Promise & Peril of Plain English: Mutual Fund Disclosure Readability

Abstract

The SEC requires mutual funds to write disclosures for the average investor using plain English. These requirements make funds\u27 investment strategies and associated risks transparent and accessible to investors. Improved investor understanding furthers the SEC\u27s regulation-through-disclosure regime. But our examination of funds\u27 summary prospectuses--an abbreviated discussion of a fund\u27s 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 reveals 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 that positive past returns predict easier-to-read disclosures, but an increase in fund risk predicts harder-to-read disclosures. Further, we find that compliance with other metrics of plain English, like short sentences and active voice, predicts easier-to-read disclosures. In other words, compliance in one dimension of plain English writing suggests compliance in other aspects as well. Our results suggest several recommendations. The SEC should update their plain English guidance and adopt text mining measures to better monitor and enforce disclosure standards. Finally, given the incentives to draft overinclusive and exhaustive disclosures, the SEC should issue guidance on liability for summary prospectus risk omissions if full disclosure is made elsewhere