[Federal Register Volume 65, Number 56 (Wednesday, March 22, 2000)]
[Proposed Rules]
[Pages 15500-15519]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-6948]



[[Page 15499]]

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Part IV





Securities and Exchange Commission





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17 CFR Part 230 et al.



Disclosure of Mutual Fund After-Tax Returns; Proposed Rule

  Federal Register / Vol. 65, No. 56 / Wednesday, March 22, 2000 / 
Proposed Rules  

[[Page 15500]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 230, 239, 270, and 274

[Release Nos. 33-7809; 34-42528; IC-24339; File No. S7-09-00]
RIN: 3235-AH77


Disclosure of Mutual Fund After-Tax Returns

AGENCY: Securities and Exchange Commission

ACTION: Proposed rule

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SUMMARY: The Securities and Exchange Commission is proposing rule and 
form amendments under the Securities Act of 1933 and the Investment 
Company Act of 1940 to improve disclosure to investors of the effect of 
taxes on the performance of open-end management investment companies 
(``mutual funds'' or ``funds''). Under the proposed amendments, mutual 
funds would be required to disclose after-tax returns based on 
standardized formulas comparable to the formula currently used to 
calculate before-tax average annual total returns. The proposals also 
would require funds that include after-tax returns in advertisements 
and other sales materials to include standardized after-tax returns.

DATES: Comments must be received on or before June 30, 2000.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G. 
Katz, Secretary, Securities and Exchange Commission, 450 5th Street, 
N.W., Washington, D.C. 20549-0609. Comments also may be submitted 
electronically at the following E-mail address: [email protected]. 
All comment letters should refer to File No. S7-09-00; this file number 
should be included on the subject line if E-mail is used. All comments 
received will be available for public inspection and copying in the 
Commission's Public Reference Room, 450 5th Street, N.W., Washington, 
D.C. 20549-0102. Electronically submitted comment letters will be 
posted on the Commission's Internet site (http://www.sec.gov).

FOR FURTHER INFORMATION CONTACT: Maura S. McNulty, Senior Counsel, 
Martha B. Peterson, Special Counsel, or Kimberly Dopkin Rasevic, 
Assistant Director, (202) 942-0721, Office of Disclosure Regulation, 
Division of Investment Management, Securities and Exchange Commission, 
450 5th Street, N.W., Washington, D.C. 20549-0506.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'') is proposing for comment amendments to Form N-1A [17 
CFR 239.15A and 274.11A],   the registration form used by mutual   
funds to register under the Investment Company  Act  of  1940  [15 
U.S.C. 80a-1 et seq.] (``Investment Company Act'') and to offer their 
shares under the Securities Act of 1933 [15 U.S.C. 77a et seq.] 
(``Securities Act''). The Commission also is proposing amendments to 
rule 482 under the Securities Act [17 CFR 230.482] and rule 34b-1 under 
the Investment Company Act [17 CFR 270.34b-1].

Table of Contents

I. Introduction
II. Discussion
    A. Requirement to Disclose After-Tax Return
    B. Location of Required Disclosure
    C. Format of Disclosure
    D. Exemptions from the Disclosure Requirement
    E. Advertisements and Other Sales Literature
    F. Formulas for Computing After-Tax Return
    1. Tax Bracket
    2. Historical versus Current Tax Rates
    3. Calendar versus Fiscal Year Measurement Period
    4. State and Local Tax Liability
    5. Federal Alternative Minimum Tax and Phaseout Adjustments
    6. Timing and Method of Tax Payment
    7. Tax Treatment of Distributions
    8. Capital Gains and Losses Upon a Sale of Fund Shares
    G. Narrative Disclosure
    H. Alternatives to Disclosure of After-Tax Return
    I. Technical and Conforming Amendments
    J. Compliance Date
III. General Request For Comments
IV. Cost/Benefit Analysis
V. Summary Of Initial Regulatory Flexibility Analysis
VI. Paperwork Reduction Act
VII. Statutory Authority
Text Of Proposed Rules And Forms

I. Introduction

    Taxes are one of the most significant costs of investing in mutual 
funds through taxable accounts. In 1998, mutual funds distributed 
approximately $166 billion in capital gains and $134 billion in taxable 
dividends.\1\ Shareholders investing in stock and bond funds paid an 
estimated $34 billion in taxes in 1997 on distributions by their 
funds.\2\ Recent estimates suggest that more than two and one-half 
percentage points of the average stock fund's total return is lost each 
year to taxes.\3\ Moreover, 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.\4\
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    \1\ Investment Company Institute (``ICI''), MUTUAL FUND FACT 
BOOK 56 (1999) (``1999 MUTUAL FUND FACT BOOK'') (distributions of 
taxable dividends included $81.9 billion on equity, hybrid, and bond 
funds and $52.1 billion on money market funds).
    \2\ Liberty Funds Distributor, Mutual Fund ``Tax Pain Index'' 
Rises Again Despite Capital Gains Rate Cut (visited Feb. 1, 2000) 
http://www.libertyfunds.com/liberty/lf/scripts/
inTheNews.jsp?BV__SessionID=@@@@0115467702. 
0949422874@@@@&BV__EngineID= calglgclfhhbfdmckgcfjicil. 0> (estimate 
of the tax burden based on net capital gains realized on mutual 
funds other than money market funds, and net investment income on 
equity, bond, and income funds).
    \3\ KPMG Peat Marwick LLP, An Educational Analysis of Tax-
Managed Mutual Funds and the Taxable Investor (``KPMG Study''), at 
14.
    \4\ Jonathan Clements, Fund Distributions are a Taxing Problem; 
How the Tax Man Dines on Your Funds, THE WALL STREET JOURNAL, Aug. 
31, 1999, at C1.
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    Despite the tax dollars at stake, many investors lack a clear 
understanding of the impact of taxes on their mutual fund 
investments.\5\ Generally, a mutual fund shareholder is taxed when he 
or she receives income or capital gains distributions from the fund and 
when the shareholder redeems fund shares at a gain.\6\ The tax 
consequences of distributions are a particular source of surprise to 
many investors when they discover that they can owe substantial taxes 
on their mutual fund investments that appear to be unrelated to the 
performance of the fund. Even if the value of a fund has declined 
during the year, a shareholder can owe taxes on capital gains 
distributions if the portfolio manager sold some of the

[[Page 15501]]

fund's underlying portfolio securities at a gain.\7\
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    \5\ In a recent telephone survey, 1,000 mutual fund investors 
were asked about their tax knowledge. Eighty-five percent of 
respondents claimed taxes play an important role in investment 
decisions, but only thirty-three percent felt that they were very 
knowledgeable about the tax implications of investing. Eighty-two 
percent were unable to identify the maximum rate for long-term 
capital gains. The Dreyfus Corporation, Dreyfus' 1999 Tax Informed 
Investing Study (visited Jan. 14, 2000) http://www.dreyfus.com/>. In 
another survey, 1,555 mutual fund investors were asked a variety of 
questions to test their knowledge about mutual funds. Only 60 
percent correctly answered a question asking them to identify 
factors that may influence after-tax returns. Brill's Mutual Funds 
Interactive, Humberto Cruz: Take the Investor Literacy Test (visited 
Jan. 31, 2000) http://www.fundsinteractive.com/features/crz07991.html>.
    \6\ I.R.C. 61(a)(3) and (7) (providing that an individual's 
gross income includes dividends and gains derived from dealings in 
property); I.R.C. 852(b)(3)(8) (capital gain dividend from a mutual 
fund treated as gain from sale or exchange of capital asset held for 
more than one year); I.R.C. 1001 (gain from sale or other 
disposition of property is excess of amount realized over adjusted 
basis, and loss is excess of the adjusted basis over amount 
realized). See IRS Publication 564, Mutual Fund Distributions 
(1999), at 2-4 (explaining tax treatment of distributions of income 
and capital gains by mutual funds to their shareholders).
    \7\ This is attributable, in part, to the fact that a mutual 
fund generally must distribute substantially all of its net 
investment income and realized capital gains to its shareholders in 
order to qualify for favorable tax treatment as a ``regulated 
investment company'' (``RIC''). I.R.C. 852 and 4982(b). As a RIC, a 
mutual fund is generally entitled to deduct dividends paid to 
shareholders, resulting in its shareholders being subject to only 
one level of taxation on the income and gains distributed to them. 
I.R.C. 851 (circumstances under which an investment company may be 
treated as a RIC) and 852(b)(2) (calculation of taxable income of a 
RIC).
    See, e.g., Year-End Tax Tips, Bob Edwards (National Public 
Radio, Morning Edition radio broadcast, Dec. 28, 1999) (describing 
tax consequences of mutual fund distributions as a ``shock'' to 
investors).
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    The tax impact of mutual funds on investors can vary significantly 
from fund to fund. For example, the amount and character of a fund's 
taxable distributions are affected by its investment strategies, 
including the extent of a fund's investments in securities that 
generate dividend and other current income, the rate of portfolio 
turnover and the extent to which portfolio trading results in realized 
gains, and the degree to which portfolio losses are used to offset 
realized gains. One recent study reported that the annual impact of 
taxes on the performance of stock funds varied from zero, for the most 
tax-efficient funds, to 5.6 percentage points, for the least tax-
efficient.\8\ While the tax-efficiency of a mutual fund is of little 
consequence to investors in 401(k) plans or other tax-deferred 
vehicles, it can be very important to an investor in a taxable account, 
particularly a long-term investor whose tax position may be 
significantly enhanced by minimizing current distributions of income 
and capital gains.
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    \8\ KPMG study, supra note 3, at 14 (reporting the impact of 
taxes on performance of 496 stock funds for the ten-year period 
ending December 31, 1997).
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    Recently, there have been increasing calls for improvement in the 
disclosure of the tax consequences of mutual fund investments. Mutual 
funds, as well as third party providers that furnish information to 
mutual fund shareholders, are responding to this growing investor 
demand by providing after-tax returns, calculators that investors can 
use to compute after-tax returns, and other tax information.\9\ In 
addition, several fund groups have created new funds promoting the use 
of more tax-efficient portfolio management strategies.\10\ At the same 
time, a bill has been introduced in Congress that would require the 
Commission to revise its regulations to require improved disclosure of 
mutual fund after-tax returns.\11\ Many press commenters also have 
highlighted the need for improvements in mutual fund tax 
disclosure.\12\
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    \9\ For example, Eaton Vance Management and The Vanguard Group 
have recently announced plans to begin reporting after-tax returns 
to shareholders. Eaton Vance to Disclose After-Tax Returns, FUND 
ACTION, Dec. 20, 1999, Vol. X/No. 51, at 6; Access Vanguard, 
Vanguard to Publish After-Tax Returns in Equity and Balanced Fund 
Reports (Oct. 11, 1999) (visited Feb. 1, 2000) http://www.vanguard.com/cgi-bin/pressroom/PRPrevious.html>. Fidelity 
Investments and Charles Schwab & Co. also have begun offering 
Internet tools that feature after-tax returns of funds offered in 
their fund supermarkets. Fidelity Investments, Track After-Tax Fund 
Performance On-Line (visited February 8, 2000) http://personal300.fidelity.com/global/whatsnew/ content/94689.html.tvsr> 
(after-tax returns for most equity funds sold through the fund 
supermarket); Short Takes: Schwab Offering On-Line Research Access, 
THE AMERICAN BANKER, Jan. 5, 2000, at 6 (after-tax returns for funds 
listed by Morningstar, Inc.).
    Further, Morningstar, Inc., and Forbes report mutual fund after-
tax returns. Morningstar, MUTUAL FUND 500 (1999 ed.); Fund Survey, 
FORBES, Feb. 7, 2000, at 166.
    On-line tax calculators that calculate after-tax returns are 
also available. Andrew Tobias' Mutual Fund Cost Calculator, (visited 
Jan. 14, 2000) http://www.personalfund.com/cgibon/calculate.cgi> 
(cost calculator includes a feature that calculates after-tax 
returns); Access Vanguard, After-Tax Returns Calculator (visited 
Jan. 19, 2000) http: //majestic3.vanguard.com/FP/DA/0.1. 
vgi__FundAfterTaxSim/ 212820070619150300? AFTER__TAX __CALC=SIMPLE>.
    \10\ The many fund groups offering funds labeled as ``tax-
managed'' or ``tax-efficient'' include American Century, Eaton 
Vance, Liberty Funds, Paine Webber, Prudential, T. Rowe Price, and 
Voyager. Morningstar, Inc., currently tracks 42 tax-managed funds, 
as compared to 12 such funds only three years ago. Morningstar.com, 
Tax-Managed Funds Keep Uncle Sam at Bay (visited Feb. 23, 2000) 
http://news.morningstar.com/news/ms/ taxingissues/000125taxes.html>.
    \11\ The Mutual Fund Tax Awareness Act of 1999, H.R. 1089, 106th 
Cong., 1st Sess. (1999) (introduced by Congressman Paul Gillmor). 
See also H.R. 1089: The Mutual Fund Tax Awareness Act of 1999: 
Hearings Before the Subcomm. on Finance and Hazardous Materials of 
the House Comm. on Commerce, 106th Cong., 1st Sess. (Oct. 29, 1999) 
(Statement of the U.S. Securities and Exchange Commission Concerning 
Disclosure of the Tax Consequences of Mutual Fund Investments and 
Charitable Contributions).
    \12\ See, e.g., Karen Damato, Funds' Tally of IRS Bite Can Be 
Tricky, THE WALL STREET JOURNAL, Nov. 3, 1999, at C1; Paul J. Lim, 
Your Money; Funds and 401(k)s; As Stock Market Returns Shrink, 
After-Tax Results Gain Importance, LOS ANGELES TIMES, Oct. 17, 1999, 
at C3; Charles A. Jaffe, Mutual Fund Gains Create Interesting Tax 
Issues Later, THE KANSAS CITY STAR, Mar. 23, 1999, at D19.
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    Currently, the Commission requires mutual funds to disclose 
significant information about taxes to investors. In its prospectus, a 
mutual fund is required to disclose (i) the tax consequences of buying, 
holding, exchanging, and selling fund shares, including the tax 
consequences of fund distributions; and (ii) whether the fund may 
engage in active and frequent portfolio trading to achieve its 
principal investment strategies, and, if so, the tax consequences of 
increased portfolio turnover and how this may affect fund 
performance.\13\ A fund also must disclose in its prospectus and annual 
report the portfolio turnover rate and dividends and capital gains 
distributions per share for each of the last five fiscal years.\14\ 
While we believe this disclosure is useful, we are persuaded that funds 
can more effectively communicate to investors the tax consequences of 
investing. We are therefore proposing for public comment amendments to 
our rules and to Form N-1A, the registration form for mutual funds, 
that would require disclosure of standardized mutual fund after-tax 
returns.
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    \13\ Item 7(e) of Form N-1A; Instruction 7 to Item 4 of Form N-
1A.
    \14\ Items 9(a) and 22(b)(2) of Form N-1A. These items also 
require funds to show net realized and unrealized gain or loss on 
investments on a per share basis for each of the fund's last five 
fiscal years.
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    This is the latest Commission action in our continuing effort to 
improve the quality of mutual fund disclosure in order to help 
investors make better-informed decisions. In 1998, for example, we 
adopted comprehensive amendments to Form N-1A in order to focus the 
disclosure in a fund's prospectus on essential information that will 
assist investors in deciding whether to invest in the fund.\15\ We also 
permitted the use of a new short-form document, the fund ``profile,'' 
which summarizes key information about a mutual fund.\16\
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    \15\ Investment Company Act Release No. 23064 (Mar. 13, 1998) 
[63 FR 13916 (Mar. 23, 1998)] (``Form N-1A Adopting Release''), at 
13917.
    \16\ Investment Company Act Release No. 23065 (Mar. 13, 1998) 
[63 FR 13968 (Mar. 23, 1998)], at 13969.
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    Over the years, we have implemented a number of initiatives to 
improve fund disclosure of costs and performance. We standardized 
before-tax fund performance in advertisements and sales literature in 
order to prevent misleading performance claims by funds and to permit 
investors to make meaningful comparisons among funds.\17\ We introduced 
a uniform fee table in the prospectus \18\ and required that a fund 
discuss its performance over the past year in its prospectus or annual 
report to shareholders.\19\
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    \17\ Investment Company Act Release No. 16245 (Feb. 2, 1988) [53 
FR 3868 (Feb. 10, 1988)], at 3869.
    \18\ Item 3 of Form N-1A; Investment Company Act Release No. 
16244 (Feb. 1, 1988) [53 FR 3192 (Feb. 4, 1988)].
    \19\ Item 5(a) of Form N-1A; Investment Company Act Release No. 
19382 (Apr. 6, 1993) [58 FR 19050 (Apr. 12, 1993)] (``MDFP 
Release'').
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    More recently, we have increased our efforts to educate investors 
about mutual fund costs and how those costs

