Improved risk disclosure coming to Fund Facts

Since July 2011, mutual fund companies have been required to file Fund Facts forms for every class and series of fund, as part of the ongoing ‘point of sale’ mutual fund disclosure reform initiative. Regulators are currently in the process of amending regulations to allow delivery of the new forms to satisfy the prospectus delivery requirements, as part of the second stage of the point of sale initiative. Eventually, under the third stage, regulators intend to implement rules that would require financial advisors to provide investors with Fund Facts at the point of sale.

Since Fund Facts documents were introduced last year, however, they’ve faced considerable criticism.

“We did receive a number of comments from investor advocates…asking the CSA to delay implementation until we address what they identify as some deficiencies in the Fund Facts disclosure,” Paglia said. “The main issues that were identified were inadequate risk disclosure, lack of benchmark information and inadequate conflict of interest disclosure.”

The risk disclosure section has received the most criticism, according to Paglia. Currently, fund companies are required to classify a fund into one of five categories of risk: Low, Low to Medium, Medium, Medium to High, or High, with no additional explanation about the risks involved. Critics argue that these categories are arbitrary, since companies are not required to use a standardized risk classification methodology.

“The lack of a prescribed risk rating methodology, in their view, limits the comparability of the risk rating amongst funds,” Paglia said.

Investor advocates have also complained that Fund Facts don’t provide investors with any context or information about the types of risks associated with the fund.

As a result, Paglia said the CSA will propose a requirement for companies to include a narrative in this section of Fund Facts, explaining the level of risk and some of the specific risks of investing in the fund.

The CSA will also explore the possibility of adopting a standardized risk classification methodology. However, since this could be a lengthy process that will require consultations, Paglia said regulators are treating this as a separate project and will continue to proceed with the next stages of the point of sale initiative in the meantime.

“We are going to consult on this,” he said. “Our intention really is to go forward with stage two even if that piece of the project is not completed.”

In response to concerns about a lack of disclosure of potential conflicts of interest in Fund Facts, the CSA will propose additional disclosure related to trailing commissions, Paglia said. Specifically, the regulator will propose a requirement for fund companies to state on the Fund Facts form that trailing commissions have the potential to create a conflict of interest in the sale of a mutual fund.

Regulators will also propose that Fund Facts include the percentage of assets held in each of the top 10 investments in the fund.

“The purpose of that is to illustrate the possible concentration risk in the fund,” Paglia said.

A variety of other changes will also be proposed next week. The proposals will be out for comment until Sept. 6th, and regulators will test the documents with groups of investors to gauge the effectiveness of the changes, Paglia said.

“Our goal is to get the Fund Facts into the hands of investors as quickly as possible, and for them to have better access to information, to help inform their investment decisions,” he said. “It won’t be perfect – I don’t think it’s possible to come up with the perfect document – but through the comment period and testing, we hope we get a document that gets us at least closer to that goal.”

The CSA is aiming to finalize the second stage of the point of sale initiative by the end of the year, or by March 2013 at the latest.