IM Guidance Update

MARCH 2016 | No. 2016-02

US Securities and Exchange Commission

 Division of Investment Management

FUND DISCLOSURE REFLECTING RISKS RELATED TO CURRENT MARKET 

CONDITIONS

The staff is issuing this Guidance Update in order to foster investor protection by 

reminding mutual funds, exchange traded funds, and other registered investment 

companies of the importance to investors of full and accurate information about fund 

risks, including risks that arise as a result of changing market conditions. In particular, 

the staff believes that funds should review their risk disclosures on an ongoing basis and 

consider whether these disclosures remain adequate in light of current conditions.

Background: Importance of Risk Disclosure; Previous Commission and Staff 

Statements

Clear and accurate disclosure of the risks of investing in funds is important to informed 

investment decisions and, therefore, to investor protection. The Commission has long 

recognized the importance to investors of fund risk disclosure,1

 and the Commission’s 

disclosure requirements reflect that recognition. A mutual fund, for example, is required 

to summarize the principal risks of investing in the fund, including the risks to which 

the fund’s portfolio as a whole is subject and the circumstances reasonably likely to 

affect adversely the fund’s net asset value, yield, and total return, in both its summary 

prospectus and at the front of its statutory prospectus.2 In addition to this summary 

information, the fund’s statutory prospectus must provide a fuller description of the 

principal risks of investing in the fund.3 

Because of the importance of risk disclosure to investors, the staff has provided 

guidance on various aspects of risk disclosure on a number of occasions. For example, 

the staff has highlighted the importance of providing a concise summary of principal 

investment risks, rather than a long, complex, and detailed description of those risks, in 

the summary section of the prospectus.4 The staff has also encouraged any fund that 

exposes investors to market, credit, or other risks, and whose name suggests safety or 

protection from loss, to reevaluate the name and to consider changing the name, as 

appropriate, to eliminate the potential for investor misunderstanding.5 The staff has also 
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noted important aspects of disclosures related to fund use of derivatives, including 

the staff’s expectation that funds that use investment strategies that employ derivatives 

should disclose material risks relating to volatility, leverage, liquidity, and counterparty 

creditworthiness associated with the fund’s trading and investments in derivatives.6 

Further, the staff has observed that it is of limited usefulness to investors for funds 

to provide disclosure about the risks of investing in derivatives that is generic and 

not tailored to the specific derivative instruments in which a fund invests or will 

invest principally.7 

Risk Disclosure Addressing Changing Market Conditions

This Guidance Update is intended to address another important aspect of fund 

risk disclosure, namely, the changes in a fund’s susceptibility to risk that may result 

from changes in market conditions and the need for funds to review and assess risk 

disclosures in light of changing market conditions. Degree of risk is dynamic in nature 

rather than static; it changes in response to market conditions, and different risks 

may be heightened or lessened at different points in time. As a result, a fund may 

determine that risk disclosure that may have been adequate at one time may need to 

be reconsidered in light of new or changed market conditions. If a fund determines that 

its risk disclosure is not adequate, the staff believes that the fund should consider the 

appropriate manner of communicating changed risks to existing and potential investors, 

for example, in the prospectus, shareholder reports, fund website, and/or marketing 

materials.8 We understand that many fund boards request that the fund’s adviser report 

to the board on its process for preparing the fund’s disclosure materials.9 As part of this 

process, the staff believes that a fund’s adviser should consider providing information to 

the fund board on the steps taken by the adviser to evaluate fund risk disclosures and 

consider whether changes are appropriate.

In the staff’s view, undertaking the following steps on an ongoing basis should help 

funds in providing risk disclosures to investors that remain robust in changing 

market conditions.

