ADI 2024-14: Tailored Shareholder Report Common Issues

On October 26, 2022, the Securities and Exchange Commission ("Commission") adopted rule and form amendments that require mutual funds and exchange-traded funds ("ETFs," and together with mutual funds "funds") that are registered on Form N-1A to prepare and transmit concise and visually engaging annual and semi-annual reports (collectively, "shareholder reports") designed to highlight information that is particularly important for retail shareholders to assess and monitor their fund investments on an ongoing basis.[1] These shareholder reports include-among other things-fund expenses, performance, and portfolio holdings. In addition, funds are required to tag the information in their shareholder reports using Inline XBRL structured data language. Information that may be more relevant to financial professionals and other investors who desire more in-depth information must be made available online, filed with the Commission on Form N-CSR, and delivered free of charge in paper or electronically upon request. As of July 24, 2024, these new requirements apply to all fund shareholder reports.

The Division of Investment Management's Disclosure Review and Accounting Office (DRAO) is responsible for reviewing fund disclosures. As part of our monitoring of tailored shareholder report implementation, the staff has observed several recurring issues. DRAO's objective in publishing this ADI is to remind funds of certain requirements and flag common issues to ensure a smooth transition to these new requirements and to ensure investors receive the required information to help them make informed investment decisions and monitor their fund investments. This ADI also suggests certain practices staff has observed in reviewing tailored shareholder reports that may further assist investors. DRAO expects to update this page from time to time to include additional information. The staff has also published frequently asked questions on shareholder reports that are available at: https://www.sec.gov/investment/tailored-shareholder-reports-faqs. "

Key Takeaway: Funds should review their shareholder reports and associated website disclosures to ensure compliance with rule 30e-1 under the Investment Company Act of 1940 (the "Investment Company Act"), Item 27A of Form N-1A and Form N-CSR.

1. Expense Information. A fund must include a simplified expense presentation in its annual and semi-annual shareholder report in a specified format. The staff has observed the following recurring issues and a helpful practice in its review of expense information.
   1. Several funds appear to have annualized the expenses in dollars paid on a $10,000 investment in their semi-annual shareholder report. The semi-annual report should reflect the dollar cost over the period (as Item 27A(c) of Form N-1A directs funds to show "expenses in dollars paid on a $10,000 investment during the period") and should therefore not be annualized. The expenses as a percent of an investor's investment in the fund, on the other hand, must be on an annualized basis. See Instruction 2(c) to Item 27A(c) of Form N-1A.
   2. Several funds appear to have calculated the expenses in dollars paid on a $10,000 investment by multiplying the "Costs paid as a percentage of your investment" by $10,000. This is not correct. Funds must multiply the figure in the "Cost paid as a percentage of your investment" column by the average account value over the period based on an investment of $10,000 at the beginning of the period. See Instruction 2(a) to Item 27A(c) of Form N-1A. For example, if a fund had expenses of 0.60%, and the average account value over the period on an initial investment of $10,000 is $12,000 for the annual period, the dollar cost over the annual period would be $72 [$12,000 x 0.60%].
   3. Several funds appear to present expenses in dollars paid on a $10,000 investment (during the reporting period) to the nearest cent, when the figure must be rounded to the nearest dollar. See Instruction 1(a) to Item 27A(c) of Form N-1A.
   4. To further assist investors, funds might consider noting in their semi-annual reports that costs paid as a percentage of a $10,000 investment is an annualized figure.
      
