[House Report 106-547]
[From the U.S. Government Publishing Office]



106th Congress                                                   Report
                        HOUSE OF REPRESENTATIVES
 2d Session                                                     106-547

======================================================================



 
                 MUTUAL FUND TAX AWARENESS ACT OF 2000

                                _______
                                

 March 27, 2000.--Committed to the Committee of the Whole House on the 
              State of the Union and ordered to be printed

                                _______
                                

  Mr. Bliley, from the Committee on Commerce, submitted the following

                              R E P O R T

                        [To accompany H.R. 1089]

    The Committee on Commerce, to whom was referred the bill 
(H.R. 1089) to require the Securities and Exchange Commission 
to require the improved disclosure of after-tax returns 
regarding mutual fund performance, and for other purposes, 
having considered the same, report favorably thereon with an 
amendment and recommend that the bill as amended do pass.

                                CONTENTS

                                                                   Page
Amendment........................................................     1
Purpose and Summary..............................................     2
Background and Need for Legislation..............................     2
Hearings.........................................................     5
Committee Consideration..........................................     5
Committee Votes..................................................     5
Committee Oversight Findings.....................................     5
Committee on Government Reform Oversight Findings................     6
New Budget Authority, Entitlement Authority, and Tax Expenditures     6
Committee Cost Estimate..........................................     6
Congressional Budget Office Estimate.............................     6
Federal Mandates Statement.......................................     7
Advisory Committee Statement.....................................     7
Constitutional Authority Statement...............................     7
Applicability to Legislative Branch..............................     7
Section-by-Section Analysis of the Legislation...................     7
Changes in Existing Law Made by the Bill, as Reported............     8

                               amendment

    The amendment is as follows:
    Strike out all after the enacting clause and insert in lieu 
thereof the following:

SECTION 1. SHORT TITLE.

    This Act may be cited as the ``Mutual Fund Tax Awareness Act of 
2000''.

SEC. 2. FINDINGS.

    The Congress finds the following:
          (1) Taxes can be the single biggest cost associated with 
        mutual funds. The average stock fund investor has lost up to 3 
        percentage points of return every year to taxes.
          (2) The average portfolio turnover rate for an activity 
        managed (nonindex) fund has increased from 30 percent 20 years 
        ago to almost 90 percent today, and average capital gains 
        distributions of growth funds, per share, have more than 
        doubled in the last 10 years.
          (3) If a fund's performance is based mostly on short-term 
        gains, investors can lose a significant part of their return to 
        taxes.
          (4) Performance figures that mutual funds generally disclose 
        to their shareholders are net of fees and expenses, but not 
        taxes, and therefore do not represent the impact taxes have on 
        an investor's return.
          (5) This disclosure focuses on how much money investors made 
        before taxes, and not on how much money investors actually got 
        to keep.
          (6) Improved disclosure of the effect of taxes on mutual fund 
        performance would allow shareholders to compare after-tax 
        returns to raw performance, and would permit the investors to 
        determine whether the fund manager tries to minimize tax 
        consequences for shareholders.
          (7) While the mutual fund prospectus details the average 
        annual portfolio turnover rate, the prospectus may not 
        expressly inform shareholders about the impact the portfolio 
        turnover rate has on total returns.

SEC. 3. IMPROVEMENTS IN DISCLOSURE REQUIREMENTS.

    Within 18 months after the date of enactment of this Act, the 
Securities and Exchange Commission shall revise regulations under the 
Securities Act of 1933 and the Investment Company Act of 1940 to 
require, consistent with the protection of investors and the public 
interest, improved disclosure in investment company prospectuses or 
annual reports of after-tax returns to investors.

                          purpose and summary

    H.R. 1089, the Mutual Fund Tax Awareness Act of 2000, 
requires that the Securities and Exchange Commission (SEC) 
revise its regulations under the Securities Act of 1933 and the 
Investment Company Act of 1940 to require, consistent with the 
protection of investors and the public interest, improved 
disclosure in investment company prospectuses or annual reports 
of after-tax returns to investors. These regulations must be 
issued within 18 months after the date of enactment.