[[Page 15502]]

affect performance.\20\ Just last year, we introduced a ``Mutual Fund 
Cost Calculator'' to assist investors in determining how fund fees and 
charges affect their mutual fund returns.\21\
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    \20\ See, e.g., Securities and Exchange Commission, Mutual Fund 
Investing: Look at More Than a Fund's Past Performance (last 
modified Jan. 24, 2000) http://www.sec.gov/consumer/mperf.htm>; 
Securities and Exchange Commission, Invest Wisely: An Introduction 
To Mutual Funds (last modified Oct. 21, 1996) http://www.sec.gov/consumer/inws.htm>; ``Common Sense Investing in the 21st Century 
Marketplace,'' Remarks by Arthur Levitt, Chairman, SEC, Investors 
Town Meeting, Albuquerque, NM (Nov. 20, 1999); ``Financial Self-
Defense: Tips From an SEC Insider,'' Remarks by Arthur Levitt, 
Boston Globe ``Moneymatters'' Personal Finance Conference, Boston, 
MA (Oct. 16, 1999); Transparency in the United States Debt Market 
and Mutual Fund Fees and Expenses: Hearings Before the Subcomm. on 
Finance and Hazardous Materials of the House Comm. on Commerce, 
105th Cong., 2nd Sess. (Sept. 29, 1998) (Statement of Arthur Levitt, 
Chairman, U.S. Securities and Exchange Commission).
    \21\ Securities and Exchange Commission, The SEC Mutual Fund 
Cost Calculator (last modified December 6, 1999) http://www.sec.gov/mfcc/mfcc-int.htm>.
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    Today's proposal represents another significant step in these 
efforts. Taxes are one of the largest costs associated with a mutual 
fund investment, having a dramatic impact on the return an investor 
realizes from a fund. Our proposal will help investors to understand 
the magnitude of tax costs and compare the impact of taxes on the 
performance of different funds.
    While the Commission recognizes that a significant amount of mutual 
fund assets are held through tax-deferred arrangements, such as 401(k) 
plans or individual retirement accounts (``IRAs''), approximately half 
of non-money market fund assets held by individuals are held in taxable 
accounts.\22\ We are concerned that the millions of mutual fund 
investors who are subject to current taxation may not fully appreciate 
the impact of taxes on their fund investments because mutual funds are 
required to report their performance on a before-tax basis only.\23\ 
Although performance is only one of many factors that an investor 
should consider in deciding whether to invest in a particular fund, 
many investors consider performance one of the most significant factors 
when selecting or evaluating a fund.\24\ As a result, we believe it 
would be beneficial for funds to provide their after-tax performance in 
order to allow investors to make better-informed decisions.
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    \22\ As of year end 1998, seventy-eight percent of mutual fund 
assets ($4.3 trillion) were held by individuals. 1999 MUTUAL FUND 
FACT BOOK, supra note 1, at 41. At the end of 1998, mutual fund 
assets held in retirement accounts stood at $1.9 trillion. 1999 
MUTUAL FUND FACT BOOK, at 47. Mutual fund assets held by individuals 
in money market funds stood at $714 billion. 1999 MUTUAL FUND FACT 
BOOK, at 90, 100. Thus, 47 percent of non-money market fund assets 
held by individuals ($1.7 trillion) were held in taxable accounts.
    An investor is not taxed on his or her investments in IRAs, 
401(k) plans, and other qualified retirement plans until the 
investor receives a distribution from the plan. I.R.C. 401 et seq. 
See IRS Publication 564, Mutual Fund Distributions (1999), at 2 
(explaining tax treatment of mutual funds held in retirement 
vehicles).
    \23\ See Items 2, 5, 9, and 22(b)(2) of Form N-1A.
    \24\ We recently posted a bulletin for mutual fund investors on 
our website, in which we cautioned investors to look beyond 
performance when evaluating mutual funds and to consider the costs 
relating to a mutual fund investment, including fees, expenses, and 
the impact of taxes on their investment. Securities and Exchange 
Commission, Mutual Fund Investing: Look at More Than a Fund's Past 
Performance (last modified Jan. 24, 2000) http://www.sec.gov/consumer/mperf.htm/>.
    See ICI, Understanding Shareholders' Use of Information and 
Advisers (Spring 1997), at 21 and 24. (Total return information was 
frequently considered by investors before a purchase, second only to 
the level of risk of the fund. Eighty-eight percent of fund 
investors surveyed said that they considered total return before 
their most recent purchase of a mutual fund. Eighty percent of fund 
owners surveyed reported that they followed a fund's rate of return 
at least four times per year.).
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    Our proposals would require a fund to disclose its standardized 
after-tax returns for 1-, 5-, and 10-year periods. After-tax returns, 
which would accompany before-tax returns in fund prospectuses and 
annual reports, would be presented in two ways: (i) assuming the 
shareholder continued to hold his or her shares at the end of the 
period; and (ii) assuming the shareholder sold his or her shares at the 
end of the period, realizing taxable gain or loss on the sale. Although 
after-tax returns would not be required in fund advertisements and 
sales literature, any fund choosing to include after-tax returns in 
these materials would be required to include after-tax returns computed 
according to our standardized formula.

II. Discussion

A. Requirement to Disclose After-Tax Return

    The Commission is proposing to require that mutual funds disclose 
after-tax return, a measure of a fund's performance adjusted to reflect 
taxes that would be paid by an investor in the fund. The proposal would 
require after-tax return information to be included in the risk/return 
summary of the prospectus and in Management's Discussion of Fund 
Performance (``MDFP''), which is typically contained in the annual 
report.\25\ Funds would not be required to include after-tax returns in 
advertisements or other sales materials, although funds choosing to 
include after-tax returns in sales materials would be required to 
include after-tax returns computed according to a standardized 
formula.\26\
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    \25\ Proposed Items 2(c)(2)(i) and (iii) and 5(b)(2) of Form N-
1A.
    \26\ Proposed rules 482(e)(4), 482(e)(5)(iii), and 34b-
1(b)(1)(iii)(B).
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    We considered whether, in lieu of requiring after-tax returns to be 
included in prospectuses and annual reports, we should simply require 
that funds voluntarily choosing to include after-tax returns in any 
materials (prospectus, annual report, or sales materials) also include 
after-tax returns computed according to a standardized formula. We 
concluded that this approach would not achieve our basic goal of 
providing investors in all mutual funds with better disclosure of the 
tax consequences of their investments. Permitting funds to choose 
whether to disclose after-tax returns could leave investors without the 
information required to compare after-tax returns for each fund they 
were considering and could leave funds with the latitude to disclose 
this information only when it is favorable.
    Funds would calculate after-tax return by using a standardized 
formula similar to the formula presently used to calculate before-tax 
average annual total return.\27\ The proposal would require funds to 
disclose after-tax return for 1- 5-, and 10-year periods on both a 
``pre-liquidation'' and ``post-liquidation'' basis. Pre-liquidation 
after-tax return assumes that the investor continues to hold fund 
shares at the end of the measurement period, and, as a result, reflects 
the effect of taxable distributions by a fund to its shareholders but 
not any taxable gain or loss that would be realized by a shareholder 
upon the sale of fund shares.\28\ Post-liquidation after-tax return 
assumes that the investor sells his or her fund shares at the end of 
the measurement period, and, as a result, reflects the effect of both 
taxable distributions by a fund to its shareholders and any taxable 
gain or loss realized by the shareholder upon the sale of fund 
shares.\29\ Pre-liquidation after-tax return reflects the tax effects 
on shareholders of the portfolio manager's purchases and sales of 
portfolio securities, while post-liquidation after-tax return also 
reflects the tax effects of a shareholder's individual decision to sell 
fund shares.
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    \27\ See Item 21(b)(1) of Form N-1A.
    \28\ Proposed Item 21(b)(3) of Form N-1A.
    \29\ Proposed Item 21(b)(4) of Form N-1A.
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    The Commission proposes to require the presentation of both pre-and 
post-liquidation after-tax returns in order to provide investors with a 
more complete understanding of the impact of taxes on

