Alert June 24, 2008

SEC Proposes to Make Filing of Prospectus Risk/Return Summary Information in Interactive Data Format Mandatory for Mutual Funds

The SEC voted to publish for comment proposed rules that would require open-end management investment companies (“mutual funds”) to make an electronic filing with the SEC that presents the risk/return summary information in their prospectuses in interactive data format and to post that interactive data on their Web sites, and has issued a formal release describing its proposal (the “Proposing Release”).  (The risk/return summary appears at the front of the mutual fund prospectuses and includes information about a fund’s investment objectives and strategies, risks, costs (including fee table information) and historical performance.)  The SEC’s proposal also would expand the voluntary program for interactive data filings to permit all registered investment companies and certain other filers to submit portfolio holdings information in interactive data format without filing other financial information such as financial statements. 

Background.  Data tagging labels information in electronic filings using standardized definitions so that the information can be retrieved, searched and analyzed through automated means. Data tagging is designed to increase the ability of investors, analysts and others to collect and use information in disclosure documents filed electronically with the SEC.  The SEC website includes a mutual fund comparison tool that demonstrates the use of data tagged information extracted from filings made by funds participating in a voluntary program begun in 2007.   The mutual fund comparison tool allows users to compare mutual fund risk/return summary information, including investment objectives and strategies, risks, costs, and performance, that is submitted in interactive data format.  The proposed rules build upon the SEC’s voluntary filer program started in 2005.  The 2005 program allowed companies to submit financial statements, on a supplemental basis, in interactive data format.  In 2007, the SEC expanded the program to allow mutual funds to voluntarily submit, on a supplemental basis, information contained in the risk/return summary section of their prospectuses in interactive data format.

Requirements of the Proposed Rule.  The SEC’s proposal would not change the current substantive disclosure requirements for the mutual fund prospectus risk/return summary.  The proposal would only require mutual funds to file risk/return summary information in a new format as an exhibit.  Under the proposed rules, a mutual fund that files a registration statement or post-effective amendment on Form N‑1A that includes risk/return summary information must submit no later than 15 business days after that filing’s effective date a post-effective amendment pursuant to Rule 485(b) under the Securities Act of 1933, as amended (the “1933 Act”), that contains an exhibit presenting the risk/return summary in interactive data format.  This follow-on filing would be comparatively brief consisting only of the exhibit, a facing page, a signature page, a cover letter explaining the nature of the amendment, and a revised exhibit index.  A mutual fund that maintained a website would also be required to provide the interactive data filed with the SEC on its website by the end of the business day on the earlier of the date that the interactive data was submitted to the SEC or required to be submitted to the SEC.  A fund could not fulfill the website posting requirement by providing a hyperlink to the SEC website.  The information provided under the proposed requirements would be the same as that currently provided by the mutual funds participating in the voluntary program for filing risk/return summary information using interactive data, which the SEC intends to continue to make available until the effective date for the proposed requirements, if adopted. 

Voluntary Program - Portfolio Holdings.  The SEC’s proposal would modify the voluntary interactive data filing program to allow (i) investment companies registered under the 1940 Act, (2) business development companies, and (3) other entities that report under the Securities Exchange Act of 1934, as amended, and prepare their financial statements in accordance with Article 6 of Regulation S‑X, to submit exhibits under the voluntary interactive data program that contain a tagged schedule of portfolio holdings, specifically Schedule I - Investments in Securities of Unaffiliated Issuers under Regulation S‑X, without having to submit other financial information, such as financial statements, in interactive data format.  As under the voluntary program currently, a tagged exhibit with portfolio holding information would have to disclose that (a) the financial information is “unaudited” or “unreviewed,” as applicable, and that the purpose of submitting the tagged exhibit is to test the related format and technology and, as a result, investors should not rely on the exhibits in making investment decisions.  The SEC’s proposal would not affect the ability of registered investment companies to participate in the voluntary program that permits certain issuers to file their financial statements in interactive data format.  (Financial statement filings submitted by investment companies under the voluntary program consist of a complete set of financial statements that reflects all periods presented in the corresponding official EDGAR filing, which may omit notes to the financial statements and related schedules, other than Schedule I – Investments in Securities of Unaffiliated Issuers, and financial highlights or condensed financial information.  Voluntary financial statement filings may also include related audit opinions, interim review reports, reports of management on the financial statements, certifications, or Management’s Discussion of Fund Performance.)

