SEC States that Investment Company Derivatives-Related Disclosure Is Inadequate

July 30, 2010

The SEC sent a letter to the Investment Company Institute (ICI), the trade group for the mutual fund industry, stating that investment companies should provide investors with more understandable disclosures related to derivatives, including the risks associated with them.

In the SEC's view, derivatives-related disclosures by some funds are not consistent with the intent of Form N-1A's requirements and can be improved.  The SEC's primary observation was that some funds provide generic disclosures about derivatives that, in its view, may be of limited usefulness for investors in evaluating the anticipated investment operations of the fund, including how the fund's investment adviser actually intends to manage the fund's portfolio and the consequent risks.

The SEC noted that all funds that use or intend to use derivative instruments should assess the accuracy and completeness of their disclosure, including whether the disclosure is presented in an understandable manner using plain English.  It further stated that any principal investment strategies disclosure related to derivatives should be tailored specifically to how a fund expects to be managed and should address those strategies that the fund expects to be the most important means of achieving its objectives and that it anticipates will have a significant effect on its performance.   In determining the appropriate disclosure, a fund in the SEC's view should consider the degree of economic exposure the derivatives create, in addition to the amount invested in the derivatives strategy.  This disclosure also should describe the purpose that the derivatives are intended to serve in the portfolio and the extent to which derivatives are expected to be used.  Additionally, the disclosure concerning the principal risks of the fund should similarly be tailored to the types of derivatives used by the fund, the extent of their use, and the purpose for using derivative transactions.

The SEC also provided guidance about derivatives disclosure in investment company shareholder reports and financial statements.

Click here to access the letter.


Investment Advisers, Mutual Funds, Regulatory