Agencies, Funds Aim for Improved Prospectuses
With the optimism that precedes the start of a new year, some regulators and mutual fund industry officials are expressing hope that they will be able to introduce changes in 1995 that will make it easier for fund shareholders to figure out what they own.
The heavy level of redemptions by bond fund investors this year suggests that many people didn’t really understand the risks they were assuming.
In addition, a survey by the Securities and Exchange Commission in late 1993 found that many investors lacked knowledge of even such rudimentary points as whether mutual funds sold by banks and even brokerages are covered by federal deposit insurance.
Further, when a small number of funds suffered big losses this year from the speculative use of derivatives, it pointed up a need for more understandable explanations of these esoteric investments.
The net effect: motivation to go back to the drawing board.
“Investors are not as informed as they should be,” SEC Chairman Arthur Levitt Jr. said in a speech last month. “There are misconceptions even about such basic products as mutual funds.”
The target of reform is that unwieldy old standby, the prospectus. At Levitt’s urging, fund companies are taking a new look at making these important disclosure pamphlets more user-friendly.
Currently, eight large fund families are working as a group to develop a prototype “profile” prospectus. This would summarize key information contained in the regular prospectus, allowing investors to make comparisons among funds more quickly and easily. Investors would receive both the short and long forms as a package.
SEC research indicates that “people want the whole prospectus but don’t want to have to read the whole thing right away,” said Jane White, head of shareholder communications for T. Rowe Price Associates of Baltimore, one of the eight firms working on the project.
In the summary, key topics such as the fund’s description, fees, risk profile and more would be presented in a standard order.
Levitt is also prodding fund companies to make their regular prospectuses more readable.
Prospectuses are legal documents that serve not only to inform investors but also to protect the fund’s management company and other contractors from lawsuits. This helps explain why they have become so complex and lengthy.
“There’s a tension between what lawyers will want to draft as a way of protection and investors’ desire for a very simple explanation,” said Roy W. Adams, a securities lawyer and chief operating officer of Solon Asset Management, a fund group in Walnut Creek, Calif.
“If people are going to want to sue fund groups, then the lawyers will want to err on the side of more disclosure,” he said.
Then, too, the SEC itself has been an obstacle in the pursuit of brevity and clarity.
“A major source of the problem is the SEC itself, which, along with several state securities regulators, has required that mutual fund prospectuses be loaded with technical details and legalisms,” Erick Kanter, a spokesman for the Investment Company Institute, said in response to Levitt’s November speech. The ICI is the fund industry’s trade association and is headquartered in Washington.
In his talk, Levitt promised that the SEC would offer an expedited review process for fund companies that develop more readable prospectuses.
One notable prospectus make-over idea that the SEC has floated in recent months would provide for a standardized risk measure, perhaps summarized by a numerical rating. In theory, this would make it easier for investors to size up the various dangers facing a particular fund and also make risk comparisons among funds simpler.
But the idea is already drawing fire.
“No one risk measure can possibly account for all the risks a fund assumes,” said Catherine Gillis, an editor for Morningstar Inc., the Chicago-based fund-rating service.
A single rating, particularly if it is made by a government agency, could lull investors into a false sense of security, she argued.
And because prospectuses are printed only once or twice a year, it’s possible that such a measure could quickly become outdated in a fast-moving market, Adams said.
He conceded, though, that there’s a lot of enthusiasm on the part of state and federal regulators for some type of single risk rating or seal of approval.
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Besides the prospectus changes noted above, a few other regulatory modifications could come about in 1995, including the following:
* Tougher investment standards for tax-exempt money market funds, including requirements that they diversify more broadly. Taxable money funds must already meet these.
* More prominent discussion of derivatives within the first few pages of the prospectus for any funds using derivatives.
* New disclosure guidelines for funds with different classes of shares. Specifically, funds would have to prominently disclose the existence and costs associated with the other share classes.
None of these proposals will prompt lots of snappy headlines. But they do promise to make 1995 a fairly active year for mutual fund regulations.
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Julian Lerner, one of the mutual fund industry’s senior stock pickers, will retire as lead manager of the AIM Charter Fund on March 31. Lerner, 70, has been at the helm of the $1.58-billion portfolio since 1968, compiling an impressive track record. Morningstar gives the fund an above-average four-star rating.
Upon Lerner’s departure, AIM Charter will be led by Lanny Sachnowitz, with other management team members to be announced later. Lerner, also a senior vice president of Houston-based AIM Capital Management, will remain as a consultant for one year.