                  background and need for legislation

    Mutual funds, as a group of investments, are relatively tax 
efficient, especially when compared with other investment and 
savings alternatives. For example, while many savings vehicles 
provide returns that are taxable as ordinary income on a yearly 
basis, mutual funds generate returns which can be wholly or 
partially taxed at the more favorable long-term capital gains 
rates.
    Today, Americans have invested trillions of dollars in 
mutual funds, with about half of this amount in taxable 
accounts. The SEC requires that the general effect of investing 
in mutual funds be disclosed to investors in a narrative in a 
fund's prospectus. Mutual funds must inform investors of the 
tax consequences to shareholders of buying, holding, 
exchanging, and selling fund shares including, as applicable, 
specific disclosures that distributions from the fund may be 
taxed as ordinary income or capital gains, that distributions 
may be subject to tax whether they are received in cash or 
reinvested, and that exchanges for shares of another fund will 
be treated as a sale of the fund's shares and subject to tax. 
Further, funds which may engage in active and frequent trading 
of portfolio securities also are required to explain the tax 
consequences of increased portfolio turnover, and how this may 
affect a fund's performance.
    Mutual funds are also required to list past performance 
figures in a fund's prospectus. Such performance figures are 
disclosed to shareholders net of fees and expenses, but not 
taxes. This means that listed performance figures do not take 
into account the impact taxes have on an investor's rate of 
return. Instead, disclosure focuses on how much money investors 
made before taxes, but not how much money investors actually 
got to keep.
    Mutual fund shareholders invested in taxable funds are 
taxed on their investments in two ways. First, when funds 
distribute income and net realized gains (whether received in 
cash or reinvested in additional shares), shareholders are 
required to pay taxes on those distributions. Second, when the 
investors redeem their fund shares at a gain (whether received 
in cash or exchanged for shares in another fund), the investors 
must pay taxes.
    Concerning taxes on distributions, the Internal Revenue 
Code effectively requires a mutual fund to distribute all net 
income and realized gains from investments on a yearly basis. 
Such distributions are taxable to shareholders in two ways: (1) 
Distributions attributable to dividends, taxable interest and 
net short-term capital gains are taxable to investors as 
ordinary income; and (2) distributions attributable to net 
long-term capital gains are taxable as long-term capital gains. 
In 1998 alone, mutual funds distributed approximately $166 
billion in capital gains and $134 billion in taxable dividends.
    Most non-index funds experience high portfolio turnovers. 
The average portfolio turnover rate for an actively managed 
non-index fund has increased from 30 percent 20 years ago, to 
90 percent today. While high portfolio turnover in non-index 
funds will not necessarily result in higher taxes for 
investors, in practice it frequently does. Fund managers who 
turn over their portfolios without considering the tax 
consequences of their decisions on fund investors may realize 
gains from the sale of portfolio securities without offsetting 
losses, resulting in higher yearly taxes for investors.
    Taxes are one of the most significant costs of mutual fund 
investment. Based on calculations using data from Morningstar, 
the average domestic equity mutual fund has lost nearly two and 
one-half percentage points per year to taxes on distributions 
of dividends and capital gains made to the fund's shareholders. 
In the last five years, it is estimated that investors in 
diversified U.S. stock funds surrendered an average of 15 
percent of their annual gains to taxes. Despite these facts, 
many individual investors still do not understand how these 
taxes affect their mutual fund investments, and they do not 
understand that differences in fund investment strategies can 
produce markedly different tax consequences.
    If every fund lost the same amount to taxes each year, then 
little useful information would be gained by reporting after-
tax returns. However, funds vary tremendously in the tax 
burdens they place on their shareholders. Performance reporting 
that considers only pre-tax returns could lead taxable 
investors to believe that the past performance of a particular 
fund was much better than it actually was for a taxable 
shareholder.
    One of the fundamental principles underlying securities 
regulation is that investors should have access to the most 
accurate information reasonably available concerning the 
performance of their investments. This is certainly true for 
mutual funds. Because under present disclosure regulations the 
impact of ordinary income and capital gains taxes are not 
included in listed historical performance figures, a 
potentially inaccurate impression may be created for investors. 
Investors must be better informed about how much money they get 
to keep once taxes on returns are taken into consideration. By 
doing so, investors will be in a better position to choose 
mutual funds which best suit their investment needs.
    During the October 29, 1999 hearing on the bill before the 
Subcommittee on Finance and Hazardous Materials, witnesses 
agreed that it was important to provide investors with 
information concerning after-tax rates of returns for mutual 
funds. While all witnesses supported the goals of this 
legislation, they differed on the methodology to be employed by 
the SEC for reporting after-tax rates of return to mutual fund 
shareholders.
    Joel M. Dickson, Ph.D., of The Vanguard Group, Inc., 
testified in favor of a methodology which assumes that fund 
shares are not liquidated at the end of the measurement period. 
While this pre-liquidation return methodology may understate 
taxes for those investors who did in fact redeem shares before 
the expiration of the measurement period, Dr. Dickson preferred 
this method because it focuses on the effects on all 
shareholders of the taxes resulting from the portfolio 
manager's investment decisions. Further, Dr. Dickson testified 
that the SEC should employ a methodology for computing after-
tax rates of return for mutual fund investors which 
incorporates the highest individual Federal income tax rate in 
effect at the time of distribution. Dr. Dickson also testified 
that The Vanguard Group employs a similar methodology in 
voluntarily providing information about their after-tax rates 
of return to investors.
    David B. Jones, Vice President of Fidelity Management & 
Research Company, testified that a methodology including post-
liquidation returns gives a more realistic impression of a 
typical investor's after-tax return, especially for longer time 
periods. Mr. Jones testified that focusing solely on pre-
liquidation returns risks fostering the impression that taxes 
can be deferred indefinitely, and tends to exaggerate the 
benefits of tax deferral. While Fidelity also voluntarily lists 
after-tax rates of return for some of their funds, they only 
list pre-liquidation rates of return in conjunction with post-
liquidation return rates.
    Given the differing opinions about the correct methodology 
to be employed in deriving after-tax rates of return for mutual 
funds, the legislation defers to the SEC about whether to list 
such returns on a pre- or post-liquidation basis, or both.
    The Committee notes that there have been increasing demands 
for improvement in the disclosure of tax consequences of mutual 
fund investments. Mutual funds and third party providers are 
responding to this growing investor demand by providing after-
tax information and offering Internet tools that investors can 
use to compute after-tax returns. Several fund groups have 
created new funds promoting the use of more tax-efficient 
portfolio management strategies. The Committee commends these 
developments but believes that the standardized disclosures 
called for by this legislation will best help investors 
understand the magnitude of tax costs and compare the impact of 
taxes on the performance of different funds.
    In response to the Committee's interest in H.R. 1089 and to 
investor demand for better information about the impact of 
taxes on mutual fund performance, the SEC on March 15, 2000, 
issued a proposed rule (Release Nos. 33-7809; 34-42528; IC-
24339; File No. S7-09-00) that would require funds to present 
both pre- and post-liquidation after-tax returns. The Committee 
expects that, in developing the best methodology for computing 
after-tax rates of return for mutual funds, the SEC will 
consider the comments of the industry, investors, and others on 
this recently issued proposal.