• Monitor Market Conditions and their Impact on Fund Risks. In order for a fund 

to determine whether its risk disclosures appropriately address current market 

conditions, the fund should effectively monitor market conditions on an ongoing 

basis and assess the impact of changing conditions on the fund and the risks 

associated with its investments. Monitoring market conditions for their impact on 

the fund is, of course, a part of prudent portfolio management by the adviser, so we 

would expect that funds would routinely engage in this practice as a normal part of 

day-to-day operations.
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• Assess Whether Fund Risks Have Been Adequately Communicated to Investors 

in Light of Current Market Conditions. If a fund determines that changed market 

conditions have affected the risks associated with the fund, the fund should assess 

the significance of the change and whether it is material to investors. If so, a 

fund should consider whether its existing disclosures are adequate in light of the 

changed conditions. 

• Communicate with Investors. A fund that determines that changes in current 

market conditions have resulted in changes to the fund’s risks that are material 

to investors, and that its current disclosures do not adequately communicate the 

changes, should update its communications to investors as needed. The fund 

should provide any such updated communications to investors, at the time and in 

the manner required by the federal securities laws and as otherwise appropriate. 

Means of communication to be considered include the prospectus (which, for 

example, would be updated when the fund determines that the risk disclosure in its 

prospectus would be materially misleading) and shareholder reports, as well as less 

formal methods, such as website disclosure and letters to shareholders. 

In its reviews of fund disclosures concerning risks, the staff has observed a number of 

instances where funds have updated disclosures to address current market conditions. 

To illustrate the types of disclosures that a fund may wish to consider, we describe 

below examples of disclosures we have seen in two circumstances where market 

conditions are changing. The first relates to disclosures by fixed income funds regarding 

interest rate risk, liquidity risk, and duration risk. The second relates to investments by 

funds in debt securities issued by the Commonwealth of Puerto Rico and its agencies 

and instrumentalities (together, “Puerto Rico debt”). In each case, we have observed 

disclosures that highlight current conditions in a manner that we believe can make 

risk disclosure more timely, more meaningful, and more complete. We have observed 

prospectuses, shareholder reports, and fund websites where such disclosures are 

included. We believe that such disclosures could help investors better evaluate the risks 

of investment in the fund in light of changing circumstances. 

Fixed Income Funds 

Following the financial crisis of 2008, the Federal Reserve Board lowered the target 

range for the federal funds rate to near zero and implemented quantitative easing 

programs. Quantitative easing ended in 2014. In a statement issued in March of 

2015, the Federal Open Market Committee stated that it anticipated that it would be 

appropriate to raise the target range for the federal funds rate when it had seen some 

further improvement in the labor market and was reasonably confident that inflation 
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would move back to its two percent objective over the medium term.10 In December 

of 2015, the Federal Open Market Committee decided to raise the target range for 

the federal funds rate to one-quarter to one-half percent and addressed how it would 

determine the timing and size of future adjustments to the target range for the federal 

funds rate.11

Interest Rate Risk. We have observed that prospectus disclosure for a number of 

bond funds addresses these current conditions. We have also observed disclosure in 

shareholder reports, particularly in the Management’s Discussion of Fund Performance 

and Presidents’ letters, as well as fund websites, bearing on current conditions and the 

level of current interest rate risk. Some funds include in their disclosure references to 

current historically low interest rates. In addition, some funds also include references to 

recent and potential future changes in government policy that may affect interest rates. 

These disclosures indicate that current conditions may result in a rise in interest rates, 

which in turn may result in a decline in the value of the fixed income investments held 

by the fund. We believe that the benefit of addressing current conditions in this manner 

is that it can alert investors that, for the present, interest rate risk may be heightened.12 

Indeed, some fund disclosures expressly state that the current conditions may pose an 

increased risk.

Liquidity Risk. In addition, in connection with disclosure of interest rate risk, some funds 

are disclosing that a potential rise in interest rates may result in periods of volatility 

and increased redemptions. Some of these funds state that, as a result of increased 

redemptions, they may have to liquidate portfolio securities at disadvantageous prices 

and times, which could reduce the returns of the fund. Some funds are also disclosing 

that the reduction in dealer market-making capacity in the fixed income markets that 

has occurred in recent years has the potential to decrease liquidity. Disclosures such 

as these may be useful in alerting investors to the secondary impacts that could result 

from increased interest rates.

