SEC Adopts Form N-1A Amendments and Profile Rule

Washington, DC, March 20, 1998 - The Securities and Exchange Commission has adopted proposals that significantly change disclosure requirements for mutual funds. First, it has substantially revised Form N-1A, the registration form for mutual funds. Second, it has adopted new Rule 498 under the Securities Act of 1933, allowing funds to use a simplified "profile" that will give investors the option of purchasing fund shares or requesting the full prospectus. The Institute strongly supported both proposals in its comment letter.

The effective date for both proposals is June 1, 1998. New registration statements or post-effective amendments filed on or after December 1, 1998 must comply with the N-1A amendments. The final compliance date for filing post-effective amendments to comply with the new N-1A requirements is December 1, 1999. The N-1A adopting release states that the same compliance dates apply to the plain English requirements for fund prospectuses. (These requirements apply to the front and back cover pages and risk/return summary in fund prospectuses, and to profiles in their entirety.) Funds are permitted to comply with amended Form N-1A at any time after the effective date. Funds also may file profiles beginning on this date. Funds may continue to use "pilot profiles" as supplemental sales literature after the June 1, 1998 effective date.

Amendments To Form N-1a
Summary of the Amendments
The amendments to Form N-1A are designed to improve mutual fund prospectus disclosure by, among other things, focusing the document on essential information about a particular fund and minimizing disclosure about technical, legal, and operational matters generally common to all funds. Significant new requirements include:

The Commission adopted the amendments to Form N-1A substantially as proposed. The most significant changes to the proposal include:

These and other aspects of the amended form are discussed below.

General Principles
As noted above, the amendments to Form N-1A are designed to improve fund prospectus disclosure by focusing it on essential information about a particular fund and minimizing disclosure about technical, legal, and operational matters that generally are common to all funds. The N-1A adopting release calls for all persons who participate in the preparation and review of fund disclosure documents (including the staff administering the new prospectus and profile requirements) to act consistently with certain basic disclosure principles. For example:

General
The N-1A amendments require that fund prospectuses contain a risk/return summary at the beginning that will provide information about a fund's investment objectives, principal strategies, risks, performance, and fees. In response to concerns raised by commenters, the N-1A adopting release states that funds are not required to include additional risk disclosure elsewhere in the prospectus if the disclosure in the risk/return summary meets the requirements of Item 4 of the form. The amendments will permit, but not require, funds to present the information in the risk/return summary in a question-and-answer format. (As discussed below, the same is true for the profile.) Proposed disclosure about the availability of a fund's shareholder reports will be required on the back cover page instead of in the risk/return summary.

Narrative Risk Disclosure
Narrative risk disclosure in the summary "should identify briefly the principal risks of investing in the particular fund and emphasize those risks reasonably likely to affect the fund's performance," according to the N-1A adopting release. The release states that "the Commission believes that it generally would be inconsistent with the summary risk requirement for a fund to include a 'laundry list' of generic risk factors that may apply to any fund and that does not identify the risks of investing in the fund."

The amended form permits, but does not require, funds to include disclosure about the types of investors for whom the fund is intended or the types of investment goals that may be consistent with an investment in the fund. In another change from the proposal, the Commission has eliminated the option of discussing the rewards of investing in a fund in the risk summary. As was proposed, special risk disclosures about money market funds and funds advised by or sold through banks will be required in the risk/return summary, rather than on the cover page (as is currently the case). Form N-1A will no longer call for special disclosure concerning the risks of single-state money market funds.

3. Bar Chart
The risk/return summary must include a bar chart showing a fund's annual return for each of the last ten calendar years. In a change from the proposal, funds with fiscal years other than calendar year must include a footnote to the bar chart setting forth year-to-date return information as of the end of the most recent quarter. The bar chart may include returns for more than one fund, as long as the information is clear and understandable. As noted above, the Commission has added a requirement that funds also disclose their best and worst returns for a quarter during the ten-year (or other) period covered by the bar chart, to illustrate that fund shares may be subject to short-term price fluctuations.

The Commission has revised the proposal regarding application of the bar chart requirement to multiple class funds. As originally proposed, such funds would have been required to present in the bar chart information with respect to the class that had the longest performance history or, if more than one class had returns for at least ten years, the class with the greatest net assets as of the end of the most recent calendar year. The final amendments provide that multiple class funds may choose the class to be reflected in the bar chart, subject to certain limitations, including that (1) the bar chart must reflect the performance of any class that has returns for at least ten years, and (2) if two or more classes have returns for different periods shorter than ten years, the bar chart must reflect the returns for the class that has the longest performance history.

