Mutual fund investors, circle Aug. 1 on your calendars, and label it Prospectus Freedom Day.
That’s the date set by federal and state securities regulators for the introduction of a simplified fund prospectus, now a lengthy and often impenetrable legal document that outlines a fund’s investment techniques and risks for potential investors.
The new version, called a fund profile, will be a two-page summary, in simple language, of the full document. Initially, profiles will be available for a stock, bond and money market fund from each of eight big companies working with regulators on the project.
Although the profiles will be distributed along with the traditional prospectuses for now, the hope among some regulators and all the fund companies is that the streamlined documents can stand on their own eventually.
Along with federal and state regulators, the fund companies-Bank of America, Capital Research and Management, Dreyfus, Fidelity Investments, IDS Financial Services, T. Rowe Price, Scudder and Vanguard-will conduct a survey of profile recipients to see whether the documents contain enough information for an investor to make an intelligent decision.
If the profiles are found to be sufficient and are approved for all funds, they could radically change how mutual funds are bought and sold.
Now, fund companies are required to distribute a prospectus to investors and ask if they have read the document before selling fund shares. That leaves investors to wade through what often turns out to be a 50-page tome written in legalese.
If the new approach takes hold, an investor will merely have to consult the slender fund profile and its 11 brief sections, easily digested in minutes. To ensure comprehensive disclosure, the fund company will deliver the full prospectus with a confirmation of a fund purchase.
For fund companies that sell their shares directly to the public, the potential benefits are great. If the short profiles are approved as stand-alone documents, they could easily be reproduced in newspaper and magazine advertisements.
That would allow consumers to buy a mutual fund after reading an ad-a proposal made three years ago by the Securities and Exchange Commission and greeted with vehement opposition by state regulators and some members of Congress.
The latest proposal has been received guardedly by state regulators, a fractured group whose individual members offer vastly differing opinions of what constitutes adequate risk disclosure.
But following intense lobbying by Arthur Levitt Jr., chairman of the SEC, the North American Securities Administrators Association, which represents state securities regulators, agreed recently to a one-year test of the document “in the interest of significantly improving the understanding of investors.”
To those who fear crucial information in the full prospectus will fall by the wayside, supporters point out that the fund profile is intended to be a prelude to, not a replacement for, the complete document.
They add that so many people tune out when handed a prospectus now that anything might be an improvement.
“Even if it is theoretically true that most people would make a better investment decision after reading the full prospectus, the fact is that most people don’t read it,” said Matthew P. Fink, president of the Investment Company Institute, the mutual fund trade group in Washington, which strongly supports the plan.
The profile offers information on fund goals or objectives, investment strategies, risk, appropriateness for a particular investor, fees and expenses, past performance, investment adviser or fund manager, and details about purchases, redemptions, distributions and other services.
It is true, of course, that the fund profile does not contain all the information that an investor might want before buying a fund’s shares. As a gesture in this direction, the participating companies agreed not to use “prospectus” at all to describe the new document and simply to use “fund profile.”
Despite some missing information that would be found in a prospectus, such as what portion of a fund can be invested in illiquid securities or low-rated bonds, the profiles will include some features that could improve disclosure.
For example, they will contain one item that the fund industry is pushing as a universal standard for risk disclosure: a bar chart of total return for each year. Unlike the common mountain charts that show how an initial investment of say $1,000 would have grown over the years, this bar chart shows gains and losses at a glance. Investors can readily see that they would have lost money in some years and how much.
And whatever the arguments against allowing investors to buy funds directly after reading ads, the fund profile satisfies a greater need. It puts investors who do their own research on more even footing with those who buy funds through brokers.
Funds can now be sold through brokers without an investor seeing a prospectus of any kind-the idea being that the trained sales representative will tell the investor everything he needs to know.
With the fund profile, investors could get useful information conveyed in a simple format, much as it would be in a conversation.
