Proposed Rules For Mutual Fund Reports to Shareholders and Quarterly Portfolio Disclosure

In December 2002, the SEC proposed changes in the disclosures that mutual funds make in their reports to shareholders. The proposals, if adopted, would:

  • Permit mutual funds to include a summary portfolio schedule in their reports to shareholders;
  • Require shareholder reports to include tabular or graphic presentations of fund portfolio holdings by identifiable categories;
  • Require mutual funds to disclose fund expenses borne by shareholders during the reporting periods;
  • Require mutual funds to include management's discussion of fund performance in their annual report to shareholders.

Disclosure of Fund Portfolio Holdings

Mutual funds are currently required to include complete portfolio holdings in the reports that shareholders receive twice a year. However, because of its size or investment strategy, a fund may hold securities in hundreds or thousands of portfolio companies, which could require up to 40 or more pages to list. Having to provide such a lengthy portfolio schedule results in significant printing and mailing costs and often does little to increase investor understanding of the fund's primary investment focus.

Summary Portfolio Schedule. The SEC has therefore proposed to allow a summary portfolio schedule, in lieu of a complete portfolio schedule, to be included in the annual and semi-annual reports provided to shareholders. The proposed summary portfolio schedule would help streamline shareholder reports and reduce expenses while helping investors to focus on a fund's principal holdings and to better evaluate a fund's risk profile and investment strategy. The complete schedule, however, would still have to be available free of charge to investors upon request.

The SEC is recommending that the proposed summary portfolio schedule include a fund's 50 largest holdings and each investment that exceeds 1% of the fund's net assets. The format of the proposed summary portfolio schedule would be similar to the complete schedule of investments that is currently included in shareholder reports. The SEC has asked for comments from the industry on what a summary portfolio schedule should include, so it is hard to predict whether the SEC's recommendations for the contents of the schedule will ultimately be adopted.

The proposal would also exempt money market funds from including any portfolio schedule in shareholder reports. However, a money market fund's complete portfolio schedule would still have to be filed with the SEC on Form N-CSR and be available to shareholders upon request and free of charge.

Tabular or Graphic Presentation of Portfolio Holdings. The SEC has further proposed requiring mutual funds to include in their annual and semi-annual shareholder reports a tabular or graphic presentation of a fund's portfolio holdings. Such presentation would use reasonably identifiable categories (e.g., industry sector, geographic region or credit quality) and show the percentage of net asset value attributable to each category. While the presentation should be designed to provide the most useful information to investors about the types of investments made by the fund in light of its investment objectives, each fund would be given flexibility to determine the format of its presentation as well as the categories to be used to ensure that the portfolio information is tailored in a manner appropriate to its holdings.

Quarterly Filing of Complete Portfolio Schedule. With respect to complete portfolio schedules, the SEC proposes to require mutual funds to make these filings on a quarterly basis rather than semi-annually as is currently required. This proposal is intended to balance investor interest in more frequent portfolio information with the costs associated with making such information available, which are ultimately borne by investors. Under the proposal, funds would be required to file their complete portfolio schedules for the second and fourth fiscal quarters on Form N-CSR. In addition, funds would be required to file their schedules for the first and third fiscal quarters on new Form N-Q within 60 days of the end of the quarter. Please note, however, that the proposals would only require the filing of a fund's portfolio schedule and not the actual delivery of such information to shareholders. Nonetheless, a fund would be required to include in its annual and semi-annual reports to shareholders a statement that:

  • the fund files its complete schedule of portfolio holdings with the SEC for the first and third quarters of each fiscal year on Form N-Q;
  • the fund's Forms N-Q are available on the SEC's website at;
  • the fund's Forms N-Q may be reviewed and copied at the SEC's Public Reference Room and how information on the operation of the Public Reference Room may be obtained; and
  • a description of how the information may be obtained if the fund makes the Form N-Q information available to shareholders upon request.

Disclosure of Fund Expenses

The SEC proposals also include a requirement that mutual funds disclose in their shareholder reports the fund expenses borne by shareholders during the reporting period. Specifically, the proposal would require fund shareholder reports to include:

  1. the cost in dollars associated with an investment of $10,000, based on the fund's actual expenses and return for the period; and
  2. the cost in dollars associated with an investment of $10,000, based on the fund's actual expenses for the period and an assumed return of 5% per year.

The first figure is intended to allow investors to estimate the actual costs that they bore over the reporting period. The second figure is intended to provide investors with a basis for comparing the level of current period expenses at different funds. The proposed disclosures would supplement the fee disclosure required in the mutual fund prospectuses and are designed to increase investor understanding of the ongoing fees they pay for investing in a fund.

The method of calculation for the proposed fee disclosure would be similar to what is currently required for the expense example in the fee table of the mutual fund prospectus, with modifications to show that the example in shareholder reports reflects actual historical expenses borne by an investor, rather than hypothetical future expenses.

If any increases or decreases in fund operating expenses occurred during the reporting period that would materially affect the information in the example had those changes been in place throughout the reporting period, the fund would be required to restate the expense information using the current fees as if they had been in effect throughout the entire reporting period in a footnote to the example.

The proposed expense disclosure would be accompanied by an explanation that mutual funds charge both transaction costs and ongoing costs and that the expense example is intended to help a shareholder understand his or her ongoing costs and compare these costs with the ongoing costs of investing in other funds.

Management's Discussion of Fund Performance ("MDFP")

Currently, a mutual fund is required to include MDFP in its prospectus unless the information is included in the fund's latest annual shareholders report. While many funds already include MDFP in their annual reports, the SEC is proposing to require that the MDFP be included in the annual report to enable investors to assess the information provided by the MDFP together with other "backward looking" information in order to better understand a fund's performance over the prior year.

The obvious purpose of this proposed requirement is to create consistency in the location of such information and to ensure that the certifications made by a mutual fund's principal executive and financial officers regarding the information contained in the fund's annual reports cover the MDFP.

*article courtesy of Quarles & Brady