Experts mourn loss of digital option, cost of shareholder report rule

Final rule reverses two years of work toward cost-cutting, flexible electronic delivery of shareholder account statements  from open end funds

Frustrated industry observers expected higher operational costs and potentially confused shareholders to result from the tailored-shareholder reporting rule the SEC adopted Oct. 26, which prescribes shorter documents and reverses an electronic reporting provision that went into effect less than two years ago.

While implementation of the new requirements will likely fall on a fund complex’s operations and communications staff, boards will want to understand how the layout and content of shareholder reports will change, according to Abigail Hemnes, a partner in the Asset Management and Investment Funds practice at K&L Gates.

The goal of the new rule is to make investment information easy enough to read and understand for fund consumers to make rational decisions about their own investments and financial goals. The rule requires that fund advisers design reports that present data on performance, fees and other issues that are tailored to the needs and sophistication level of investors, and present that data in a way that is “concise and visually engaging.”

Shareholder reports were, on average, 134 pages long during 2020, and some were as long as 1,000 pages, noted SEC Commissioner Caroline Crenshaw before voting to approve the new rule at the Oct. 26 open meeting. The rule will go into effect Jan. 24, 2023, with an 18-month transition period that pushes the deadline for final approval back until July 24, 2024.

The issue itself is familiar, but the final version of the rule completely reverses many of the most popular elements much of the industry assumed was its main purpose, Hemnes said.

The draft version of the rule, which was proposed in 2020 during the administration of former SEC Chair Jay Clayton, addressed issues about length and complexity by allowing investment advisers to provide statement data to shareholders electronically rather than only on paper, Hemnes said.

The final version of the rule adds a requirement that funds with multiple classes of shareholders create separate reports for each separate shareholder class, which means shareholders would receive only reports that apply to their own ownership class.

A tale of two documents

Consumers don’t look forward to wading through 100-page financial statements at the end of a long work day, but they also tend to use those long regulatory statements to check a few transactional numbers and for recordkeeping, not for planning their financial futures, according to Cory Clark, chief marketing officer of Dalbar, Inc., an audit and certification provider that provides comparative evaluations to financial-services firms benchmarking or trying to improve the effectiveness of account statements and other customer-contact mechanisms.

Communicating with retail investors is a tale of two documents, Clark said. The regulatory document consumers skim through when they’re alone standing at the kitchen table do an adequate job of listing transactional elements.

Retail investing is a “tale of two documents,” Clark said, and the one most defined by the SEC is no one’s favorite.

“The preferred servicing tool in financial services is not the regulatory statement, however, it’s the performance report or relationship report,” Clark said. “That’s where you’re likely to see performance, progress toward goals, deeper analytics, fundamentals of the portfolio, allocations – but the key is that the advisers want this to be the document that provides important relationship information such as fees and performance and they want to have those discussions face to face.”

That division of purpose is one reason financial-services firms haven’t put the same kind of effort into regulated reports that they put into the design of relationship reports they use to get face time with customers, Clark said.

It also explains a lot about the resistance to change of many shareholder-report designs that prioritize the efficient use of space, not usability, to keep down paper and distribution costs.

“Changes are almost entirely driven by paper reduction,” Clark said. “Any change that could lead to larger statements, more pages, more paper, is not likely to go through. The objective of these departments is to get online delivery enrollment and keep the paper statement as short as possible.”

That’s one reason it was such a blow that the final version of the tailored-report rule removed mutual funds, ETFs and any fund registered on Form N-1A from eligibility for SEC Rule 30e-3, which allowed issuers to distribute reports electronically starting in January 2021 unless a shareholder specifically requests otherwise.

“It’s frustrating from a fund-industry perspective because fund complexes have spent the past two years coming into compliance with [Rule 30e-3] so they could provide access to shareholder reports via notice and access, and now all that work they’ve done is going to be unwound,” Hemnes said. “Now instead of sending a notice of availability of a shareholder report they’re going to have to send an actual shareholder report, and it will have to be mailed unless a shareholder has affirmatively opted into electronic delivery.”

The reversal appears to rankle SEC Commissioner Hester Peirce, a consistent Gensler critic, who asked attendees at a panel discussion about best practices in shareholder reporting to “please think about how technology can be used to enhance investor interest in and interaction with account information.”

“Account statements that convey information in a way that investors can understand and use are fundamental to investor protection,” she said.

Rather than simplifying reporting for shareholders, reinstating the paper distribution requirement makes the whole process a lot more complicated, especially when many shareholders may prefer to receive that information electronically, according to Matt Giordano, a partner and deputy leader of the Public Investment Management practice at KPMG.

“There were some issues with [Rule 30e-3] but, essentially, it allowed you to mail somebody a postcard saying your financial statements are available online rather than shipping them statements or an annual report, which would have saved the industry a lot of money,” Giordano said. “There is likely to be a lot of talk around the removal of open-end funds from eligibility for [Rule 30e-3], which seemed like a step toward equal-access delivery.”

The need to design, print and distribute paper reports will drive up the cost of materials, distribution and staff time, which will put even more pressure on fund advisers trying to keep fund fees low, Giordano said.

“It is a lot for funds to deal with,” Hemnes said. “In the short term, it’s likely to be very expensive for fund advisers, which is probably one reason there was so much pushback on these delivery requirements.