Performance Table
The amended form requires funds to include a table showing their average returns for the last one, five, and ten years, along with those of a broad-based securities market index. In response to comments, the Commission revised the proposal to require that the table contain information as of calendar yearend, rather than fiscal yearend, to provide consistency with the bar chart and avoid possible investor confusion. The Commission also followed suggestions to permit funds that have been in existence for more than ten years to include a "life of fund" column in the table. Money market funds will have the option of providing their 7-day yield ending on the date of the most recent calendar year end or disclosing a toll-free telephone number that investors may call to obtain a fund's current 7-day yield.

Fee Table
The risk/return summary also will include a fund's fee table. Most of the proposed changes to the fee table were adopted as proposed. These changes include, for example, increasing the amount used in the example to $10,000, adding a new line item for shareholder account fees, and simplifying the narrative disclosure that accompanies the fee table. Proposed changes to the captions of certain line items have been revised in minor respects to make them more readily understandable and accurate. As indicated above, in a change from the proposal, the amended form requires that the fee table reflect fund operating expenses without regard to account expense reimbursements and fee waiver arrangements. Operating expenses net of reimbursements and waivers may be disclosed in a footnote.

Investment Strategies and Risk Disclosure
Rather than focusing on the characteristics and risks of each type of security in which a fund may invest, the amended form will require disclosure of a fund's principal investment strategies and the principal risks of the fund as a whole. The form and the N-1A adopting release provide guidance for determining whether a strategy is a principal investment strategy. Based on concerns expressed by the Institute and others, the amended form does not mandate any specific quantitative risk disclosure.

The amended form will continue to require disclosure of a fund's policies on industry concentration in the prospectus. The N-1A adopting release states, however, that the Commission has requested that the Division of Investment Management "review its positions on concentration, consulting with industry representatives as appropriate, with a view toward allowing funds a greater degree of flexibility in establishing concentration policies." The prospectus will also have to disclose, if applicable, that in response to unfavorable market conditions, a fund may make temporary investments that are not consistent with its principal investment objectives and policies. Disclosure of the percentage of a fund's assets that may be committed to temporary defensive positions, the risks of these positions, and their likely effect on the fund's performance, will not be required. In addition, disclosure concerning the consequences of a fund's portfolio turnover rate will be required in the context of disclosure about a fund's principal trading strategies-but only if the fund anticipates that active and frequent trading of portfolio securities will be a likely result of implementing its principal investment strategies.

Management, Organization, and Capital Structure
The Commission proposed to abbreviate prospectus disclosure about a fund's management and organization and to move certain information about management, organization, and capital structure to the SAI. Most of these changes were adopted as proposed. The amended form will continue to require information in the prospectus about investment advisory services provided to, and investment advisory fees paid by, a fund (in addition to the fee table disclosure of advisory fees). Sub-advisory fees will be disclosed in the SAI. Portfolio manager disclosure requirements will remain substantially the same as under the current form; however, new instructions to the form will provide additional guidance on disclosure obligations for funds as to which day-to-day management responsibilities are shared.

A requirement to describe briefly the responsibilities of a fund's board of directors under the applicable laws of the jurisdiction in which it is organized has been moved to the SAI. Based on comments it received, the Commission determined not to require any additional disclosure about fund directors (such as their names, experience, compensation, addresses, or telephone numbers) in the prospectus. The N-1A adopting release states, however, that the Commission has directed the Division of Investment Management to consider director disclosure issues as part of an initiative to improve shareholder reports.

Shareholder Information
The Commission will permit funds to provide information about purchase and redemption procedures to investors in a separate document. The N-1A adopting release outlines three options for doing so: (1) if a fund's prospectus contains at least the minimum purchase and sale information required by Form N-1A, the fund may create and use a separate purchase and sale disclosure document as supplemental sales literature; (2) the information may be set forth in a separate section of the SAI, and may be made available to investors as a separate document, either alone or with the SAI, upon request; or (3) a fund could remove all purchase and sale information from its prospectus and place it in a separate document that is incorporated by reference into the fund's prospectus and delivered with the prospectus.

As indicated above, contrary to its proposal, the Commission determined to continue to require that funds disclose the methods used to value their assets in the prospectus. This decision was based on investor complaints, and the staff's review of fund prospectus disclosure concerning pricing, in the aftermath of market volatility last October. Funds also will be required to provide a statement about the effect of the fund's use of "fair value net asset calculation."

