As discussed above, the final rules will require that a shareholder
report cover a single class of a multiple-class fund.\157\ Therefore,
we do not believe it is necessary to include additional information
regarding share class eligibility. Similarly, because shareholders will
continue to receive annual prospectus updates under the final rules, we
do not believe it is necessary to require or permit funds to include a
fund's investment objective (which also appears in the prospectus) in
the shareholder report. We believe that adding the fund's investment
objective would be duplicative and, in light of this, unnecessarily
increase the length of the shareholder report.
---------------------------------------------------------------------------

    \157\ See Instruction 4 of Item 27A(b) of amended Form N-1A.
---------------------------------------------------------------------------

    The final rules also will not require a fund to describe material
changes on the cover page of the shareholder report. Because the
shareholder report will be a relatively short document, we anticipate
investors would see this information within a few pages following the
cover page or beginning of the report. However, we agree with
commenters that it may be useful for shareholders to be alerted to
material changes that occurred during the reporting period. Therefore,
in a change from the proposal, if a shareholder report includes a
discussion of material fund changes, the final rules will require the
cover page of the report to include a prominent statement, in bold-face
type, explaining that the report describes certain changes to the fund
that occurred during the reporting period.\158\
---------------------------------------------------------------------------

    \158\ Item 27A(b) of amended Form N-1A.
---------------------------------------------------------------------------

    Finally, we do not believe it is necessary to adopt an instruction
to the required legend specifically allowing funds that serve as the
underlying investment options for variable contracts to modify the
legend in a manner that is consistent their structure. As discussed
above, Instruction 7 to Item 27A already allows funds to modify a
required legend or narrative information so long as the modified
language contains comparable information.\159\ A more specific
instruction for funds that serve as the underlying investment options
for variable contracts is unnecessary.
---------------------------------------------------------------------------

    \159\ See supra text accompanying footnote 121.
---------------------------------------------------------------------------

b. Fund Expenses
    The final rules will require a simplified expense presentation in
the annual report, modified from the proposed presentation to take into
account concerns raised by commenters. Under the final rules, a fund
will be required to provide a table showing the expenses associated
with a hypothetical $10,000 investment in the fund during the preceding
reporting period in two formats: (1) as a percent of a shareholder's
investment in the fund

(i.e., expense ratio), and (2) as a dollar amount. In a change from the
proposal, the expense presentation under the final rules will not
require the table also to include information about the fund's total
return during the period.\160\ Additionally, the final rules do not
include the proposed requirement for a fund to include an explanation,
in a footnote to the expense example, that expense information does not
reflect shareholder transaction costs associated with purchasing or
selling fund shares.
---------------------------------------------------------------------------

    \160\ See Proposing Release, supra footnote 8, at n.142. The
proposed expense presentation would have required a fund to show a
beginning account value of $10,000, costs paid during the period,
the fund's total return during the period before costs were paid,
and the ending account value based on the fund's net asset value
return. See id. at nn.154-155 and accompanying text. Under the
proposal, ETFs were required to include the ending value of the
account based on market value return. See id. at n.159 and
accompanying text.
---------------------------------------------------------------------------

Simplified Expense Table
    The final rules include a simplified expense table that will
replace the current expense example in the shareholder report, which
consists of two different tables, along with the currently-required
narrative preamble.\161\ Commenters generally supported simplifying the
expense presentation in the shareholder report and eliminating the
narrative preamble to the table.\162\ In addition, the expense table
under the final rules is more simplified than the proposed presentation
and is designed to provide shareholders with a basis for comparing the
level of current period expenses of different funds (as percentages are
comparable), as well as to permit shareholders to estimate the costs,
in dollars, that they incurred over the reporting period. The expense
presentation will appear as follows, and the individual aspects of the
example are described in more detail below.
---------------------------------------------------------------------------

    \161\ See Proposing Release, supra footnote 8, at text
accompanying nn.145-146 (explaining that the current expense
presentation requires funds present two tables: the first showing
the actual cost in dollars for a $1,000 investment in the fund over
the prior six-month period based on the actual return of the fund,
and the second showing the cost in dollars for a $1,000 investment
in the fund over the prior six-month period based on a hypothetical
5% annual return); see id. at n.162 and accompanying text
(discussing the currently-required narrative preamble).
    \162\ See, e.g., ICI Comment Letter; AFREF Comment Letter; NASAA
Comment Letter; CFA Institute Comment Letter; Abdullah Comment
Letter. But see Consumer Federation of America II Comment Letter
(suggesting that the Commission conduct investor testing to
determine if investors would prefer the current presentation).

        What Were the Fund Costs for the Last [Year/Six Months]?
              [Based on a hypothetical $10,000 investment]
------------------------------------------------------------------------
                                                         Costs paid as a
                                           Costs of a    percentage of a
         [Fund or class name]               $10,000          $10,000
                                           investment       investment
------------------------------------------------------------------------
                                                     $                %
------------------------------------------------------------------------

    As proposed, the final rules require a fund to provide the expenses
associated with a hypothetical $10,000 investment in the fund during
the preceding reporting period. Currently, funds are required to show
expenses associated with a $1,000 investment. The Commission proposed
an increased dollar value in order to present a more realistic
investment amount for an individual shareholder today.\163\ Commenters
supported the higher $10,000 assumed investment amount.\164\ One
commenter, however, stated that funds with a higher minimum investment
should be required to show that higher investment amount in the expense
presentation.\165\ As this would undermine comparing different funds,
we are not requiring funds with higher minimum investment amounts to
show that higher amount.
---------------------------------------------------------------------------

    \163\ See Proposing Release, supra footnote 8, at n.151 and
accompanying text.
    \164\ See, e.g., Consumer Federation of America II Comment
Letter; Morningstar Comment Letter.
    \165\ ICI Comment Letter.
---------------------------------------------------------------------------

    In addition to the cost in dollars of a $10,000 investment and the
expense ratio, the proposed expense table also would have required a
fund to show returns information, which was designed to facilitate
shareholders' understanding of how costs and performance affect their
ending account values. Some commenters, including retail investors,
requested that the expense example exclude returns information, and
provide only costs.\166\ These commenters stated that presenting
returns information in the expense table might be confusing for
shareholders and repetitive of the performance information that appears
later in the document. Additionally, one commenter supported an
approach that includes returns information in the expense table, but
stressed the importance of highlighting the costs paid in dollars and
expense ratio tables through text features, such as bold-face type, to
emphasize the importance of those two data points.\167\ After
considering commenters' concerns, the presentation of fund expenses
under the final rules will not include fund returns information because
we agree that presenting returns information in the expense example is
duplicative of the returns information that is presented in the MDFP
section of the report and could add unnecessary complexity and
confusion to the expense presentation. For example, because a fund's
reported return would relate to the fund's fiscal year, including
return information could result in different funds presenting
substantially different returns based primarily on whether a given
fund's fiscal year included a time period with aberrant market
performance. We also believe that the simplified presentation--
presenting just the costs in dollars and the expense ratio--would help
to focus investors on this key information.\168\
---------------------------------------------------------------------------

    \166\ See, e.g., Comment Letter of Sandra Degan (Aug. 25, 2020)
(``Sandra Degan Comment Letter''); Comment Letter of Ubiquity (Sept.
14, 2020) (``Ubiquity Comment Letter''); Williams Comment Letter;
Tom and Mary Comment Letter; Barker Comment Letter. Additionally,
two commenters objected to the ETF-specific requirement to show the
ending account value based on both NAV and market value return, and
stated that ETFs should only be required to show NAV. See Ubiquity
Comment Letter, Tom and Mary Comment Letter.
    \167\ CFA Institute Comment Letter.
    \168\ Because the final rules will not include fund return
information in the expense example, the expense table will not
include the proposed ``ending value of the account'' column and
related instructions, including the proposed instructions requiring
the presentation of expense information as a mathematical expression
and the requirement to give more prominence to the ``cost paid'' and
``cost paid as a percentage of your investment' columns than the
other columns in the table. Similarly, commenter concerns regarding
the disclosure related to ETF-specific requirement to show the
ending account value based on both NAV and market value return are
moot.
---------------------------------------------------------------------------

Additional Aspects of the Shareholder Report's Presentation of Expenses
    Some commenters suggested additional modifications to the proposed
expense presentation. First, we proposed an expense table title: ``What
were your Fund costs for the period? (based on a hypothetical $10,000
investment).'' Additionally, under the proposal, the column in the
table that would include the fund's expense ratio was entitled ``costs
paid as a percentage of your investment.'' One commenter requested we
modify these two headers to remove the references to ``your'' because
an investor might reasonably interpret these uses of the possessive
pronoun as actually reflecting that investor's own personal
experience.\169\ We agree, that the use of the term ``your'' in the
header to the table and the title of the expense ratio column could
confuse investors, and we have changed these two headers to clarify
that the expenses presented in

the table are a reflection of a hypothetical $10,000 investment.
---------------------------------------------------------------------------

    \169\ NASAA Comment Letter.
---------------------------------------------------------------------------

    Additionally, the final rules will replace the proposed header
reference to ``the period'' with a more specific reference to either
``the past year'' or ``the past six months,'' depending on whether the
report is an annual or semi-annual report. We believe this more
specific heading reference to the relevant period will help
shareholders better appreciate that the figures in the semi-annual
report expense table reflect a shorter period than the annual report
(and thus these figures will likely be smaller than the parallel
figures in the annual report).
    The proposal also would have included a new footnote to the expense
presentation that would have required a fund to include a footnote
briefly explaining, in plain English, that the expense information does
not reflect shareholder transaction costs associated with purchasing or
selling fund shares.\170\ This was designed to inform investors that
there may be additional costs not reflected in the expense example, if
applicable. Some retail investors stated that the proposed footnote is
of limited value and recommended streamlining it.\171\ After
considering commenter concerns, we agree this footnote would provide
limited information to investors, particularly since it would not have
included quantitative information regarding these costs, and these
costs may vary based on distribution channel, making it difficult to
present this information concisely in the footnote or otherwise. By
merely alerting investors to the possibility of additional costs, the
proposed footnote could make the table less readable without providing
investors information they could use effectively in evaluating the
expense presentation. We therefore are not adopting that proposed
footnote.
---------------------------------------------------------------------------

    \170\ The proposal would have also required a fund to include a
footnote to the proposed returns information that would be included
in the expense presentation, describing other costs that are
included in the fund's total return if material to the fund. Because
the final rules' expense presentation does not include returns-
related information, we are not adopting this footnote requirement.
See Proposing Release, supra footnote 7, at n.164.
    \171\ Williams Comment Letter; Tom and Mary Comment Letter.
---------------------------------------------------------------------------

    We are adopting, as proposed, an instruction that will direct funds
to calculate ``Costs of a $10,000 investment'' by multiplying the
figure in the ``Cost paid as a percentage of a $10,000 investment''
column by the average account value over the period based on an
investment of $10,000 at the beginning of the period.\172\ The figure
in the ``Cost paid as a percentage of your investment'' column, in
turn, will be the fund's expense ratio as it appears in the fund's most
recent audited financial statements or financial highlights.\173\
---------------------------------------------------------------------------

    \172\ See Instruction 2(a) to Item 27A(c) of amended Form N-1A.
As proposed, the computation instructions will also require funds to
assume reinvestment of all dividends and distributions. See
Instruction 2(b) to Item 27A(c) of amended Form N-1A.
    \173\ See Instruction 2(c) to Item 27A(c) of amended Form N-1A.
In the semi-annual report, the fund's expense ratio will be
calculated in the manner required by Instruction 4(b) to Item 13(a)
of current and amended Form N-1A, using the expenses for the fund's
most recent fiscal half-year. Id.
---------------------------------------------------------------------------

