Investors Hold Boards Accountable—When Equipped With the Right Reports

Theresa Hamacher is the Chair of the Morningstar Funds Trust Board of Trustees. This post is based on her comment letter submitted to the SEC on behalf of Morningstar independent trustees Barry Benjamin, Linda Davis Taylor, and Enrique Vasquez.

Fund boards have long served as independent watchdogs for shareholders, monitoring investment performance, fund expenditures, risk management and conflicts of interest. But to hold boards accountable for that protection, shareholders first need to be aware that boards exist.

The U.S. Securities and Exchange Commission has proposed updating mutual fund and exchange-traded fund shareholder reports and disclosures to better meet the needs of retail investors. The changes, however, relegate vital information about the board to online documents shareholders are much less likely to read or ever see.

For investors evaluating their assets, this means becoming less informed about the boards charged with protecting their interests. As members of the Morningstar Funds Trust Board of Trustees, we are concerned that less transparency about board governance in shareholder reports could make it more difficult for investors to hold boards accountable.

SEC embraces shorter, plain English reports

The commission has moved to simplify the shareholder reports intended to communicate a fund’s progress to investors. These lengthy documents are often laden with “lawyer-speak” and lack critical context needed to determine whether funds met their goals and held to their strategies.

Specifically, the proposal targets content and delivery, requiring firms to highlight key information such as expenses, performance and holdings, while clearly demonstrating how disclosures relate to market events and investor expectations. It would also urge firms to include tables, bulleted lists, question-and-answer formats or other features to help investors visualize and process data. It is a “less is more,” plain English approach that would result in a clearer, more concise picture of shareholder assets.

Proposal increases clarity while compromising transparency

We fully support the commission’s efforts to offer more digestible content with a streamlined shareholder report, replacing annual prospectus updates. We believe such changes lead to better educated and more engaged shareholders.

However, as part of the move to shorten and clarify content in the revised shareholder reports, the SEC also proposes moving information that may be “less relevant” online, to be filed semi-annually on the new Form N-CSR. That form would include all information on the board—statements about its fundamental role as well as more detailed disclosures on issues such as compensation and the contract renewal process.

The only way that shareholders could, therefore, learn about the board under the proposal is by actively seeking out two relatively obscure documents, Form N-CSR or the statement of additional information (SAI). The board’s opportunity to explain its role and convey its significance would be significantly constrained. It effectively means investors would almost never receive a “push” communication alerting them to the role and practices—or even the existence—of the board.

We believe shareholders would benefit from additional information on the board’s role, diversity make-up, compensation, investment requirements and contact information. In our capacity as overseers, we have submitted a comment letter that recommends several changes to the shareholder reports as outlined in the SEC’s proposal.

Require basic board statement

First, we propose that all fund shareholder reports include a statement about the role that the board plays in protecting their interests. In addition, this section should include the number of independent directors or trustees, as well as a statement that instructs investors on how to find more information on board and fund governance matters. Contact information should also be allowed so boards can encourage feedback from shareholders.

Make room for board diversity disclosure

Given the evidence supporting a link between diversity in the boardroom and better decision-making, we believe it is important that funds be permitted to provide information regarding diversity in shareholder reports. This change would give mutual fund boards the opportunity to participate in a corporate trend. According to EY, 45% of Fortune 100 companies reported on diversity in their 2019 proxy statements, up from 23% just three years ago. Transparency is also an essential first step in promoting greater diversity in the asset management industry.

Expand investors’ ability to gauge alignment of interests

Boards should be able to communicate independent trustee compensation to shareholders and any changes regarding pay over the past year. We believe that disclosing this information helps hold boards accountable for their compensation decisions. Boards should also be permitted to communicate to shareholders that directors or trustees are required to invest in the fund because this aligns boards with shareholder interests.

With these changes, we recognize that boards have different leadership styles and represent a variety of fund types, ultimately adopting a wide cross section of strategies and board practices. We therefore advocate allowing flexibility in how to share information on diversity, compensation and fund holdings. Over time, boards can evaluate how successful their disclosures are in informing investors and modify their formats accordingly.

Like the SEC, we seek to equip shareholders with information to better evaluate and monitor their assets. Ultimately, we want to maximize their potential for long-term value creation, improve their overall experience, and contribute to the growth of healthy markets.

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