                                hearings

    The Subcommittee on Finance and Hazardous Materials held a 
hearing on Increasing Disclosures to Benefit Investors on 
October 29, 1999. The Subcommittee received testimony from the 
following witnesses: Joel M. Dickson, Ph.D., Senior Investment 
Analyst, The Vanguard Group, Inc.; Mr. David B. Jones, Vice 
President, Fidelity Management and Research Company; and Mr. 
Matthew P. Fink, President, Investment Company Institute. The 
SEC submitted written testimony for the hearing record.

                        committee consideration

    On November 2, 1999, the Subcommittee on Finance and 
Hazardous Materials met in open markup session and approved 
H.R. 1089 for Full Committee consideration, as amended, by a 
voice vote. On March 15, 2000, the Committee on Commerce met in 
open markup session and ordered H.R. 1089 reported to the 
House, amended, by a voice vote.

                            Committee Votes

    Clause 3(b) of Rule XIII of the Rules of the House of 
Representatives requires the Committee to list the record votes 
on the motion to report legislation and amendments thereto. 
There were no record votes taken in connection with ordering 
H.R. 1089 reported. A motion by Mr. Bliley to order H.R. 1089 
reported to the House, without amendment, was agreed to by 
voice vote.
    The following voice vote was taken on amendments to the 
bill:
    An amendment in the nature of a substitute by Mr. Gilmor, 
No. 1, making technical changes to the bill, was agreed to by 
voice vote.

                      Committee Oversight Findings

    Pursuant to clause 3(c)(1) of rule XIII of the Rules of the 
House of Representatives, the Committee held a legislative 
hearing and made findings that are reflected in this report.

           Committee on Government Reform Oversight Findings

    Pursuant to clause 3(c)(4) of rule XIII of the Rules of the 
House of Representatives, no oversight findings have been 
submitted to the Committee by the Committee on Government 
Reform.