[[Page 15503]]

a fund's performance. The relative value of these two measures of 
after-tax performance is the subject of ongoing debate among industry 
participants. Those who support the use of pre-liquidation after-tax 
return argue that pre-liquidation after-tax return provides the most 
relevant information for analyzing the tax impact of decisions by the 
portfolio manager.\30\ Others argue that this measure of after-tax 
return, taken alone, tends to overstate the benefits of tax deferral on 
shareholder gains.\31\
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    \30\ See H.R. 1089: The Mutual Fund Tax Awareness Act of 1999: 
Hearings Before the Subcomm. on Finance and Hazardous Materials of 
the House Comm. on Commerce, 106th Cong., 1st Sess. (Oct. 29, 1999) 
(Statement of Joel M. Dickson, Principal, The Vanguard Group, Inc.) 
(stating that ``the primary advantage of the pre-liquidation 
calculation is that it isolates the effects on all shareholders of 
the taxes resulting from the portfolio manager's investment 
decisions'').
    \31\ See H.R. 1089: The Mutual Fund Tax Awareness Act of 1999: 
Hearings Before the Subcomm. on Finance and Hazardous Materials of 
the House Comm. on Commerce, 106th Cong., 1st Sess. (Oct. 29, 1999) 
(Statement of David B. Jones, Vice President, Fidelity Management & 
Research Co.) (stating that ``pre-liquidation returns risk fostering 
the impression that taxes can be deferred indefinitely, which is not 
the case for most investors; and tend to exaggerate the benefits of 
tax deferral'').
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    We believe that pre-liquidation after-tax return is important 
because it provides information about the tax-efficiency of portfolio 
management decisions. We also believe, however, that it is important 
for shareholders, many of whom hold shares for a relatively brief 
period, to understand the full impact that taxes have on a mutual fund 
investment that has been sold.\32\ Therefore, we are proposing to 
require funds to disclose both measures of after-tax return.
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    \32\ A recent report estimates that over the past decade the 
average holding period of mutual funds has decreased from over 10 
years to about 3 years. Steve Galbraith, Mary Medley, Sean Yu, The 
Apotheosis of Stuart--Lighting the Candle in U.S. Equities, 
Bernstein Research Call, Sanford C. Bernstein & Co., Jan. 10, 2000.
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    We are proposing that funds reflect the deduction of any fees and 
charges payable upon a sale of fund shares, such as sales charges or 
redemption fees, in post-liquidation after-tax returns but not in pre-
liquidation after-tax returns.\33\ This is consistent with the fact 
that post-liquidation after-tax returns assume a sale of fund shares by 
the investor, while pre-liquidation after-tax returns do not. Funds are 
currently required to disclose before-tax returns reflecting the 
deduction of any fees and charges payable upon a sale of fund 
shares.\34\ These before-tax returns may usefully be compared to the 
post-liquidation after-tax return measure that we are proposing 
(because both types of returns reflect fees and charges payable upon a 
sale of fund shares), but they may not usefully be compared to the pre-
liquidation after-tax return measure that we are proposing (which does 
not reflect fees and charges payable upon sale of fund shares).
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    \33\ Instruction 6 to proposed Item 21(b)(4) and Instruction 6 
to proposed Item 21(b)(3) of Form N-1A.
    \34\ Instruction 4 to Item 21(b)(1) of Form N-1A.
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    We are therefore proposing to require that funds also disclose 
before-tax returns that do not reflect the deduction of fees and 
charges payable upon a sale of fund shares. This would provide 
investors with a before-tax return measure that can be compared with 
the pre-liquidation after-tax return measure that we are proposing.\35\ 
In the alternative, we considered requiring that pre-liquidation after-
tax return reflect the deduction of any fees and charges payable upon a 
sale of fund shares. Pre-liquidation after-tax return computed in this 
way could usefully be compared to the before-tax return that is 
currently required to be disclosed, but we were concerned that 
investors would be confused by a pre-liquidation after-tax return 
measure that assumed no sale of fund shares for purposes of computing 
tax consequences but nonetheless reflected fees and charges payable 
upon a sale of fund shares.
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    \35\ Proposed Items 2(c)(2)(iii)(A), 5(b)(2)(i), and 21(b)(1) of 
Form N-1A.
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    Commenters are requested to discuss whether we should require 
disclosure of after-tax returns. Is this information useful to, and 
understandable by, investors? Commenters are asked to address the 
relative merits of requiring disclosure of after-tax returns versus 
standardizing the computation of after-tax returns for funds that 
choose to disclose after-tax returns. Should disclosure be mandatory 
only for funds that hold themselves out as ``tax-managed'' or otherwise 
managed with a view to shareholder tax consequences?
    Should we require disclosure of both pre-liquidation and post-
liquidation after-tax returns or is disclosure of one of these measures 
sufficient? Commenters also are requested to discuss how we should 
address the issue of providing a useful comparison for pre-liquidation 
after-tax returns. Should we, as proposed, require the disclosure of 
before-tax return that does not reflect the deduction of any fees and 
charges payable upon a sale of fund shares? Or should we require funds 
to reflect the deduction of any fees and charges payable upon a sale of 
fund shares in pre-liquidation after-tax returns or take some other 
approach? Finally, commenters are asked to address whether we should 
require disclosure of after-tax returns for an index or a peer group of 
funds.

B. Location of Required Disclosure

    The proposal would require mutual funds to disclose after-tax 
returns in the performance table contained in the risk/return summary 
of the prospectus and in the MDFP, which is typically contained in the 
annual report.\36\ The proposal also would have the effect of requiring 
the inclusion of after-tax returns in any fund profile because a 
profile must include the prospectus risk/return summary.\37\
---------------------------------------------------------------------------

    \36\ Proposed Items 2(c)(2)(iii) and 5(b)(2) of Form N-1A.
    \37\ Rule 498(c)(2)(iii) under the Securities Act [17 CFR 
230.498(c)(2)(iii)]. In addition, after-tax returns would be 
required in registration statements filed on Form N-14 [17 CFR 
239.23], the registration form used by mutual funds to register 
securities to be issued in mergers and other business combinations 
under the Securities Act. See Items 5(a) and 6(a) of Form N-14 
(cross-referencing Items 2 and 5 of Form N-1A).
---------------------------------------------------------------------------

    We are proposing to require that after-tax returns be included in 
the prospectus because, for the overwhelming majority of prospective 
investors who base their investment decision, in part, on past 
performance, after-tax returns can be useful in understanding past 
performance.\38\ Including after-tax returns in the performance table 
of the risk/return summary would assist prospective investors in their 
investment decisions by making after-tax returns easy to find and easy 
to compare with before-tax returns, which are currently presented in 
this location.\39\
---------------------------------------------------------------------------

    \38\ An estimated 88 percent of mutual fund shareholders 
considered the total return of the fund before their most recent 
fund purchase. Seventy-five percent of mutual fund shareholders 
considered the fund's performance relative to similar funds. ICI, 
UNDERSTANDING SHAREHOLDERS' USE OF INFORMATION AND ADVISERS (Spring 
1997), at 21.
    \39\ Item 2(c)(2)(iii) of Form N-1A.
---------------------------------------------------------------------------

    We are proposing to include after-tax returns in the MDFP because, 
for existing shareholders, after-tax returns are an important element 
to consider when evaluating fund performance.\40\

[[Page 15504]]

The Commission added the MDFP requirement in response to investor 
concerns that mutual funds did not provide sufficient information to 
permit investors readily to evaluate fund investment results.\41\ 
Including after-tax returns as part of the MDFP presentation will 
enhance its usefulness.
---------------------------------------------------------------------------

    \40\ Eighty percent of mutual fund shareholders monitor the 
performance of their fund holdings at least four times per year. 
ICI, UNDERSTANDING SHAREHOLDERS' USE OF INFORMATION AND ADVISERS 
(Spring 1997), at 24.
    Form N-1A requires that the prospectus include the MDFP unless 
the information is included in the fund's latest annual report to 
shareholders and the fund provides a copy of the annual report, upon 
request and without charge, to each person to whom a prospectus is 
delivered. Item 5 of Form N-1A. A significant majority of funds 
currently include the MDFP in their annual reports to shareholders. 
The Commission has directed the Division of Investment Management to 
draft proposed amendments to fund periodic reporting requirements, 
and has asked that, in connection with such a proposal, the Division 
consider whether the MDFP would be more useful to investors in 
shareholder reports. Form N-1A Adopting Release, supra note 15, at 
13929.
    \41\ MDFP Release, supra note 19, at 19052.
---------------------------------------------------------------------------

    We have considered alternative locations for disclosure of after-
tax returns, including: (i) The bar chart in the risk/return summary; 
(ii) the section of the prospectus describing the tax consequences to 
shareholders of buying, holding, exchanging, and selling fund shares; 
and (iii) the financial highlights table, which appears in both 
prospectuses and annual reports.\42\ Each of these other locations, 
however, presents some drawbacks that resulted in our decision not to 
propose it as the location for after-tax returns.
---------------------------------------------------------------------------

    \42\ Items 2(c)(2), 7(e), and 9 of Form N-1A.
---------------------------------------------------------------------------

    The bar chart is prominently located in the prospectus, but it is 
intended to reflect fund volatility, not overall fund performance. \43\ 
In addition, the performance shown in the bar chart does not reflect 
the deduction of sales loads or account fees and is presented for only 
a single class of a multiple class fund.\44\ Although the tax section 
of the prospectus could provide a centralized location for tax 
information, inclusion of after-tax returns in this section would make 
them far less prominent than the before-tax returns included in the 
risk/return summary. The financial highlights table contains other tax 
information, such as dividends, capital gain distributions, and 
portfolio turnover rate.\45\ On the other hand, the financial 
highlights table is not as prominently located in the prospectus as the 
risk/return summary. Further, the information presented in the 
financial highlights table is presented on a year-by-year basis, rather 
than on the average annual return basis over 1-, 5-, and 10-year 
periods that is used in computing standardized before-tax returns.
---------------------------------------------------------------------------

    \43\ Item 2(c)(2)(i) of Form N-1A; Form N-1A Adopting Release, 
supra note 15, at 13922.
    \44\ Instructions 1 and 3 to Item 2(c)(2) of Form N-1A.
    \45\ Item 9 of Form N-1A.
---------------------------------------------------------------------------

    We also have considered vehicles other than the prospectus and 
annual reports for the disclosure of after-tax returns, including:
     Requiring disclosure of after-tax returns in the Statement 
of Additional Information (``SAI'');
     Providing funds with the option of disclosing after-tax 
returns on their Internet website in lieu of including after-tax 
returns in the prospectus or annual report; and
     Permitting funds to provide after-tax returns upon 
shareholder request only.
    We determined not to propose any of these approaches because each 
would place the burden of obtaining after-tax return information on the 
investor, which could greatly reduce investors' receipt of this useful 
information.
    Comment is requested on the appropriate location for disclosure of 
after-tax returns and how best to convey this information to both 
existing and prospective investors. Should this information be included 
in the prospectus, annual report, profile, or elsewhere? Commenters are 
asked to address the specific location in any document where this 
information should be included (e.g., risk/return summary, MDFP) and 
the advantages and disadvantages of the suggested location. Commenters 
should address the locations discussed in this release and any other 
locations that they believe would be appropriate.

C. Format of Disclosure

    We are proposing that before and after-tax returns be presented in 
a standardized tabular format as follows: \46\
---------------------------------------------------------------------------

    \46\ Proposed Items 2(c)(2)(iii) and 5(b)(2) of Form N-1A.
    Although the proposed performance table in the prospectus risk/
return summary includes the return of a broad-based securities 
market index as shown in the text, the table required in the MDFP 
does not. The MDFP includes the performance of a broad-based 
securities market index in the line graph that accompanies the 
table. See proposed Item 2(c)(2)(iii) of Form N-1A; Item 5(b)(1) of 
Form N-1A.