Duration risk. Many funds, in connection with disclosure of interest rate risk, also 

disclose that longer-term securities may be more sensitive to interest rate changes. 

Some funds provide numerical examples to illustrate how interest rate changes may 

have a greater impact on securities with longer terms. This disclosure, when coupled 

with disclosure about current, historically low interest rates and the potential for 

increases in those rates, may be effective in communicating to investors the heightened 

risk that rising interest rates may pose to a fund whose portfolios include longer-term 

fixed income securities.
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Puerto Rico Debt

A number of funds have investments in Puerto Rico debt. For some time, there have 

been concerns that Puerto Rico would default on its debt or restructure its upcoming 

obligations.13 Indeed, on August 3, 2015, the Puerto Rico Public Finance Corporation 

reportedly failed to make a bond payment that was due, because the Commonwealth’s 

legislature had not appropriated the necessary funds.14 Again, on January 4, 2016, 

Puerto Rico reportedly failed to make scheduled payments to some bondholders.15

Some tax-exempt funds have names that indicate that they invest in securities that are 

exempt from both federal income tax and the tax of a particular state (e.g., the Florida 

Tax-Exempt Fund). Because Puerto Rico debt is exempt from taxation by all states,16

some of these “single-state” funds may have significant exposure to Puerto Rico debt.17

We have observed that a number of these funds, in addition to required disclosure that 

they may invest in tax-exempt securities of issuers located outside of the named state,18

expressly disclose in their prospectus risk disclosure that they invest in Puerto Rico 

debt. This disclosure has also been included in the prospectuses of other types of funds 

that have significant exposure to Puerto Rico debt. We believe that this disclosure can 

help communicate to investors that the fund is exposed to risks associated with 

Puerto Rico.

We have also observed that some funds that include express disclosure about the 

risks associated with Puerto Rico debt have updated that disclosure to communicate 

the existence of heightened risk under current conditions. We have observed such 

disclosure in fund prospectuses, as well as shareholder reports and fund websites. 

These disclosures refer to current factors that may be expected to have an impact 

on the value of the Puerto Rico debt held by the fund. For example, some of the 

disclosures refer to significant financial difficulties, including budget deficits, that Puerto 

Rico is currently experiencing. Disclosures also refer to recent downgrades in ratings of 

Puerto Rico debt, and state that these downgrades may adversely affect market values 

and liquidity of the fund’s securities. In the staff’s view, any fund investing in Puerto Rico 

debt should consider, based on the nature and significance of its investments, whether 

such disclosure is appropriate.

* * *

The Division believes that full and accurate information about fund risks, including risks 

that arise as a result of changing market conditions, is important to investors in mutual 

funds, exchange traded funds, and other registered investment companies. As noted 
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above, in our disclosure reviews, we have observed instances of funds providing useful 

information to their investors regarding current market conditions. We encourage 

funds to review their risk disclosures on an ongoing basis and consider whether these 

disclosures remain adequate in light of current conditions.

Endnotes

1 For instance, in a 1998 release adopting amendments to Form N-1A, the form used 

by mutual funds to register under the Investment Company Act of 1940 and to offer 

their shares under the Securities Act of 1933, the Commission stated:

 A fund’s prospectus principally should include essential information about 

 the fundamental characteristics of, and risks of investing in, the fund. 

 Whenever possible, a fund should present this information in a manner that: 

 — assists investors in comparing and contrasting the fund with other funds; 

 — avoids simply restating legal or regulatory requirements to which funds 

 generally are subject; and

 — avoids a disproportionate emphasis on possible investments or activities of 

 the fund that are not a significant part of the fund’s investment operations. 