   New Budget Authority, Entitlement Authority, and Tax Expenditures

    In compliance with clause 3(c)(2) of rule XIII of the Rules 
of the House of Representatives, the Committee finds that H.R. 
1089, the Mutual Fund Tax Awareness Act of 2000, would result 
in no new or increased budget authority, entitlement authority, 
or tax expenditures or revenues.

                        Committee Cost Estimate

    The Committee adopts as its own the cost estimate prepared 
by the Director of the Congressional Budget Office pursuant to 
section 402 of the Congressional Budget Act of 1974.

                  Congressional Budget Office Estimate

    Pursuant to clause 3(c)(3) of rule XIII of the Rules of the 
House of Representatives, the following is the cost estimate 
provided by the Congressional Budget Office pursuant to section 
402 of the Congressional Budget Act of 1974:

                                     U.S. Congress,
                               Congressional Budget Office,
                                    Washington, DC, March 23, 2000.
Hon. Tom Bliley,
Chairman, Committee on Commerce,
House of Representatives, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office has 
prepared the enclosed cost estimate for H.R. 1089, the Mutual 
Fund Tax Awareness Act of 2000.
    If you wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contacts are Mark Hadley 
(for federal costs) and Jean Wooster (for the private-sector 
impact).
            Sincerely,
                                          Barry B. Anderson
                                    (For Dan L. Crippen, Director).
    Enclosure.

H.R. 1089--Mutual Fund Tax Awareness Act of 2000

    CBO estimates that enacting H.R. 1089 would have no impact 
on the federal budget. Because the bill would not affect direct 
spending or receipts, pay-as-you-go procedures would not apply. 
H.R. 1089 contains no new intergovernmental or private-sector 
mandates as defined in the Unfunded Mandates Reform Act.
    H.R. 1089 would require the Securities and Exchange 
Commission (SEC) to revise regulations to improve the 
disclosure of information on after-tax returns in investment 
company prospectuses or annual reports. On March 15, 2000, the 
SEC proposed a rule to require disclosure of the after-tax 
returns to investors based on a standardized formula, so the 
bill would not change the agency's current work plans. Because 
CBO expects that the rule would be implemented under current 
law, H.R. 1089 would not impose a new mandate on the private 
sector.
    The CBO staff contacts are Mark Hadley (for federal costs), 
and Jean Wooster (for the private-sector impact). This estimate 
was approved by Peter H. Fontaine, Deputy Assistant Director 
for Budget Analysis.

                       Federal Mandates Statement

    The Committee adopts as its own the estimate of Federal 
mandates prepared by the Director of the Congressional Budget 
Office pursuant to section 423 of the Unfunded Mandates Reform 
Act.

                      Advisory Committee Statement

    No advisory committees within the meaning of section 5(b) 
of the Federal Advisory Committee Act were created by this 
legislation.

                   Constitutional Authority Statement

    Pursuant to clause 3(d)(1) of rule XIII of the Rules of the 
House of Representatives, the Committee finds that the 
Constitutional authority for this legislation is provided in 
Article I, section 8, clause 3, which grants Congress the power 
to regulate commerce with foreign nations, among the several 
States, and with the Indian tribes.

                  Applicability to Legislative Branch

    The Committee finds that the legislation does not relate to 
the terms and conditions of employment or access to public 
services or accommodations within the meaning of section 
102(b)(3) of the Congressional Accountability Act.

             Section-by-Section Analysis of the Legislation

Section 1. Short title

    This section provides the short title of the legislation, 
the ``Mutual Fund Tax Awareness Act of 2000''.

Section 2. Findings

    Section 2 sets forth the findings for this bill.

Section 3. Improvements in disclosure requirements

    This section requires the SEC, within 18 months after the 
date of enactment of this bill, to revise regulations under the 
Securities Act of 1933 and the Investment Company Act of 1940 
to improve disclosure in investment company prospectuses or 
annual reports of after tax returns to investors. While the 
bill does not specify a methodology or form for after tax 
return information, it does direct the SEC to make rules 
consistent with the public interest and the protection of 
investors. Although this section requires the SEC to improve 
disclosure for ``investment companies,'' the Committee intends 
for improvement to be made for mutual funds (i.e., open-end 
management investment companies) and not necessarily for other 
types of investment companies.

         Changes in existing law made by the bill, as reported

    This legislation does not amend any existing Federal 
statute.