    Additionally, as proposed, we are retaining three current
instructions that we believe continue to provide important information
to shareholders.\174\ First, if a fund incurred any ``extraordinary
expenses'' during the reporting period, the fund may briefly describe,
in a footnote to the expense table, what the actual expenses would have
been if these extraordinary expenses were not incurred.\175\ The
Commission received no comments on this instruction. Second, if a fund
is a feeder fund, the fund must reflect the aggregate expenses of the
feeder fund and the master fund in the expense table and include a
footnote stating that the expense table reflects the expenses of both
the feeder and master funds.\176\ One commenter supported continuing to
permit funds to report aggregated fees with the related footnote, and
noted that allowing reporting in this manner allows investors to more
easily understand the total expenses they are paying.\177\ No
commenters opposed the instruction. Finally, if a fund's shareholder
report covers a period of time that is less than a full reporting
period, the fund must include a footnote to the table noting this and
explaining that expenses for a full reporting period would be higher
than the figures shown.\178\ We received no comments on this
instruction.\179\
---------------------------------------------------------------------------

    \174\ See Proposing Release, supra footnote 7, at paragraph
following n.171.
    \175\ See Instruction 1(d) to Item 27A(c) of amended Form N-1A
(defining ``extraordinary expenses'' as ``expenses that are
distinguished by their unusual nature and by the infrequency of
their occurrence. Unusual nature means the expense has a high degree
of abnormality and is clearly unrelated to, or only incidentally
related to, the ordinary and typical activities of the Fund, taking
into account the environment in which the Fund operates. Infrequency
of occurrence means the expense is not reasonably expected to recur
in the foreseeable future, taking into consideration the environment
in which the Fund operates. The environment of a Fund includes such
factors as the characteristics of the industry or industries in
which it operates, the geographical location of its operations, and
the nature and extent of government regulation'').
    \176\ See Instruction 1(b) to Item 27A(c) of amended Form N-1A.
    \177\ Morningstar Comment Letter.
    \178\ See Instruction 1(c) to Item 27A(c) of amended Form N-1A.
This would generally apply to newly-formed funds that are required
to file an annual or semi-annual report for a period shorter than
the reporting period.
    \179\ While the proposal included an instruction that would have
required a separate expense table, or a separate line item in the
expense table, for each class of as multiple-class fund, this
instruction is moot in light of the final rules' requirement that a
shareholder report cover only a single class of a multiple-class
fund. See Instruction 4 to Item 27A(a) of amended Form N-1A; see
also footnote 106 and accompanying text; see also Proposing Release,
supra footnote 7, at n.174 and accompanying text.
---------------------------------------------------------------------------

Feedback on Including Additional or Different Information About Fund
Costs
    Some commenters also responded to the Commission's request for
comment on differences in the expense presentations in the annual
report and prospectus.\180\ These presentations currently differ in
that the shareholder report expense example is derived from a fund's
audited financial statements and therefore reflects actual historical
expenses that a shareholder incurred over the past year (i.e.,
backwards-looking expenses). The prospectus fee table and expense
example, on the other hand, reflect hypothetical future expenses (i.e.,
forward-looking expenses).\181\ Some commenters argued that the expense
presentations of the prospectus and annual report should be
aligned.\182\ Similarly, one commenter suggested that the shareholder
report expense example should disclose the prospectus expense ratio and
explain any differences in a footnote.\183\ Furthermore, some
commenters suggested that the expense presentation in the shareholder
report should include additional transaction costs, beyond commissions,
including costs paid from fund assets for investment research and
payments made to affiliated securities lending agents.\184\ Conversely,
one commenter urged the Commission to exclude interest expenses and
dividends paid on short sales from the current expense ratio, on the
basis that these

adjustments would make expense information more comparable across
funds.\185\ Finally, other commenters also argued that the Commission
should require funds to disclose--on fund websites or in the
prospectus, as a complement to shareholder report disclosure--best
execution policies reflecting ``efforts to ensure that fund transaction
costs, including commission dollars generated by the fund,'' directly
benefit shareholders.\186\
---------------------------------------------------------------------------

    \180\ See Proposing Release, supra footnote 8, at text following
n.600; see also, e.g., Dominic Rosa Comment Letter; Barker Comment
Letter; Tom and Mary Comment Letter; Capital Group Comment Letter;
Morningstar Comment Letter.
    \181\ Currently, the prospectus fee table also reflects sales
loads that an investor would pay and AFFE, whereas the shareholder
report expense presentation does not, because these elements are not
reflected in the fund's financial statements. See Proposing Release,
supra footnote 8, at n.148 and accompanying text.
    \182\ Dominic Rosa Comment Letter; Barker Comment Letter; Tom
and Mary Comment Letter; Capital Group Comment Letter.
    \183\ Morningstar Comment Letter.
    \184\ Dimensional Comment Letter; AFREF Comment Letter.
    \185\ See Morningstar Comment Letter (arguing that removing
interest and dividend expenses from the expense ratio gives
investors a better sense for what a fund company is charging them
for the cost of running the fund and allows funds with different
types of investments to present their expenses in a comparable way.
Morningstar has adjusted its methodology for calculating fund
expense ratios in their data to exclude interest and dividend
expenses).
    \186\ Comment Letter of Healthy Markets Association (Nov. 6,
2020) (``Healthy Markets Association Comment Letter''); see also CFA
Institute Comment Letter.
---------------------------------------------------------------------------

    Because the prospectus and shareholder report differ in the time
periods that they reflect (i.e., the prospectus is ``forward looking''
while the shareholder report is ``backward looking''), aligning the
expense presentations in these documents presents significant
challenges. Additionally, we believe that it would be confusing to
investors to be given two expense ratios in the shareholder report (one
backwards-looking, derived from the audited financial statements, and
the other from the forward-looking prospectus). Furthermore, because
the shareholder report is designed to provide shareholders with a
summary of the key information provided in the fund's audited financial
statements, we continue to believe that the types of costs reflected in
the shareholder report expense example should be derived from those
that are included in the fund's audited financial statements. As
discussed above, however, helping investors more readily understand
fund fees and expenses is an important priority of the Commission and
we believe that the general topic of fund fee disclosure effectiveness,
in light of comments received, merits further consideration.\187\
---------------------------------------------------------------------------

    \187\ See supra text following footnote 84.
---------------------------------------------------------------------------

c. Management's Discussion of Fund Performance
    Substantially as proposed, the final rules will largely maintain
the current requirements for the MDFP section of the annual report,
with several targeted changes.\188\ In particular, we are adopting
amendments to the current MDFP requirements to make the disclosure more
concise. Additionally, the final rules include additional performance-
related information that is available in fund prospectuses, including
certain performance information and comparative information showing the
average annual total returns of one or more relevant benchmarks,
modified from the proposal to take into account the final rule's
requirement for the shareholder report to cover a single class of a
multiple-class fund. We also are amending, as proposed, the definition
of an appropriate broad-based securities market index to require that
all funds compare their performance to the overall applicable
securities market, for purposes of both fund annual reports and
prospectuses.
---------------------------------------------------------------------------

    \188\ See Proposing Release, supra footnote 7, at text following
n.176 (explaining that the current MDFP disclosure generally
includes: a narrative discussion of the factors that materially
affected the fund's performance; a performance line graph; a table
showing the fund's average annual total returns; a discussion of the
effect of any policy or practice of maintaining a specified level of
distributions to shareholders on the fund's investment strategies
and per share net asset value, as well as the extent to which the
fund's distribution policy resulted in distributions of capital; and
for ETFs that do not provide certain premium or discount information
on their websites, a table showing the number of days the fund
shares traded at a premium or discount to net asset value).
---------------------------------------------------------------------------

i. Narrative MDFP Disclosure
    As proposed, the final rules retain the current requirement for
funds' annual reports to include a narrative discussion of factors that
materially affected a fund's performance during the most recent fiscal
year, with minor modifications from the current requirements to
encourage concise disclosure.\189\ In particular, the final rules amend
the current requirement to specify the disclosure must ``briefly
summarize'' the ``key'' factors that materially affected the fund's
performance during the last fiscal year, including the relevant market
conditions and the investment strategies and techniques used by the
fund's investment adviser. As proposed, the final rules instruct funds
not to include lengthy, generic, or overly broad discussions of these
factors.\190\ The instruction, as proposed, also directs funds to use
graphics or text features--such as bullet lists or tables--to present
the key factors, as appropriate. Finally, as proposed, the final rules
will not allow funds to include any additional information--such as a
fund president's letter to shareholders, interviews with portfolio
managers, general market commentary, and other similar information--in
the shareholder report.\191\
---------------------------------------------------------------------------

    \189\ See Item 27A(d)(1) of amended Form N-1A.
    \190\ See Instruction 1 to Item 27A(d)(1) of amended Form N-1A.
    \191\ See supra text accompanying footnote 131. Additional
information could, however, accompany the shareholder report
provided that it meets the prominence requirements for materials
that accompany the report. See Instruction 12 to Item 27A(a) of
amended Form N-1A.
---------------------------------------------------------------------------

    Commenters supported the proposed amendments to the narrative MDFP
section and stated that the proposed approach appropriately maintains a
fund's flexibility in presenting information that is most salient to
investors, while requiring such information to be presented in a
visually engaging and accessible format.\192\ In addition, survey data
submitted by a commenter indicated that retail investors, and older
investors in particular, expressed that the new presentation would help
them better understand fund performance.\193\
---------------------------------------------------------------------------

    \192\ See, e.g., Consumer Federation of America II Comment
Letter; ICI Comment Letter; Fidelity Comment Letter.
    \193\ Broadridge Comment Letter.
---------------------------------------------------------------------------

    We are adopting the narrative MDFP section as proposed because we
continue to believe providing shareholders with a more streamlined and
visually engaging presentation of the key factors affecting fund
performance will allow shareholders to focus on the most salient fund
information.\194\ Our approach balances the need for funds to have
flexibility in determining what information is salient given a fund's
unique strategy and risk profile, while encouraging funds to present
that information in a manner that is most effective for shareholders.
Therefore, we do not believe it is necessary to further limit the
narrative MDFP disclosure.
---------------------------------------------------------------------------

    \194\ See Proposing Release, supra footnote 7, at text following
n.180.
---------------------------------------------------------------------------

ii. Performance Line Graph and Guidance on Use of Market Indexes in
Performance Disclosure
    Substantially as proposed, the final rules will retain the
requirements for the performance line graph currently included in
annual reports, with certain amendments designed to improve the current
presentation and to reflect that a shareholder report will cover a
single class of a multiple-class fund.\195\ The shareholder report must
include a performance line graph that shows the performance of a
$10,000 investment in the fund and in an appropriate broad-based
securities market index over a 10-year period.\196\ In addition, a fund
has

the option to compare its performance to other indexes, including more
narrowly based indexes that reflect the market sectors in which the
fund invests. We continue to believe the line graph presentation helps
shareholders understand how the fund has performed over a 10-year time
horizon compared to an appropriate broad-based securities market index
and other relevant indexes, as applicable.\197\
---------------------------------------------------------------------------

    \195\ See Item 27A(d)(2) of amended Form N-1A and related
instructions.
    \196\ An ``appropriate broad-based securities market index'' is
administered by an organization that is not an affiliated person of
the fund, its investment adviser, or principal underwriter, unless
the index is widely recognized and used. See Instruction 6 to Item
27A(d)(2) of amended Form N-1A.
    \197\ See Proposing Release, supra footnote 7, at nn.191-193 and
accompanying text.
---------------------------------------------------------------------------

    We are adopting the instructions related to the line graph largely
as proposed, with some conforming changes to reflect other aspects of
the final rules. First, in a change from the proposal, the final rules
include an instruction that requires a fund to present performance
information for the class covered in the shareholder report. Second, as
proposed, the final rules remove the current instruction that allows
the line graph to cover periods longer than the past 10 fiscal years.
Third, as proposed, the final rules include an instruction that defines
a ``broad-based'' index as one that represents the overall applicable
domestic or international equity or debt markets, as appropriate.\198\
And as proposed, the instructions under the final rules will continue
to permit a fund to include narrower indexes that reflect the market
segments in which the fund invests in its performance presentation,
along with the required appropriate broad-based securities market
index.\199\
---------------------------------------------------------------------------