                      AVERAGE ANNUAL TOTAL RETURNS
                      [For the periods ended ----]
------------------------------------------------------------------------
                                      1 year      5 years      10 years
------------------------------------------------------------------------
If You Continue to Hold Your
 Shares at End of Period:
    Before-Tax Return............          __%          __%          __%
    After-Tax Return.............          __%          __%          __%
If You Sell Your Shares at End of
 Period:
    Before-Tax Return............          __%          __%          __%
    After-Tax Return.............          __%          __%          __%
Index (reflects no deduction for           __%          __%          __%
 fees, expenses, or taxes).......
------------------------------------------------------------------------

Before-and after-tax returns would be required to be presented in the 
order specified, using the captions provided by Form N-1A.\47\ The 
table of returns would be required for each class of a fund offered in 
the prospectus. The four types of return for each class would be 
required to be presented adjacent to one another and not interspersed 
with the returns of other classes or funds.\48\ This should facilitate 
comparisons among the returns shown.
---------------------------------------------------------------------------

    \47\ Proposed Items 2(c)(2)(iii) and 5(b)(2) of Form N-1A.
    \48\ Instruction 3(c) to proposed Item 2 and Instruction 12 to 
proposed Item 5 of Form N-1A.
---------------------------------------------------------------------------

    We considered giving funds flexibility to create different formats 
for presenting the required information. We elected not to propose this 
alternative because of potential investor confusion. We believe that it 
would be easier for shareholders both to compare funds and to 
understand the differences among the different measures of return for 
any particular fund if all funds present this information in the same 
manner, using the same captions. Commenters are requested to address 
whether the Commission should require that before-and after-tax return 
information be presented in a specific format, using required captions. 
Does the proposed table present before-and after-tax return information 
in a clear and understandable way? Do the proposed captions adequately 
describe the information presented? Will investors be able to 
understand the presentation for funds with multiple classes and 
multiple portfolios? Is there a more

[[Page 15505]]

effective way to present after-tax returns for these funds?

D. Exemptions from the Disclosure Requirement

    We are proposing to exempt money market funds from the requirement 
to disclose after-tax returns.\49\ We are also proposing to permit a 
fund that is offered as an investment option in a participant-directed 
defined contribution plan or variable insurance contract to omit the 
after-tax return information in a prospectus for use by participants in 
the plan or owners of the contract.\50\
---------------------------------------------------------------------------

    \49\ Proposed Item 2(c)(2)(iii) of Form N-1A. Money market funds 
are already exempted from the requirements of Item 5 of Form N-1A.
    \50\ Proposed General Instruction C.3(d)(i) of Form N-1A. The 
proposed instruction would permit a fund to omit from its prospectus 
the information required by Items 2(c)(2)(iii)(A), (B), and (D), and 
2(c)(2)(iv), 5(b)(2)(i), (ii), and (iv), and 5(b)(3) if the fund's 
prospectus will be used exclusively to offer fund shares as 
investment options in specified types of plans.
---------------------------------------------------------------------------

    Money market funds typically do not accumulate or distribute 
capital gains and their returns are generally in the form of income 
distributions, which are taxable on a current basis. As a result, the 
tax consequences of investing in different money market funds should be 
similar, i.e., current taxation on income distributions. For this 
reason, requiring money market funds to disclose after-tax returns 
would not significantly assist an investor in comparing different money 
market funds. In addition, it could place money market funds at a 
competitive disadvantage vis-a-vis competing financial products, such 
as bank savings accounts and certificates of deposit, that are not 
required to disclose after-tax returns. For these reasons, we have 
determined not to extend to money market funds the requirement to 
disclose after-tax returns.
    We also are proposing to permit a fund to omit the after-tax return 
information in a prospectus used exclusively to offer fund shares as 
investment options for:
     A defined contribution plan that meets the requirements 
for qualification under section 401(k) of the Internal Revenue Code 
(``Code'');
     A tax-deferred arrangement under section 403(b) or 457 of 
the Code;
     A variable insurance contract as defined in section 817(d) 
of the Code, if covered in a separate account prospectus; or
     A similar plan or arrangement pursuant to which an 
investor is not taxed on his or her investment in the fund until the 
investment is sold.\51\
---------------------------------------------------------------------------

    \51\ Id. We propose expanding the types of prospectuses that may 
omit or modify certain information required by Form N-1A to include 
prospectuses used to offer fund shares as investment options for 
plans or arrangements similar to those currently enumerated in 
General Instruction C.3.(d)(i) of Form N-1A. Proposed General 
Instruction C.3(d)(i)(D) of Form N-1A. We are proposing this change 
in order to accommodate future changes in the tax law that may 
permit new types of plans or arrangements similar to those currently 
enumerated in the instruction.
---------------------------------------------------------------------------

The proposed after-tax return information would largely be irrelevant 
to investors in those arrangements because they are not subject to 
current taxation on fund distributions and their tax consequences on a 
sale of fund shares are different than those experienced by investors 
in taxable accounts.\52\
---------------------------------------------------------------------------

    \52\ See IRS Publication 575, Pension and Annuity Income (1999), 
at 4 (explaining tax treatment of earnings under a variable annuity 
contract) and 8-19 (explaining tax treatment of distributions from 
retirement plans); IRS Publication 525, Taxable and Non-Taxable 
Income (1999), at 3 (explaining tax treatment of contributions to a 
retirement plan) and 22 (explaining tax treatment of proceeds of a 
life insurance contract); IRS Publication 575, Pension and Annuity 
Income (1999), at 4 (tax treatment of Section 457 Deferred 
Compensation Plan); IRS Publication 571, Tax Sheltered Annuity 
Programs for Employees of Public Schools and Certain Tax-Exempt 
Organizations (1999), at 2 (explaining tax treatment of Section 
403(b) tax sheltered annuities).
---------------------------------------------------------------------------

    The Commission considered whether to exclude tax-exempt funds from 
the requirement to disclose after-tax returns.\53\ While most, if not 
all, income distributed by a tax-exempt mutual fund generally will be 
tax-exempt, a tax-exempt mutual fund may also make capital gains 
distributions that are taxable and an investor is taxable on gains from 
the sale of fund shares.\54\ As a result, the performance of a tax-
exempt fund may be affected by taxes and taxes may have a greater or 
lesser impact on different tax-exempt funds. Therefore, we have not 
proposed to exclude tax-exempt funds from the required disclosure.\55\
---------------------------------------------------------------------------

    \53\ The Division of Investment Management has taken the 
position that an investment company with a name that implies that 
its income distributions will be exempt from federal income taxation 
should have a fundamental policy requiring that during periods of 
normal market conditions (i) the fund will have at least 80 percent 
of its net assets in tax-exempt securities or (ii) the fund's assets 
will be invested so that at least 80 percent of the income will be 
tax-exempt. The Commission has proposed to codify this position. 
Investment Company Act Release No. 22530 (Feb. 27, 1997) [62 FR 
10955 (Mar. 10, 1997)], correction [62 FR 24161 (May 2, 1997)], at 
10958.
    \54\ Interest on any state or local bond is excluded from gross 
income. However, there is no exclusion for capital gains resulting 
from the sale of such bonds. See I.R.C. 103(a); IRS Publication 564, 
Mutual Fund Distributions (1999), at 2 (describing tax treatment of 
tax-exempt mutual funds).
    \55\ A tax-exempt fund, like any other fund, may assume, when 
calculating after-tax returns, that no taxes are due on the portions 
of any distribution that would not result in federal income tax on 
an individual. Instruction 3 to proposed Item 21(b)(3) and 
Instruction 3 to proposed Item 21(b)(4) of Form N-1A.
---------------------------------------------------------------------------

    We request that commenters discuss whether the proposed exemptions 
from the after-tax return disclosure requirements are appropriate. 
Should tax-exempt funds or any other types of funds be exempted from 
the requirements?

E. Advertisements and Other Sales Literature

    The Commission is proposing to require that all fund advertisements 
and sales literature that include after-tax performance information 
also include after-tax returns computed according to the standardized 
formulas prescribed in Form N-1A for computation of after-tax returns 
in the risk/return summary and MDFP.\56\ Any quotation of non-
standardized after-tax return also would be subject to the same 
conditions currently applicable to quotations of non-standardized 
performance that are included in fund advertisements and sales 
literature.\57\ Requiring advertisements and sales literature that 
include after-tax returns also to include standardized pre-and post-
liquidation after-tax returns is intended to prevent advertisements and 
sales literature from being misleading and to permit shareholders to 
compare claims about after-tax performance.
---------------------------------------------------------------------------

    \56\ Proposed rule 482(e)(4) would permit the standardized 
after-tax returns for 1-; 5-; and 10-year periods to be contained in 
an advertisement, provided that the standardized after-tax returns 
(i) are current to the most recent calendar quarter ended prior to 
the submission of the advertisement for publication; (ii) are 
accompanied by quotations of standardized before-tax return; (iii) 
include both pre-and post-liquidation standardized after-tax 
returns; (iv) are set out with equal prominence to one another and 
in no greater prominence than the required quotations of 
standardized before-tax return; and (v) identify the length of and 
the last day of the 1-, 5-, and 10-year periods.
    Any other measures of after-tax return could be included in 
advertisements if accompanied by the standardized measures of after-
tax return. Proposed rule 482(e)(5)(iii). Similarly, measures of 
after-tax return could be included in other sales materials if 
accompanied by the standardized measures of after-tax return. 
Proposed rule 34b-1(b)(1)(iii)(B).
    \57\ Specifically, any measure of after-tax return in a rule 482 
advertisement would have to reflect all elements of return and could 
be set out in no greater prominence than the required quotations of 
standardized before-tax and after-tax returns. The advertisement 
would have to identify the length of and the last day of the period 
for which performance is measured. Proposed rule 482(e)(5)(i), (iv), 
and (v).
    In addition, any sales literature that contains a quotation of 
performance that has been adjusted to reflect the effect of taxes 
would remain subject to the other requirements of rule 34b-1.
---------------------------------------------------------------------------

    Comment is requested regarding the inclusion of after-tax returns 
in fund advertisements and other sales literature. Is the proposed 
requirement to disclose standardized after-tax returns in any 
advertisement or other sales literature containing after-tax

[[Page 15506]]

returns appropriate? Should any funds be exempted from this 
requirement? Commenters are also requested to address whether the 
Commission should require that all fund advertisements and sales 
literature that include any quotation of performance, including before-
tax performance, include standardized after-tax returns.

F. Formulas for Computing After-Tax Return

    Our proposals would require that funds compute after-tax returns 
using standardized formulas that are based largely on the current 
standardized formula for computing before-tax average annual total 
return.\58\ After-tax returns would be computed assuming a hypothetical 
$1,000 one-time initial investment and the deduction of the maximum 
sales load and other charges from the initial $1,000 payment.\59\ Also, 
after-tax average annual total returns would be calculated for 1-;, 5-
;, and 10-year periods.\60\
---------------------------------------------------------------------------

    \58\ Item 21(b)(1) of Form N-1A. Under the proposal, before-and 
after-tax returns included in the risk/return summary and the MDFP 
would be calculated as provided in proposed Item 21(b)(1)-(4) of 
Form N-1A. Instruction 2(a) to proposed Item 2 and proposed Item 
5(b)(2) of Form N-1A.
    \59\ Proposed Items 21(b)(3) and 21(b)(4) of Form N-1A; 
Instruction 1 to proposed Item 21(b)(3) and Instruction 1 to 
proposed Item 21(b)(4) of Form N-1A.
    \60\ Proposed Items 21(b)(3) and 21(b)(4) of Form N-1A.
---------------------------------------------------------------------------

    The computation of after-tax return depends on several assumptions, 
such as tax bracket, that vary from investor to investor. As a result, 
the proposed standardized after-tax return measures are not intended as 
precise computations of any individual investor's after-tax returns 
from a fund, but as guides to understanding the effect of taxes on the 
fund's performance. In this regard, the proposed standardized after-tax 
return measures are similar to the standardized before-tax returns, 
which also are dependent on assumptions such as the purchase and sale 
date of fund shares, and do not precisely measure an individual 
investor's before-tax returns. The Commission believes that the 
presentation of standardized after-tax returns, coupled with the 
presentation of standardized before-tax returns, will provide investors 
with a more complete and accurate picture of a fund's performance than 
the before-tax returns standing alone.
    The assumptions that the Commission proposes to require funds to 
use in calculating after-tax returns are described in this section. 
Commenters are asked to discuss any aspect of the proposed formulas for 
computing after-tax returns, including the proposed assumptions and 
whether other assumptions would be more appropriate. Commenters are 
asked to quantify the significance of different assumptions.
1. Tax Bracket
    We are proposing that standardized after-tax returns be calculated 
assuming that distributions and gains on a sale of fund shares are 
taxed at the highest applicable individual federal income tax rate.\61\ 
Computing after-tax returns with maximum tax rates will provide 
investors with the ``worst-case'' federal income tax scenario. Coupled 
with before-tax returns that reflect the imposition of taxes at a 0% 
rate, this ``worst-case'' scenario will effectively provide investors 
with the full range of historical after-tax returns. Short of providing 
investors with after-tax returns computed at each tax rate, which we 
have decided not to propose because of the complexity of the resulting 
disclosure, we believe that providing investors with the full range of 
federal income tax outcomes (0% and maximum rate) would provide 
investors the most complete information. In reaching this conclusion, 
we looked for guidance to current industry practice. Both funds and 
third party providers of information that provide after-tax performance 
information to investors frequently use the highest tax rates when 
calculating after-tax return.\62\
---------------------------------------------------------------------------

