The Electronic Distribution And Marketing Of Mutual Funds

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1 The Electronic Distribution And Marketing Of Mutual Funds Alexander C. Gavis A. Introduction 1. Mutual fund companies were pioneers in using electronic media to deliver documents to investors, including account and confirmation statements and prospectuses and shareholder reports. Fund companies also developed comprehensive websites, or virtual investor centers, which contain product information, advertisements, and account servicing features. 2. Up until 2000, the Securities and Exchange Commission ( SEC ) had provided extensive guidance (in 1995, 1996, and 2000) on the appropriate steps for delivering documents to investors. In the summer of 2000, Congress enacted the Electronic Signatures in Global and National Commerce Act ( E-Sign ), which changed the landscape for electronic transactions and delivery of documents. In October 2001, the SEC took the first steps in reconciling its guidance by permitting an electronic-only insurance product. 3. In recent interpretations and rules, the SEC has been developing access equals delivery and notice and access models for electronic delivery of certain types of financial documents. The concept of notice and access has come to fruition in regulations for delivery of mutual fund proxy materials and fund summary prospectuses. 4. Both the SEC and the Financial Industry Regulatory Authority ( FINRA or NASD ) have provided useful guidance to fund companies on electronic advertising. The most significant and complicated aspect of this guidance has been in the area of hyperlinks and use of third-party content on fund company websites. 5. This outline describes: a. The SEC s Guidance to Mutual Funds on Electronic Delivery and Distribution; Alexander C. Gavis is a member of the corporate legal department of Fidelity Investments, FMR LLC. The views expressed in this outline are those of the author and do not reflect those of Fidelity Alexander C. Gavis. ALI-ABA Business Law Course Materials Journal 39

2 40 ALI-ABA Business Law Course Materials Journal April 2009 b. E-Sign and the SEC s Responses to E-Sign (Rule 160 and the American Life product); c. Conflicts Between E-Sign and the SEC s Guidance; and d. The Regulation of Mutual Fund Electronic Advertising. B. The SEC s Guidance On Electronic Delivery And Distribution 1. SEC s No-Action Position And Releases a. No-Action Position. The SEC established the basic ground rules for electronic delivery in early It was first asked by counsel for a brokerage firm to provide no-action guidance on how brokers might deliver confirming prospectuses to customers in electronic format. The SEC s no-action response letter provided the underpinnings for its views on the viability of electronic delivery of information under the federal securities laws. See Brown & Wood (pub. avail. Feb. 17, 1995). b. October 1995 Interpretive Release. In October 1995, the SEC issued an interpretive release that provided specific views on how the electronic delivery of documents such as prospectuses, shareholder reports, and proxy solicitation materials might be achieved under the Securities Act of 1933 ( Securities Act ), the Securities Exchange Act of 1934 ( Exchange Act ), and the Investment Company Act of See Use of Electronic Media for Delivery Purposes, Securities Act Release No (October 6, 1995). i. The release addressed the use of a broad range of electronic media, including CD-ROM, video and audio tape, electronic mail, Internet websites, facsimiles, and software, and a broad range of documents, including prospectuses, shareholder reports, and proxy statements. ii. The release indicated that the use of electronic media should be at least an equal alternative to the use of paper-based media and that given the numerous benefits of electronic distribution of information and the fact that in many respects it may be more useful to investors than paper, its use should not be disfavored. iii. Three central factors were identified that should be considered by market participants when providing electronic delivery of prospectuses and shareholder reports: notice, access, and evidence to show delivery. The SEC warned, however, that the factors are not the only factors relevant to determining whether the legal requirements pertaining to delivery or transmission of documents have been satisfied. (1) Notice. Market participants who provide electronic delivery of information should consider the extent to which the electronic communication provides timely and adequate notice to investors that information for them is available. The SEC indicated that electronic delivery requires that investors receive virtually the same level of notice that would be provided by paper delivery. (2) Access. Investors who are provided information through electronic delivery should be provided with comparable access to the information as would be provided in the paper context. The use of a particular medium by a market participant should not be so burdensome that intended recipients cannot effectively access the information provided. Moreover, as is the

