“Any fool can make things bigger, more complex, and more violent. It takes a touch of genius – and a lot of courage – to move in the opposite direction.”
– Albert Einstein
On September 9, 2019, the Division of Investment Management (IM) of the Securities and Exchange Commission (SEC) issued disclosure guidance (so-called accounting and disclosure information) addressing mutual fund principal risk disclosure in summary prospectuses.1 The guidance sets forth several suggestions to improve principal risk disclosure.
Setting the Table
- What are “Principal Risks”? According to IM, they include risks that are reasonably likely to adversely affect a fund’s net asset value, yield and total return.2
- What factors can affect a fund’s principal risks? These will include the fund’s:
- investment objective(s);
- investment strategies; and
Suggestions for Improving Principal Risk Disclosure
- Ordering Risks by Importance.
- IM recommends this instead of ordering risks alphabetically. IM also recognizes that this judgment is subjective, can change over time and observed that “we would not generally expect to comment on a fund’s ordering of risks by importance.”
- Tailoring Risk Disclosures.
- ☑ – tailor risk disclosure that is specific to the fund in light of the way the fund is managed.
- ⓧ – principal risk disclosure that discusses investments not identified in the fund’s principal investment strategies.
- Disclosing that a Fund is Not Appropriate for Certain Investors.
- IM encouraged funds to consider disclosing that a fund is not appropriate for certain investors given the fund’s characteristics.
PRACTUS TIP: We recommend, particularly with respect to intermediary-sold funds, that a fund think long and hard before adding this type of disclosure. An intermediary may have a good reason to recommend a particular type of fund to an investor even if the fund may not be appropriate to other similarly situated investors. This disclosure may create a trap for the unwary. Moreover, the SEC itself previously considered requiring funds to disclose the types of investors for whom a fund may be an appropriate or inappropriate investment. The SEC received significant negative comment on its proposal and determined to permit, but not require, this type of disclosure.
- Other Disclosure Considerations.
- IM reiterated that principal risks should be summarized in a summary prospectus, and that more detailed information should be presented elsewhere in the prospectus.
- IM encouraged funds to disclose non-principal risks and non-principal investment strategies in their statements of additional information, not in their prospectuses.
- Funds are encouraged to review periodically their risk disclosures, including the order in which principal risks are presented, to assess whether the disclosures remain adequate.
A few key takeaways for funds and those responsible for preparing their disclosure documents:
- Summarize your principal risks in your summary prospectus.
- Explain your principal risks in more detail elsewhere in your statutory prospectus.
- Relegate discussions of non-principal risks and non-principal investment strategies to the SAIs.
- Make sure your principal investment risks tie back to your principal investment strategies.
- Order your risks by importance; review them as market conditions and investment techniques change.
- It’s better for a fund complex to tailor risk disclosures to the risks of particular funds rather than use cookie cutter risk disclosures for all funds.
- While the IM staff would like you to identify investors for whom a fund may not be appropriate, be willing to disappoint them.
1 Improving Principal Risks Disclosure, Division of Investment Management Accounting and Disclosure Information 2019-08 (Sept. 9, 2019) (ADI 2019-08) (visited Sept. 11, 2019).
2 Principal risks also include risks to which the Fund’s portfolio as a whole is subject. Form N-1A, Item 4(b)(1)(i).