The N-1A adopting release discusses the staff's consideration of investor complaints about restrictions on the "portability" of fund shares (i.e., the ability to transfer fund shares held in an account at a brokerage firm to an account at a different brokerage firm). It states that the Commission believes that disclosure about such restrictions may be important to a typical investor, but is not convinced that such disclosure belongs in fund prospectuses. The Commission's staff will continue to discuss with the NASD staff other means of alerting investors to restrictions on portability of fund shares.

Changes to the disclosure of tax consequences of investing in a fund were adopted substantially as proposed.

Distribution Arrangements
As was proposed, the amended form will require disclosure about distribution arrangements (including sales charges and Rule 12b-1 fees, and multiple class and master-feeder fund arrangements) in a central location in the prospectus. Certain related technical disclosures have been moved to the SAI. Disclosure about service fees will not be required in this section of the prospectus. With respect to multiple class and master-feeder funds, the Commission followed recommendations to eliminate existing requirements to disclose information about additional classes or feeders that are not offered in the prospectus.

Financial Highlights Information
The amended form retains the financial highlights table but, as was proposed, permits it to appear anywhere in the prospectus (rather than requiring it on a particular page, as currently is the case). In addition, the table has been simplified. First, it will be required to cover a five-year period, rather than a ten-year period. Second, disclosure about average commission rates is no longer required. (The release states that the Commission will consider requiring this information in Form N-SAR.) Additional comments recommending changes to or elimination of the financial highlights table will be considered in the context of a future Commission rulemaking initiative addressing financial statement requirements generally.

Front and Back Cover Pages
As the Commission proposed, the front cover of a fund prospectus will be required to disclose only the following three items: the fund's name, the date of the prospectus, and a simplified version of the standard Commission disclaimer about the securities offered in the prospectus. Funds will be permitted to include additional information on the front cover, subject to a general rule about the presentation of information not required in the prospectus. Information about the availability of additional information about a fund will be consolidated on the back cover page. Funds will be required to send an SAI within three business days of a request for it, and the Commission's Office of Compliance Inspections and Examinations will examine funds' compliance with this requirement in the course of routine inspections. A fund may state on the back cover of the prospectus that additional information is available through a financial intermediary. The fund will retain the obligation, however, to ensure that information is sent within three business days of a request. According to the release, the Commission expects that funds will fulfill this obligation through contractual arrangements.

Part B - Statement of Additional Information
The Commission adopted several technical and conforming changes to the SAI as proposed. It will review the SAI disclosure requirements as part of a future initiative to simplify and update SAI disclosure.

Part C - Other Information
The amended form will no longer require the filing of model retirement plans used to offer fund shares, schedules showing how fund performance is calculated, or voting trust agreements. In addition, the Commission deleted the requirement to include a table showing the number of holders of each class of a fund's shares. The Commission also followed recommendations to eliminate the requirement for a new fund to file updated financial statements within four to six months of the effective date of the registration statement.

General Instructions
General
The Commission has reorganized and simplified the General Instructions to Form N-1A to make them easier to use. Amendments to General Instruction C clarify the application of the recently adopted plain English requirements to fund prospectuses. General Instruction C also has been revised to reflect the basic disclosure principles underlying the amendments and includes certain drafting guidelines. In addition, it provides guidance on the use of Form N-1A by more than one fund and by multiple class funds.

Modified Prospectuses for Certain Funds
As the Commission proposed, the amended form will permit a fund that is offered as an investment alternative in a participant-directed defined contribution plan to tailor its prospectus for use by plan participants by omitting or modifying certain information. Based on commenters' suggestions, funds that serve as investment options for variable insurance contracts also will be permitted to use modified prospectuses.

Incorporation by Reference
Revised General Instruction D addresses incorporation by reference, and continues to permit funds to incorporate the SAI by reference into the prospectus. The revised instruction clarifies that funds may not incorporate by reference information that Form N-1A requires to be included in the prospectus. The N-1A adopting release cites Section 19(a) of the Securities Act and Section 38(c) of the Investment Company Act, which protect a fund from liability under these acts for actions taken in good faith in conformity with any Commission rule. It states that the N-1A amendments are designed to provide better guidance to funds as to what information should be in the prospectus and the SAI to assist funds seeking to act in good faith conformity with Form N-1A.

Form N-1A Guidelines and Related Staff Positions
The N-1A adopting release indicates that some of the Guides to current Form N-1A and additional staff positions on disclosure matters expressed in Generic Comment Letters ("GCLs") have become outdated or call for disclosure that is inconsistent with the goals of the amendments. Accordingly, while certain disclosure requirements from the Guides and the GCLs have been incorporated into the amended form, the Commission is rescinding its 1972 and 1983 releases concerning the Guides and neither the Guides nor the GCLs will apply to registration statements prepared on the amended form.