3 Electronic Distribution And Marketing Of Mutual Funds 41 case with a paper document, a recipient should have the opportunity to retain the information or have ongoing access equivalent to personal retention. (3) Evidence of Delivery. Market participants should adopt measures that will confirm that investors received the information in electronic format. (A) The release provided several examples of methods that could be used to satisfy this requirement, including the receipt of an informed consent from an investor to receive the electronic information through a particular electronic medium. (B) Other forms of evidence of delivery might involve an electronic mail return receipt or a confirmation that the investors have actually accessed, downloaded, or printed the information, or providing a hyperlink to a prospectus from another document that the investor had already received or accessed. iv. The release provides 52 examples in the form of hypothetical fact situations to illustrate various applications of the SEC s concepts. Of the examples, 22 specifically relate to mutual funds. c. May 1996 Interpretive Release. In a follow-up interpretive release, published in May 1996 and directed toward the use of electronic media by broker-dealers, transfer agents, and investment advisers, the SEC provided seven additional examples clarifying certain examples in the October 1995 Release in response to public comments. See Use of Electronic Media for Delivery Purposes, Securities Act Release No (May 9, 1996). d. April 2000 Interpretive Release. On April 28, 2000, the SEC issued an interpretation updating the 1995 and 1996 guidance on the use of electronic media for delivery purposes. See Use of Electronic Media, Securities Act Release No (April 28, 2000). i. The Release addressed issuers responsibility for website content. ii. It set forth basic legal principles for issuers and market intermediaries for conducting online offerings. iii. It addressed new technology concepts such as Internet discussion forums and electronic-only offerings. e. Significant E-Delivery Changes In The April 2000 Release i. Telephonic Consent Permitted (1) The 1995 Release stated that actual proof that a document was delivered was not required. Instead, informed consent to receive the document in electronic form would satisfy the delivery prong of the notice, access, and delivery requirements. (2) The 1996 Release stated that informed consent could be given in written or electronic format. (3) The 2000 Release permits an issuer or market intermediary to obtain an informed consent telephonically, as long as: (A) A record of that consent is retained; and

4 42 ALI-ABA Business Law Course Materials Journal April 2009 (B) The telephonic consent is obtained in a manner that ensures its authenticity. ii. Global Consent Permitted (1) Investors may give global consent relating to all documents of any issuer as long as the consent is informed. (2) Informed global consent could be obtained within an account-opening agreement that contains a separate section with electronic delivery authorization. (3) A global consent that is merely a provision of a larger agreement that an investor must execute to receive other services may not fully inform the investor. (4) Global consent would not satisfy the evidence of delivery requirement if opening an account is conditioned on providing the global consent. (A) Exception. An online brokerage firm that requires all accounts to be opened online and all account transactions to be conducted online may condition the opening of an account on providing global consent to electronic delivery. iii. Delivery Of Documents In PDF (1) Issuers and market intermediaries may deliver documents in portable document format (PDF) if they: (A) at the time consent is obtained, inform investors of the requirements necessary to download a PDF file; and (B) At no cost, provide investors with any necessary software and technical assistance. iv. Clarification Of Envelope Theory (1) The 1995 Release articulated an envelope theory that permitted issuers to consider documents to have been delivered together, as if in the same paper envelope, if they were in close proximity. (2) The 2000 Release clarified that: (A) The mere posting of a section 10 prospectus on a website does not cause the entire website (or even items in close proximity) to become part of the prospectus; (B) A link from an external document to a section 10 prospectus does not transform the external document into a prospectus; and (C) Information on a website would become part of a section 10 prospectus only if an issuer (or someone acting on behalf of an issuer) makes it a part of the prospectus, such as by linking from within the prospectus to an external document. f. Technology Concepts From April 2000 Release i. Access Alone May Not Equal Delivery

5 Electronic Distribution And Marketing Of Mutual Funds 43 ii. (1) The access equals delivery model would assume that investors all have access to the Internet and would allow delivery to be effective solely by the issuer posting the required document on its website. (2) The 2000 Release rejected this model given that many do not have access to the Internet and that investors may not want electronic delivery due to the size of documents and the time it takes to download and print documents. Direct Notice Necessary (1) In the 2000 Release the SEC re-affirmed its position that direct notice of the availability of a legally required document is necessary. As one example, a broker-dealer could not meet its Rule 10b-10 obligations by solely posting a notice on its website that the trade confirmation is available. iii. Implied Consent Not Acceptable (1) The implied consent model would allow electronic delivery of documents to investors if the investors did not affirmatively object when notified of the issuer s or intermediary s intention to deliver documents in electronic form. (2) The 2000 Release rejected the implied consent model but requested commentary on circumstances under which implied consent would be appropriate. g. Electronic-Only Offerings i. The 1995 Release permitted the structuring of an electronic-only offering in which investors could participate only if they agree to accept electronic delivery of all documents in connection with the offering. Even with electronic-only offerings, an issuer or intermediary must: (1) Provide the required documents in paper form if the investor revokes consent before valid delivery is made; and (2) Provide a paper copy of information previously delivered electronically when an investor so requests. ii. The 2000 Release requested comment on whether the paper back-up system should be required for electronic-only offerings. iii. The Release specifically addressed mutual funds, requesting comment on any potential adverse effects of limiting electronic-only offerings to investors who provide irrevocable consent to electronic delivery of all future disclosure documents. C. Electronic Signatures In Global And National Commerce Act ( E-Sign Act) 1. Scope Of E-Sign a. E-Sign covers any transaction in or affecting interstate or foreign commerce. 15 U.S.C. section 7001 et seq. A transaction is defined very broadly as: i. [A]n action or set of actions relating to the conduct of business, consumer, or commercial affairs between two or more persons, including any of the following types of conduct :

GETTING WIRED AT THE SEC: REFORMING THE PROXY PROCESS TO ACCOUNT FOR NEW TECHNOLOGIES

GETTING WIRED AT THE SEC: REFORMING THE PROXY PROCESS TO ACCOUNT FOR NEW TECHNOLOGIES I. INTRODUCTION A March 2004 study by Nielsen//NetRatings showed that almost 75% of Americans have access to the Internet