    \198\ The amendments to the definition of an appropriate broad-
based securities market index would affect performance presentations
in fund prospectuses, as well as fund annual reports.
    \199\ See Instruction 7 to Item 27A(d)(2) of amended Form N-1A.
This release sometimes refers to the appropriate broad-based
securities market index as the ``primary index'', and any narrower
index(es) as ``secondary index(es).''
---------------------------------------------------------------------------

    Commenters generally supported the retention of the performance
line graph as well as the prohibition on showing more than 10 years of
performance.\200\ Some commenters requested enhancements to the line
graph. For example, one commenter suggested the line graph should
include percentage values along with dollar amounts to facilitate
comparisons.\201\ Additionally, one commenter suggested allowing funds
to add labels at each significant point in the line graph to enhance
comprehension of risk and improve the user experience.\202\ Two
commenters suggested funds should be required to include a bar chart of
returns, similar to what is currently included in the prospectus, along
with the line graph.\203\
---------------------------------------------------------------------------

    \200\ See, e.g., Consumer Federation of America II Comment
Letter; Cornell Law School Comment Letter; Morningstar Comment
Letter; Morningstar Trustees Comment Letter; CFA Institute Comment
Letter. But see ICI Comment Letter (objecting to the prohibition
showing performance beyond 10 years).
    \201\ Cornell Law School Comment Letter.
    \202\ Morningstar Comment Letter.
    \203\ Morningstar Trustees Comment Letter; CFA Institute Comment
Letter.
---------------------------------------------------------------------------

    We continue to believe, as discussed more fully in the Proposing
Release, that limiting the performance line graph to 10 years is
important to avoid unrealistic investor performance-related
expectations and allow investors to easily identify volatility.\204\ We
also believe adding labels at significant points on the line graph may
clutter the presentation and hinder an investor's ability to understand
the information provided.
---------------------------------------------------------------------------

    \204\ See Proposing Release, supra footnote 7, at text following
n.196 (discussing, for example, that for funds that have been in
existence for a long period of time (e.g., 40 years), a line graph
that shows the performance of a $10,000 investment at the outset of
the fund may not be particularly relevant for the average
shareholder, who likely has not been invested in the fund for such
an extended period of time).
---------------------------------------------------------------------------

    Further, we continue to believe the line graph is more useful for
investors in the shareholder report than a bar chart. Like a bar chart,
a line graph helps illustrate the variability of a fund's returns
(e.g., whether the fund's returns have been volatile or relatively
consistent from year to year). But given the other benefits of the line
graph--particularly that it presents performance in dollar terms that
may be easier for some shareholders to assess--the final rules we are
adopting maintain the line graph presentation.\205\ Moreover, the line
graph presentation may help investors understand the general benefits
of long-term investments (e.g., compound interest).
---------------------------------------------------------------------------

    \205\ This complements the percentage-based presentation in the
average annual total returns table. See Proposing Release, supra
footnote 8, at n.193.
---------------------------------------------------------------------------

Comments on Broad-Based Securities Market Index
    Commenter reactions to the proposed definition of an appropriate
broad-based securities market index were mixed. Some commenters
supported the retention of the requirement to present performance
relative to a broad-based index, as well as the proposed
definition.\206\ One commenter stated that the requirement to compare
performance to the overall applicable securities markets would be
useful to investors, as it makes the information more comparable across
funds, and should ``also help prevent funds from selecting for
comparison a narrow index designed to make their own performance look
artificially strong.'' \207\ Another, supporting the proposed
requirement, stated that the requirement would ``ensure that investors
have a simple, readily-accessible window into the performance of a
specific investment fund against the broader performance of the
securities markets.'' \208\ Some commenters asked for additional
guidance. For example, one commenter suggested that the definition
incorporate more specific criteria regarding index methodology.\209\
Another commenter requested the Commission to provide additional
clarity on indexes that would satisfy the proposed definition, such as
country-specific indexes, ESG indexes, and indexes of particular
capitalizations.\210\ Further, another commenter suggested that the
Commission publish a list of permissible indexes.\211\
---------------------------------------------------------------------------

    \206\ See, e.g., Comment Letter of Index Industry Association
(Jan. 4, 2021) (``Index Industry Association Comment Letter'');
Consumer Federation of America II Comment Letter; NASAA Comment
Letter; Tom and Mary Comment Letter; Ubiquity Comment Letter.
    \207\ See Consumer Federation of America II Comment Letter; see
also Index Industry Association Comment Letter (comparing fund
performance against a broad-based market index in fund reporting
materials ``promotes transparency and helps shareholders evaluate
their goals''); see also Abdullah Comment Letter (stating that it is
problematic that funds include narrow indexes as their broad-based
index).
    \208\ See NASAA Comment Letter.
    \209\ Id.
    \210\ Tom and Mary Comment Letter.
    \211\ Ubiquity Comment Letter.
---------------------------------------------------------------------------

    In contrast, many industry commenters objected to the proposed
definition.\212\ These commenters argued that, for some fund strategies
like multi-asset funds and alternative strategy funds, a comparison to
an index representing the entire market would be less useful and could
be misleading to investors because these fund strategies are not
designed to invest in, nor provide the performance associated with, any
particular overall market. Commenters also questioned the default
requirement to include a broad-based index in a fund's performance line
graph. Although the proposal allows funds to show a secondary index
that is more tailored to the fund's strategy, commenters argued
including any broad-based market index would be confusing to investors
in certain

circumstances.\213\ For example, one commenter argued that investor
confusion could result if the Commission were to require an index fund
that seeks to track a narrow index as a principal investment strategy
to compare itself to a different, broad-based index.\214\ Furthermore,
some commenters argued the proposed broad-based index requirement would
impose additional licensing fees on funds.\215\ Similarly, one
commenter argued retaining the current ``widely recognized and used''
standard for using an affiliated index as a fund's primary index
disadvantages smaller funds, whose affiliated indexes would be less
likely to meet this standard and for which the expense of licensing a
``widely recognized and used'' index may be more significant.\216\
---------------------------------------------------------------------------

    \212\ See, e.g., ICI Comment Letter (suggests changing index
definition to ``appropriate index''); SIFMA Comment Letter;
Morningstar Comment Letter; Fidelity Comment Letter; Capital Group
Comment Letter; John Hancock Comment Letter; TIAA Comment Letter;
Comment Letter of IHS Markit (Jan. 4, 2021) (``IHS Markit Comment
Letter'').
    \213\ Id.
    \214\ Supplemental Comment Letter of the Investment Company
Institute (Oct. 10, 2022) (``ICI Comment Letter on the OIAD
Benchmark Study''). But see Abdullah Comment Letter (``Since 40% of
fund assets are index funds, it would be interesting to see whether
the performance [of] an index that lines up quite closely with an
index fund is useful to investors. I hypothesize that such a
presentation provides no benefit to an investor and so should not be
permitted as the sole benchmark.'').
    \215\ ICI Comment Letter; SIFMA Comment Letter; Vanguard Comment
Letter; Dimensional Comment Letter; Fidelity Comment Letter; T. Rowe
Price Comment Letter; see also infra paragraph accompanying
footnotes 751-752 (discussing potential effects of the final rules'
changes to the term ``appropriate broad-based securities market
index'' on the costs that funds bear, including additional costs to
funds in the form of index-licensing fees, and stating that the
amount of these costs will depend, among other things, on market
competition among index providers). But see Index Industry
Association Comment Letter (stating fees charged by broad-based
index providers are small and costs to funds would be minimal).
    \216\ ICI Comment Letter.
---------------------------------------------------------------------------

    Some commenters suggested alternatives designed to alleviate
investor confusion concerns and to enhance benchmark indexes'
informational value. For example, some commenters urged the Commission
to consider requiring labeling the primary index as a ``general market
index'' (or similar) to clarify how an investor should use the
information it presents.\217\ Other commenters suggested the primary
index should be one that is specifically tailored to the fund's
strategy and the secondary index should be one that represents the
overall market.\218\ Some of these commenters also suggested that funds
be permitted to provide additional information about more narrowly
tailored indexes, such as the index's underlying components and their
weights,\219\ and an explanation of why the fund believes that the
chosen index is an appropriate indicator of the fund's
performance.\220\
---------------------------------------------------------------------------

    \217\ Fidelity Comment Letter; CFA Institute Comment Letter.
    \218\ Morningstar Comment Letter; Federated Hermes Comment
Letter; John Hancock Comment Letter; IHS Markit Comment Letter; T.
Rowe Price Comment Letter.
    \219\ T. Rowe Price Comment Letter.
    \220\ IHS Markit Comment Letter.
---------------------------------------------------------------------------

    After considering comments and the findings of the OIAD Benchmark
Study, we are adopting the proposed definition of ``appropriate broad-
based securities market index'' and retaining the current requirement
that a fund must include such an index in its performance line graph.
We continue to believe all funds should compare their performance to
the overall market and that including a broad-based index in
performance disclosure gives investors readily-accessible contextual
information about market performance.\221\ While performance disclosure
that includes an index based on a narrow segment of the market may be
useful for comparison purposes, this does not substitute for the
inclusion of an index that provides information about the performance
of the fund against the broader market. For example, if the Commission
were to permit an index fund that seeks to track a narrow index as a
principal investment strategy to show only the performance of the
narrow index it seeks to track, and the performance of the fund and the
index were very similar (as they would be to the extent that the fund
tracks the index closely), such a performance presentation would show
the extent to which the fund tracks the index but would be less helpful
to investors to provide broader performance context.\222\ As another
example, the inclusion of a broad-based index helps an investor in a
sector-specific fund determine not only how the fund's performance
relates to that of its peers, but how the fund's performance relates to
the performance relative to the market as a whole. Therefore, investors
in such funds would benefit from additional contextual information
regarding the performance of the overall market.\223\
---------------------------------------------------------------------------

    \221\ See supra footnotes 206-208 and accompanying text.
    \222\ See supra footnote 214.
    \223\ See, e.g., CFA Institute Comment Letter (``Even if a fund
outperforms its benchmark, that may be slight consolation if the
strategy itself performs poorly against the market. Therefore, the
investor should also compare a fund's returns against the market as
a whole.'').
---------------------------------------------------------------------------

    The final rules' approach is supported in part by the findings of
the OIAD Benchmark Study, which observed that benchmarks can help
contextualize a fund's performance information for investors, and that
some investors use this information to make investment decisions.\224\
The study also found that investors of varying levels of sophistication
report preferring performance disclosure that includes both broad and
narrow benchmarks.\225\ Furthermore, while commenters suggested that
narrower benchmarks could provide more useful comparative information,
the OIAD Benchmark Study concluded that investors' decision-making was
generally driven by the positioning of the fund's performance relative
to the benchmark presented (i.e., whether the fund underperformed or
outperformed the benchmark), irrespective of whether the benchmark
presented is narrow or broad.\226\ Therefore, as we continue to believe
a comparison to the overall market is important contextual information
for investors, the evidence that the study provided does not, in our
view, support changing the proposed approach or adopting an alternative
requirement (for example, requiring the

inclusion of an ``appropriate'' benchmark as opposed to an
``appropriate broad-based'' benchmark). In addition, the study showed
that investors find a fund significantly less attractive when a
performance graph shows the fund's performance accompanied by a single
benchmark that outperforms the fund. Therefore, to the extent that it
could be easier for a fund to find a narrow benchmark that
underperforms the fund than a broad benchmark, we do not see a reason
to discontinue the current requirement to include a broad benchmark, as
the requirement to include only a narrower benchmark could lead to
gaming behavior. Two commenters specifically addressed the OIAD
Benchmark Study and raised concerns regarding the methodology used by
the study and the impact such methodology had on the study's
conclusions.\227\ However, the elements of the OIAD Benchmark Study
that support the approach under the final rules are not impacted by the
methodology concerns that commenters raised.\228\
---------------------------------------------------------------------------

