SEC's New Guidance on Electronic Media
Disclosure of Mutual Fund After-Tax Returns
Foreign Custody Rules Update
NASDR Reminds Members of Their Fund Advertising Responsibilities
Watch What’s On Your Web Site, SEC Says in New GuidanceThe SEC recently published a release on the use of electronic media by issuers (including investment companies) and market intermediaries (see www.sec.gov/rules/concept/34-42728.htm). The release provides additional guidance on the use of electronic media in several areas. This article discusses some of the key points of the release relating to electronic delivery of information and an issuer’s liability for Web site content.
Electronic Delivery
The three fundamental principles established in prior SEC releases for electronic delivery of information continue to apply. Compliance with legal requirements in delivering information depend upon notice, access and evidence of delivery. However, the SEC has attempted to clarify several regulatory issues in this release, as described below.
Telephone Consent
In prior published guidance the SEC stated that one method of satisfying the requirement for evidence of delivery is to obtain an informed consent from an investor to receive information through a particular electronic medium. Until now, however, the SEC’s position has been that the consent must be obtained in writing or by electronic communication. Because of the amount and scope of business that is transacted by telephone today, the SEC has changed its view. An informed consent may be obtained by telephone, as long as a record of that consent is retained (e.g., a detailed memorandum regarding the information conveyed to the investor, the scope of the investor’s consent, what electronic medium will be used, the date, and the persons on the call). Depending on the circumstances, a letter to the investor to confirm the investor’s consent and describing the manner, cost and risks of electronic delivery may be prudent.
Use of Portable Document Format
In the SEC’s view, documents may be delivered in PDF, if delivery in that format is not so burdensome as to effectively prevent access. Therefore, an investor must be informed of the requirements for access to PDF documents when consent to delivery in that format is obtained, and the investor must receive any necessary software and technical assistance at no cost. Typically, companies that publish documents on the Internet in PDF provide a hyperlink enabling a user to download Adobe Acrobat at no cost.
In addition, as suggested by one of the examples in the release, the company should provide a toll-free number for a user to call to obtain technical assistance or information in paper format from the company.
Simultaneous Delivery of Multiple Documents
In prior guidance the SEC confirmed that documents that are either in close proximity on the same Web site menu or hyperlinked may be considered to be simultaneously delivered for purposes of the federal securities laws. In this release, the SEC clarified that information on a company’s Web site will not be considered part of a company’s prospectus simply because the prospectus is also on the Web site. An issuer or intermediary must have acted to make the information part of the prospectus (e.g., by a hyperlink within the prospectus to the other information), in which case the company must file the other information as part of its registration statement and is subject to liability for that information. Providing a link to the prospectus from another document, however, will not cause the other document to become part of the prospectus (although both documents would still be considered to be delivered together).
Web Site Content
Generally, an issuer is responsible for the accuracy of its statements that it reasonably could expect to reach investors or the securities markets. In addition, an issuer may have liability for the statements of another person, if those statements can be attributed to the issuer. Attribution may result from either an issuer’s involvement in the preparation of the information or an issuer’s subsequent endorsement or approval.
Federal securities laws apply in the same manner to the content of an issuer’s Web site as to any other statements made by or attributable to the issuer. Therefore, when an issuer is offering securities, the issuer’s Web site must be reviewed to ensure that the information is consistent with the issuer’s prospectus and that none of the information is itself an offer that does not meet the requirements of federal securities laws. In addition, an issuer may become responsible for information to which the issuer establishes a hyperlink in its Web site. Information may be attributed to an issuer as a result of a hyperlink, if the context of the hyperlink in the issuer’s Web site or the issuer’s presentation of hyperlinks in its Web site suggest that the issuer is endorsing or approving the information. The release suggests various relevant factors. What does the issuer say about the link? Does the context suggest an endorsement? Is the source of the information clear to users? A clear, prominent statement disclaiming any responsibility for or endorsement of the linked information may be a useful precaution and, absent other contrary factors, may preclude attribution. Even then, however, selective presentation of hyperlinked information may be problematic. In the SEC’s view, attribution could result from attempting to control information and selectively direct users to information. For example, when there is a great deal of information on a topic available, a hyperlink to information that is not representative of the available information might suggest an endorsement. In addition, a pattern of establishing and terminating links depending upon the nature of the information regarding the issuer may also suggest endorsement or approval.
DISCLOSURE OF MUTUAL FUND
AFTER-TAX RETURNS
Recently, the Securities and Exchange Commission (SEC) proposed to amend its rules to require each mutual fund to disclose its standardized after-tax returns for one, five and 10-year periods (see www.sec.gov/rules/proposed/33-7809.htm). These amendments are part of the SEC’s efforts to educate investors regarding the impact of taxes on their mutual fund investments.