Information in the Guides and GCLs about legal requirements, interpretive positions, and descriptions of filing procedures will be updated and organized into a new "Investment Company Registration Guide," that will be made available as soon as practicable.

Administration of Form N-1A
The N-1A adopting release states that achieving the goals underlying the amendments will require discipline on the part of the Commission and its staff, as well as funds and their various advisors. It urges all parties involved in the disclosure process to look both to the disclosure requirements and to the disclosure principles reflected in the amended form. The release states that the Commission has instructed its staff to adhere closely to the disclosure principles when providing comments on fund registration statements and interpreting provisions of the form. In addition, the Commission "has generally instructed the staff to avoid as much as possible using disclosure requirements as a means of regulating the conduct of funds, which are subject to extensive substantive regulation under the Investment Company Act."

Coordination with the NASD
The N-1A adopting release notes that certain NASD rules restrict the ability of NASD members to engage in various activities relating to funds unless specified disclosures are made in fund prospectuses. The release indicates that the Commission believes "it is of the utmost importance that all disclosure contained in fund prospectuses conform to the principles of effective communication reflected in Form N-1A, as amended." According to the release, the NASD staff has agreed to evaluate all of its existing requirements for consistency with these principles and propose such changes as may be needed to achieve greater consistency. If it imposes further prospectus disclosure requirements in the future, the NASD will seek to do so in accordance with the Commission's disclosure principles. In a footnote to the release, the Commission encourages the NASD to follow these same principles as much as possible in considering and proposing disclosure requirements for fund advertisements.

Fund Profile Rule (Rule 498)
Summary of the Rule
The Commission adopted Rule 498 substantially as proposed but also revised it in several respects that reflect comments received. Rule 498 permits any mutual fund to provide investors with a profile that summarizes key information about the fund. Profiles may be distributed through any means, including direct mail, print media, broadcast, and electronic media. The profile is similar in many respects to that developed by the Institute and its members that participated in the pilot program for the profile. Unlike under the pilot program, however, investors who receive the fund profile would have the option of purchasing fund shares or requesting and reviewing the fund's prospectus. An investor that purchases fund shares based on the profile must receive the fund's prospectus with the purchase confirmation.

General Requirements
Profile Format
The profile must present specified items of disclosure in a particular sequence. Funds may, but are not required to, present the required information in a question-and-answer format. A profile may describe more than one fund; the profile adopting release points out that describing more than one fund in a profile could be a useful means of providing investors with information about related investment alternatives offered by a fund group. While there is no express limitation on the number of funds that may be included in a profile, information about multiple funds needs to be set out in a concise and summary manner in a format designed to communicate the information effectively. Rule 498 has been modified to clarify that information that is common to all funds described in the profile need be stated only once, and the rule permits the binding of separate profiles for different funds together in one document.

Profile Disclosure
Cover Page
The profile need not contain a separate cover page, provided that certain basic information about the fund is included as introductory information at the beginning of the profile. The information that must be included is as follows: identification of the document as a "profile," a legend explaining the profile's purpose, the fund's name and, at the fund's option, its investment objective or the type of fund offered or both, and the approximate date of the profile. Unlike the proposal, funds are not required to also provide in this part of the profile the date of the most recent performance information. Rather, the date of the performance information included in the profile can accompany the performance information. Rule 498 permits a fund to reflect updated performance information in a "sticker" or by similar means to avoid frequent reprinting of the profile to change this section of the profile.

Required Legend and Availability of Additional Information
Rule 498 requires a specific legend to appear on the cover page of, or at the beginning of, a profile that refers to the summary nature of the profile and the availability of the fund's prospectus and other information about the fund at no charge. There is no suggestion in the legend that the profile excludes material information.The legend must provide a toll-free or collect telephone number for investors to request the prospectus or other information about the fund. A fund may indicate, as applicable, that the prospectus is available on its Internet site or by e-mail request. The legend also may state that additional information about the fund is available from a financial intermediary.

Consistent with the proposal, Rule 498 requires a fund to send its prospectus, shareholder reports, and SAI to requesting investors within three business days of a request. As with Form N-1A, the profile adopting release notes that a fund whose information is available through a financial intermediary retains the obligation to ensure that the three-day requirement is met and that such an obligation is expected to be fulfilled through a contractual arrangement with the financial intermediary. In addition, the profile adopting release reiterates that Commission staff will be examining for compliance with the three-day requirement.

