The Promise & Perils of Plain English Mutual Fund Disclosures

Abstract

The SEC requires mutual funds to write disclosures for the average investor using plain English. These requirements make funds’ investment strategies and associated risks transparent and accessible for investors. Increasing investor understanding furthers the SEC’s regulation-through-disclosure regime—the primary method through which mutual funds are regulated. But our examination of funds’ summary prospectus—an abbreviated discussion of a fund’s strategies and risks—suggests that funds often fail to meet the plain English standard. Our analysis of all summary prospectuses filed between 2010 and 2020 reveal that mutual funds write long, hard-to-read, and complex disclosures. Importantly, we find that failure to draft disclosures in plain English is more than a technical error. Using a regression model, we find systematic patterns suggesting that funds may skirt the SEC’s plain English rules to dampen the revelation of past poor performance. In particular, positive past returns predict easier-to-read disclosures, but an increase in fund risk predicts harder-to-read disclosures. Our results suggest three recommendations. First, given this reality, the SEC should update their plain English guidance to funds. Second, the SEC may benefit from adopting text mining measures to better monitor and enforce disclosure standards. Finally, given the incentives to draft overinclusive and exhaustive disclosures, the SEC may want to sever liability for summary prospectus risk omissions if full disclosure is made elsewhere.

Keywords: investment company, mutual funds, text mining, NLP, disclosures, SEC, compliance, risk, investment strategy

JEL Classification: K22, G23, G38, G14