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Prospectus confusion is about to shrink

Published Oct. 4, 2005

Mutual fund investors, circle Aug. 1 on your calendars and label it Prospectus Freedom Day.

That's the date set by federal and state securities regulators for the introduction of a simplified fund prospectus, now a lengthy and often impenetrable legal document that outlines a fund's investment techniques and risks for potential investors.

The new version, called a fund profile, will be a two-page summary, in simple language, of the full document. Initially, profiles will be available for a stock, bond and money market fund from each of eight big companies working with regulators on the project.

Although the profiles will be distributed along with the traditional prospectuses for now, the hope among some regulators and all the fund companies is that the streamlined documents will be able to stand on their own eventually.

The fund companies, with federal and state rulemakers, will conduct a survey of profile recipients to see whether the documents contain enough information for an investor to make an intelligent decision.

If the profiles are found to be sufficient and are approved for all funds, they could radically change how mutual funds are bought and sold.

Now, fund companies are required to distribute a prospectus to investors and ask if they have read the document before selling fund shares. That leaves investors to wade through what often turns out to be a 50-page tome written in legalese.

If the new approach takes hold, an investor will merely have to consult the slender fund profile and its 11 brief sections, easily digested in minutes. To ensure comprehensive disclosure, the fund company will deliver the full prospectus with a confirmation of a fund purchase.

For fund companies that sell their shares directly to the public, the potential benefits are great. If the short profiles are approved as stand-alone documents, they could easily be reproduced in newspaper and magazine advertisements. That would allow consumers to buy a mutual fund after reading an ad _ a proposal made three years ago by the Securities and Exchange Commission and greeted with vehement opposition by state regulators and some members of Congress.

The latest proposal has been received guardedly by state regulators, a fractured group whose individual members offer vastly differing opinions of what constitutes adequate risk disclosure.

But after intense lobbying by SEC Chairman Arthur Levitt Jr., the North American Securities Administrators Association, which represents state securities regulators, agreed two weeks ago to a one-year test of the document "in the interest of significantly improving the understanding of investors."

Levitt has made a simplified prospectus a priority. "It's my hope and expectation that as a result of using the profile prospectus that for the first time most investors can read and understand" the disclosure document, he said recently.

Philip A. Feigin, Colorado securities commissioner and president of the state regulators association, still expresses some reservations about the profiles, but said he is committed to the project.

"This will guide how mutual funds disclose things for the next 20 years," Feigin said. "A lot of the information, and the way it's presented, in the current prospectus is counterproductive. It's dense and very dry."

Nevertheless, he and other state regulators are concerned that the shortened forms won't tell investors enough about the risks they face and the types of securities a fund might own, among other matters.

"There are a lot of things about liability and redemption of shares, for example, that cannot be handled in the profile document," Feigin said. "Those are things someone might want to know. Some people love to pore over the details in a prospectus."

To those who fear that crucial information in the full prospectus will fall by the wayside, supporters point out that the fund profile is intended to be a prelude to, not a replacement for, the complete document.

They add that so many people tune out when handed a prospectus now that anything might be an improvement.

"Even if it is theoretically true that most people would make a better investment decision after reading the full prospectus, the fact is that most people don't read it," said Matthew P. Fink, president of the Investment Company Institute, the mutual fund trade group in Washington, which strongly supports the plan.

The profile offers information on fund goals or objectives, investment strategies, risk, appropriateness for a particular investor, fees and expenses, past performance, investment adviser or fund manager, and details about purchases, redemptions, distributions and other services.

For example, a prototype fund profile supplied to the New York Times by a fund company answers this question, "Is the fund appropriate for me?" The profile, for a growth and income fund, states: "The fund may be appropriate for investors who are willing to ride out stock market fluctuations in pursuit of potentially high long-term returns. The fund is designed for those who seek a combination of growth and income from equity and some bond investments. The fund by itself is not a balanced investment plan."

It is true, of course, that the fund profile does not contain all the information that an investor might want before buying a fund's shares. As a gesture in this direction, the participating companies agreed not to use "prospectus" at all to describe the new document, but simply to use "fund profile."

An example of the type of information likely to be absent from the fund profile can be found, oddly enough, in a brochure published by the Investment Company Institute called Reading the Mutual Fund Prospectus.

The full prospectus contains information about the tax implications of switching funds, writing checks against a fund balance and withdrawing money in an emergency _ details not likely to be included in the profile.

Bank of America, Capital Research and Management, Dreyfus, Fidelity Investments, IDS Financial Services, T. Rowe Price, Scudder and Vanguard are putting the finishing touches on their fund profiles. A few variations are expected among their documents, but the general form of the prototypes is clear.

Despite some missing information, like what portion of a fund can be invested in illiquid securities or low-rated bonds, the profiles will include some features that could improve disclosure.

For example, they will contain one item that the fund industry is pushing as a universal standard for risk disclosure: a bar chart of total return for each year. Unlike the common mountain charts that show how an initial investment of, say, $1,000 would have grown over the years, this bar chart shows gains and losses at a glance. Investors can readily see that they would have lost money in some years and how much.

And whatever the arguments against allowing investors to buy funds directly after reading advertisements, the fund profile satisfies a greater need. It puts investors who do their own research on more even footing with those who buy funds through brokers.

With the fund profile, investors could get useful information conveyed in a simple format _ much as it would be in a conversation.