    \224\ See OIAD Benchmark Study, supra footnote 53; see also ICI
Comment Letter on the OIAD Benchmark Study (noting the importance of
performance benchmarks to investors).
    \225\ OIAD Benchmark Study, supra footnote 53 at ``Figure 9.
Preferences for benchmarks.'' In the sections of the OIAD Benchmark
Study that analyze benchmarks that currently exist in the mutual
fund industry, the study identified funds' broad-based benchmarks
first by identifying data from the Morningstar Direct open-end fund
database that capture ``primary'' and ``secondary'' indexes, and
then by reclassifying these indexes as broad and narrow benchmarks
based on the correlation of each index with the S&P 500 Index.
Commenters objected to the use of the S&P 500 Index in the study's
methodology, arguing that the Commission should not ``define or
insinuate that a broad-based index must or should have certain
correlation to the S&P 500 Index.'' See Abdullah Comment Letter; see
also ICI Comment Letter on the OIAD Benchmark Study (stating that
``de facto SEC endorsement of certain indexes would create market
distortions and likely increase fund licensing costs''). The OIAD
Benchmark Study, including its methodology and findings, does not
reflect findings or conclusions by the Commission as to what
constitutes a broad-based index under the final rules. See infra
text accompanying footnotes 230-233 (providing general guidance and
examples of the indexes that would qualify as broad-based indexes
under the rule).
    \226\ See OIAD Benchmark Study, supra footnote 53; see also ICI
Comment Letter on the OIAD Benchmark Study (stating that ``the
underlying results do not find evidence that survey participants
believed that the broad benchmark is a better reference point than
the narrow benchmark''). A different academic study also examines
fund performance benchmarks, but with a focus on funds' behavior
with respect to the performance benchmarks that they select, how
benchmark changes affect the appearance of funds' benchmark-adjusted
performance, as well as fund flows that result from changes in
performance benchmarks. See Kevin Mullally and Andrea Rossi, Moving
the Goalposts? Mutual Fund Benchmark Changes and Performance
Manipulation (June 24, 2022), available at Mullally, Kevin and
Rossi, Andrea, Moving the Goalposts? Mutual Fund Benchmark Changes
and Performance Manipulation (June 24, 2022) available at https://ssrn.com/abstract=4145883.
    \227\ See Abdullah Comment Letter; see also ICI Comment Letter
on the OIAD Benchmark Study.
    \228\ Those concerns chiefly focused on the sections of the OIAD
Benchmark Study that analyze benchmarks that currently exist in the
mutual fund industry (Section 2, ``Institutional Background on
Benchmark Requirements,'' Section 7, ``Analysis of Benchmark
Performance Data,'' and Section 8, ``General Discussion''). These
concerns focused on the methodology for determining which benchmark
in a fund's disclosure is the broad-based benchmark that is required
to appear in its performance disclosure. The discussion of the OIAD
Benchmark Study included in this section of the release, on the
other hand, relates to the results of the large behavioral
experiment that the study describes, as well as the qualitative
pilot study.
---------------------------------------------------------------------------

    We recognize that there is a broad diversity of investment
strategies that funds employ, and that certain funds, such as multi-
asset and alternative strategy funds, do not invest within a single
overall market or attempt to provide returns that are related to the
returns of any single overall market. However, comparing the
performance of these types of funds against an overall market index
will provide shareholders with valuable information regarding how their
investments might have performed had their money been invested directly
in the holdings included in the index. Further, as discussed above we
continue to believe that such a presentation may be useful to
investors. And investors may continue to prefer such a presentation, as
the OIAD Benchmark Study did not find evidence supporting the notion
that study participants believe that a narrow benchmark is a better
reference point than a broad benchmark.\229\ Additionally, the final
rules will allow funds to include narrower indexes, reflecting the
market segments in which the fund invests, in the performance
presentation. This flexibility will allow funds with unique investment
strategies to show the performance of an index that is more closely
aligned with the fund's investments.
---------------------------------------------------------------------------

    \229\ See supra paragraph accompanying footnote 212; see also
id.
---------------------------------------------------------------------------

    A ``broad-based'' index that ``represents the overall applicable''
market will of course not necessarily include every security in a given
market.\230\ The revised definition is designed to ensure that a fund's
broad-based index is one that reasonably represents the applicable
market. To assist funds in their selection of indexes, we are providing
some general guidance and examples of the types of indexes that would
satisfy the final rules. For example, for a fund that invests primarily
in the equity securities of a non-U.S. country, an index representing
the overall equity market of the non-U.S. country would satisfy the
final rule's requirements.\231\ In contrast, an appropriate benchmark
for a fund that invests primarily in the equity securities of a subset
of the U.S. market, such as healthcare companies, should show its
performance against the overall U.S. equities market, rather than a
benchmark consisting of only healthcare companies. Such a fund could
also show its performance against an additional, more narrowly tailored
healthcare index.\232\ We similarly do not believe that indexes that
include characteristics such as ``growth,'' ``value,'' ``ESG,'' or
``small- or mid-cap'' represent the overall market, and therefore these
indexes would not be appropriate broad-based securities market indexes
under the final rules.
---------------------------------------------------------------------------

    \230\ ICI Comment Letter (stating that, when selecting an index,
funds will have to make judgements on how broad an index should be).
    \231\ See Disclosure of Mutual Fund Performance and Portfolio
Managers, Investment Company Act Release No. 19382 (Apr. 6, 1993)
[58 FR 19050 (Apr. 12, 1993)], at n.21 and accompanying paragraph.
    \232\ See Instruction 7 to Item 27A(d)(2) of amended Form N-1A.
---------------------------------------------------------------------------

    An ``appropriate'' broad-based securities market index that a fund
selects may include components that do not directly overlap with the
fund's investments, if the index's components share similar economic
characteristics to the fund's investments such that they provide an
appropriate point of comparison. For example, funds such as multi-asset
and alternative strategy funds that do not invest within a single
overall debt or equity market could select an index that shares other
economic characteristics with the fund, such as an index that has
similar volatility to the fund. Additionally, as the Commission stated
in the Proposing Release, a fund that invests in both equity and debt
securities could include more than one appropriate broad-based
securities market index.\233\ Such a fund could also include a blended
index--one that combines the performance of more than one index, such
as equity and debt indexes--as an additional index to supplement the
appropriate broad-based securities market index(es) that the fund
includes.
---------------------------------------------------------------------------

    \233\ Proposing Release, supra footnote 8, at text accompanying
n.202.
---------------------------------------------------------------------------

    Furthermore, because the indexes that are available for funds to
select change over time, we are not publishing a list of permissible
indexes. We also are not further restricting permissible indexes by
incorporating more specific criteria regarding index methodology, as
maintaining more specific criteria that are evergreen would be
challenging in light of developments in funds' investment strategies
and changes in the availability of indexes over time. We also are not
adopting commenter suggestions to label indexes or to allow funds to
provide additional contextual information regarding indexes because we
think the name of the index itself is sufficient for investor
understanding and will give investors the opportunity to seek further
information on the indexes chosen by the fund.\234\
---------------------------------------------------------------------------

    \234\ See OIAD Benchmark Study, supra footnote 53 (finding no
evidence to support the claim that textual clarifications of
benchmark's improved investor comprehension or otherwise altered
investment decisions). But see Abdullah Comment Letter (stating that
the final rules should require funds to provide textual
clarifications of indexes where the index components are not obvious
from the index's name or is not otherwise well known to investors).
Funds that wish to provide further information regarding the fund's
performance as it compares to the indexes provided may do so in the
narrative MDFP section of the release to the extent that such
disclosure meets the requirements of that section.
---------------------------------------------------------------------------

    While we appreciate commenters' concerns regarding index licensing
fees, we continue to believe comparative performance disclosure
provides contextual information investors need in order to make
informed investment decisions. After considering suggestions that
smaller funds could more readily use affiliated indexes if the
Commission were to amend the current requirement for such indexes to be
``widely recognized and used,'' we are retaining the current
requirement. This is an important protection against potential
conflicts of interest, including the potential ability of an affiliated
index

provider to manipulate an underlying index to the benefit of the fund.
iii. Performance Table
    Substantially as proposed, the final rules will retain the current
requirement that funds' annual reports include a table presenting
average annual total returns for the past 1-, 5-, and 10-year periods,
with certain amendments designed to reflect that a shareholder report
will cover a single class of a multiple-class fund.\235\ Specifically,
as proposed, the final rules will require the table to include several
additional pieces of information: (1) the average annual total returns
of an appropriate broad-based securities market index; \236\ and (2)
the fund's average annual total returns without sales charges (in
addition to current disclosure showing returns reflecting applicable
sales charges). While the proposal would have required average annual
total return information for all available share classes, the final
rules require this information only for the share class to which the
report relates, and therefore the final rules will not include this
proposed requirement.
---------------------------------------------------------------------------

    \235\ See Item 27A(d)(2) of amended Form N-1A and related
instructions.
    \236\ As proposed, the final rules also will permit funds to
include returns information for one or more other relevant indexes,
such as a more narrowly based index that reflects the market sectors
in which the fund invests. See Proposing Release, supra footnote 7,
at n.215 and accompanying text.
---------------------------------------------------------------------------

    Additionally, as proposed, the final rules simplify the statement
that currently accompanies the line graph and table.\237\ Also as
proposed, funds will be required to use text features to make this
statement noticeable and prominent through, for example, graphics,
larger font size, or different colors or font styles. Furthermore,
substantially as proposed, the final rules include a new instruction
allowing funds to add brief additional disclosure that would
contextualize the line graph and average annual returns table.
Specifically, if a material change occurred to the fund during the
relevant performance period, such as a change in investment adviser or
a change to the fund's investment strategies, the fund may include a
brief legend or footnote to describe the change and when it
occurred.\238\ Finally, as proposed, the final rules require funds that
provide updated performance information through widely accessible
mechanisms, such as fund websites, to include a statement in the
shareholder report directing shareholders to where they can find this
information.\239\
---------------------------------------------------------------------------

    \237\ Under the final rules, funds will be required to include a
statement to the effect that the fund's past performance is not a
good predictor of how the fund will perform in the future. The final
rules also make a conforming change to similar language that must
appear in the prospectus. See Item 4(b)(2) of amended Form N-1A.
    \238\ Funds will have discretion to determine when to disclose
information about a prior material change to a fund in connection
with its performance presentation. However, a fund will need to
disclose information about such a change if, absent that disclosure,
the fund's performance presentation would otherwise be misleading.
See Proposing Release, supra footnote 7, at nn.227-229 and
accompanying text.
    \239\ If a fund were to include such a statement, it also would
be required to provide a means of facilitating access to the updated
performance information, including, for example, a hyperlink to
where the information may be found if the shareholder report is
provided electronically or a URL address or QR code if the
shareholder report is delivered in paper format.
---------------------------------------------------------------------------

    Commenters generally supported the proposed changes to the average
annual total returns table, noting that the changes will better align
this table in the shareholder report with the returns reported in the
prospectus.\240\ One commenter suggested that funds should be required
to show the 3-year period of returns, in addition to the proposed 1-,
5- and 10-year periods.\241\ This commenter stated that an additional
intermediate time horizon is especially important for funds with less
than 10 years of performance. Because funds with less than 10 years of
performance will be required to show performance for the life of the
fund, we do not believe that an additional intermediate period of
returns would benefit investors, particularly since the performance
table already shows two other intermediate periods that are relatively
close in time (i.e., 1- and 5- year periods).\242\
---------------------------------------------------------------------------

