First Deadline Looming for SEC Electronic Disclosure Compliance

When the SEC adopted the new Rule 30e-3 earlier this year, creating a new system for electronic delivery of fund information, it also established a transition disclosure period that starts in January, during which "funds that choose to implement the new delivery method for shareholder reports provide prominent disclosures in prospectuses and certain other shareholder documents that will notify investors of the upcoming change in transmission format.”

The Securities and Exchange Commission (SEC) in June adopted a new rule, 30e-3, aimed at improving the experience of investors in mutual funds, exchange-traded funds (ETFs) and other investment funds. 

In short, the rule permits asset managers to deliver shareholder reports by making them publicly accessible on a free website and sending investors a paper notice of each report’s availability via mail. If an investor prefers to continue receiving shareholder reports by mail, asset managers will have to oblige them.

Retirement plan clients can expect the new system to take full effect in early 2021, but in the meantime there is a lengthy transition disclosure period starting January 1, 2019.

Important facts about the transition period

When it announced 30e-3, the SEC simultaneously adopted amendments to Rule 498 under the Securities Act of 1933 (and related fund registration forms) to require that “during a certain transition period, funds that choose to implement the new delivery method for shareholder reports provide prominent disclosures in prospectuses and certain other shareholder documents that will notify investors of the upcoming change in transmission format.”

SEC explains the transition period as part of “a set of protections establishing that investors who prefer to receive reports in paper will continue to receive them in that format.” These protections include, among others, “a minimum length phase-in period that ends no earlier than December 31, 2020, and notice requirements that must be implemented and followed beginning January 1, 2019, or the date shares are first publicly offered, if a registered investment company would want to use new rule 30e-3 as of January 1, 2021.”

Compliance with these SEC stipulations will require funds to provide “prominent disclosures on the cover page or beginning of their summary prospectuses, and cover pages of their statutory prospectuses, and annual and semi-annual reports, informing investors of the change in delivery format options if the funds intend to rely on the rule prior to January 1, 2022.”

“These amendments to rule 498 and Forms N-1A, N-2, N-3, N-4, and N-6 will be effective January 1, 2019, for a temporary period of three years (i.e., between January 1, 2019 and December 31, 2021),” SEC explains. “Effective January 1, 2022, these disclosures will no longer be required, and the related requirements in rule 498 and Forms N-1A, N-2, N-3, N-4, and N-6 will be removed. Additional amendments to rule 498, including an amendment to permit the inclusion of information about electronic delivery, will become effective January 1, 2019 and will remain effective indefinitely.”

One additional factor to consider is that the rule requires a paper notice be sent to an investor each time a current shareholder report is made accessible online. The notice must include instructions for how an investor can elect—at any time—to receive all future reports in paper, or request to receive particular reports in paper on an ad hoc basis.

Further SEC action is likely

Back in June, the SEC also asked the public for additional suggestions for how the delivery of fund information could be modernized. The commission invited investors, academics, literacy and design experts, market observers and fund advisers and boards of directors to provide feedback on how to improve the experience of fund investors. The stated aim was to find new ways to create more interactive and personalized disclosures.

The Investment Company Institute took up that call and submitted an expansive comment letter that reviews the current framework regulating fees that intermediaries charge funds for distributing required disclosure materials to fund investors, such as shareholder reports and prospectuses. As part of its letter, ICI included a variety of suggested improvements that, on its assessment, could save investors millions of dollars if effectively implemented.

According to ICI, modern mutual fund investing is generally conducted via intermediary omnibus positions—i.e., shareholder positions held with intermediaries such as broker/dealers. This is especially prevalent in the retirement plan domain, and as ICI shows, these omnibus positions today make up a significant portion of all mutual fund assets.

According to ICI, there are clear benefits to this system, such as the fact that it allows intermediaries to take advantage of economies of scale, automate trade processing and implement advanced recordkeeping capabilities. It also permits intermediaries to more closely align their mutual fund and brokerage systems and more efficiently manage their customer’s entire financial portfolio across a spectrum of investments.

However, according to ICI, there are also clear drawbacks. First and foremost, this system of intermediary-driven investing means that fund providers themselves actually have limited information about the identity of their beneficial shareholders—and thus no ability to communicate with them directly. Even more problematic, according to ICI, the current system “lacks appropriate incentives.”

As the firm writes, current SEC rules require funds to reimburse intermediaries “for reasonable expenses incurred in forwarding fund materials to beneficial owners of fund shares.” ICI says intermediaries generally outsource forwarding of fund materials to a fulfillment vendor that then invoices the fund to pay the expenses. According to ICI’s analysis, this reimbursement system “creates a disconnection between the party that negotiates the vendor fees (i.e., the intermediary) and the party that pays the vendors’ bill (i.e., the fund).”