2. Management's Discussion of Fund Performance (MDFP). A fund (other than a money market fund) is required to include MDFP in its annual shareholder reports and is permitted to include it in their semi-annual shareholder reports. The MDFP disclosure requirements are designed to provide a streamlined and visually engaging presentation of the key factors affecting fund performance. The staff has observed the following recurring issues in its review of MDFP disclosures.
   1. A fund must include a performance table presenting average annual total returns for the past 1-, 5-, and 10-year periods. This performance is based on the fund's net asset value. However, we have observed that many ETFs also disclose their performance based on market value.[2] This additional presentation is not permitted to be included in the shareholder reports. See Instruction 3 to Item 27A(a) and Instruction 5 to Item 27A(d)(2), of Form N-1A.
   2. A fund (other than a money market fund) is required to compare its performance to an appropriate broad-based securities market index both in its shareholder reports and in its prospectus. A "broad-based" index is defined as one that represents the overall applicable domestic or international equity or debt markets, as appropriate. See Instruction 6 to Item 27A(d)(2) of Form N-1A; see also Item 4(b)(2)(iii) of Form N-1A. We remind registrants that industry-focused indexes, indexes with characteristics such as "growth," "value," or "small- or mid-cap", and other indexes that comprise only a subset of the overall applicable market, do not qualify as an appropriate broad-based securities market index, nor would commodity indexes.[3] In addition to comparing its performance to an appropriate broad-based securities market index, a fund is also permitted to show a narrower index (or indexes) that reflect(s) the market segment(s) in which the fund invests. See Instruction 7 to Item 27A(d)(2) of Form N-1A; see also TSR Adopting Release at text accompanying footnotes 230-233.
   3. A fund is required to include a statement to the effect that past performance is not a good predictor of the fund's future performance. While most funds include this disclosure, we have observed that many funds do not use text features to make the statement noticeable and prominent. See Item 27A(d)(2)(iii)(A) of Form N-1A.

1. Fund Statistics. Certain fund statistics must be included in a fund's annual and semi-annual shareholder report, including the fund's: (1) net assets, (2) total number of portfolio holdings, (3) portfolio turnover rate (other than for money market funds), and (4) the total advisory fees paid by the fund during the reporting period. A fund is also permitted to disclose any additional statistic(s) that the fund believes would help shareholders better understand the fund's activities and operations during the reporting period.

   We have observed that some funds include portfolio-level statistics, such as average maturity or average credit rating, under the heading "Graphical Representation of Holdings." These holdings-based statistics should instead be disclosed under the heading "Fund Statistics." See Item 27A(e) of Form N-1A.
   

2. Graphical Representation of Holdings. A fund must include in its annual and semi-annual shareholder reports one or more tables, charts, or graphs depicting the fund's portfolio holdings by category, as of the end of the reporting period. A fund is permitted to show its holdings based on the percentage of (1) net asset value, (2) total investments, (3) total exposure, or (4) net exposure attributable to each category.
   1. We have observed that some funds disclose holdings as a percentage but do not specify if the percentage is based on net asset value, total investments, or total or net exposure. Form N-1A provides that funds should disclose the basis for their presentation. See Item 27A(f) of Form N-1A.
   2. We have observed that some funds categorize their holdings based on credit quality but do not provide the special disclosures required for this type or presentation. Form N-1A provides that if a fund depicts portfolio holdings according to the credit quality, it should include a brief description of how the credit quality of the holdings were determined, and if credit ratings assigned by a credit rating agency are used, the fund should concisely explain how they were identified and selected. See Item 27A(f) of Form N-1A.
   3. Form N-1A provides significant flexibility to funds to select how to categorize their holdings. To further assist investors, funds might consider selecting categories that are most helpful for investors to assess and monitor their fund investments.
      
3. Material Changes. A fund's annual shareholder report must include a brief description of certain material changes that have occurred since the beginning of the reporting period. If there have been such changes, the cover page (or beginning) of the shareholder report must prominently state that the report describes material fund changes. See Items 27A(b)(5) and 27A(g) of Form N-1A.

   We have observed that some funds disclose material fund changes while omitting the required cover page disclosure. Other funds include the cover page disclosure but do not include any disclosures about material fund changes.
   