    \61\ Instruction 4 to proposed Item 21(b)(3) of Form N-1A; 
Instructions 4 and 7(d) to proposed Item 21(b)(4) of Form N-1A.
    Currently, the highest individual marginal income tax rate 
imposed on ordinary income is 39.6%, and the highest rate imposed on 
long-term capital gains is 20%. I.R.C. 1(a)-(d), (h).
    \62\ See, e.g., Access Vanguard, Vanguard to Publish After-Tax 
Returns in Equity and Balanced Fund Reports (Oct. 11, 1999) (visited 
Feb. 1, 2000) http://www.vanguard.com/cgi-bin/pressroom/PRPrevious.html>; Fidelity Investments, Track After-Tax Fund 
Performance On-Line (visited Feb. 1, 2000) http://personal400.fidelity.com/global/whatsnew/content/94689.html.tvsr/>; 
Morningstar, MUTUAL FUND 500 (1999 ed.); Catherine Voss Sanders, 
Making April Less Taxing, 5 MORNINGSTAR INVESTOR, Feb. 1997; 
Association for Investment Management and Research, AIMR PERFORMANCE 
PRESENTATIONS STANDARDS HANDBOOK (2d ed. 1997), at 59; Mutual Fund 
Scoreboard, Business Week, Feb. 1, 1999. But see The Ultimate Mutual 
Fund Guide 2000, MONEY, Feb. 2000, at 64 (reporting mutual fund tax-
efficiency calculated based on the return of an investor in the 28 
percent federal tax bracket); Fund Survey, FORBES, Feb. 7, 2000, at 
166 (reporting after-tax returns reflecting ``the tax liability of 
an upper-middle income investor'').
---------------------------------------------------------------------------

    We considered proposing that after-tax returns be presented using 
intermediate tax rates in order to approximate the rates paid by 
typical mutual fund investors.\63\ We decided not to propose this 
approach because it would not provide information regarding the maximum 
impact that federal income taxes could have on a fund's return and 
because of the complexity of determining the appropriate intermediate 
rate from one year to the next as tax brackets and tax rates change. We 
also considered proposing that after-tax returns be presented using 
multiple rates, but rejected this approach because it would result in a 
fairly complex table of returns that could be overwhelming.
---------------------------------------------------------------------------

    \63\ The median income of mutual fund shareholders is 
approximately $ 55,000. ICI, 1998 Profile of Mutual Fund Investors 
(Summer 1999). An individual taxpayer with taxable income over 
$25,750 but not over $62,450 is taxed at a marginal rate of 28 
percent.I.R.C. 1(c).
---------------------------------------------------------------------------

    We request comment on our proposal to use maximum tax rates to 
compute after-tax returns. Are there preferable alternatives? 
Commenters who believe that maximum tax rates should not be used 
because they are higher than the rates paid by typical mutual fund 
investors are asked to address whether their concerns are mitigated by 
our decision not to reflect state and local taxes, which will tend to 
result in an understated overall tax burden.\64\ Commenters are asked 
to address whether the after-tax performance rankings of funds relative 
to each other depend on the tax rates used to compute returns and, if 
so, to indicate how this should affect the rate adopted by the 
Commission for the computation of after-tax returns. Commenters who 
favor the use of an intermediate rate should specify how the rate 
should be selected and how the rate should be established each year. 
Commenters who favor the use of multiple rates should suggest a format 
for presenting the resulting table of returns.
---------------------------------------------------------------------------

    \64\ See discussion below at II.F.4 (State and Local Tax 
Liability).
---------------------------------------------------------------------------

2. Historical versus Current Tax Rates
    The Commission is proposing to require funds to calculate after-tax 
returns for 1-, 5-, and 10-year periods using the historical tax rates 
that were in effect during these periods, rather than the rates that 
are in effect at the time the computation is performed.\65\ The use of 
historical rates will more accurately reflect a fund's actual after-tax 
returns. Moreover, to the extent that a fund has been managed in 
response to the then-current tax environment, it seems most appropriate 
to judge the effectiveness of the management strategy by applying tax 
rates that were

[[Page 15507]]

in place at the time. In addition, if current rates were used, the 
historical after-tax returns for previous periods would effectively 
change every time the current rates change.
---------------------------------------------------------------------------

    \65\ Instruction 4 to proposed Item 21(b)(3) and Instructions 4 
and 7 to proposed Item 21(b)(4) of Form N-1A.
---------------------------------------------------------------------------

    Under our proposal, the rates to be used for computing after-tax 
returns for the most recent ten complete calendar years and the current 
calendar year would be as follows:

                                       Maximum Individual Income Tax Rates
                                                   [1990-2000]
----------------------------------------------------------------------------------------------------------------
                                                         Long-term gains                       Short-term gains/
                         Year                            \66\  (Percent)     Mid-term gains     ordinary income
                                                                                                   (Percent)
----------------------------------------------------------------------------------------------------------------
2000..................................................                 20  .................                39.6
1999..................................................                 20  .................                39.6
1998..................................................                 20  .................                39.6
7/29/97-12/31/97......................................                 20                 28                39.6
5/7/97-7/28/97........................................                 20  .................                39.6
1/1/97-5/6/97.........................................                 28  .................                39.6
1996..................................................                 28  .................                39.6
1995..................................................                 28  .................                39.6
1994..................................................                 28  .................                39.6
1993..................................................                 28  .................                39.6
1992..................................................                 28  .................                31
1991..................................................                 28  .................                31
1990..................................................                 28  .................                33
----------------------------------------------------------------------------------------------------------------

    We request comment on the advantages and disadvantages of using 
historical or current tax rates in computing after-tax return. We also 
request comment on whether the above table accurately states the 
highest tax rates for the periods and categories specified. The 
Commission anticipates that, if we adopt a rule requiring disclosure of 
after-tax returns using maximum historical rates, it will not be 
necessary for the Commission to publish the rates for future years. Is 
there any reason why it would be necessary for us to publish those 
rates?
---------------------------------------------------------------------------

    \66\ I.R.C. 1; Standard Federal Tax Reports, 99 Index (CCH) 144, 
para. 601.
    The holding period for long-term gains is more than 12 months, 
except for the period from July 29, 1997, through December 31, 1997, 
when it was more than 18 months. During that period, a ``mid-term'' 
capital gains rate applied if property was held more than 12 months 
but not more than 18 months. See I.R.C. 1222 (defining short-and 
long-term capital gain); IRS Publication 564, Mutual Fund 
Distributions (1997), at 9; IRS Publication 564, Mutual Fund 
Distributions (1998), at 1 (describing changes in holding periods in 
1997).
---------------------------------------------------------------------------

3. Calendar versus Fiscal Year Measurement Period
    Under the proposal, after-tax returns that appear in a fund's 
performance table in the risk/return summary would be calculated based 
on calendar-year periods, consistent with the before-tax return 
disclosure that currently appears in the risk/return summary.\67\ 
After-tax returns that appear in the MDFP would be calculated on a 
fiscal year basis, consistent with the before-tax return disclosure 
that currently appears in the MDFP.\68\ We believe that this 
presentation would facilitate investor comparisons of before-tax and 
after-tax returns.
---------------------------------------------------------------------------

    \67\ Proposed Item 2(c)(2)(iii) of Form N-1A; Item 2(c)(2)(iii) 
of Form N-1A (calendar-year disclosure of before-tax returns in 
risk/return summary).
    \68\ Proposed Item 5(b)(2) of Form N-1A; Item 5(b)(2) of Form N-
1A (fiscal year disclosure of before-tax returns in MDFP).
---------------------------------------------------------------------------

    Comment is requested on our proposal to require calendar year 
after-tax returns in the risk/return summary and fiscal year after-tax 
returns in the MDFP. Commenters who believe the proposal should be 
modified should address whether similar modifications should be made in 
the presentation of before-tax returns. Will the use of either the 
fiscal year or the calendar year encourage funds to ``time'' 
distributions or portfolio transactions in any way to artificially 
enhance the after-tax returns presented?
4. State and Local Tax Liability
    In order to simplify the computation and presentation of after-tax 
returns, we propose to exclude state and local tax liability although 
this will tend to result in after-tax returns that are somewhat 
overstated.\69\ State and local tax rates vary widely, and there is no 
single tax rate that could serve as a reasonable proxy for the state 
and local tax burden.\70\ Presentation of separate after-tax returns 
for all 50 states and the District of Columbia would be overwhelming 
for investors and burdensome for funds.
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    \69\ Instruction 4 to proposed Item 21(b)(3) and Instruction 4 
to proposed Item 21(b)(4) of Form N-1A.
    In general, funds and third parties that provide investors with 
information regarding after-tax returns do not reflect the effect of 
state and local taxes on return. See, e.g, Access Vanguard, Vanguard 
to Publish After-Tax Returns in Equity and Balanced Fund Reports 
(Oct. 11, 1999) (visited Feb. 1, 2000) http://www.vanguard.com/cgi-bin/pressroom/PRPrevious.html>; Fidelity Investments, Track After-
Tax Fund Performance On-Line (visited Feb. 1, 2000) http://personal400.fidelity.com/ global/whatsnew/content/94689.html.tvsr>; 
Association for Investment Management and Research, AIMR PERFORMANCE 
PRESENTATIONS STANDARDS HANDBOOK (2d ed. 1997) at 59; Morningstar, 
MUTUAL FUND 500 (1999 ed.); Fund Survey, FORBES, Feb. 7, 2000, at 
166.
    \70\ Some states, such as Alaska, Florida, and Nevada, charge no 
personal income tax, while other states impose taxes at rates as 
high as 12%. See Federation of Tax Administrators, State Individual 
Income Tax Rates, (visited Jan. 14, 2000) http://www.taxadmin.org/fta /rate/ind__inc.html>.
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    We request comment on whether the after-tax return calculations 
should reflect the effect of state and local taxes. Commenters who 
support adjusting after-tax returns for state and local taxes should 
address how that should be done. Commenters also should address 
alternative means, such as narrative disclosure, by which funds can 
convey to investors the impact of state and local taxes.
5. Federal Alternative Minimum Tax and Phaseout Adjustments
    Tax law provides favored treatment to certain kinds of income and 
expenses. Taxpayers who benefit from this special treatment may be 
subject to at least a minimum amount of tax through the ``alternative 
minimum tax.'' \71\ In addition, certain tax credits, exemptions, and 
deductions are phased out for taxpayers whose adjusted gross

[[Page 15508]]

