SEC Helps Transparency but Ignores Other Plans

The Securities and Exchange Commission voted on a series of proposals on Aug. 28, 2024, that we’ve been monitoring for years. In implementing a few but skipping over others, the SEC improved transparency for investors but could have gone further still.

The SEC’s most important decision is to begin requiring monthly filing and disclosure of mutual fund portfolios via the N-PORT form, rather than quarterly, which has been the norm. There will still be a 60-day lag before investors can see the data on the SEC’s EDGAR website, but the practice will allow for a much more detailed picture of a fund’s exposures and by extension its management style and risks.

Monthly disclosures are a big improvement. As Morningstar strategist Robby Greengold observes, a fund releasing portfolios on a quarterly basis could buy stocks within the quarter and sell them before the quarter’s end, and to the rest of the world, it was as though those stocks were never held.

The agency also approved a series of smaller measures, including a requirement that firms disclose information about outside vendors they may be using to determine and report the liquidity of their portfolios. The remainder were mostly technical in nature, affecting how securities are reported and classified.

Implementing a monthly disclosure system arguably has a different feel today than it would have several years ago. There used to be a lot more concern among fund companies and investors about the potential for front-running or copycatting a fund’s trades. Greengold argues that the proliferation of fully transparent actively managed exchange-traded funds appears to have softened objections from active fund managers. Many increasingly admit to feeling comfortable with the high frequency of public disclosure, which can be as often as daily.

Turned Away at the Door

Among three key proposals the SEC rejected, the most drastic would have mandated “swing pricing” for purchases and sales of fund shares to protect investors when very large inflows or outflows might otherwise dilute returns. The SEC made the tool available to US fund companies back in 2018 but did not mandate its use, and not a single US fund has employed it. A great idea in theory, that requirement would have had major side effects, likely upending the entire system of buying and selling funds and sending ripples throughout the investment industry.

In effect, swing pricing would involve adjusting the prices at which a fund is purchased or sold at the end of a day following significant inflows or outflows. The practice is meant to protect shareholders from extra costs they might incur if trades triggered by those flows are large enough to significantly move the market. Swing pricing can only work, though, if funds employ a so-called hard close when they strike net asset values—after which no orders can be received—to ensure they have enough information on asset flows to properly adjust (or swing) their prices.

That would completely change transactions made through intermediaries and retirement funds, in particular. The current system permits intermediaries to take buy and sell orders up to 4 p.m. Eastern time—at that day’s closing NAV—but to convey trade details to fund companies later in the day or even the next morning.

Even if you were to discount the nearly unanimous industry complaints lodged against the proposal, it’s clear that overhauling the entire system to accommodate the practice would have massive implications. American Funds, for example, noted that approximately 80% of mutual fund investors work through one kind of intermediary or another. Under swing pricing, most of them would have to place their orders very early in the day to receive that day’s price. Anything submitted after that cutoff would have to be processed one day later, with the next day’s price.

Washed-Out Liquidity Proposals

A rejected proposal to improve the reporting of portfolio liquidity received much less attention. The SEC was looking to revamp a rule that was finalized in 2016 that requires firms to report the percentage of each portfolio that falls into one of four buckets: highly liquid, moderately liquid, less liquid, and illiquid. Each has a definition relating to relating to the projected time required to sell something without significantly changing its market value.

The new proposal would have meant eliminating one bucket and adjusting the definitions of the remaining three. One change would have meant defining an assumed trade size as the sale of 10% of every holding in a fund, which would be a massive challenge for most bond funds. Another element would have attached the label of “illiquid” to any holding not likely to be converted to cash in seven or fewer days. That would have affected funds holding bank loans and might have led to the closure of dedicated bank-loan funds entirely.

Neither the original nor the proposed system are anywhere near perfect, but making the information public every three months was part of the plan and would have been a very investor-friendly decision. That data could have painted a much more detailed picture of portfolio risks, potentially changing the way investors evaluate and choose their mutual funds. Doing so had been part of the original 2016 rule, but that feature was ripped out at the last minute. Its revival was encouraging, but its rejection once more is a poor outcome for investors.