1 See Memorandum to SEC Rules Committee No. 44-00 and Tax Committee No. 11-00, dated March 21, 2000.
[11917]
May 30, 2000
TO: SEC RULES COMMITTEE No. 81-00
TAX COMMITTEE No. 25-00
RE: DRAFT COMMENT LETTER ON SEC AFTER-TAX RETURNS RULE PROPOSAL
______________________________________________________________________________
As we previously informed you,1 the SEC has proposed rule and form amendments that would
require funds to disclose after-tax returns. The Institute has prepared a draft letter in response to the
SEC’s proposal. A copy of the letter is attached and it is summarized below.
Comments must be filed with the SEC by June 30th. The Institute has scheduled a meeting
for June 8, 2000 to discuss the draft letter. The meeting will be held at 10:00 a.m. at the Institute, in
the David Silver Conference Room on the 12th Floor. Please contact Stephanie Holly at (202) 326-
5814 to let her know whether you will be attending the meeting, if you have not already done so. If
you will be unable to attend the meeting but would like to provide comments on the Institute’s draft
letter, please contact any of the following Institute staff by Thursday, June 8th. Please note that we
plan to circulate another draft letter shortly after the June 8th meeting.
phone fax email
Amy B.R. Lancellotta (202) 326-5824 (202) 326-5827 amy@ici.org
Keith D. Lawson (202) 326-5832 (202) 326-5841 lawson@ici.org
Barry E. Simmons (202) 326-5923 (202) 326-5827 bsimmons@ici.org
Summary of the Institute’s Comments
The Institute’s draft letter supports the objectives of the Commission’s proposals – to improve
“after-tax” disclosure to investors. The letter expresses concern, however, that the Commission’s after-
tax returns proposals, as drafted, would not provide investors with prospectus disclosure that presents
clear, concise and understandable information about an investment in a fund. The letter recommends a
series of modifications that are needed including the following that are of particular importance.
! First, disclosure of after-tax returns should be mandated in a fund’s prospectus only, rather
than also in the MDFP. The letter explains that there is no reason to provide this disclosure
in two separate documents and notes that it is more appropriate in the prospectus, to assist
investors in making an investment decision about the fund. In addition, the sheer volume of
the disclosure would overwhelm the MDFP in the annual report.
! Second, within the prospectus, after-tax return disclosure should be included in the tax section
of the prospectus, rather than the risk/return summary. The letter notes that investors would
2benefit if all of the tax information about a fund were provided in one central location. In
addition, because disclosure of after-tax numbers along with the required extensive narrative
disclosure will be lengthy, including it in the risk/return summary would overwhelm other
important information included in the summary.
! Third, the proposed standardized formula for computing the after-tax return number should
reflect tax rates for ordinary income and capital gains that are representative of the rates paid
by average fund investors, rather than the maximum federal tax rate. Using the highest rate
would be misleading to many investors because it would grossly overstate the impact of taxes
on them.
The draft letter comments on other aspects of the Commission’s proposals as follows:
Required After-Tax Numbers
The Institute’s letter supports the Commission’s proposal to present both "pre-liquidation and
"post-liquidation" after-tax returns, but does not support the Commission's proposal to require
disclosure of four types of return. Rather, the letter notes that requiring four sets of performance
numbers will result in "information overload" and that the use of a "pre-liquidation before-tax”
performance number would inappropriately create competitive disadvantages between funds with front-
end loads and funds with contingent deferred sales charges.
The letter recommends, therefore that the proposal be modified to require that “pre-liquidation”
after-tax returns reflect the deduction of any exit fees and to eliminate the requirement that funds
disclose before-tax returns that do not reflect these fees. The letter recommends that in order to address
any possible confusion regarding the first set of after-tax return numbers, the Commission should revise
the proposed captions to read as follows:
! Impact of taxes on fund distributions
! Impact of taxes on fund distributions and sale of fund shares
Standardized Formula For Computing After-Tax Returns
The Institute's letter comments on the Commission's proposed formula for computing after-tax
returns. Specifically, the letter recommends that: (1) the formula use the more representative marginal
federal ordinary income and long-term capital gains tax rates that apply to investors (married filing
jointly) with taxable income of $55,000; (2) the formula not reflect the impact of either the alternative
minimum tax or the phase-outs of itemized deductions and personal exemptions; (3) the formula not
attempt to adjust for widely varying state and local taxes; (4) historic tax rates be used to calculate after-
tax returns; (5) the formula reduce the reinvested dividend amount to reflect the tax applicable to the
distribution; (6) the taxable amount and character of each distribution to be treated as specified by the
fund on the dividend declaration date, adjusted to reflect subsequent recharacterizations; (7) all
hypothetically-redeemed shares be treated as generating long-term capital gains or losses; and (8) any
redemption loss offset a corresponding amount of capital gain from unrelated transactions.
Exemptions From the Disclosure Requirement
The Institute’s letter supports the Commission’s proposal to exempt from the disclosure
requirement money market funds and the prospectus of funds that are offered as an investment option
3in (1) any retirement plan pursuant to which an investor is not taxed until the investment is sold or (2) a
variable insurance contract (“tax-deferred plans”). The letter also recommends that the Commission
exempt from the rule all bond funds, specifically, any fund that invests a certain percentage of its assets
in bonds and distributes significantly all of the interest income on its bond portfolio at least monthly.
The letter explains that capital gain distributions by bond funds tend to be fairly uniform and that unlike
equity funds, where portfolio managers may actively trade securities based upon projections of future
increases or decreases in value, bond fund managers typically dispose of securities only (1) because of
concerns about deteriorating credit quality, (2) to move along the yield curve or (3) to meet shareholder
redemptions. None of these three factors is likely to have any significant impact on the relative
performance of funds on an after-tax basis.
Compliance Date
The draft letter recommends that the proposed six month transition date be extended to twelve
months after the effective date of the amendments. In addition, the letter recommends that in order to
reduce certain administrative burdens, the Commission should permit a fund complex to file a
registration statement under the amended rules pursuant to Rule 485(a) of the Securities Act of 1933 for
a single fund in the complex that contains the requisite disclosure that would be representative of the
disclosure that would be contained in the prospectuses of the other funds in the complex.
Barry E. Simmons
Assistant Counsel
Attachment