    \240\ See, e.g., ICI Comment Letter; Morningstar Comment Letter;
Consumer Federation of America II Comment Letter; Capital Group
Comment Letter (also suggested changing the order of items in report
to show the average annual total returns table before fund
expenses). We are maintaining the ordering of the items in the
shareholder report as proposed because we believe that expense
information should be highlighted first for shareholders.
    \241\ Morningstar Comment Letter.
    \242\ Additionally, shareholders interested in reviewing
performance during periods not shown in the performance table can
find this information in the performance line graph. See supra text
accompanying footnote 196.
---------------------------------------------------------------------------

iv. Other MDFP Amendments
    As proposed, the final rules simplify the current annual report
requirement for a fund to discuss the effect of any policy or practice
of maintaining a specified level of distribution to shareholders (a
``stable distribution policy'') on the fund's investment strategies and
per share net asset value during the last fiscal year, as well as the
extent to which the fund's distribution policy resulted in
distributions of capital. Specifically, under the final rules, a fund
that has a stable distribution policy and was unable to maintain the
specified level during the past fiscal year would need to disclose
this.\243\ As proposed, the final rules also maintain disclosure
concerning distributions that resulted in returns of capital.\244\ The
final rules' requirements, which--as proposed--modify current
requirements by focusing on circumstances when a fund was unable to
meet the specified level of distribution in its stable distribution
policy or had distributions that resulted in returns of capital, are
designed to provide more meaningful disclosure to shareholders.\245\ No
commenters discussed these requirements.
---------------------------------------------------------------------------

    \243\ See Item 27A(d)(3) of amended Form N-1A.
    \244\ See id.
    \245\ The Commission recently adopted amendments to limit the
requirement that ETFs provide premium and discount information in
their annual reports to only those ETFs that do not provide premium
and discount disclosure on their websites in accordance with 17 CFR
270.6c-11 [Investment Company Act rule 6c-11]. See Exchange-Traded
Funds, Investment Company Act Release No. 33646 (Sept. 25, 2019) [84
FR 57162 (Oct. 24, 2019)]. As proposed, the final rules do not amend
this annual report requirement beyond a technical amendment to
clarify that it only applies to ETFs.
---------------------------------------------------------------------------

    The final rules, like current annual report requirements, do not
require money market funds to include MDFP. Two commenters supported
maintaining the current approach for money market funds.\246\ One
requested that the Commission clarify that money market funds are
permitted, but not required, to provide MDFP in their shareholder
reports, and are allowed to include some, but not all the required MDFP
disclosures.\247\ The final rules permit money market funds to retain
the current option of including MDFP discussion in their shareholder
reports and clarify that they are permitted but not required to
disclose some or all of the information required in the MDFP so long as
the information they choose to include meets the requirements of the
relevant item, and related instructions on the form, and is not
incomplete, inaccurate, or misleading.\248\
---------------------------------------------------------------------------

    \246\ ICI Comment Letter; Fidelity Comment Letter.
    \247\ ICI Comment Letter.
    \248\ See Item 27A(d) of amended Form N-1A.
---------------------------------------------------------------------------

d. Fund Statistics
    Substantially as proposed, the final rules require a fund to
disclose certain fund statistics in its annual report, including the
fund's: (1) net assets, (2) total number of portfolio holdings, (3) for
funds other than money market funds, portfolio turnover rate, and (4)
the total advisory fees paid by the fund

during the reporting period.\249\ As proposed, the final rules also
permit a fund to disclose any additional statistics that the fund
believes would help shareholders better understand the fund's
activities and operations during the reporting period. These provisions
are designed to provide succinct fund information, in a user-friendly
format, that encourage investors to focus on certain significant
factors in evaluating the fund's operations and performance.
---------------------------------------------------------------------------

    \249\ See Item 27A(e) of amended Form N-1A. In a change from the
proposal, the final rules include a new statistic related to the
disclosure of the total advisory fees the fund paid. Additionally,
in a change from the proposal, which would have required all funds
to disclose their portfolio turnover rate, the final rules exclude
money market funds from the requirement to disclose portfolio
turnover rate. See infra footnote 260 and accompanying text.
---------------------------------------------------------------------------

    The final rules include several related instructions.\250\ First,
in a change from the proposal (which did not include such an
instruction), under the final rules the required fund statistics must
precede any additional permitted statistics the fund chooses to
include. We believe that disclosing the required statistics first will
enhance comparability of the required fund statistics across funds.
Next, as proposed, if a fund provides a statistic also required under
Form N-1A, the fund must follow Form N-1A instructions describing the
calculation method for the relevant statistic. Additionally, as
proposed, the final rules include an instruction that encourages a fund
to use tables, bullet lists, or other graphics or text features to
present the fund statistics.
---------------------------------------------------------------------------

    \250\ See Instructions to Item 27A(e) of amended Form N-1A.
---------------------------------------------------------------------------

    As proposed, if a statistic is included in, or could be derived
from, a fund's financial statements or financial highlights, the final
rules require a fund to use or derive such statistic from the fund's
most recent financial statements or financial highlights. Substantially
as proposed, the final rules permit a fund to describe briefly the
significance or limitations of any disclosed statistics in a
parenthetical or similar presentation. The proposed instruction also
would have permitted a footnote explaining the significance or
limitation of any disclosed statistic. In a change from the proposal
and consistent with commenters' suggestions, the final rules do not
permit a footnote presentation because we believe that footnotes in
this context would detract from the concise nature of the statistic
disclosure, therefore diminishing the effectiveness of disclosed
information that may be important to shareholders, and that such a
presentation is inconsistent with the Commission's goal of streamlined,
plain English disclosure in funds' shareholder reports.\251\
Additionally, in a change from the proposal, the instructions to the
final rules include multiple-class funds' requirements for calculating
statistics based on the fund's performance or fees, in light of the
final rules' requirement that a shareholder report cover a single class
of a multiple-class fund.\252\ Finally, as proposed, the final rules
state that any additional statistics that a fund chooses to include are
to be reasonably related to the fund's investment strategy.
Collectively, these instructions are designed to enhance comparability
of shareholder reports across funds and prevent disclosure ``creep.''
\253\
---------------------------------------------------------------------------

    \251\ See, e.g., Tom and Mary Comment Letter; Williams Comment
Letter.
    \252\ This instruction specifies that, if a fund is a multiple-
class fund, and the fund provides a statistic that is calculated
based on the fund's performance or fees (e.g., yield or tracking
error), the fund must show the statistic for the class of the fund
to which the report relates.
    \253\ See supra text accompanying footnote 33 (noting that
funds' shareholder reports generally have become longer and more
complex over the years).
---------------------------------------------------------------------------

    Commenters generally supported the proposed requirements to include
certain fund statistics in the shareholder report.\254\ Some commenters
requested that certain additional statistics be required or expressly
permitted. For example, one commenter suggested funds ``with a stated
ESG-oriented investment strategy'' be allowed to incorporate relevant
ESG statistics if they wish, and ``make reference to supplementary ESG
focused content as appropriate.'' \255\ Another commenter urged the
Commission to require a fund to disclose its unrealized capital gains
per share as well the fund's historical standard deviation of returns
compared to its benchmark's standard deviation of returns.\256\
Additionally, one commenter requested we expressly permit other
optional statistics related to the fund's portfolio or the portfolio
relative to the fund's benchmark index, such as average market
capitalization, average price/earnings ratio, and average earnings
growth rate, among others.\257\ Finally, one commenter suggested that
money market funds be exempt from the requirement to disclose portfolio
turnover rate.\258\
---------------------------------------------------------------------------

    \254\ See, e.g., Morningstar Comment Letter; ICI Comment Letter;
Comment Letter of Purcell Communications (Nov. 11, 2020) (``Purcell
Communications Comment Letter''); Angel Comment Letter.
    \255\ Purcell Communications Comment Letter (addressing funds
with environmental, social, and governance (``ESG'') investment
practices).
    \256\ Angel Comment Letter.
    \257\ ICI Comment Letter.
    \258\ Id. This commenter noted that money market funds are not
required to calculate and disclose portfolio turnover as part of the
financial highlights table, and excluding them from this fund
statistic requirement would be consistent with this approach. See
Instruction 4(c) to Item 13 of amended Form N-1A (mis-numbered as
Instruction 4(b) to Item 13 of current Form N-1A).
---------------------------------------------------------------------------

    The final rules do not require any of the additional statistics
that commenters suggested. We continue to believe that required
statistics should be limited to those that are generally applicable to
all funds and provide useful context for other required information
elsewhere in the shareholder report. Because funds will be required to
provide a graphical presentation of holdings, knowing the fund's net
assets will allow a shareholder to appreciate better the impact of each
holding on the overall performance of the fund.\259\ Similarly, we
continue to believe that, together with the graphical holdings
information and net assets, knowing the number of a fund's holdings
could help investors to understand better the fund's diversification,
which could in turn provide insight into the fund's susceptibility to
market fluctuations.
---------------------------------------------------------------------------

    \259\ Because the measure of a fund's net assets is included in
the fund's audited financial statements, the fund will be required
to use or derive such statistic from the fund's audited financial
statements.
---------------------------------------------------------------------------

    Additionally, because a higher portfolio turnover rate generally
indicates higher transaction costs and may result in higher taxes, we
continue to believe that disclosing the fund's portfolio turnover rate
provides shareholders with a more complete view of the costs associated
with investing in the fund. However, we agree with the commenter's
suggestion to exclude money market funds from the requirement to
disclose portfolio turnover, as most money market funds' securities
mature in one year or less and have reflected this change in the final
rules.\260\
---------------------------------------------------------------------------

    \260\ See Item 27A(e) of amended Form N-1A.
---------------------------------------------------------------------------

    We are not requiring a fund to disclose its unrealized capital
gains per share as suggested by one commenter, although a fund could
include this information at its option in addition to the required
statistics. We recognize that capital gains distributions can have
significant tax consequences for investors holding fund shares in
taxable accounts, particularly if these distributions are unexpected.
However, we do not believe that most retail shareholders would
appreciate the tax implications of unrealized capital gains without
additional explanatory disclosure, which would add length and

complexity to the shareholder report.\261\ Additionally, because
disclosure of unrealized capital gains per share would not be relevant
to all fund types, such as ETFs, we do not believe it is necessary to
require the disclosure of a statistic that is not relevant across a
large percentage of funds.
---------------------------------------------------------------------------

    \261\ See, e.g., Angel Comment Letter. While this commenter
urged the Commission to require unrealized capital gains as a fund
statistic, the commenter stated that the value of such disclosure to
retail investors is limited to alerting investors that ``this is an
important item, giving them the desire to learn more about it.''
---------------------------------------------------------------------------

    Similarly, we are not adopting another commenter's suggestion to
mandate disclosure of historical standard deviation of returns compared
to a fund's benchmark's standard deviation of returns because we do not
believe it would be useful to most retail investors without additional
disclosure explaining how they should consider such information in
their investment decision process.\262\ The Commission has considered
whether funds should be required to disclose uniform risk metrics in
the past, and as fund strategies continue to diversify and increase in
complexity, we will continue to consider whether additional risk-
related disclosure or reporting is appropriate and can be disclosed in
a manner that is salient to retail investors.\263\
---------------------------------------------------------------------------

    \262\ See, e.g., id. (stating that, in addition to the
historical deviation of the fund over the last 1, 5, and 10 year
periods, funds should be required to include the historical
deviation of the fund's benchmark for investors to be able to
appreciate how much risk their fund has taken over the last 1, 5,
and 10 year periods as compared to the benchmark's standard
deviation).
    \263\ See Improving Descriptions of Risk by Mutual Funds and
Other Investment Companies, Investment Company Act Release No. 20974
(Mar. 29, 1995) [60 FR 17172 (Apr. 4, 1995)]. Funds currently report
certain portfolio- and position-level risk metrics on Form N-PORT.
See Items B.3, C.9.f.v, C.11.c.vii, and C.11.g.iv of Form N-PORT.
---------------------------------------------------------------------------