4. Availability of Additional Information Online. A fund's annual and semi-annual shareholder reports must include a statement that informs investors about certain additional information that is available on the fund's website. In addition, rule 30e-1 under the Investment Company Act requires a fund to make the disclosures required by Items 7-11 of Form N-CSR and its complete portfolio holdings as of the close of the fund's most recent first and third fiscal quarters publicly accessible, free of charge, at the website address specified at the beginning of the fund's shareholder report. The staff has observed the following recurring issues and a helpful practice.
   1. Some funds have included broken links in their shareholder reports. Because the shareholder reports are built on a layered disclosure approach that highlights key information and provides additional information online for investors who desire more in-depth information, it is important to ensure that the links provided in the shareholder report work.
   2. A fund is required to provide a link to the additional information on its website (or a QR code, or other means of facilitating access to such information). The link must be specific enough to lead investors directly to the particular information, rather than to the home page or a section of the fund's website other than on which the information is posted. The link may be to a central site with prominent links to the referenced information. See Instruction 9 to Item 27A(a) of Form N-1A; Instructions 1-2 to Item 27A(i) of Form N-1A. The staff observed that some funds do not comply with this requirement because they do not include a link specific enough to lead investors directly to a specific item or alternatively to a central site with prominent links to the referenced information. In other cases the staff was unable to find all of the required information on the specified website.
   3. A fund is required to make the disclosures required by Items 7-11 of Form N-CSR available on a website. Many funds include this information as a single PDF file on their websites. While the relevant rules and forms do not prescribe what this information must be called when it is referenced on a fund website, we have noticed that funds refer to this information as "[semi-] annual reports", "N-CSR" or "Financial Statements." To further assist investors, funds might consider referring to this information by a term that is more descriptive of the collective information required by Items 7-11 of Form N-CSR. For example, some funds refer to these disclosures as "Annual Financial Statements and Additional Information."
      
5. Inline XBRL Data Tagging. Funds are required to tag the information in their shareholder reports using Inline XBRL structured data language in accordance with rule 405 of Regulation S-T and the EDGAR Filer Manual.

   A fund (other than a money market fund) is required to compare its performance to one or more appropriate broad-based securities market indexes. A fund may also compare its performance to additional indexes. We have observed that some funds are tagging all their indexes as broad-based indexes instead of tagging their additional indexes with the separate tag intended for additional indexes.
   

6. Additional Issues.
   1. Some funds include extraneous and sometimes lengthy disclosures such as disclaimers or risk disclosures that are not required or permitted by Item 27A of Form N-1A. A fund is permitted to add information to the shareholder report that is necessary to make the required disclosure items not misleading and the Commission stated that disclosure in response to this provision generally should be brief. See Instruction 3 to Item 27A(a) of Form N-1A and TSR Adopting Release at text accompanying footnote 120. However, we remind registrants that the contents of shareholder reports are restricted to information which is required or permitted under Item 27A of Form N-1A. See Instruction 3 to Item 27A(a) of Form N-1A.
   2. Funds are reminded that they are required to present the information in shareholder reports in the same order as is required under Item 27A of Form N-1A. See Instructions 1 and 2 to Item 27A(a) of Form N-1A.
   3. Funds are reminded that they may omit disclosures that may be inapplicable (such as material fund changes and changes in and disagreements with accountants). See Instruction 7 to Item 27A(a) of Form N-1A.

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ADIs are recurring publications that summarize the staff's views regarding various requirements of the federal securities laws.

The statements in this ADI represent the views of the staff of the Division of Investment Management. This update is not a rule, regulation, or statement of the Securities and Exchange Commission. Further, the Commission has neither approved nor disapproved its content. This ADI, like all staff statements, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person. Future changes in rules, regulations, and/or staff no-action and interpretive positions may supersede some or all of the information in a particular ADI.

We hope that this ADI will assist registrants in complying with their disclosure requirements. We also welcome feedback on this guidance and on any disclosure matters. If you have any questions or feedback, please contact:

Disclosure Review and Accounting Office

Phone: 202.551.6921

Email: [email protected]