 Registration Form Used by Open-End Management Investment Companies, 

Investment Company Act Release No. 23064 (March 13, 1998) [63 FR 13916 at 13919 

(March 23, 1998)], available at http://www.sec.gov/rules/final/33-7512r.htm.

2 Item 4(b) of Form N-1A.

3 Item 9(c) of Form N-1A.

4 Guidance Regarding Mutual Fund Enhanced Disclosure, IM Guidance Update 

2014-08 at 2-3 (June 2014).

5 Fund Names Suggesting Protection from Loss, IM Guidance Update 2013-12 

(Nov. 2013).

6 Disclosure and Compliance Matters for Investment Company Registrants That 

Invest in Commodity Interests, IM Guidance Update 2013-05 at 2-3 (Aug. 2013).
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7 Letter from Barry D. Miller, Associate Director, Division of Investment Management, 

U.S. Securities and Exchange Commission, to Karrie McMillan, General Counsel, 

Investment Company Institute (July 30, 2010), available at https://www.sec.gov/

divisions/investment/guidance/ici073010.pdf.

8 See Letter from Carolyn B. Lewis, Assistant Director, Division of Investment 

Management, U.S. Securities and Exchange Commission, to Investment Company 

Registrants (Feb. 3, 1995) (It is a fund’s responsibility, “on an ongoing basis to 

analyze fund risk and review prospectus risk disclosure, and to update prospectus 

disclosure when appropriate.”); Statement of the Commission Regarding Disclosure 

of Year 2000 Issues and Consequences by Public Companies, Investment Advisers, 

Investment Companies, and Municipal Securities Issuers, Securities Act Release No. 

7558 (July 29, 1998) [63 FR 41394 at 41402 (Aug. 4, 1998)], available at http://www.

sec.gov/rules/interp/33-7558.htm (“. . . it is unlawful for investment companies to 

omit from registration statements and other public filings ‘any fact necessary in 

order to prevent the statements made therein, in light of the circumstances under 

which they were made, from being misleading.’ If investment companies determine 

that their Year 2000 risks are material, they are required to discuss such risks in their 

registration statements and other public documents . . . .”); Adoption of Integrated 

Disclosure System, Securities Act Release No. 6383 (March 3, 1982) [47 FR 11380 

at 11395 (March 16, 1982)] (“One of the basic concerns which must be met in the 

context of shelf registration is ensuring that investors are provided accurate and 

current information where offers or sales are not to be made immediately after the 

registration statement becomes effective.” ). 

9 ABA Section of Business Law, Fund Director’s Guidebook, § 11.A (1) (2015). 

10 Federal Reserve Monetary Policy Release, Federal Reserve Issues FOMC Statement 

(March 18, 2015), available at http://www.federalreserve.gov/newsevents/press/

monetary/20150318a.htm.

11 Federal Reserve Monetary Policy Release, Federal Reserve Issues FOMC Statement 

(Dec. 16, 2015), available at http://www.federalreserve.gov/newsevents/press/

monetary/20151216a.htm.

12 See Risk Management in Changing Fixed Income Market Conditions, IM Guidance 

Update 2014-01 (Jan. 2014) (suggesting steps that fund advisers may consider with 

respect to risk management and disclosure matters relating to changing conditions 

in fixed income markets).
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13 See Matt Wirz, Nick Timiraos, and Aaron Kuriloff, Puerto Rico, Treasury in Talks 

to Restructure Island’s Debt, Wall Street Journal (Oct. 14, 2015), available at 

http://www.wsj.com/articles/puerto-rico-treasury-in-talks-to-restructure-islandsdebt-1444853744; Michelle Kaske and Elizabeth Campbell, Puerto Rico Debt-Crisis 

Grows as Island Defaults, Conserves Cash, Bloomberg Business (Aug. 3, 2015), 

available at http://www.bloomberg.com/news/articles/2015-08-04/puerto-ricodebt-crisis-grows-as-payments-halt-agency-defaults; Elizabeth Foos, Puerto 

