. But the point is: you have to do something that you didn’t have to do before."
"The problem is that this extra step is a hurdle for investors, and may be one that, for some investors, is just too high," Stein said. "Or, to frame it differently, will investors proactively choose to leap over the hurdle to get the information they need to make informed investment decisions?"
Commissioner Hester Peirce spoke positively about the Rule, comparing its adoption to a ray of sunshine after a long period of rain. "I feel the same way about this rule – a ray of light is breaking through the clouds of our often ineffective, wasteful, paper-intensive disclosure scheme. This recommendation is superior to the proposal because it should result in greater cost savings, yet also better achieve the goal of ensuring that investors are aware of their options. This rule is a good step."
Outgoing commissioner Michael Piwowar said that he was "delighted" to support Rule 30e-3. "This rule is long overdue, but it epitomizes the phrase ‘better late than never.’"
Under this Rule, funds are permitted to satisfy their delivery obligations for shareholder reports by one of three options:
Mailing reports on paper,
Delivering reports electronically to investors who have chosen this method under the agency’s electronic delivery guidance,
Providing notice and web site accessibility, or
A combination of the above.
"Investors who prefer paper could – at any time – elect to receive all future reports in paper that are sent by the fund complex or forwarded by the financial intermediary, or request to receive particular reports in paper on an ad hoc basis," the SEC said. "Each notice provided to investors under the Rule is required to explain how investors may access the report and request paper copies."
Here, according to a fact sheet provided by the agency, are the details:
Report accessibility. The shareholder report and the fund’s most recent prior report must be publicly accessible, free of charge, at a specified web site.
Availability of quarterly holdings. "Quarterly holdings for the last fiscal year must also be publicly accessible at the website," the agency said. "These holdings would include those in the shareholder reports, which would cover the second and fourth fiscal quarters, and would also including holdings for the first and third fiscal quarters."
Format. Funds must satisfy conditions designed to ensure accessibility of reports for shareholders, including format and location.
Notice. "Investors will receive a notice of the availability of each report that includes a web site address where the shareholder report and other required information is posted and instructions for requesting a free paper copy or electing paper transmission in the future," the SEC said. Such a notice may also contain additional information, including instructions by which an investor can elect to receive shareholder reports or other documents by electronic delivery, and additional content from the shareholder report.
Print upon request. Funds must send a free paper copy of any of these materials upon request.
Investor elections to receive paper report. "At any time, an investor may elect to receive all future reports in paper by calling a toll-free telephone number or otherwise notifying the fund or intermediary," the agency said. "Elections to receive reports in paper with respect to one fund will apply to other funds held currently or in the future in the same account with the fund complex or financial intermediary."
Extended transition period. The earliest that notices may be transmitted to investors in lieu of paper reports is January 1, 2021. Funds will be required to provide two years of notices to shareholders before they begin relying on the Rule, if they rely on the rule before January 1, 2022.
Seeking comments on further modernization
The SEC doesn’t want to stop electronic access to shareholder reports. It wants to further enhance the experience for investors, but seeks input from the public on just how to do so and what to offer. "This request for comment is the first major step in a long-term initiative, led by the Division of Investment Management, to improve the investor experience by updating the design, delivery and content of fund disclosure for the benefit of individual investors," the agency said.
The SEC specifically wants comments from individual investors, academics, literacy and design experts, market observers, fund advisers and boards of directors – and it wants them not just for shareholder reports, but for prospectuses, advertising and other types of disclosure. The call for comment also asks how to make better use of 21st century technology, including "how to make disclosure more interactive and personalized."
The public comment request "is a cyclical request that comes up frequently," said Stadulis. "This is the latest chapter."
Now that Rule 30e-3 is adopted, "the Commission believes that it is appropriate to consider more broadly the overall framework for the processing fees that broker-dealers and other intermediaries charge funds."
After all, such fees are charged for expenses involved in forwarding paper shareholder reports and other materials to beneficial shareholders under current rules of the New York Stock Exchange and other self-regulatory organizations. "The Commission seeks public comment and additional data on the current processing fee framework for fees charged by intermediaries for the distribution of disclosure materials other than proxy materials (e.g., shareholder reports and prospectuses) to fund investors to better understand the potential effects on funds and their investors." More specifically, the SEC wants comments on topics including:
Assessment of processing fees,
Transparency of processing fees,
Remittances received by financial intermediaries for delivery of fund documents,
Whether the structure and level of processing fees should be set by another entity, and
Appropriateness of these fees in cases where intermediaries are separately paid shareholder servicing fees from fund assets.