The SEC is scheduled to vote on October 13, 2016, to finalize rules heightening the disclosure and liquidity requirements for investment companies.
The rules are intended to strengthen the SEC’s supervision of the asset management industry’s 16,600 funds and 11,500 investment advisers. Over the years, the complexity of financial products offered by investment companies has increased, and an update to the industry’s disclosure rules is expected to help the SEC better monitor the industry. The heightened requirements are also expected to help the market regulator address the risks funds pose to the financial system.
The final rules are expected to be based on proposals the SEC issued last year.
In May 2015, the commission issued Release No. 33-9776, Investment Company Reporting Modernization, to propose an increase in the reporting requirements for fund companies. In September 2015, the SEC proposed in Release No. 33-9922, Open-End Fund Liquidity Risk Management Programs; Swing Pricing; Re-Opening of Comment Period for Investment Company Reporting Modernization Release, to strengthen the way mutual funds and exchange-traded funds (ETFs) manage cash holdings so that shareholders can redeem shares without hurting the price for other investors.
Release No. 33-9776 asks mutual funds to fill out a new monthly portfolio form, Form N-PORT, with information about the value of their securities holdings, repurchase agreements they have agreed to, securities lending activities, exposures to trading partners, and terms of derivatives contracts. But investor advocates and the mutual fund industry are most eager to find out if the SEC will mandate changes to the method for delivering shareholder reports.
Today, paper copies of annual and semiannual mutual reports are mailed to shareholders unless they indicate a preference for electronic delivery. Release No. 33-9776 proposed to flip the default and allow mutual funds to provide the reports via the Internet. If shareholders want paper copies, they would need to request them.
If the SEC decides to keep the current paper-default requirement, it will represent a minor setback for the mutual fund industry. Its main lobbying group, the Investment Company Institute (ICI), has been strongly lobbying for electronic delivery because the switch will save about $200 million annually in printing and mailing costs. The ICI said the savings will be passed on to investors because the mailing costs are paid by shareholders as part of their fees. The industry also said the switch will help protect the environment.
Investor protection advocates, on the other hand, said electronic delivery will harm individuals without ready Internet access, especially the elderly, minorities, and those with disabilities. Moreover, they cited studies showing a general preference for paper documents because they heighten the ability to absorb and understand the information.
Barbara Roper, director of investor protection with the Consumer Federation of America and a member of the SEC’s Investor Advisory Committee (IAC), emphasized that investor advocates do not oppose electronic delivery, but they do not want investors to lose their right to hard copies of shareholder reports.
“We oppose defaulting investors to electronic delivery based on negative consent,” Roper said. “Nothing prevents investors who prefer electronic delivery from getting electronic delivery now. The industry is eager to accommodate that preference. But many investors still prefer to receive paper documents. Don't their preferences matter? Because of the inadequacies of negative consent, this proposal would reduce the likelihood that investors receive disclosures in the format they prefer.”
For the cash management proposal, the SEC wants to require mutual funds and ETFs to categorize and monitor the liquidity of a portfolio’s position under Release No. 33-9922.
The liquidity would be classified into one of six categories based on the number of days it would take to convert the securities to cash without taking a significant loss.
Instead of classifying a position as simply liquid or illiquid, the proposal would have funds reflect a security’s liquidity range from very liquid to substantially illiquid.
The SEC also wants to allow, but not require, funds to use “swing pricing,” which reflects the costs of shareholders’ trading activity in a fund’s share price, or net asset value (NAV). Swing pricing allows funds to have the purchasing and redeeming shareholders absorb the costs of their trading and not have other shareholders cover them. A fund that uses swing pricing would reflect in its NAV a specified amount, the swing factor, once the level of net purchases into or net redemptions from the fund exceeds a specified percentage of the fund’s NAV, known as the swing threshold. Funds would be required to consider various factors to determine the swing threshold and swing factor, and to test the threshold each year.
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