income is above a specified amount.\72\ The proposed after-tax return 
formulas would not take into account the effect of either the 
alternative minimum income tax or phaseouts.\73\
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    \71\ I.R.C. 55. See IRS Publication 17, Your Federal Income Tax 
(1999), at 203 (explaining the effect of the alternative minimum 
tax).
    \72\ E.g., I.R.C. 151(d)(3) (phaseout of personal exemptions). 
See IRS Publication 501, Exemptions, Standard Deduction and Filing 
Information (1999).
    \73\ Proposed Instruction 4 to Item 21(b)(3) and proposed 
Instruction 4 to Item 21(b)(4) of Form N-1A.
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    We believe that adjusting after-tax returns to reflect the impact 
of these provisions of tax law would complicate the after-tax return 
calculations without providing a commensurate benefit to a significant 
number of investors. Comment is requested regarding whether the after-
tax return formulas should reflect the impact of the alternative 
minimum tax, the phaseouts, or any other taxes or adjustments not 
reflected in the proposed formulas.
6. Timing and Method of Tax Payment
    The proposed after-tax return calculations would assume that any 
taxes due on a distribution are paid out of that distribution at the 
time the distribution is reinvested and would reduce the amount 
reinvested.\74\ We have chosen this method to simplify the 
calculations, although we recognize that many investors do not pay 
income taxes out of the corresponding distributions. For example, a 
taxpayer might pay his or her taxes out of a bank account, either on 
estimated tax payment due dates or on April 15 of the year following 
the tax year. Or a taxpayer might pay taxes by redeeming fund shares at 
the time a tax payment is due. We request comment on how the after-tax 
return formulas should reflect the timing and method of tax payment. 
Commenters favoring methods other than that proposed should specify in 
detail how the proposed formula should be modified to reflect those 
methods.
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    \74\ Instruction 2 to proposed Item 21(b)(3) and Instruction 2 
to proposed Item 21(b)(4) of Form N-1A.
    This methodology is generally consistent with that used by 
industry participants. See, e.g., Morningstar, MUTUAL FUND 500 (1999 
ed.); Fidelity Investments, Track After-Tax Fund Performance On-Line 
(visited Feb. 1, 2000) http://personal400.fidelity.com/ global/
whatsnew/content/94689.html.tvsr>; Access Vanguard, Vanguard After-
Tax Return Calculator (visited Feb. 1, 2000) http: //
majestic2.vanguard.com /FP/DA/ 0.1.vgi__Fund After Tax Sim /
092110731601095233? AFTER__ TAX__CALC=SIMPLE>.
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7. Tax Treatment of Distributions
    The proposed after-tax return formulas would require that the 
taxable amount and tax character (e.g., ordinary income, short-term 
capital gain, long-term capital gain) of each distribution be as 
specified by the fund on the dividend declaration date, adjusted to 
reflect subsequent recharacterizations. Tax-exempt interest and non-
taxable returns of capital would be assumed to result in no taxes.\75\
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    \75\ Instruction 3 to proposed Item 21(b)(3) and Instruction 3 
to proposed Item 21(b)(4) of Form N-1A.
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    We have not proposed to specify in detail the tax consequences of 
fund distributions or other features having more complicated tax 
characteristics (e.g., distributions derived from REIT income, 
distributions derived from commodities gains, foreign tax credits or 
deductions that pass through with respect to foreign source income). 
Funds should determine the tax consequences of such distributions or 
features by applying the tax law in effect on the date the distribution 
is reinvested. Commenters are requested to address whether the formula 
for calculating after-tax returns should be more specific in any way.
8. Capital Gains and Losses Upon a Sale of Fund Shares
    The proposal would require that post-liquidation after-tax return 
be computed assuming a complete sale of fund shares at the end of the 
1-, 5-, or 10-year measurement period, resulting in capital gains taxes 
or a tax benefit from any resulting capital losses.\76\ In computing 
the taxes from any gain or the tax benefit from any loss, the rate used 
would be required to correspond to the tax character of the capital 
gain or loss (e.g., short-term or long-term). The tax character of the 
capital gain or loss would be determined by the length of the 
measurement period (1, 5, or 10 years) in the case of the initial 
$1,000 investment and the length of the period between the reinvestment 
and the end of the measurement period in the case of reinvested 
distributions.\77\ A fund would therefore be required to track the 
actual holding periods of reinvested distributions and could not assume 
that they have the same holding period as the initial $1,000 
investment.\78\
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    \76\ Instructions 6 and 7 to proposed Item 21(b)(4) of Form N-
1A.
    The capital gain or loss on the sale of fund shares would be 
computed by subtracting the tax basis from the redemption proceeds. 
Instruction 7(a) to proposed Item 21(b)(4) of Form N-1A. The tax 
basis would include the $1,000 initial payment and reinvested 
distributions, net of taxes assumed paid from the distributions, but 
not net of any sales loads imposed upon reinvestment. In addition, 
the tax basis would be adjusted for any distributions representing 
returns of capital and any other tax basis adjustments applicable to 
an individual taxpayer. Instruction 7(b) to proposed Item 21(b)(4) 
of Form N-1A.
    \77\ Instruction 7(d) to proposed Item 21(b)(4) of Form N-1A.
    We note that, in computing post-liquidation returns for a one-
year period, all gains realized upon a sale of fund shares at the 
end of the one-year period would be short-term. See I.R.C. 1222(1) 
(providing that the term ``short-term capital gain'' means ``gain 
from the sale or exchange of a capital asset held for not more than 
1 year, if and to the extent such gain is taken into account in 
computing gross income'').
    \78\ Instruction 7(c) to proposed Item 21(b)(4) of Form N-1A.
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    The tax laws limit the extent to which a fund shareholder may 
deduct capital losses when the taxpayer does not have offsetting 
gains.\79\ In order to simplify the computation of post-liquidation 
after-tax returns, we are proposing to allow funds to assume that a 
taxpayer has sufficient capital gains of the same character to offset 
any capital losses upon a sale of fund shares and therefore that the 
taxpayer may deduct the entire capital loss.\80\
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    \79\ Under the Code, when calculating taxable income, an 
investor may fully offset short-term capital gains with short-term 
capital losses and fully offset long-term capital gains with long-
term capital losses. Net short-term capital gain or loss may then be 
offset against net long-term capital gain or loss. If capital gains 
exceed capital losses, the investor is taxed on the difference at a 
rate that is determined by whether the net gain is short-or long-
term. If capital losses exceed capital gains, the difference may be 
deducted from ordinary income, subject to a yearly limit of $3,000. 
I.R.C. 1211(b)(2) (providing that in the case of a taxpayer other 
than a corporation, losses from sales or exchanges of capital assets 
shall be allowed only to the extent of the gains from such sales or 
exchanges, plus (if such losses exceed such gains) the lower of 
$3,000 ($1,500 in the case of a married individual filing a separate 
return) or the excess of such losses over such gains.) See IRS 
Publication 544, Sales and Dispositions of Assets (1999), at 30 
(explaining tax treatment of capital gains and losses).
    \80\ Instruction 7(d) to proposed Item 21(b)(4) of Form N-1A.
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    Commenters are requested to discuss the proposed computation of 
capital gains taxes and the tax benefits from capital losses on a sale 
of fund shares. Should funds be required to track the actual holding 
periods of reinvested distributions, as proposed, or should they be 
permitted to assume that reinvested distributions have the same holding 
period as the initial $1,000 investment? Should capital losses on a 
sale of fund shares be permitted to be deducted in full, or should the 
deduction be limited in some way?

G. Narrative Disclosure

    The proposal would require funds to include a short, explanatory 
narrative adjacent to the performance table in the risk/return summary 
and the MDFP.\81\ This is intended to facilitate investor

[[Page 15509]]

understanding of the table. The narrative would be required to be in 
plain English, but we are not proposing to mandate that specific 
language be used.\82\ The proposal would require the following 
information to be included in the narrative disclosure: \83\
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    \81\ Proposed Items 2(c)(2)(iv) and 5(b)(3) of Form N-1A.
    The line graph in the MDFP also would be required to be 
accompanied by a statement to the effect that the account value 
shown in the graph does not reflect the taxes that a shareholder 
would pay on fund distributions or the redemption of fund shares. 
Proposed Item 5(b)(2) of Form N-1A.
    \82\ See rule 421(b) and (d) under the Securities Act [17 CFR 
230.421(b) and (d)](requiring that all information in the prospectus 
be presented in clear, concise, and understandable fashion and that 
registrants use plain English principles in the organization, 
language, and design of the summary and risk factors sections of 
their prospectuses); General Instruction C.1 to Form N-1A (fund 
prospectus should be easy to understand and promote effective 
communication); Item 2 of Form N-1A (requiring that the response to 
Item 2 be stated in plain English).
    \83\ Proposed Items 2(c)(2)(iv) and 5(b)(3) of Form N-1A.
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     The differences among the four types of return presented, 
including whether the returns reflect redemption and the charges and 
taxes associated with redemption;
     Before-tax returns assume that all distributions are 
reinvested;
     The assumptions used in calculating after-tax returns, 
including (i) the use of the historical highest individual federal 
marginal income tax rates; (ii) the assumption that taxes are paid out 
of fund distributions and that distributions, less taxes, are 
reinvested; (iii) the exclusion of state and local taxes; and (iv) if 
post-liquidation after-tax returns are higher than before-tax returns 
net of fees and charges payable upon sale of fund shares, the reason 
for this result, including the assumption that a shareholder has 
sufficient gains from other sources to offset all losses from the 
redemption of fund shares;
      Actual after-tax returns depend on an investor's tax 
situation and may differ from those shown;
     The after-tax returns shown are not relevant to investors 
who hold their fund shares through tax-deferred arrangements, such as 
401(k) plans or individual retirement accounts; and
     After-tax returns reflect past tax effects and are not 
predictive of future tax effects.
    Comment is requested on the proposed narrative disclosure. Should 
any of the proposed items be eliminated? Should any other items be 
added? Should the narrative disclosure be specifically required to 
precede or follow the performance table? Should it appear in another 
location? Should funds have the flexibility to craft their own 
narrative disclosure, as proposed, or should the Commission require 
specific language for part or all of the explanation?
    We are not proposing to require that specific items of narrative 
disclosure be included in fund advertisements and other sales materials 
that present after-tax performance. Should we require any narrative 
disclosure in advertisements and sales literature and, if so, what 
should it be?

H. Alternatives to Disclosure of After-Tax Return

    We considered other possible methods for improving the disclosure 
of the tax consequences of mutual fund investments, including tax-
efficiency ratios and potential capital gains exposure.
    Tax-Efficiency Ratios. A tax-efficiency ratio is a ratio of after-
tax and before-tax returns that measures the proportion of before-tax 
return that remains after taxes.\84\ We are not proposing to require 
funds to disclose tax-efficiency ratios because we believe that these 
ratios may be more difficult for investors to interpret than after-tax 
returns. In any event, tax-efficiency ratios may be readily derived 
from before- and after-tax returns by taking the quotient of these two 
numbers.
---------------------------------------------------------------------------

    \84\ See Morningstar, MUTUAL FUND 500 (1999 ed.) (reporting 
mutual fund tax-efficiency ratios); The Ultimate Mutual Fund Guide 
2000, MONEY, Feb. 2000, at 64 (reporting mutual fund tax-
efficiency).
---------------------------------------------------------------------------

    Potential Capital Gains Exposure. When the securities in a mutual 
fund portfolio appreciate in value, the tax liability is deferred until 
the securities are sold by the fund and the gains are distributed. An 
investor who invests in a mutual fund with large amounts of unrealized 
capital gain, or capital gains that have been realized but not 
distributed, can potentially have significantly greater tax liability 
in the future than an investor in a similar fund that has less 
unrealized or undistributed gain. We considered requiring funds to 
include in their prospectuses a measure of capital gains exposure that 
shows the percentage of a fund's assets that represents unrealized and 
realized but undistributed capital gains.\85\ While we believe that 
this measure could provide useful information, it would not provide 
information about the historical tax consequences of a fund's 
distributions. We believe that pre- and post-liquidation after-tax 
returns, taken together, would provide a more complete picture.
---------------------------------------------------------------------------

    \85\ Both Morningstar, Inc., and Business Week publish measures 
of capital gains exposure. Morningstar, MUTUAL FUND 500 (1999 ed.); 
Mutual Fund Scoreboard, BUSINESS WEEK, Feb. 1, 1999.
---------------------------------------------------------------------------

    We request comment on these and other measures that could provide 
investors with enhanced information about the tax consequences of 
mutual fund investments. Are any measures preferable to after-tax 
returns? We also request comment on whether, and how, narrative 
disclosure in this area should be improved. For example, should the 
prospectus be required to describe the potential tax consequences to an 
investor of purchasing fund shares shortly before a dividend 
declaration date (i.e., ``buying the dividend'') or purchasing shares 
in a fund that has significant amounts of unrealized gain in its 
portfolio securities? \86\ Should shareholder reports be required to 
describe the tax management strategies the fund used in the most recent 
period?
---------------------------------------------------------------------------

    \86\ When a fund makes a distribution to its shareholders, the 
net asset value of the shares declines by the amount of the 
distribution. Thus, a person who makes a taxable investment in a 
mutual fund shortly before a distribution may have part of his or 
her initial investment returned in the form of a taxable 
distribution.
---------------------------------------------------------------------------

I. Technical and Conforming Amendments

    We are proposing to amend Rule 482(e)(3) under the Securities Act 
in order to clarify that the average annual total returns that are 
required to be shown in any performance advertisement are before-tax 
returns net of fees and charges payable upon a sale of fund shares.\87\ 
This clarification is necessary because we have added other types of 
return to Form N-1A.
---------------------------------------------------------------------------

    \87\ 17 CFR 230.482(e)(3).
---------------------------------------------------------------------------

    We also are proposing to amend rule 34b-1(b)(3) under the 
Investment Company Act, which excludes performance information 
contained in periodic reports to shareholders from the updating 
requirements of rule 34b-1. The proposed amendment extends the 
exclusion to standardized after-tax return information contained in 
periodic reports to shareholders.\88\
---------------------------------------------------------------------------

    \88\ 17 CFR 270.34b-1(b)(3)(iii)(B).
---------------------------------------------------------------------------

    We also are proposing to delete an instruction contained in Form N-
1A that provides that total return information in a mutual fund 
prospectus need only be current to the end of the fund's most recent 
fiscal year.\89\ The instruction is unnecessary because the items of 
Form N-1A that require funds to include total returns in the prospectus 
have explicit instructions about how current the total return 
information must be.\90\
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    \89\ Instruction 6 to Item 21(b)(1) of Form N-1A.
    \90\ Item 2(c)(2)(iii) of Form N-1A (providing that total 
returns included in the risk/return summary must be current to the 
end of the most recently completed calendar year); Item 5(b)(2) of 
Form N-1A (providing that total return in the MDFP must be as of the 
end of the last day of the most recent fiscal year).
---------------------------------------------------------------------------

J. Compliance Date

    If we adopt the proposed disclosure requirements, we expect to 
require all

[[Page 15510]]

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 Commission 
requests comment on this proposed compliance date.