Liability.  In general terms, interactive data on its own would not be subject to various liability provisions under the federal securities laws that apply to filings with the SEC and certain offering materials, but would be subject to liability for their substantive content under other provisions of the federal securities laws.  In addition, the substantive content of interactive data when made viewable by software on the SEC website would be subject to the same liability under the federal securities laws as the corresponding risk/return summary in the traditional prospectus filed in the mutual fund’s registration statement, provided the two disclosures were identical in all material respects.  The proposed rules include provisions that would protect a mutual fund from liability for violations of the proposed technical filing and coding requirements if (A) the mutual fund failed to meet those requirements despite its good faith and reasonable effort, and (B) the mutual fund corrected the failure as soon as reasonably practicable after it became aware of the failure.  The Proposing Release notes that mutual funds may choose to rely on financial printers, consultants, and software companies for assistance in preparing filings, but would retain ultimate responsibility for both their risk/return summary information and their tagged data.

Consequences of Non-Compliance Under the SEC’s proposal, a fund that did not provide a required interactive data submission, or post the interactive data on its website as required, would have its ability to file post-effective amendments under Rule 485(b) automatically suspended, the only exception being a future filing made solely to submit interactive data, which would enable the fund to cure the deficiency.  (Rule 485(b) provides for immediate effectiveness of amendments that update a fund’s financial statements (the annual update) and make non-material and certain other changes.  A fund unable to file under Rule 485(b) must generally file under Rule 485(a) which permits an effective date on the sixtieth day after filing at the earliest (subject to acceleration at the SEC staff’s discretion).  The SEC’s proposal would include a continuing hardship exemption similar to the one already available for electronic filers.

Other Aspects.  The Proposing Release highlights a number of anticipated benefits of the proposal to mutual funds, third parties and the SEC itself.  Among the potential benefits for mutual funds is that interactive data could provide a significant opportunity to automate regulatory filings and business information processing, with the potential to increase the speed, accuracy, and usability of mutual fund disclosure and lower costs.  The Proposing Release also posits that a mutual fund that introduced standardized interactive data format at earlier stages of its reporting cycle could reduce the need for repetitive manual data entry and with it, the likelihood of human error. 

The SEC staff expects that its ability to use software to review filings in interactive data format would increase the number of filings that it could review.  The Proposing Release discusses the anticipated use of validation software to check interactive data for compliance with applicable technical requirements and to identify problematic data.  The software would also enable the SEC staff to easily identify and count non-standard special labels and tags.  Although the SEC anticipates that the list of interactive data tags would be sufficiently developed to support the range of disclosures funds are likely to make in the risk/return summary, XBRL, the taxonomy for the interactive data format, is extensible, which allows a mutual fund to add to the standard list of tags to accommodate circumstances the standard list does not address.  However, to promote comparability across funds, the SEC would limit the use of extensions to circumstances where the appropriate element does not exist in the standard list of tags and would require that wherever possible, preparers change the label for an element that exists in the standard list of tags, instead of creating a new customized tag.

Implementation and Public Comment.  If the proposed rules are adopted this fall, the SEC envisions that the proposed requirements would become mandatory beginning with initial registration statements, and post-effective amendments that were annual updates to effective registration statements, that became effective after December 31, 2009.  As discussed above, if the SEC adopts the proposed filing requirements for risk/return summary information in interactive data format, it intends to eliminate the risk/return summary information component of the voluntary interactive data program after the compliance date for mandatory filing.  The SEC has requested public comment on many specific aspects of its proposal.  Comments on the proposed rules should be submitted on or before August 1, 2008.