Rico Back in the Hot Seat, Morningstar (July 30, 2015), available at http://ibd.

morningstar.com/article/article.asp?id=708465&CN=brf295,http://ibd.morningstar.

com/archive/archive.asp?inputs=days=14;frmtId=12,%20brf295; Michael A. Fletcher, 

Puerto Rico Bonds Downgraded to Junk Levels, Washington Post (Feb. 4, 2014), 

available at http://www.washingtonpost.com/business/economy/puerto-rico-bondsdowngraded-to-junk-levels/2014/02/04/c9495a22-8ddf-11e3-833c-33098f9e5267_

story.html.

14 Michael A. Fletcher, Debt-Plagued Puerto Rico Defaults on a Bond Payment for the 

First Time, Washington Post (Aug. 3, 2015), available at http://www.washingtonpost.

com/business/economy/puerto-rico-defaults-on-a-bond-payment-for-the-firsttime/2015/08/03/8a703c0a-3a20-11e5-9c2d-ed991d848c48_story.html.

15 Mary Williams Walsh, Struggling Puerto Rico Defaults on Its Debt Payments, 

New York Times (Jan. 4, 2016), available at http://www.nytimes.com/2016/01/05/

business/dealbook/puerto-rico-defaults-on-debt-payments.html; Robert Slavin, It’s 

Bondholders’ Move After Puerto Rico Defaults, Bond Buyer (Jan. 5, 2016), available 

at http://www.bondbuyer.com/news/regionalnews/its-bondholders-move-afterpuerto-rico-defaults-1093208-1.html.

16 48 U.S.C. 745 provides: 

 All bonds issued by the Government of Puerto Rico, or by its authority, shall 

be exempt from taxation by the Government of the United States, or by the 

Government of Puerto Rico or of any political or municipal subdivision thereof, 

or by any State, Territory, or possession, or by any county, municipality, or other 

municipal subdivision of any State, Territory, or possession of the United States, 

or by the District of Columbia.

17 Rule 35d-1(a)(4) under the Investment Company Act provides in part: 

 A fund with a name suggesting that the fund’s distributions are exempt from 

both federal and state income tax is required to adopt a fundamental policy 
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 (i) To invest, under normal circumstances, at least 80% of the value of 

its assets in investments the income from which is exempt from both federal 

and state income tax; or

 (ii) To invest, under normal circumstances, its assets so that at least 

80% of the income that it distributes will be exempt from both federal and state 

income tax. 

18 Frequently Asked Questions about Rule 35d-1 (Investment Company Names) 

at Question 3, available at https://www.sec.gov/divisions/investment/guidance/

rule35d-1faq.htm; Investment Company Names, Investment Company Act Release 

No. 24828 at n. 30 (Jan. 17, 2001) [66 FR 8509 at 8512 (Feb. 1, 2001)], available at 

http://www.sec.gov/rules/final/ic-24828.htm.

IM Guidance Updates are recurring publications that summarize the staff’s views 

regarding various requirements of the federal securities laws. The Division generally 

issues IM Guidance Updates as a result of emerging asset management industry trends, 

discussions with industry participants, reviews of registrant disclosures, and no-action 

and interpretive requests.

The statements in this IM Guidance Update represent the views of the Division of 

Investment Management. This guidance is not a rule, regulation or statement of the 

Securities and Exchange Commission. Further, the Commission has neither approved 

nor disapproved its content. Future changes in rules, regulations and/or staff no-action 

and interpretive positions may supersede some or all of the guidance in a particular 

IM Guidance Update.

The mission of the Securities and Exchange Commission is to protect investors; maintain fair, 

orderly, and efficient markets; and facilitate capital formation.

If you have any questions about this IM Guidance Update, please contact:

Disclosure Review Office

Phone: 202.551.6921

Email: IMOCC@sec.gov