After-tax returns, which would accompany before-tax returns in fund prospectuses and annual reports, would be presented in two ways: (i) assuming the shareholder continued to hold his or her shares at the end of the period; and (ii) assuming the shareholder sold his or her shares at the end of the period, realizing taxable gain or loss on the sale. The amended rules would not require advertisements to include after-tax returns. However, the amended rules would require any advertisements that include after-tax returns to compute them according to a standardized formula.
The SEC is soliciting comments on the proposal. The comment period expires on June 30, 2000.
The SEC has adopted new rule 17f-7 and amended rule 17f-5 (www.sec.gov/rules/final/ic-24424.htm). The new rule and rule amendments will permit funds to maintain their assets in foreign securities depositories based on conditions that reflect the operations and roles of these depositories.
Amended rule 17f-5 will continue to govern a fund’s use of a foreign bank custodian. The amended rule excludes arrangements with foreign securities depositories from its scope because they are now addressed by new rule 17f-7. Under rule 17f-7, a fund may maintain its assets with a foreign securities depository if certain conditions are met. Decisions to maintain fund assets with a depository would be made by the fund or its adviser, based upon information provided by the fund’s primary custodian. The depository must be an eligible securities depository, which is defined by the rule to mean a depository that acts as or operates a system for the central handling of securities that is regulated by a foreign financial regulatory authority. An eligible securities depository must also perform certain record keeping functions for its participants and undergo periodic examinations. Furthermore, a fund’s primary custodian must be contractually bound to provide the fund or its adviser with an analysis of the custodial risks of using the depository, monitor the depository on a continuing basis and notify the fund of any material changes in risks associated with using the depository.
The new rule and rule amendments will be effective on June 12, 2000 with a compliance date of July 2, 2001. In the interim, a fund may operate its foreign custody arrangements in accordance with the new rule and amendments or in accordance with the 1997 amendments to Rule 17f-5. Funds may also operate foreign custody arrangements in compliance with Rule 17f-5 as it existed prior to the 1997 amendments, subject to the definition of an eligible foreign custodian as amended in 1997.
NASDR REMINDS MEMBERS
OF THEIR FUND ADVERTISING RESPONSIBILITIES
NASD Regulation recently issued a notice to NASD members to remind them of their responsibilities in advertising fund performance (http://www.nasdr.com/pdf-text/0021ntm.txt). The notice follows close on the heels of the SEC’s recent announcement of its initiative concerning fund prospectus disclosure and fund advertising (see the April 2000 edition of Investment Management Update).
In its notice to members, NASDR cautioned members to avoid communicating with the public in an exaggerated and misleading manner. NASDR also urged members to take an active role in explaining the impact of a hot equity market on a fund’s short and long-term performance in their fund advertising materials and recommended that disclosure be crafted in a manner to avoid creating unrealistic investor expectations with regard to future fund performance. The notice even suggested that it may be necessary to include information beyond what is required under Rule 482 when unusual performance is presented in order for sales material not to be misleading.
Investment funds that are organized outside the United States and that are treated as partnerships for U.S. tax purposes will face significantly revised reporting and documentation systems starting in January 2001.
Currently, most foreign partnerships that receive interest from U.S. investments provide the payer with evidence that the investment fund is foreign. For many payers that has been sufficient documentation to treat the interest as "portfolio interest" not subject to U.S. withholding tax. Many payers have assumed that the "back-up withholding" tax of 31 percent does not apply to such payments. Starting in January 2001, in order to not withhold the statutory 30 percent tax on payments to foreign persons or the 31 percent back-up withholding tax, a foreign partnership will need to provide the payer with form W-8 (proof of non-U.S. status) or W-9 (proof of U.S. taxpayer ID number) for each of the partners, for each payment received. Failure to provide the forms will result in the withholding of the 30 percent or 31 percent tax, as appropriate.
The documentation requirement applies to all types of investment income that would otherwise be subject to the 30 percent tax, so dividends and royalties are also caught in the web.
For foreign partnerships that do not want to provide the documentation, the IRS will consider an agreement that allows the partnership to take care of the withholding on its payments to the partners — it shifts the burden from the U.S. payer of the interest to the partnership. The agreement is subject to conditions to insure that the correct taxes will be collected and forms received.
Any foreign partnership that cannot or does not want to comply with the documentation production should consider negotiating an agreement with the IRS to become a foreign withholding partnership. We can help you through that process.