A recent federal court decision is causing mutual fund industry lawyers to have reservations about simplifying fund prospectuses even as mutual fund companies are redoubling their efforts to produce the revised documents.

A decision by the Second Circuit of U.S. Court of Appeals in a case involving the Alliance North American Government Income mutual fund underscores the importance of simple, complete explanations of the risks of investing in funds, lawyers say. The Appeals Court last month refused to throw out a case involving the fund, in effect saying that it is possible the fund's prospectus misled investors about risks because of allegedly inadequate disclosure.

The decision came on a motion to dismiss -- a procedural move intended to end a case long before trial. The decision did not conclude that Alliance misled investors. An Alliance spokesperson was not available for comment.

The Alliance North American decision signals that mutual funds must closely scrutinize the adequacy of their fund disclosures, said Robert A. Robertson, a lawyer in private practice at Gordon, Altman, Butowsky, Weitzen, Shalov & Wein in New York.

"You need to be straightforward about the risk of investing" in a fund, Robertson said. "At times it's very difficult for the industry to be straightforward."

Robertson and other industry lawyers made their comments at a conference last week on investment management regulation in New York. Lawyers discussed the importance of simplifying disclosure, which is occurring throughout the industry because of new SEC rules requiring the shortening and reorganizing of prospectuses as well as the use of simpler language in them.

The North American Government Income decision has made lawyers pay more attention to prospectus disclosure. In that case, the fund suffered losses when the Mexican government devalued the peso in December, 1994. The Second Circuit said the fund's value had declined "dramatically," but the precise amount of losses was not disclosed. Investors alleged the prospectus did not sufficiently disclose the risks they faced.

The North American Government Income fund listed in its prospectus hedging techniques the fund could use to reduce the risk caused by fluctuating currencies. The prospectus offered a 10-paragraph explanation of the types of hedging devices the fund intended to use. According to the plaintiffs, however, the fund did not use those hedging techniques because of their cost. The prospectus did disclose risks, including those from changes in the value of currency. The Second Circuit said that the general disclosure about currency risk may not have been sufficient. The court ruled that the warnings in the prospectus did not free the fund from liability because it warned investors of a danger that was different than the one the plaintiffs said they were not sufficiently alerted to.

The decision drew some criticism. Richard M. Phillips, a partner at Kirkpatrick & Lockhart in Washington, said the court too narrowly interpreted the warning the prospectus did contain. Narrow readings of prospectuses are potentially "dangerous" for the fund industry as it tries to simplify prospectus disclosure, Phillips said. He said he hoped the SEC would file friend of the court briefs in cases where funds have simplified their disclosures consistent with SEC requirements but were still challenged.

Barry Barbash, director of the SEC's Division of Investment Management until last month and now an attorney in private practice at Shearman & Sterling in Washington, predicted in a speech that the SEC would continue to devote attention to improving fund disclosure. The implementation of simplified prospectuses and other filings represents "the great challenge" for the SEC, Barbash said. The agency is likely to look for ways to improve disclosure through annual and semi-annual reports of funds, he said.

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