Risk/Return Summary
The first four items of the profile elicit information substantially identical to the proposed risk/return summary at the beginning of every fund prospectus. This includes a fund's investment objectives/goals, a fund's principal investment strategies, the principal risks of investing in a fund (including special risk disclosure requirements regarding money market funds and funds advised by or sold through a bank), the risk/return bar chart and table, and the fund's fee table. (These requirements are discussed in greater detail in Section I.C above.) Unlike Form N-1A, Rule 498 requires fund profiles: (i) to include disclosure in the risk/return summary (not on the back cover page) noting the availability of the fund's shareholder reports; and (ii) to update the information in the table as of the end of each succeeding calendar quarter as soon as practicable after the completion of the quarter.

Portfolio Manager Disclosure
Rule 498's disclosure requirements regarding investment advisers, sub-advisers, and portfolio managers are substantially similar to the proposed requirements. Specifically, Rule 498 requires a fund to identify its investment adviser, sub-adviser(s) and portfolio manager(s). The profile must disclose the length of time that a portfolio manager has managed the fund and the portfolio manager's business experience for the last 5 years. For both portfolio managers and sub-advisers, specific disclosure is not required if three or more manage a portion of the fund's portfolio, except that disclosure is required regarding any portfolio manager or sub-adviser that is (or is reasonably expected to be) responsible for the management of a significant portion of the fund's net assets. A portfolio manager (or sub-adviser) of 30% or more of a fund's net assets generally would be deemed to be responsible for the management of a significant portion of the fund's net assets.

Other Disclosure Requirements
Consistent with the proposal, Rule 498 requires funds to disclose: (a) how to purchase fund shares, including the minimum initial or subsequent investment requirements, the initial sales load, and, if applicable, initial sales load breakpoints or waivers; (b) how to sell fund shares, including that shares are redeemable, the procedures for redeeming shares, and any charges or sales loads that may be assessed upon redemption (including the existence of any waivers); (c) the terms and conditions under which it makes distributions and the expected tax treatment of the distributions; and (d) a brief summary of services available to fund investors.

Filing Requirements
Rule 498 requires funds to file profiles with the Commission 30 days prior to first use. Funds must file amended profiles within 5 business days after use (instead of 30 days prior to use, as proposed). Profiles must be filed electronically on EDGAR. In addition, the first profile filing for a fund must be accompanied by the submission of the profile in the format in which it will be distributed to investors (e.g., paper). Subsequent filings will be required to be solely in electronic format.

Eligibility to Use the Profile and Potential Liability
Eligibility
In the profile proposing release, the Commission stated that, if material information about a fund exists but is not addressed by the nine items of disclosure required to be in the profile, a fund may not use the profile. As adopted, the rule requires funds to include only the information specified by the rule's nine items and any suggestion that certain funds may be ineligible to use fund profiles has been eliminated from the rule.

Liability
The profile adopting release notes that several commenters expressed concern that use of the profile could result in claims under Section 12(a)(2) of the Securities Act of 1933 alleging that the profile is misleading because it omits information disclosed in the fund's prospectus. Despite the suggestion of some commenters, Rule 498 does not permit funds to incorporate by reference the prospectus into the profile. According to the Commission, incorporation by reference would be inconsistent with the profile's purpose as a document providing summary information about a fund in a self-contained format.

The Commission did make several statements regarding liability consistent with recommendations. The Commission stated its belief that "a fund using a profile generally should not face liability for omitting information included in the fund's prospectus if the profile includes the information required or permitted by Rule 498: potential liability would arise only if a profile contains a material misstatement or omits a statement necessary to make the disclosure in the profile not materially misleading." In addition, the Commission stated that "the intended purpose of a profile as a summary disclosure document supports the view that a fund using the profile should not be subject to liability under the federal securities laws for omitting information from the profile that is included in the fund's prospectus." Finally, the Commission provided assurances regarding the availability of Section 19(a) of the Securities Act with respect to the profile. Specifically, the Commission stated that "a fund that provides investors with a profile in good faith compliance with rule 498 would be able to rely on Section 19(a) against a claim that its profile did not include information that is disclosed in the fund's prospectus."

E. Miscellaneous
As with amended Form N-1A, Rule 498 permits profiles to be tailored for funds offered as options under qualified defined contribution retirement plans. Such a profile may be accompanied by a plan enrollment form, and may contain a modified legend and other disclosures.