Introduction
The Securities and Exchange Commission ("SEC") on June 16, 2010 proposed amendments to investment company advertising rules that would impact how target date funds are marketed.1 The proposed amendments are intended to provide investors with enhanced disclosure regarding these funds.
Target Date Funds
Many fund complexes offer "target date funds" that contain stated "target dates" in their names (e.g., 2025), which are intended to correspond to the approximate year an investor plans to retire. Typically, target date funds invest in a mix of asset classes and are designed to automatically shift the fund's asset allocation to become more conservative over time. Generally, the fund's asset allocation eventually becomes fixed at a point in time, referred to in the Proposing Release as the "landing point." This automatic shift in asset allocation has been referred to as a target date fund's "glide path."
Background and Scope of Proposed Amendments
Market losses experienced by target date funds in 2008, as well as the wide variation in returns among target date funds with the same stated target date and the growth of target date funds in the 401(k) market,2 have given rise to regulatory concerns regarding whether investors understand the risks associated with target date funds. In particular, the SEC is concerned that the naming conventions used by target date funds have contributed to investor misunderstanding. The SEC is also concerned that target date funds are marketed as a simple and complete approach to investing, and that investors may not understand the risks. The proposed amendments are intended to address these concerns.
The SEC has proposed amendments to Rules 156 and 482 under the Securities Act of 1933, as amended (the "1933 Act"), and Rule 34b-1 under the Investment Company Act of 1940, as amended (the "1940 Act"). Rule 156 sets forth factors to be considered in determining whether investment company sales literature is misleading. Rule 482 governs sales literature and advertisements of investment companies. An advertisement subject to Rule 482 is a type of "prospectus" under Section 10(b) of the 1933 Act,3 and therefore its use may result in prospectus liability. Rule 34b-1 governs advertisements and sales literature of investment companies, including, but not limited to, supplemental sales material that is preceded or accompanied by a statutory prospectus.4
The proposed amendments to Rules 482 and 34b-1 would apply to advertisements and supplemental sales literature that place a "more than insubstantial focus" on one or more target date funds.5 This is intended to allow, among other things, a fund complex to use advertising that shows a list of funds in the complex and their performance without triggering the special disclosure for target date funds called for by the proposed amendments. According to the Proposing Release, what constitutes a "more than insubstantial focus" would depend on the particular facts and circumstances, but is intended to cover a broad range of materials. The proposed amendments also include a definition of "target date fund" that is not grounded in the use of a date, but in equity and fixed income exposures that change over time.6 While the proposed definition is similar to the description of a target date fund provided in the DOL's regulations for QDIAs, it is not as restrictive. The proposed definition is intended to apply to all funds that are being marketed to investors as target date funds.
Content Requirements
Use of Target Date in Fund Names
The proposed amendments to Rules 482 and 34b-1 would require a target date fund that includes the target date in its name to disclose the fund's intended asset allocation at the fund's target date. This would need to be disclosed immediately adjacent to (or, in a radio or television advertisement, immediately following) the first use of the fund's name and in a manner reasonably calculated to draw an investor's attention to the information. 7 An advertisement or supplemental sales material that is submitted for publication or use prior to the target date would be required to disclose the percentage allocations of the fund among types of investments at the target date.8
For advertisements and supplemental sales literature that are submitted for publication or use on or after the target date, the proposed amendments would require disclosure of the fund's current asset allocation as of the most recent calendar quarter ended prior to submission or first use.9 The proposed amendments do not prescribe the asset classes to be used in disclosing a target date fund's asset allocation or the methodology for calculating the percentage allocations. Instead, each target date fund would have the flexibility to determine which asset classes to present and the specific methodology to be used. The Proposing Release notes, however, that current target date fund prospectuses typically use asset classes such as "equity," "fixed income," and "cash and cash equivalents," and that the SEC "would expect that many target date funds would use these asset classes in making the required disclosure."10
Depiction of Target Date Fund's Asset Allocation
The proposed amendments to Rules 482 and 34b-1 would require advertisements and supplemental sales literature that are in print or delivered through an electronic medium to include a table, chart, or graph depicting the target date fund's asset allocation over time, together with a statement that would highlight the fund's final asset allocation.11 The table, chart, or graph would be required to clearly depict the percentage allocations among types of investments over the entire life of the fund at identified periodic intervals that are no longer than five years in duration. In addition, the table, chart, or graph must show the asset allocation at the fund's inception, target date, and landing point.12
In regard to marketing material that relates to a single target date fund, the table, chart, or graph must present the actual percentage allocations from the fund's inception through the most recent calendar quarter ended prior to the submission of the materials for publication, as well as the future intended percentage allocations. In addition, the table, chart, or graph must identify the periodic intervals (not longer than five years) and the inception date, target date, landing point, and most recent calendar quarter end using specific dates (e.g., years). A fund family would be permitted to advertise multiple target date funds that have the same asset allocation pattern in a single advertisement, provided the materials include either (i) a separate presentation for each fund that meets the rule requirements, or (ii) a single table, chart, or graph that depicts the intended percentage allocations of the funds and that identifies the periodic intervals and other required dates using numbers of years before and after the target date. In the Proposing Release, the SEC has provided examples of presentations of charts that would meet this requirement for single and multiple target date fund advertisements.
