[12173]
July 5, 2000
TO: BOARD OF GOVERNORS No. 39-00
ACCOUNTING/TREASURERS COMMITTEE No. 26-00
SEC RULES COMMITTEE No. 95-00
TAX COMMITTEE No. 28-00
RE: INSTITUTE COMMENT LETTER ON SEC AFTER-TAX RETURNS PROPOSAL
The Institute has filed a comment letter on the SEC’s proposal to require funds to disclose after-
tax returns.1 Overall, the Institute’s letter supports the objectives of the Commission’s proposals. The
letter states, however, that the Commission’s proposed approach has several shortcomings and, thus,
recommends significant modifications to various aspects of the proposal. The Institute’s letter is
attached, and it is summarized below.
1. Location of the Required Disclosure
The Institute’s letter recommends that disclosure of after-tax returns be mandated in a fund’s
prospectus only, and not also in the Management’s Discussion of Fund Performance (“MDFP”), which is
typically contained in the annual report. The letter explains that this disclosure is more appropriate in the
prospectus, and that requiring both documents to include after-tax returns would be inappropriate,
unnecessary, and contrary to the Commission’s long-standing philosophy favoring integrated disclosure.
Moreover, the letter points out that including the disclosure in both documents could be confusing to
investors because of the use of potentially different measurement periods (i.e., calendar year for the
prospectus numbers and fiscal year for the MDFP numbers), and that the sheer volume of such disclosure
would overwhelm the MDFP.
The Institute’s letter recommends that within the prospectus, after-tax return disclosure should be
included in the tax section, rather than the risk/return summary as proposed. The letter explains that
investors would benefit if all of the information about the tax consequences of investing in 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.
The Institute’s letter supports the Commission’s proposal to not require funds to include after-tax
returns in fund advertisements and sales literature, unless they choose to do so (in which case they would
be required to include after-tax returns computed in accordance with the proposed standardized formula).
As an alternative, the letter states that the Commission could consider requiring funds to disclose that the
performance data in sales materials do not reflect the impact of taxes, and that after-tax return information
1 See Memorandum to Board of Governors No. 15-00, Accounting/Treasurers Members No. 11-00, SEC Rules Members No. 19-
00 and Tax Members No. 11-00, dated March 21, 2000.
2is contained in the fund’s prospectus. The letter recommends that in order to put claims of tax efficiency
in proper perspective this aspect of the proposal should be modified in one respect; that is, to require
funds to include after-tax returns in sales materials in which a before-tax return is accompanied by a claim
of “tax efficiency.”
2. Required After-Tax Return Numbers
The Institute’s letter supports two types of after-tax numbers – “pre-liquidation” and “post-
liquidation” returns – in order to provide a balanced and meaningful presentation. The letter, however,
opposes the Commission’s proposal to require three new sets of numbers – two after-tax numbers (one
that assumes a fund’s shares are held through the reporting period and one that assumes they are
redeemed at the end of the period) and one new before-tax number (that does not reflect the deduction of
any contingent deferred sales charges (“CDSCs”) or redemption fees). The letter recommends that the
Commission should instead adopt the alternative approach discussed in its proposing release, in which the
“pre-liquidation“ after-tax numbers would reflect the deduction of any CDSCs and redemption fees. This
approach would eliminate the need for the proposed new before-tax number, the purpose of which is to
provide investors with comparison to the pre-liquidation after-tax number. The letter adds that any
potential confusion that might result from this approach can be addressed by revising the captions in the
proposed standardized table and through appropriate narrative disclosure.
The letter also recommends that in order to avoid inundating investors with numbers, a multiple
class fund should be permitted to disclose after-tax returns for only one class, rather than for all classes
offered by the prospectus.
3. Standardized Formula for Computing After-Tax Returns
The letter supports many aspects of the Commission’s proposed formula but strongly opposes the
use of the highest marginal tax rate. The letter recommends instead the use of marginal federal ordinary
income and long-term capital gains tax rates that are more representative of the average fund investor’s
tax situation. Specifically, the letter proposes that the federal tax rates be the historic tax rates for
ordinary income and long-term capital gains applicable to investors (married filing jointly) with taxable
income of $55,000. The letter also recommends that the formula be changed so that all hypothetically
redeemed shares are treated as generating long-term capital gains (or losses).
4. 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 prospectuses of those funds that offer their shares as investment
options for defined contribution plans, tax-deferred arrangements, variable insurance contracts, and
similar plans and arrangements. The letter recommends that the Commission also exempt bond funds.
The letter explains that investors generally purchase bond funds to receive current distributions of
income, which will be tax-exempt or taxable depending on the type of fund purchased, and that because
these investors understand the tax consequences of the periodic distributions they receive, after-tax
returns disclosure is not necessary for them. The Institute recommends that if the Commission is
unwilling to exclude all bond funds from the proposal, then, at the very least, the Commission should
exclude tax-exempt bond funds from the proposed disclosure requirement. This exemption is appropriate
because periodic distributions by a tax-exempt bond fund generally will be exempt from tax, resulting in
minimal tax consequences for investors in such a fund.
5. Compliance Date
3The Institute’s letter disagrees with the Commission’s proposal to require all new registration
statements, post-effective amendments that are annual updates to effective registration statements, reports
to shareholders, and profiles filed six months or more after the effective date of the amendments to
comply with the proposed amendments. The letter explains that a six-month time frame would be
inadequate in most circumstances and recommends instead a twelve-month transition period.
The letter notes, however, that a six-month transition period would be appropriate for funds that
include after-tax returns in advertisements and sales literature. The letter also recommends that the
Commission clarify in its adopting release that funds will be permitted to file post-effective amendments
with the new disclosure under Rule 485(b) of the Securities Act, if otherwise eligible to do so under the
rule.
6. Need for the Commission to Re-Evaluate Rules If Tax Law is Changed
The Institute’s letter makes clear that the SEC should reconsider the after-tax return disclosure
requirement if the current tax regime applicable to mutual fund shareholders changes. The letter notes
that there are legislative proposals currently under active consideration, for example, to permit investors
to exclude some or all capital gains from taxable income and to permit fund shareholders to defer tax on
reinvested capital gain distributions. The letter cautions that if any proposals along these lines are
enacted, the proposed after-tax returns disclosure will have little relevance.
Barry E. Simmons
Assistant Counsel
Attachment
Attachment (in .pdf format)