    Finally, we do not believe it is necessary to prescribe specific
statistics that a fund is permitted, but not required, to include. Such
an approach could lead funds to include all of these additional
statistics due to the perception that the Commission is encouraging
these specific statistics, regardless of whether they would be salient
to the fund's shareholder base. It also may lead to disclosure
``creep'' and result in a significantly longer and more complex
shareholder report, contrary to our stated objectives.
    We are, however, in a change from the proposal adopting the
requirement for funds to disclose an additional statistic regarding the
total amount of advisory fees paid. To calculate the total advisory
fees paid, the fund will be required to disclose the amount of
investment advisory fees that are payable to the investment adviser and
disclosed in the fund's statement of operations.\264\ This statistic
provides investors the aggregate amount of actual advisory fees, in
dollars paid.\265\ This aggregated fund expense information complements
the information in the expense table and provides fund shareholders
with a more complete view of the fund's expenses in a concise manner.
---------------------------------------------------------------------------

    \264\ See paragraph 2(a) of rule 6-07 of Regulation S-X [17 CFR
210.6-07]. The total amount of advisory fees should be disclosed on
a net basis, which will require the calculation of this amount to
include any reductions or reimbursements of such fees that were in
effect during the reporting period.
    \265\ The rules generally provide that, when a multiple class
fund shows statistics that are calculated based on the fund's
performance or fees, such a fund must show the statistic only for
the share class that the report covers. See Instruction 7 to Item
27A(e) of amended Form N-1A. However, the total amount of advisory
fees paid, as disclosed in the fund statistics section of the
shareholder report, should not be disclosed on a class-specific
basis, and must instead be disclosed for the fund as a whole,
consistent with rule 6-07 of Regulation S-X. We believe that it is
important for investors to have a complete view of the total amount
of income an adviser receives from the fund in order to appreciate
fully the amounts paid to the adviser and to ensure that this number
is comparable across shareholder reports of other funds,
irrespective of the class that report covers.
---------------------------------------------------------------------------

    In the Proposing Release, the Commission sought feedback on whether
other data elements from the financial statements should be included in
the shareholder reports and whether there are ways to enhance
transparency of fund expenses.\266\ In particular, the Commission
sought feedback regarding whether, and if so how, funds could provide
investors with additional information regarding how a fund's adviser
and its affiliates receive compensation from the fund in order to
better understand fund costs and potential conflicts of interest.\267\
Commenters suggested a variety of ways to amend the shareholder report
expense table to provide shareholders with a more complete view of the
fees charged by the fund.\268\ After considering these comments, we
believe requiring funds to disclose, in dollars, the total amount of
advisory fees paid as a single statistic in the shareholder report will
give an additional tool to investors to understand the aggregate fees
that investors pay for fund management and will complement the fund
expense table, which provides the amount of fees paid on a hypothetical
$10,000 investment. The fees paid on a hypothetical $10,000 investment
will help investors approximate their own expenses, while the aggregate
fees paid to the adviser will help contextualize that information by
allowing investors to consider their own expenses relative to the total
amount of advisory fees paid. We also believe that this simplified
presentation of the more complex and detailed expense disclosure
included in the fund's financial statements will further the
Commission's goal of providing concise disclosure that will help
shareholders better understand information provided in the fund's
financial statements.
---------------------------------------------------------------------------

    \266\ Proposing Release, supra footnote 8, at text accompanying
n.411.
    \267\ Id. at text accompanying n.593 (also requesting feedback
on, among other things, whether funds should disclose any revenue
paid to the fund's adviser or its affiliates that the fee table does
not reflect (e.g., outside of the management fee), as a percent of
fund assets or a percent of the fund's total expenses).
    \268\ See supra footnotes 180-186 and accompanying text.
---------------------------------------------------------------------------

    Some commenters suggested certain enhancements and additional
guidance on the proposed statistics requirements. For example, one
commenter suggested that, if a fund statistic changed significantly
during the most recent fiscal year, the fund should be permitted to
briefly describe the factors that contributed to the change.\269\
Another commenter suggested funds that choose to change a statistic be
required to maintain the prior statistic for an additional year, to
avoid cherry-picking.\270\ Additionally, one commenter suggested that,
if a fund uses a statistic not otherwise included in the fund's other
regulatory documents, the fund should be required to direct
shareholders to where they can find information on the methodology the
fund used to calculate the statistic.\271\
---------------------------------------------------------------------------

    \269\ ICI Comment Letter.
    \270\ Ubiquity Comment Letter.
    \271\ Morningstar Comment Letter.
---------------------------------------------------------------------------

    Aside from the changes discussed above, we are not adopting any
other changes to the proposed instructions. We do not believe it is
necessary to allow funds to describe the factors that contributed to
any significant changes to disclosed statistics that occurred during
the most recent fiscal year. Such an explanation could require
potentially technical, narrative disclosure that would make the
statistics disclosure less concise and less salient. If a fund believes
that such contextual information would be useful to investors in
understanding the fund's performance over the relevant period, the fund
can provide such narrative explanation in the MDFP section of the
report. We believe it is important to limit any narrative disclosure in
the fund statistics section in order to maintain the usefulness of such
disclosures to investors. Relatedly, while the final rules will allow
funds to

describe any significance or limitations of any disclosed statistics in
a parenthetical or similar presentation, funds should carefully
consider the inclusion of any statistic that requires extensive
narrative explanation. As proposed, any statistic that the fund opts to
include in the shareholder report must be one that is reasonably
related to the fund's investment strategy and one that the fund
believes would help shareholders better understand the fund's
activities and operations during the reporting period. A statistic that
requires extensive explanation may be confusing to retail investors and
therefore may not help them to better understand the fund's activities
and operations.
    For similar reasons we are not adopting a commenter's suggestion
that funds be required to continue to disclose a permitted statistic
for an additional year before removing it because we believe that such
a requirement would unnecessarily increase the length and complexity of
the shareholder report. In addition, if a change in the fund's
investment strategy during the reporting period caused a statistic to
be less relevant, requiring a fund to disclose such a statistic for an
additional year would be confusing to investors. Furthermore, we are
not adopting the suggested requirement for funds to direct shareholders
to where they can find information on the methodology the fund used to
calculate a permitted statistic, because we believe that such a
requirement could significantly increase the length of the shareholder
report.
e. Graphical Representation of Holdings
    Substantially as proposed but with certain changes designed to
address commenters' feedback, the final rules retain the current
requirements related to the graphical representation of holdings that
funds include in their shareholder reports, including certain revisions
designed to improve the current disclosure. Funds will be required to
disclose one or more tables, charts, or graphs depicting the fund's
portfolio holdings by category, as of the end of the reporting period,
as they do today.\272\ As proposed, the final rules specify that a fund
must disclose its graphical representation of holdings using
categories, and with a basis of presentation, that are reasonably
designed to depict clearly the types of investments made by the fund,
given its investment objectives.\273\ The purpose of the graphical
representation of holdings disclosure requirement is to illustrate, in
a concise and user-friendly format, the allocation of a fund's
investments across particular categories of investments (such as asset
classes). Commenters indicated that investors view this data as
important to understanding their fund investments.\274\ We continue to
believe that a layered approach to the disclosure of portfolio
holdings, where a graphical representation of holdings continues to
appear in the annual report, and more detailed and current portfolio
holdings information--which currently appears in the shareholder report
as the fund's schedule of investments--is available online and upon
request, helps shareholders understand how the fund invested its
assets.\275\
---------------------------------------------------------------------------

    \272\ The categories that funds may depict in the graphical
representation of holdings may include, for example, type of
security, industry sector, geographic region, credit quality, or
maturity.
    \273\ Funds' graphical representation of holdings disclosure
currently must adhere to these requirements under Item 27(d)(2) of
current Form N-1A. No commenter addressed these requirements.
    \274\ Responses to the Investor Feedback Flier generally
indicated that the respondents found the graphical representation of
holdings information useful in monitoring their investments. See
supra footnote 47 and accompanying text. Additionally, survey data
that one commenter provided similarly found a majority of investors
said that this presentation is useful to them. See supra footnote 48
and accompanying text.
    \275\ Proposing Release, supra footnote 8, at text accompanying
nn.261-262 (discussing the Commission's understanding of investors'
preferences with respect to disclosure of funds' portfolio
holdings). The full schedule of portfolio holdings will be available
online and upon request on at least a quarterly basis. See rule 30e-
1(b)(2). We discuss the availability of the schedule of investments
in infra sections II.C.1.a and II.C.2.a. See also rule 6c-11 under
the Investment Company Act, which requires daily portfolio holdings
for ETFs relying on the rule.
---------------------------------------------------------------------------

    We are adopting several changes to the current graphical
representation of holdings requirements. First, substantially as
proposed, we are newly permitting a fund to show its holdings based on
total exposure to particular categories of investments. Funds will be
permitted to use this presentation method in addition to ones currently
available to them, namely, showing holdings based on the percentage of
net asset value or total investments attributable to each
category.\276\ We also, as proposed, are adopting minor revisions to
the current instructions with respect to funds that depict portfolio
holdings according to credit quality. These revisions are designed to
keep related disclosures brief and concise. Finally, in a change from
the proposal and in consideration of comments received, the final rules
explicitly permit a fund to include, along with the graphical
representation of holdings, a list of its largest 10 portfolio holdings
and the percentage of the fund's net asset value, total investments, or
total exposure attributable to each such holding.
---------------------------------------------------------------------------

    \276\ See Item 27(d)(2) of current Form N-1A.
---------------------------------------------------------------------------

Presentation Based on Total Exposure
    The final rules include flexibility, as proposed, for funds to base
the tabular or graphic representation of holdings on the fund's total
exposure to particular categories of investments.\277\ However, in a
change from the proposal, the final rules will not allow funds to base
this presentation only on the fund's net exposure to particular
categories of investments. The final rules allow funds to show net
exposure in addition to the required total exposure presentation.\278\
One commenter specifically supported the proposal to allow such a net
presentation as useful for funds that have significant derivatives
investments.\279\ Conversely, another commenter advised that providing
total, rather than net, exposure provides investors a true sense of the
fund's exposures.\280\
---------------------------------------------------------------------------

    \277\ See Item 27A(f) of amended Form N-1A.
    \278\ Id.
    \279\ ICI Comment Letter (also stating that this presentation is
particularly beneficial to funds that hold both long and short
positions because, under the proposal, they would be allowed present
the long and short positions separately (i.e., total exposure) or
show the combined effect of both positions (i.e., net exposure)).
    \280\ Morningstar Comment Letter (arguing that funds should be
required to show long and short exposures by asset class, rather
than only the net allocation to better represent the exposures of
the portfolio).
---------------------------------------------------------------------------

    We continue to believe that expanding the permissible presentations
to allow a fund to show its holdings based on their investment exposure
will provide a more meaningful presentation for funds that use
derivatives to obtain investment exposure as part of their investment
strategies. Upon further consideration of comments received, we are
persuaded that showing only a net exposure presentation of holdings may
not be representative of a fund's exposures, particularly for certain
funds that hold both long and short positions. For example, allowing
these funds to show only a net exposure presentation could lead
investors to believe that the fund's exposure to a particular sector or
industry is lower than that provided by the fund's investments.\281\
---------------------------------------------------------------------------

    \281\ As an example, if a fund had a 5% long position in XYZ
Automotive Co. and a 4% short position in QRS Automotive Inc., a
total exposure presentation would require the fund to show the 5%
long position in the automotive industry and separately show a 4%
short position. A net exposure presentation would only show a
position of 1% in the automotive industry, however, based on the
assumption that the two investments would be inversely correlated.
But any assumed correlation may not hold under all circumstances.