The proposed amendments would also require certain key information about the glide path to be disclosed to investors in narrative fashion. In particular, the asset allocation presentation would need to be immediately preceded by a statement including the following information: (i) that asset allocation changes over time; (ii) the landing point; (iii) that the asset allocation becomes fixed at the landing point, as well as final asset allocation; and (iv) whether, and the extent to which, the percentage asset allocations may be modified without a shareholder vote.13
Radio and television advertisements would not be subject to the table, chart, or graph requirement. Instead, such advertisements that are submitted for use prior to the landing point must disclose the landing point, an explanation that the asset allocation of the fund becomes fixed at the landing point, and the intended percentage allocations of the fund at the landing point.14 The proposed disclosure would be required to be given emphasis equal to that used in the major portion of the advertisement.
Disclosure of Risks and Considerations Relating to Target Date Funds
The proposed amendments to Rules 482 and Rule 34b-1 would require target date funds to include disclosure that informs investors of certain risks and considerations that an investor should consider before investing in a target date fund. In this regard, target dates funds would be required to include, among other things, a statement that an investor should consider, in addition to age or retirement date, other factors including risk tolerance, personal circumstances, and his or her complete financial situation; that a target date fund is not a guaranteed investment and that it is possible to lose money including at and after the target date; and that a target date fund's stated asset allocations may be changed without a shareholder vote.15 This statement would be subject to the presentation requirements that currently apply to other important disclosures pursuant to Rules 482 and 34b-1.16 Finally, this statement would need to be included in the marketing materials for all target date funds, regardless of whether a fund includes a date in its name.
Antifraud Guidance
The proposed amendments to Rule 156 would provide additional guidance as to the factors that could cause a statement included in sales literature for investment companies to be misleading. While the proposed amendments are intended to address the concerns that have been raised about target date funds, such amendments would apply to all investment companies.
The proposed amendments provide two circumstances in which a statement could be misleading. First, a state- ment could be misleading if it places undue emphasis on a single factor, such as an investor's age or tax bracket, as the basis for determining whether an investment is appropriate.17 Second, a statement could be misleading if suggests that an investment in a fund is a simple investment plan or that it requires little or no monitoring by the investor.18 It is our observation that this latter provision could also affect advertising for, among others, target risk funds to the extent that they are held out as simple investment vehicles.
Comment Period
The SEC is soliciting comments on these proposed amendments. Any comments are to be submitted on or before August 23, 2010.
Footnotes
1 Investment Company Advertising: Target Date Retirement Fund Names and Marketing, Release No. IC-29301 (June 16, 2010) ("Proposing Release").
2 The Department of Labor ("DOL") issued its qualified default investment alternative ("QDIA") regulation on October 24, 2007. Although the Pension Protection Act of 2006 authorized the DOL to provide regulatory guidance on "the appropriateness of designating default investments that include a mix of asset classes consistent with capital preservation or long-term capital appreciation, or a blend of both," the final QDIA regulation generally limits QDIAs to investment options "diversified so as to minimize the risk of large losses and . . . designed to provide varying degrees of long-term appreciation and capital preservation through a mix of equity and fixed income exposures." The DOL provided three alternatives for obtaining such diversified investments, one of which was a target date fund. As a result, a significant number of employers who sponsor a defined contribution plan have designated target date funds as a default investment.
3 An advertisement under Rule 482 would be considered an "omitting prospectus."
4 See Section 2(a)(10)(a) of the 1933 Act. "Statutory prospectus" refers to the prospectus required by Section 10(a) of the 1933 Act.
5 Proposed Rule 482(b)(5)(ii) – (v); proposed Rule 34b-1(c).
6 Proposed Rule 482(b)(5)(i)(A); proposed Rule 34b-1(c). Target Date Fund means an investment company that has an investment objective or strategy of providing varying degrees of long-term appreciation and capital preservation through a mix of equity and fixed income exposures that changes over time based on an investor's age, target retirement date, or life expectancy.
7 Proposed Rule 482(b)(5)(iii); proposed Rule 34b-1(c).
8 With respect to target date funds that invest in other investment companies, it would not be sufficient to disclose percentage allocations to investments in types of investment companies. Instead, such funds must disclose the underlying asset classes in which the underlying investment companies invest.
9 A target date fund would be required to disclose the current allocation to be used beginning January 1 of the target date year, even if the fund reaches the target date allocation later in the year.
10 See Proposing Release, text accompanying footnote 56.
11 Proposed Rule 482(b)(5)(iv); propose Rule 34b-1(c).
12 The table, chart, or graph requirement would apply to all target date funds, including those that do not have dates in their names.
13 A single target date fund that has reached its landing point is only required to include a statement regarding the ability of the fund's adviser to modify the glide path, since the other disclosures would be of limited relevance to investors.
14 This disclosure is limited to advertisements that relate to funds whose name includes a date, because those advertisements would be required to contain the target date allocation.
15 Proposed Rule 482(b)(5)(ii)(A) – (C); proposed Rule 34b-1(c).
16 Proposed Rule 482(b)(6); proposed Rule 34b-1(c).
17 Proposed Rule 156(b)(4)(i).
18 Proposed Rule 156(b)(4)(ii).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