III. General Request For Comments

    The Commission requests comment on the amendments proposed in this 
Release, suggestions for additional provisions or changes to existing 
rules or forms, and comments on other matters that might have an effect 
on the proposals contained in this Release. We also request comment on 
whether the proposals, if adopted, would promote efficiency, 
competition, and capital formation. We will consider those comments in 
satisfying our responsibilities under section 2(c) of the Investment 
Company Act, section 2(b) of the Securities Act, and section 3(f) of 
the Exchange Act.\91\ For purposes of the Small Business Regulatory 
Enforcement Fairness Act of 1996,\92\ the Commission also requests 
information regarding the potential effect of the proposals on the U.S. 
economy on an annual basis. Commenters are requested to provide 
empirical data to support their views.
---------------------------------------------------------------------------

    \91\ Section 2(c) of the Investment Company Act [15 U.S.C. 80a-
2(c)], section 2(b) of the Securities Act [15 U.S.C. 77b(b)], and 
section 3(f) of the Exchange Act [15 U.S.C. 78c(f)] require the 
Commission, when determining whether a rule is consistent with the 
public interest, to consider, in addition to the protection of 
investors, whether the action will promote efficiency, competition, 
and capital formation.
    \92\ Pub. L. No. 104-21, Title II, 110 Stat. 857 (1996).
---------------------------------------------------------------------------

IV. Cost/Benefit Analysis

    The Commission is sensitive to the costs and benefits imposed by 
its rules.
    The proposed rule and form changes would require a fund to disclose 
its standardized after-tax returns for 1-,   5-, and 10-year periods. 
After-tax returns would accompany before-tax returns in the risk/return 
summary of fund prospectuses and in the MDFP, which is typically 
contained in fund annual reports. Funds would be required to include a 
short, explanatory narrative adjacent to the performance table in the 
risk/return summary and the MDFP. After-tax returns would be presented 
in two ways:
    (i) assuming the shareholder continued to hold his or her shares at 
the end of the period; and (ii) assuming the shareholder sold his or 
her shares at the end of the period, realizing taxable gain or loss on 
the sale. The before- and after-tax returns would be required to be 
presented in a standardized tabular format. Although after-tax returns 
would not be required in fund advertisements and sales literature, any 
fund choosing to include after-tax returns in these materials would be 
required to include after-tax returns computed according to our 
standardized formula.

A. Benefits

    Taxes are one of the most significant costs of investing in mutual 
funds through taxable accounts. Currently, the Commission requires 
mutual funds to disclose significant information about taxes to 
investors.\93\ While this disclosure is useful, we believe funds can 
more effectively communicate to investors the tax consequences of 
investing. Therefore, the Commission is proposing amendments to Form N-
1A and rules 482 and 34b-1 that would require disclosure of 
standardized mutual fund after-tax returns.
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    \93\ In its prospectus, a mutual fund is required to disclose 
(i) the tax consequences of buying, holding, exchanging, and selling 
fund shares, including the tax consequences of fund distributions; 
and (ii) whether the fund may engage in active and frequent 
portfolio trading to achieve its principal investment strategies, 
and, if so, the tax consequences of increased portfolio turnover and 
how this may affect fund performance. See Item 7(e) of Form N-1A; 
Instruction 7 to Item 4 of Form N-1A. A fund also must disclose in 
its prospectus and annual report the portfolio turnover rate and 
dividends and capital gains distributions per share for each of the 
last five fiscal years. See Items 9(a) and 22(b)(2) of Form N-1A. 
These items also require funds to show net realized and unrealized 
gain or loss on investments on a per share basis for each of the 
fund's last five fiscal years.
---------------------------------------------------------------------------

    By requiring all funds to report after-tax performance pursuant to 
a standardized formula, the proposed amendments would allow investors 
to compare after-tax performance among funds. This could affect 
investor decisions relating to the purchase or sale of fund shares. 
This could have secondary benefits, such as the creation of new funds 
designed to maximize after-tax performance or causing existing funds to 
alter their investment strategies to invest in a more tax-efficient 
manner.
    Requiring standardized after-tax performance in the prospectus, 
annual report, and fund advertisements and sales literature also should 
help prevent confusing and misleading after-tax performance claims by 
funds. Currently, fund advertisements and sales literature may contain 
tax-adjusted performance calculated according to non-standardized 
methods. In addition to making it difficult to compare after-tax 
performance measures among different funds, the lack of a standardized 
method for computing after-tax returns creates the possibility that 
after-tax performance information as currently reported could be 
misleading or confusing to investors.
    The proposed amendments should also increase the amount of after-
tax performance information available to investors. With the exception 
of the few funds that publish after-tax performance information, 
investors currently must rely on third party providers to obtain 
information regarding a fund's after-tax performance.
    Moreover, by providing investors with information regarding a 
fund's after-tax performance, our proposal will help investors 
understand the magnitude of tax costs and how they affect fund 
performance. Increased understanding should have the beneficial effect 
of enhancing investor confidence in the fund industry.

B. Costs

    Funds affected by the proposed after-tax requirements will incur 
costs in complying with the new disclosure. Funds would have to compute 
the after-tax returns using a standardized method prescribed by Form N-
1A. The costs associated with computing the proposed after-tax 
performance would include the costs of purchasing or developing 
software, implementing a new system for computing the proposed returns, 
analyzing data for inclusion in the standardized formula, and training 
fund employees. In addition, funds would incur costs in incorporating 
the new disclosure in their prospectuses, annual reports to 
shareholders, advertisements, and sales literature. Funds could also 
incur costs in responding to questions from investors regarding the 
proposed after-tax returns.
    It is anticipated that the costs of implementing new systems to 
compute the standardized after-tax performance will largely consist of 
one-time expenses. In addition, the software development and 
implementation costs may be reduced if software vendors begin to offer 
``off-the-shelf'' programs for computing the proposed standardized 
after-tax performance data.\94\ Also, the costs of analyzing data for 
inclusion in the standardized formula would be substantially greater in 
connection with a fund's first-time compliance with the proposed 
amendments than it would be in subsequent disclosures. Likewise, the

[[Page 15511]]

costs of revising fund prospectuses, annual reports, advertisements, 
and sales literature to incorporate the new disclosure should decrease 
after the first disclosures complying with the proposed amendments have 
been made. Although the costs of updating the proposed disclosure in 
fund prospectuses, annual reports, advertisements, and sales literature 
would be ongoing, the costs incurred in subsequent disclosures should 
be less than the costs associated with the initial computations and 
disclosures because neither the formula for calculating performance nor 
the format for the disclosure is expected to change from year to year.
---------------------------------------------------------------------------

    \94\ A service provider that compiles and disseminates fund 
pricing and performance information recently announced that it will 
offer to calculate and publish after-tax returns for its fund 
clients. See Daly, Program Lets Fund Companies Offer After-Tax 
Returns (Dec. 29, 1999) (visited Feb. 9, 2000) http://www.ignites.com/>.
---------------------------------------------------------------------------

    Because funds filing initial registration statements would not have 
any performance information to report, the proposed after-tax 
performance requirements would not impose any additional costs on the 
preparation and filing of an initial registration statement on Form N-
1A. The disclosure required by the proposed amendments would appear in 
the first post-effective amendment that is required to include the 
after-tax return disclosure. The costs associated with including the 
proposed disclosure in this first post-effective amendment would 
consist of the costs required for developing a system for performing 
the standardized calculations and the costs of revising the prospectus 
to incorporate the new disclosure. Because the standardized after-tax 
disclosure that would be required in a fund's annual report would be 
very similar to the proposed standardized after-tax disclosure in the 
prospectus, the cost of including the proposed disclosure in the annual 
report would largely be limited to the cost of revising the report to 
incorporate the new disclosure. Moreover, because the proposals require 
that performance be presented in a standardized tabular format in the 
prospectus and annual report, the cost of revising these documents 
should be reduced. The costs incurred by funds choosing to include 
after-tax returns in fund advertisements and sales literature would be 
limited to the cost of revising the advertisements and sales literature 
to incorporate the same proposed standardized after-tax returns that 
would be required to appear in fund prospectuses.
    As discussed above, the proposed amendments could result in the 
creation of new funds designed to maximize after-tax performance. The 
proposed amendments could also cause existing funds to alter their 
investment strategies to invest in a more tax-efficient manner. It is 
possible that funds could incur costs as a result of these potential 
consequences.
    To assist in the evaluation of the costs and benefits that may 
result from these proposed rule amendments, the Commission requests 
that commenters provide views and data relating to any costs and 
benefits associated with these proposals.

V. Summary of Initial Regulatory Flexibility Analysis

    The Commission has prepared an Initial Regulatory Flexibility 
Analysis (``Analysis'') in accordance with 5 U.S.C. 603. The Analysis 
relates to the proposed amendments to Form N-1A and rules 482 and 34b-
1. The following summarizes the Analysis.
    The Analysis sets forth the statutory authority for the proposed 
amendments. The Analysis explains that the proposed form and rule 
changes would require a fund to disclose its standardized after-tax 
returns for 1-, 5-, and 10-year periods. The proposal would require 
after-tax return information to be included in the risk/return summary 
of the prospectus and in Management's Discussion of Fund Performance 
(``MDFP''), which is typically contained in the annual report. Funds 
would be required to include a short, explanatory narrative adjacent to 
the performance table in the risk/return summary and the MDFP. After-
tax returns, which would accompany before-tax returns in fund 
prospectuses and annual reports, would be presented in two ways: (i) 
assuming the shareholder continued to hold his or her shares at the end 
of the period; and (ii) assuming the shareholder sold his or her shares 
at the end of the period, realizing taxable gain or loss on the sale. 
The proposed after-tax returns would be required to be presented in a 
standardized tabular format. Although after-tax returns would not be 
required in fund advertisements and sales literature, any fund choosing 
to include after-tax returns in these materials would be required to 
include after-tax returns computed according to our standardized 
formula.
    The Analysis discusses the impact of the proposed amendments on 
small entities. For purposes of the Regulatory Flexibility Act, a fund 
is considered a small entity if the fund, together with other funds in 
the same group of related funds, has net assets of $50 million or less 
as of the end of its most recent fiscal year.\95\
---------------------------------------------------------------------------

    \95\ 17 C.F.R. 270.0-10.
---------------------------------------------------------------------------

    The Analysis notes that as of December 1999, there were 
approximately 2,900 open-end management investment companies that may 
be affected by one or more of the proposed amendments, including 150 
that are small entities.
    The Analysis also discusses the reporting and other compliance 
requirements associated with the proposals contained in this Release. 
The proposed amendments to Form N-1A would require funds subject to the 
amendments to disclose standardized after-tax returns in prospectuses 
and annual reports to shareholders. The proposed amendments to rules 
482 and 34b-1 would require funds to include standardized after-tax 
returns in fund advertisements and sales literature when funds 
voluntarily choose to include after-tax performance information in 
their advertisements and sales literature.
    As explained in the Analysis, after assessing the proposed 
amendments in light of the current reporting requirements and 
consulting with industry representatives, we evaluated the effect that 
the proposed amendments would have on the preparation of registration 
statements, annual reports to shareholders, advertisements, and sales 
literature. We estimate that it will take approximately 18 additional 
hours per portfolio to prepare post-effective amendments to the 
registration statement on Form N-1A.\96\ The Commission estimates that 
it will take approximately 7.5 additional hours per management 
investment company registered on Form N-1A to prepare annual reports to 
shareholders pursuant to rule 30d-1 if the investment company elects to 
include the MDFP in the annual report.\97\ The Commission estimates 
that the proposed amendments to rule 482 will impose approximately .5 
additional hours per portfolio on those funds that elect to include 
after-tax performance information in their advertisements and are 
therefore required to comply with the proposed amendments to rule 
482.\98\

[[Page 15512]]