---------------------------------------------------------------------------

    For these reasons, under the final rules, a fund that holds both
long and short positions and chooses to use total exposure as a basis
for presenting the fund's graphical representation of holdings must
depict the long and short exposures to each category of investments
separately. This approach is consistent with the definition of
``derivatives exposure'' that the Commission adopted in rule 18f-
4.\282\ We also believe that this approach is consistent with the final
rule requirement that funds disclose holdings categories and a basis of
presentation in a manner that is ``reasonably designed to depict
clearly the types of investments made by the Fund, given its investment
objectives.'' As proposed, a fund that uses total exposure as a basis
for representing its holdings will also be permitted to include a brief
explanation of this presentation.\283\ Such a fund also will be
permitted, but not required, to show a net exposure presentation.
---------------------------------------------------------------------------

    \282\ See Use of Derivatives by Registered Investment Companies
and Business Development Companies Investment Company Act Release
No. 34084 (Nov. 2, 2020) [85 FR 83162 (Dec. 21, 2020)]
(``Derivatives Adopting Release'') (requiring derivatives exposure
calculations to be based on ``gross'' notional amounts, rather than
a figure based on calculations that net long and short positions).
    \283\ See Item 27A(f) of amended Form N-1A. No commenters
addressed this permitted explanation.
---------------------------------------------------------------------------

Funds Depicting Portfolio Holdings According to Credit Quality
    For funds that choose to depict portfolio holdings according to
credit quality, we are adopting as proposed an amendment instructing
these funds to keep the required disclosures related to this
presentation brief and concise.\284\ A fund that depicts its portfolio
holdings according to credit quality is currently required to describe
how the credit quality of its holdings was determined and, if credit
ratings are used, the fund must explain why it selected a particular
credit rating.\285\ The length of this disclosure currently varies
among funds, and this amendment is designed to keep narrative
disclosures in the annual report brief. The Commission received no
comments on the proposed amendment.
---------------------------------------------------------------------------

    \284\ See id.
    \285\ See Item 27(d)(2) of current Form N-1A.
---------------------------------------------------------------------------

Permitted Disclosure of Top 10 Portfolio Holdings
    In a change from the proposal, the final rules will allow a fund to
disclose, in a table or chart that appears near the fund's graphical
representation of holdings, the fund's largest 10 portfolio
holdings.\286\ A fund that chooses to include this presentation also
may show the percentage of the fund's net asset value, total
investments, or total exposure attributable to each such holding.
---------------------------------------------------------------------------

    \286\ See Item 27A(f) of amended Form N-1A.
---------------------------------------------------------------------------

    Two commenters suggested that the Commission should require or
permit funds to include a list of top 10 or 25 holdings and the
percentage of these holdings.\287\ One of these commenters stated that
it is ``quite common'' for equity funds to include such information,
and that such lists are informative to shareholders and do not add
significantly to the length of the report.\288\ The other commenter
stated that this additional information would highlight fund
concentration risk.\289\
---------------------------------------------------------------------------

    \287\ ICI Comment Letter; Morningstar Comment Letter.
    \288\ ICI Comment Letter.
    \289\ Morningstar Comment Letter. This commenter stated that
information about a fund's top 10 holdings would indicate potential
concentration risk better than the proposed requirement for all
funds to disclose the number of portfolio holdings as part of their
disclosures on fund statistics.
---------------------------------------------------------------------------

    We agree that allowing a fund to include a list of its largest 10
holdings and the percentage of the fund's net asset value, total
investments, or total exposure that each such holding represents would
complement the other information provided in the graphical
representation of holdings and be informative to shareholders. When
combined with required disclosure on the number of portfolio holdings,
this disclosure will provide shareholders with additional information
about a fund's potential concentration risk. However, we believe that
allowing funds to show a larger number of individual holdings, such as
the largest 25 fund holdings, would unnecessarily increase the length
of the report with little added benefit to shareholders. We are
permitting disclosure of a fund's top 10 portfolio holdings, rather
than requiring it, because this disclosure may not be as useful for
certain types of funds (for example, a fund with hundreds of holdings,
each representing a very small fraction of the fund's net asset value)
as it is for others.
Other Comments on Graphical Representation of Holdings
    Additionally, one commenter suggested requiring a fund of funds to
show its asset allocation based on the underlying holdings of the
acquired funds.\290\ We are not adopting such a requirement. Because
the fiscal year end of a top-level fund may differ from that of its
underlying funds, the top-level fund may not have access to current
underlying fund holdings information as of the date of the top-level
fund's shareholder report. A top-level fund would be permitted to show
its asset allocation based on the underlying holdings of the acquired
funds, however, provided that the presentation otherwise meets the
requirements for the graphical representation of holdings disclosure we
are adopting.
---------------------------------------------------------------------------

    \290\ Id.
---------------------------------------------------------------------------

    The same commenter suggested that the Commission should require
funds to standardize the format for showing exposures such that all
funds use the same terminology and asset classes to enhance
comparability. While we appreciate the comparative value such an
approach would provide, we continue to believe that funds should have
flexibility to tailor disclosure to their specific holdings and
investment strategies in a manner that best communicates this
information to shareholders. Maintaining an evergreen, rule-based
compendium of the terminology that funds could include would be
challenging, given the diversity of fund strategies and portfolio
investments. The presentation requirements in the final rules for
funds' graphical representation of holdings disclosure balances these
considerations with our interest in clear and salient portfolio
holdings disclosure.
f. Material Fund Changes
    The final rules will require a fund to describe material changes to
the fund in the annual report.\291\ We are adopting this requirement
substantially as proposed, with certain modifications to address
commenter concerns.
---------------------------------------------------------------------------

    \291\ See Item 27A(g) of amended Form N-1A.
---------------------------------------------------------------------------

    Specifically, a fund will be required to describe a material change
since the beginning of the reporting period briefly with respect to any
of the following items:
     A change in the fund's name (as described in Item 1(a)(1)
of Form N-1A);
     A change in the fund's investment objectives or goals (as
described in Item 2 of Form N-1A);
     A change in the fund's annual operating expenses,
shareholder fees, or maximum account fee (as described in Item 3 of
Form N-1A), including the termination or introduction of an expense
reimbursement or fee waiver arrangements;
     A change in the fund's principal investment strategies (as
described in Item 4(a) of Form N-1A); \292\
---------------------------------------------------------------------------

    \292\ See Proposing Release, supra footnote 8, at n.273
(discussing the requirements of rule 35d-1, the ``names rule,'' and
discussing how disclosure of a change in the fund's principal
investment strategies could serve as a notice of a change to an
investment policy as required under the names rule).

---------------------------------------------------------------------------

     A change in the principal risks of investing in the fund
(as described in Item 4(b) of Form N-1A); and
     A change in the fund's investment adviser(s), including
sub-adviser(s) (as described in Item 5(a) of Form N-1A).\293\
---------------------------------------------------------------------------

    \293\ As proposed, the final rules will not require a fund to
disclose a change in a sub-adviser where Item 5 of Form N-1A would
not require the fund to disclose the name of the sub-adviser in its
prospectus. See Instructions 1 and 2 to Item 5 of current and
amended Form N-1A.
---------------------------------------------------------------------------

    Additionally, as proposed, a fund may describe other material fund
changes that it would like to disclose to its shareholders.\294\ In a
change from the proposal, the final rules also permit a fund to
describe other changes that may be helpful for investors to understand
the fund's operations and/or performance over the reporting
period.\295\ A fund also may disclose material planned changes in
connection with updating its prospectus for the current fiscal year. A
fund will have to provide a concise description of each change that
provides enough detail to allow shareholders to understand the change
and how it may affect shareholders.\296\
---------------------------------------------------------------------------

    \294\ See Item 27A(g) of amended Form N-1A.
    \295\ In a change from the proposal, the final rules include the
phrase ``or changes that may be helpful for investors to understand
the fund's operations and/or performance over the reporting period''
in this provision. See Item 27A(g) of amended Form N-1A. For
example, a fund could disclose plans to liquidate or merge the fund,
even if previously disclosed to shareholders.
    \296\ As proposed, this section of the shareholder report must
include a legend to the effect of the following: ``This is a summary
of certain changes [and planned changes] to the Fund since [date].
For more complete information, you may review the Fund's next
prospectus, which we expect to be available by [date] at [website
address] or upon request at [toll-free telephone number and, as
applicable, email address].''
---------------------------------------------------------------------------

    The purpose of these requirements is to highlight and consolidate
disclosure of material changes in a way that increases the salience of
this disclosure. Currently, fund shareholders typically receive
information about these changes in: (1) annual prospectus updates; or
(2) other prospectus updates they may receive throughout the year
(which can take the form of a prospectus ``sticker'' or an updated copy
of the fund's prospectus). We are concerned, however, that material
changes may not always be readily apparent to a shareholder. For
example, changes in the annual prospectus update may not be easy for an
average shareholder to identify.\297\ There is no requirement for a
fund to identify or highlight changes to the fund in its
prospectus.\298\ We also understand that there is diversity of
practices among funds regarding what changes result in a prospectus
sticker, and whether to transmit the sticker to shareholders. The
categories of fund changes that we are requiring funds to disclose in
their annual reports are meant to capture the types of material changes
to a fund's operations that we believe are important to fund
shareholders, that may influence their investment decisions, and that
are more likely to occur.
---------------------------------------------------------------------------

    \297\ This also may be the case when a fund delivers a sticker,
though a sticker typically would identify a change more explicitly.
    \298\ Some other types of registered investment companies
currently are required to identify certain changes in their
shareholder disclosure materials. See Variable Contract Summary
Prospectus Adopting Release, supra footnote 9 (requiring updating
summary prospectuses for variable contracts, which provide a brief
description of any important changes with respect to the contract
that occurred within the prior year to allow investors to better
focus their attention on new or updated information relating to the
contract); rule 8b-16(b) under the Investment Company Act (requiring
certain registered closed-end funds to identify specific types of
material changes in their annual reports).
---------------------------------------------------------------------------

    The proposal would have added a new section to the annual report
that would have required funds to describe briefly any material change
in an enumerated list of items (as well as any other material change
that the fund chooses to disclose) that has occurred since the
beginning of the reporting period or that the fund plans to make in
connection with its annual prospectus update.\299\ Commenter responses
to this proposed requirement were mixed. Some commenters supported this
requirement.\300\ Additionally, survey data submitted by one commenter
indicated that a majority of retail investors found this disclosure
useful.\301\ Other commenters objected to this disclosure.\302\ These
commenters argued that providing a list of material changes, without
the benefit of context from the prospectus, is not useful to investors.
Additionally, several commenters took issue with the proposed approach
of providing an enumerated list of material changes that would
necessitate disclosure, arguing it was too prescriptive.\303\ These
commenters recommended that the Commission adopt a more principles-
based approach, with one stating this approach would address concerns
that one fund may reasonably view a particular type of change as
material while another may not, given differences in funds' respective
investment objectives, holdings, strategies, and risk profile.\304\ One
commenter stated that, if the Commission adopts a list, it should
provide additional guidance to assist funds in determining whether a
``material'' change has occurred for any enumerated topic.\305\ In
contrast, one commenter urged the Commission to limit material changes
to those included in the list and stated that funds should not be given
the flexibility to disclose additional items in order to limit the
length of the shareholder report.\306\
---------------------------------------------------------------------------

