The Big Trade-Off

In the middle of the recent fund disclosure modernization proposal from the SEC, there is something that seems out of place.

The primary purpose of the proposal is to improve the data that the SEC collects for SEC purposes like systemic risk evaluation, examinations, informing rule-making, and evaluating industry trends. Yet included in the proposal is Rule 30e-3, which deals with the distribution of reports to investors. The proposed rule would change electronic delivery of financial statements from opt-in (shareholders need to take action to receive electronic delivery) to opt-out (shareholders need to take action to receive physical delivery), the opposite of today’s situation.

The Cost

The SEC estimates the on-going cost of N-PORT at $445 million. Based on our experience with Form PF, Form CPO-PQR and Form N-MFP, the relative complexity of Form N-PORT, and the time and effort of creating an S-X compliant schedule of investments in general, that number seems a bit high. I still expect that complying with N-PORT will be incredibly expensive, probably somewhere between $150 and $200 million per year for the industry as a whole. Either way, it is a huge quantifiable cost that will ultimately be borne in specific amounts by individual investors. The benefit of N-PORT, on the other hand, is to society in general – the qualitative, non-specific, collective benefit of stability in the capital markets. To someone saving for their kid’s college tuition or providing for their own retirement, that might be a hard trade-off to justify.

The Savings

Enter Rule 30e-3. The SEC estimates that it would save funds about $116 million, and this time their number is low. As per the 2015 ICI Fact Book, there are 53 million households each owning on average four mutual funds, or potentially 424 million units printed and mailed each year. Based on information from a 2013 Beacon study on e-delivery in the asset management industry, it costs between $13 and $18 dollars to print and mail each unit. The same study found that 22% have already opted in to electronic delivery, leaving an awful lot of cost savings to be had in the other 78%. According to an analysis by Broadridge, since electronic delivery came to proxies, the unit cost is now around $7 per unit and the savings across the entire securities market was about $320 million in 2014, an actual number that was also much higher than the SEC estimated. Lastly, in a June 5, 2015 article, Ignites reported that Vanguard estimated that a similar rule covering the electronic delivery of 401k plan information would save between $200 and $500 million a year. While these figures all have varying degrees of assumptions and estimation, they do indicate that 30e-3 will provide adequate savings to cover the cost of N-PORT.  The two combined will provide the collective benefit of stability without imposing a cost to individual investors.

The Trade-Off

While the SEC recognizes the cost of N-PORT and the cost savings of 30e-3, it does not address the two in concert in its request for comment. Is there a trade-off on offer? How will commenters deal with the interplay between Form N-PORT and Rule 30e-3? How explicit versus implicit will the trade-off be in public and in private? It is conceivable, though perhaps unlikely, that N-PORT makes it into the final rule while 30e-3 is left out. Will the industry be supportive of N-PORT without 30e-3? How trusting will the industry be of getting the implied trade-off? Will the industry want the trade-off to be explicit?  How this all turns out is one of many things about this proposal that will be interesting to watch.

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