With more than $3 trillion invested in mutual funds, both industry executives and federal regulators agree that something must be done to better convey vital information to investors. To that end, the Investment Company Institute last month asked the Securities and Exchange Commission to adopt a "profile prospectus" - a vastly simplified version of a mutual fund disclosure document. In an address to the trade group's annual meeting in May, SEC Chairman Arthur Levitt expressed his support for the effort and outlined other initiatives the SEC is taking to improve investor information. The following is excerpted from that speech.
Over the past two years, I've held a series of investor town meetings across America. These meetings not only give me an opportunity to advise people about the questions they should ask before they invest, they also provide a forum for hearing what investors want or need.
I'm amazed at the level of interest out there. At a gathering in New York (last month), more than 1,000 investors showed up. And one of the things they want most is guidance in selecting appropriate investments while avoiding pitfalls.
As we work together to improve the information investors receive about mutual funds, let us keep in mind that no matter what rules the Commission may pass, success will depend on the words you choose and the information you impart in communications with investors. I urge you - in long documents and in short - in prospectuses and shareholder reports - to speak to investors in simple English. Tell them plainly what they need to know to make an intelligent investment decision.
Many of you are already moving in this direction. The SEC is doing all it can to support you and your like-minded colleagues on the corporate side. With the help of an English professor who has written a book on writing clearly, we are creating a handbook and a series of workshops designed specifically to assist prospectus writers. Our handbook is going through a final draft now and should be ready for widespread distribution within two months.
We will soon be holding workshops for issuers and their attorneys on how to rewrite disclosure documents. The American Society of Corporate Secretaries has agreed to work with us to put on plain-English workshops at its fall meetings. You, too, will be receiving an invitation before the year is out.
Another goal of ours is to provide investors with better tools for understanding a mutual fund's risk level. As you know, the SEC's concept release on improving risk disclosure drew response far beyond our expectations - some 3,600 individual investors submitted comment letters. The ICI, in response to the release, submitted the results of a survey of more than 600 fund shareholders on their perceptions of investment risk. Most striking about those results and our comment letters is their consistency. Both indicate a wide variety of definitions of risk. Both cast significant doubt on the viability of government-mandated risk measures. And yet, both indicate that investors want better risk disclosure.
Though I've concluded that - at least for the time being - we do not need to mandate a specific risk measure, there are several steps we will take to improve the quality of risk disclosure.
We will ask that fund names be more closely related to their actual investment practices. Consider a Morningstar commentary about a "Short-Term Bond" fund that lost more than 4% of its value in 1994: "You'd think that a fund labeled 'short' would hold up in a rising interest rate environment," said the author. You certainly would. Clarity in labeling will help investors and funds alike.
We believe that a bar graph of the kind included in the profile prototypes could, with some enhancements, help investors better understand the volatility risks of a fund's portfolio. We also expect to require all funds to include a brief, plain-English risk summary in their prospectuses.
Even though I do not believe that the government needs to mandate a specific risk measure, we applaud the efforts of the private sector to develop different kinds of measures, as well as the NASD's decision to reconsider allowing the use of third-party ratings in fund advertising materials.
The commission has responded to the growing number of investors in other ways: through pamphlets, handbooks, and brochures; through a toll-free "800" number that provides answers to commonly asked questions; and through our World Wide Web site, which offers our huge Edgar data base of corporate information, as well as other material for the benefit of investors.
But our responsibility extends beyond investors to include the industry. We're committed not to make your life any more complicated than it need be. Along that line, I think we've also accomplished a lot:
Through our Office of Compliance Inspections and Examinations, we've moved from a purely cyclical approach to examinations - where funds are inspected on a regular cycle, whether they need it or not - to a risk-based approach, where funds may be inspected more or less often depending on many factors, including their size, their customer complaint history, their advertising, and their inspection history, among other things.
We're also making significant changes to the scope of our examinations. Where a fund's own internal controls are top-notch - as many are - our examiners may not need to conduct a top-to-bottom, comprehensive review of fund activities. Instead, our examiners will be selecting and focusing their attention on those areas within the fund that are the most important, and leaving routine matters to the funds' own compliance systems. These so- called "smart examinations" will result in more meaningful exams and less wasted time, both for you and for the SEC.