    \299\ See Proposing Release, supra footnote 8, at n.271-272 and
accompanying text. The proposed enumerated list of items varied from
the enumerated list under the final rules by requiring a fund to
disclose an increase, rather than a change, in the fund's ongoing
annual fees, transaction fees, or maximum account fee (as described
in Item 3 of Form N-1A) as well as requiring a fund to disclose a
change in the fund's portfolio manager(s) (as described in Item 5(b)
of Form N-1A).
    \300\ See, e.g., Morningstar Comment Letter; NASAA Comment
Letter; Fidelity Comment Letter; Consumer Federation of America II
Comment Letter.
    \301\ Broadridge Comment Letter (also stating that surveyed
investors identified certain changes in particular as important,
including changes to investment objectives, risks, strategies, fund
management, and changes that impact fund performance).
    \302\ See, e.g., Stradley Ronon Comment Letter; TIAA Comment
Letter; Tom and Mary Comment Letter (recommending instead adding the
proposed list of material changes to the beginning of the
prospectus).
    \303\ See, e.g., ICI Comment Letter; Vanguard Comment Letter;
Capital Group Comment Letter; SIFMA Comment Letter (supporting the
proposed disclosure in principle but objecting to the list
approach); John Hancock Comment Letter (suggesting replacing list
with non-exhaustive list of examples as guidance in the adopting
release).
    \304\ See ICI Comment Letter.
    \305\ SIFMA Comment Letter (providing a list of suggested
factors funds could consider, including: (1) what is the nature of
the change and does it reflect a change in the way the fund is
currently being managed and/or does it reflect a material change in
the fund's risk profile; (2) which section(s) of the prospectus does
the change impact; (3) how likely would the change be to influence a
shareholder's decision to continue to invest in the fund; and (4)
what is the length of time before existing shareholders will have
``access'' to the information (e.g., in the event the changes will
be simply folded into the annual prospectus update that will be
accessible to shareholders on the fund's website).
    \306\ Fidelity Comment Letter.
---------------------------------------------------------------------------

    Some commenters suggested alternative approaches. For example,
several suggested defining material changes as those that would require
a fund to file an amendment to the fund's registration statement
pursuant to rule 485(a) under the Securities Act.\307\ In contrast,
some commenters stated that the use of the term ``material'' in this
section raises questions with respect to the impact of this requirement
on the concept of materiality embedded in the requirements of rule
485(a) under the Securities Act.\308\ One commenter

suggested that a material change should be defined as one that triggers
a supplement or ``sticker'' filing.\309\
---------------------------------------------------------------------------

    \307\ See, e.g., ICI Comment Letter; Vanguard Comment Letter;
Federated Hermes Comment Letter.
    \308\ See SIFMA Comment Letter; John Hancock Comment Letter
(requesting the Commission clarify that changes the fund experiences
in the list of topics do not necessarily mandate a 485(a) filing);
see also rule 485(a) and (b) under the Securities Act [17 CFR
230.485] (post-effective amendments to registration statements filed
under rule 485(b) may be filed for certain specified purposes,
including ``making any non-material changes which the registrant
deems appropriate'').
    \309\ Capital Group Comment Letter. But see ICI Comment Letter;
SIFMA Comment Letter (each opposing defining material changes as
those that trigger a rule 497 sticker filing, given the diversity of
practices among funds on when to sticker and whether to transmit the
sticker to shareholders).
---------------------------------------------------------------------------

    Commenters also raised concerns regarding certain topics included
in the proposed list of material changes. For example, many commenters
argued that portfolio manager changes should not be included in the
list because these changes are immaterial in many circumstances.\310\
Additionally, several commenters opposed including planned changes in
connection with the fund's annual prospectus update, arguing funds
should only discuss actual changes because planned changes may not be
finalized.\311\ These commenters also argued that requiring disclosure
of future changes may create certain operational challenges for
funds.\312\
---------------------------------------------------------------------------

    \310\ See, e.g., SIFMA Comment Letter; Dechert Comment Letter;
ICI Comment Letter (arguing that changes in portfolio managers are
particularly irrelevant for index funds), Fidelity (arguing that
only changes in the lead portfolio manager, or a fund's single
portfolio manager, should be considered material).
    \311\ See, e.g., ICI Comment Letter; SIFMA Comment Letter;
Vanguard Comment Letter; Fidelity Comment Letter; Dechert Comment
Letter; Stradley Ronon Comment Letter.
    \312\ See, e.g., Federated Hermes Comment Letter; Dechert
Comment Letter (stating that, if funds are required to disclose
changes that are anticipated to occur after the close of the
reporting period, there will be an increased administrative burden
on funds to monitor and track changes that have not yet been
reported to shareholders and suggesting that funds could be
permitted, rather than required, to disclose future changes).
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    Commenters also requested additional guidance and clarification
regarding the list of material fund changes. Many related to fees. One
commenter requested the Commission clarify that material increases in
fees should only be disclosed if the increase is the result of a
material increase in contractual fee rates, rather than the result of a
loss in a breakpoint or a change in performance-related expenses.\313\
Another commenter suggested that, instead of requiring disclosure of
material increases in the fund's ``ongoing annual fees, transaction
fees, or maximum account fee, it would be more protective for investors
to mandate that any new fees be highlighted as well, irrespective of
how the fees are characterized or the fees' potential magnitude.''
\314\ This same commenter requested that the Commission add to the list
any change in the fund's performance benchmark. Another commenter
suggested the list also should include a decrease in fund fees and
expenses, as well as an increase.\315\
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    \313\ ICI Comment Letter.
    \314\ NASAA Comment Letter.
    \315\ Charles Schwab Comment Letter.
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    Commenters also requested guidance about the level of detail that
would appear in the required disclosure. One commenter suggested that
funds be allowed to provide a narrative explanation of the reasons for
the material change.\316\
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    \316\ CFA Institute Comment Letter; see also Morningstar Comment
Letter (suggests requiring funds disclose where shareholders can
find more information regarding material changes).
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    After considering these comments, we are adopting this requirement
substantially as proposed, with some modifications to address commenter
concerns. We are retaining a list-based approach, where a fund must
briefly describe any material change with respect to any listed item
that has occurred since the beginning of the reporting period. We
continue to believe that this approach will provide more certainty to
funds about the types of changes they must disclose and enhance
consistency of annual report disclosure across funds. We appreciate the
concern that different funds may reasonably view different types of
changes as material. We have therefore incorporated an addition to the
final rules' provision that would permit funds to include material
changes regarding topics that do not appear on the enumerated list. The
addition to this proposed provision clarifies that funds also are
permitted to describe changes that may be helpful for investors to
understand the fund's operations and/or performance over the reporting
period.
    We are not, however, defining a material change for this purpose as
a change that would require a fund to file an amendment to the fund's
registration statement under rule 485(a) under the Securities Act
because we do not believe linking this new disclosure requirement to
that rule is necessary. The concept of materiality is a bedrock feature
of the federal securities laws, and funds have extensive knowledge and
experience in applying this standard in a wide array of contexts.\317\
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    \317\ See, e.g., Basic v. Levinson, 485 U.S. 224, 231 (1988)
(``Basic v. Levinson''); see also Selective Disclosure and Insider
Trading, Release No. 33-7881 (Aug. 15, 2000) [65 FR 51715 (Aug. 24,
2000) (citing Basic v. Levinson and stating that materiality has
been defined by existing case law).
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    While a fund should base the determination of whether a change is
material on the facts and circumstances of the fund and the specific
change, we are providing general guidance on the factors that funds
could consider in making that determination. Factors funds may wish to
consider include the nature of the change, whether it reflects a
material change in the way the fund is currently being managed, whether
it reflects a material change in the fund's risk profile, which
section(s) of the prospectus the change affects,\318\ and how likely
the change would be to influence a shareholder's decision to continue
to invest in the fund. For example, if a change to the fund's principal
risks is due to a change in the way the fund is managed, such a change
would likely be considered a material change. By contrast, if a fund
that invests heavily in a foreign country changes its description of
that foreign country risk as a result of changes in the country's
political landscape, such a change would likely not constitute a
material change.
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    \318\ A change that affects the summary prospectus is more
likely to rise to the level of a material change than one that would
only affect the statutory prospectus.
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    The list of topics under the final rules differs in several ways
from the proposed list. First, we agree with the commenters who
suggested that the list should not include changes in portfolio
managers. Under many circumstances, shareholders may not consider
portfolio manager changes to be material in their ability to understand
the fund's operations and performance over the past year, and may not
consider these to be a material factor in deciding whether to buy,
sell, or hold fund shares. If a fund considers a portfolio manager
change to be a material change that should be disclosed, it would be
permitted to disclose this change under the final rules, as the final
rules include flexibility to disclose changes about topics that do not
appear on the list.\319\
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    \319\ For example, if the fund has a single portfolio manager
who is well-known in the industry and prominently identified in fund
advertisements, such a fund might consider a change in its portfolio
manager to be a material change that would warrant disclosure in the
shareholder report.
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    Second, we agree with certain commenters that a fund should have to
disclose any material change in fund fees, even those that do not
result in fee increases. We also agree with commenters who suggested
that that fee movements of any kind, and irrespective of how the fees
are characterized (i.e., regardless of whether they are the result of a
change in the contractual fees or a change in performance-related
fees), are the type of material information that we believe

retail investors would find to be important in their decisions to
continue to hold shares of the fund.\320\ Because the termination or
introduction of an expense reimbursement or fee waiver arrangement can
affect the fees that a shareholder pays, in a change from the proposal
the final rules clarify that these are changes that should be
disclosed.\321\
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    \320\ See supra section I.A.3.
    \321\ The proposed rules would have required disclosure of a
change of ``the fund's ongoing annual fees, transaction fees, or
maximum account fee.'' The terms ``ongoing annual fees'' and
``transaction fees'' reflect the terms that the Commission proposed
to replace current terms in the fee table: ``annual fund operating
expenses,'' and ``shareholder fees,'' respectively. Because we are
not adopting the proposed new terms, the proposed requirements in
the final rules for disclosing material fund changes include the
terms ``annual fund operating expenses'' and ``shareholder fees.''
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    Additionally, because a change in the fund's index will be
highlighted in the MDFP section of the shareholder report, we do not
believe it is necessary to add changes to the index in the enumerated
list of material fund changes.\322\
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    \322\ See Instruction 8 to Item 27A(d)(2) of amended Form N-1A.
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    The final rules do not require disclosure of changes the fund plans
to make in connection with its next annual prospectus update. We agree
with commenters that this requirement could create certain operational
challenges for funds because of the increased administrative burdens
funds will incur if they have to monitor changes occur after the end of
the reporting period. A fund, however, will be permitted to include
such a change in its annual report if it is a material change.\323\
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    \323\ See Item 27A(g) of amended Form N-1A. The final rules also
clarify--as the proposal did--that a fund will not be required to
disclose a material change that it already disclosed in its last
annual report.
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g. Changes in and Disagreements With Accountants
    As proposed, the final rules require funds to include a concise
discussion of certain disagreements with accountants in the annual
report. Specifically, when a fund has a material disagreement with an
accountant that has resigned or been dismissed, the final rules will
require the fund to include in its annual report: (1) a statement of
whether the former accountant resigned, declined to stand for re-
election, or was dismissed and the date thereof; and (2) a brief, plain
English description of disagreement(s) with the former accountant
during the fund's two most recent fiscal years and any subsequent
interim period that the fund discloses on Form N-CSR.\324\ As proposed,
this required information is a high-level summary of more-detailed
information that currently is required to appear in funds' shareholder
reports.\325\ Funds will be required to file the currently-required
more-detailed information, as proposed, on Form N-CSR. Funds will not
be required to disclose the absence of disagreements in response to the
final rules' shareholder report disclosure requirement.
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    \324\ See Item 27A(h) of amended Form N-1A.
    \325\ See Proposing Release, supra footnote 8, at text
accompanying nn.293 and 294. The current disclosure requirement,
like the requirement we are adopting, is applicable only if a fund's
accountant has resigned or was dismissed. In this case, the fund has
to disclose the information that 17 CFR 229.304 [Item 304 of
Regulation S-K] requires, concerning the circumstances surrounding
the former accountant's dismissal or resignation, whether in the
fund's two most recent fiscal years there were certain accounting-
related disagreements with the former accountant, and other related
information.
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