We also estimate that an additional .5 hours per response will be 
imposed by the proposed amendments to rule 34b-1 on those funds that 
choose to include after-tax performance information in their sales 
literature.\99\
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    \96\ Since an investment company filing an initial registration 
statement on Form N-1A has no performance history to disclose, the 
proposed amendments would not affect such initial filings. This 
estimate is based upon staff assessment of the proposed amendments 
in light of the current hour burden and current reporting 
requirements.
    \97\ Form N-1A requires that the prospectus include the MDFP 
unless the information is included in the fund's latest annual 
report to shareholders and the fund provides a copy of the annual 
report, upon request and without charge, to each person to whom a 
prospectus is delivered. This estimate is based upon staff 
assessment of the proposed amendments in light of the current hour 
burden and current reporting requirements.
    \98\ As discussed more fully in Section VI, infra, the hour 
burden associated with rule 482 is included in Form N-1A. This 
estimate is based upon staff assessment of the proposed amendments 
in light of the current hour burden and current reporting 
requirements.
    \99\ This estimate is based upon staff assessment of the 
proposed amendments in light of the current hour burden and current 
reporting requirements.
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    As stated in the Analysis, the Commission considered several 
alternatives to the proposed amendments, including establishing 
different compliance or reporting requirements for small entities or 
exempting them from all or part of the proposed amendments. The 
Commission believes that establishing different requirements applicable 
specifically to small entities is inconsistent with the protection of 
investors. We note that mutual funds that qualify as small entities are 
already required to disclose standardized performance. The Commission 
also believes that adjusting the proposals to establish different 
compliance requirements for small entities could undercut the purpose 
of the proposed amendments: to emphasize to investors the impact of 
taxes on a fund's return and to enable investors to make effective 
comparisons among various fund performance claims.
    The Commission encourages the submission of written comments on 
matters discussed in the Analysis. Comment specifically is requested on 
the number of small entities that would be affected by the proposed 
amendments and the impact of such proposals on small entities. 
Commenters are asked to describe the nature of any impact and provide 
empirical data supporting the extent of the impact. These comments will 
be placed in the same public comment file as comments on the proposals. 
A copy of the Analysis may be obtained by contacting Maura S. McNulty, 
Securities and Exchange Commission, 450 5th Street, N.W., Washington, 
D.C. 20549-0506.

VI. Paperwork Reduction Act

    Certain provisions of the proposed amendments contain ``collection 
of information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 [44 U.S.C. 3501, et seq.], and the Commission has 
submitted the proposed collections of information to the Office of 
Management and Budget (``OMB'') for review in accordance with 44 U.S.C. 
3507(d) and 5 CFR 1320.11. The titles for the collections of 
information are: (1) ``Form N-1A under the Investment Company Act of 
1940 and Securities Act of 1933, Registration Statement of Open-End 
Management Investment Companies;'' (2) ``Rule 30d-1 under the 
Investment Company Act of 1940, Reports to Stockholders of Management 
Companies;'' (3) ``Registration Statements--Regulation C;'' \100\ and 
(4) ``Rule 34b-1 of the Investment Company Act of 1940, Sales 
Literature Deemed to Be Misleading.'' An agency may not conduct or 
sponsor, and a person is not required to respond to, a collection of 
information unless it displays a currently valid control number.
---------------------------------------------------------------------------

    \100\ The proposed amendments would modify rule 482, which is 
part of Regulation C under the Securities Act of 1933. Regulation C 
describes the disclosure that must appear in registration statements 
under the Securities Act and Investment Company Act. The PRA burden 
associated with rule 482, however, is included in the investment 
company registration statement form, not in Regulation C. In this 
case, the proposed amendments to rule 482 will affect the burden 
hours for Form N-1A, the registration form for open-end investment 
companies that currently advertise pursuant to rule 482. We estimate 
that the burden associated with Regulation C will not change with 
the amendments to rule 482.
---------------------------------------------------------------------------

    Form N-1A (OMB Control No. 3235-0307) was adopted pursuant to 
section 8(a) of the Investment Company Act [15 U.S.C. 80a-8] and 
section 5 of the Securities Act [15 U.S.C. 77e]. Rule 30d-1 (OMB 
Control No. 3235-0025) was adopted pursuant to Section 30(e) of the 
Investment Company Act [15 U.S.C. 80a-29]. Rule 482 of Regulation C 
(OMB Control No. 3235-0074) was adopted pursuant to section 10(b) of 
the Securities Act [15 U.S.C. 77j(b)]. Rule 34b-1 (OMB Control No. 
3235-0346) was adopted pursuant to section 34(b) of the Investment 
Company Act [15 U.S.C. 80a-33(b)].
    Because taxes are one of the largest costs associated with a mutual 
fund investment, the Commission is proposing form and rule amendments 
to Form N-1A, rule 482, and rule 34b-1 to help investors understand the 
magnitude of tax costs and how they affect fund performance.
    Our proposals would require a fund to disclose its standardized 
after-tax returns for 1-, 5-, and 10-year periods. The proposal would 
require after-tax return information to be included in the risk/return 
summary of the prospectus and in Management's Discussion of Fund 
Performance (``MDFP''), which is typically contained in the annual 
report. Funds would be required to include a short, explanatory 
narrative adjacent to the performance table in the risk/return summary 
and the MDFP. After-tax returns, which would accompany before-tax 
returns in fund prospectuses and annual reports, would be presented in 
two ways: (i) Assuming the shareholder continued to hold his or her 
shares at the end of the period; and (ii) assuming the shareholder sold 
his or her shares at the end of the period, realizing taxable gain or 
loss on the sale. The before- and after-tax returns would be required 
to be presented in a standardized tabular format. Although after-tax 
returns would not be required in fund advertisements and sales 
literature, the Commission is also proposing amendments to rules 482 
and 34b-1 that would require any fund choosing to include after-tax 
returns in these materials to include after-tax returns computed 
according to our standardized formula.
    The information required by the proposed amendments is primarily 
for the use and benefit of investors. The Commission is concerned that 
mutual fund investors who are subject to current taxation may not fully 
appreciate the impact of taxes on their fund investments because mutual 
funds are currently required to report their performance on a before-
tax basis only. Many investors consider performance one of the most 
significant factors when selecting or evaluating a fund, and we believe 
that requiring funds to disclose their after-tax performance would 
allow investors to make better-informed decisions. The information 
required to be filed with the Commission pursuant to the information 
collections also permits the verification of compliance with securities 
law requirements and assures the public availability and dissemination 
of the information.

Form N-1A

    Form N-1A, including the proposed amendments, contains collection 
of information requirements. The purpose of Form N-1A is to meet the 
registration and disclosure requirements of the Securities Act and the 
Investment Company Act and to enable funds to provide investors with 
information necessary to evaluate an investment in the fund. The likely 
respondents to this information collection are open-end funds 
registering with the Commission on Form N-1A.
    We estimate that 170 initial registration statements are filed 
annually on Form N-1A, registering 298 portfolios, and that the current 
hour burden per portfolio per filing is 824 hours, for a total annual 
hour burden of 245,552 hours.\101\ We estimate that 4,500 post-
effective amendments to registration statements are filed

[[Page 15513]]

annually on Form N-1A, for 7,875 portfolios, and that the current hour 
burden per portfolio per post-effective amendment filing is 104 hours, 
for an annual burden of 819,000 hours.\102\ Thus, we estimate a current 
total annual hour burden of 1,064,552 hours for the preparation and 
filing of Form N-1A and post-effective amendments on Form N-1A.
---------------------------------------------------------------------------

    \101\ These estimates are based on filings received in calendar 
year 1999. The currently approved hour burden per portfolio for an 
initial Form N-1A is 824 hours.
    \102\ These estimates are based on filings received in calendar 
year 1999. The currently approved hour burden per portfolio for 
post-effective amendments to Form N-1A is 104 hours.
---------------------------------------------------------------------------

    The proposed amendments would not affect the hour burden of an 
initial filing of a registration statement on Form N-1A since an 
investment company filing such an initial form would have no 
performance history to disclose. Post-effective amendments to such 
registration statements, however, would contain performance figures and 
thus be affected by the proposed amendments. We estimate that the 
proposed amendments would increase the hour burden per portfolio per 
filing of a post-effective amendment by 18 hours.\103\ Of the 7,875 
funds referenced in post-effective amendments, 1,040 are money market 
funds, which would be exempted from the proposed after-tax disclosure 
requirements. An additional 1,575 funds are used as investment vehicles 
for variable insurance contracts, which would be permitted to omit the 
after-tax information. Thus, approximately 5,260 of the 7,875 funds 
referenced in post-effective amendments would be affected by the 
proposed amendments.\104\ The Commission estimates that if the proposed 
amendments to Form N-1A are adopted, the total annual hour burden for 
all funds for preparation and filing of initial registration statements 
and post-effective amendments on Form N-1A would be 1,159,311 
hours.\105\
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    \103\ This estimate is based on the staff's consultations with 
industry representatives.
    \104\ The number of funds referenced in post-effective 
amendments that would be affected by the proposed amendments is 
computed by subtracting those funds that are exempt from or 
permitted to omit the proposed after-tax disclosure from the number 
of funds referenced in post-effective amendments (7,875-1,040-1,575, 
or 5,260). For purposes of our analysis, we have not excluded 
certain funds that also would be permitted to omit the after-tax 
return disclosure, such as funds that distribute prospectuses for 
use by investors in 401(k) plans or other similar tax-deferred 
arrangements. While these funds would be permitted to omit the 
after-tax return disclosure in prospectuses distributed to investors 
in these tax-deferred arrangements, they would still incur a burden 
from including the disclosure in prospectuses distributed to all 
other investors.
    \105\ This total annual hour burden is calculated by adding the 
total annual hour burden for initial registration statements and the 
total annual hour burden for post-effective amendments, including 
the additional burden imposed by the proposed amendments. As 
explained, the hour burden per portfolio for an initial filing would 
remain at 824 hours, for a total burden of 245,552 hours. The hour 
burden per portfolio for a post-effective amendment would be 122 
hours (104 + 18), with a burden of 104 hours imposed on all 7,875 
portfolios (104  x  7,875, or 819,000) and the additional 18 hours 
affecting 5,260 portfolios (18  x  5,260, or 94,680). Moreover, 
since the burden associated with rule 482 is included in Form N-1A 
(as discussed in note 100, supra), the Form N-1A burden would 
include the estimated rule 482 burden of .5 hours (the rule 482 
burden is discussed below) that would be imposed on the three 
percent of funds that we estimate would advertise after-tax returns 
[.5  x  (5,260  x  3%), or 79]. Thus, the total annual hour burden 
for all funds for the preparation and filing of initial registration 
statements and post-effective amendments on Form N-1A, including the 
proposed amendments would be 1,159,311 hours (245,552 + 819,000 + 
94,680 + 79).
---------------------------------------------------------------------------

    Compliance with the disclosure requirements of Form N-1A is 
mandatory. Responses to the disclosure requirements will not be kept 
confidential.

Rule 30d-1 Shareholder Reports

    Rule 30d-1, including the proposed amendments, contains collection 
of information requirements.\106\ Section 30(e) and rule 30d-1 require 
registered management investment companies to transmit to shareholders, 
at least semi-annually, reports containing financial statements and 
certain other information. The reports are intended to apprise current 
shareholders of the operational and financial condition of the fund.
---------------------------------------------------------------------------

    \106\ The proposed amendments to Form N-1A require that if a 
fund elects to include the MDFP in its annual report, it must 
include the after-tax return information in its annual report.
---------------------------------------------------------------------------

    There are approximately 3,490 management investment companies 
subject to rule 30d-1.\107\ The Commission estimates that of those 
3,490 management investment companies, approximately 2,280 would be 
subject to the after-tax disclosure requirements.\108\ We estimate that 
the current hour burden for preparing and filing shareholder reports in 
compliance with rule 30d-1 is 202.5 hours. With the proposed 
amendments, we estimate that the hour burden will be increased by 7.5 
hours \109\ to 210 hours, for a total annual hour burden to the 
industry of 723,825.\110\
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    \107\ These estimates are based on filings received in calendar 
year 1999. The currently approved hour burden per registered 
management investment company subject to rule 30d-1 is 202.5 hours.
    \108\ The Commission estimates that 2,900 of the 3,490 
investment companies subject to rule 30d-1 are registered on Form N-
1A and therefore would be subject to the proposed amendments. Of 
these 2,900 investment companies, the Commission estimates that 
approximately 200 offer only money market funds and would therefore 
be exempt from the proposed amendments, and that approximately 300 
other investment companies would also be exempt because they serve 
as investment options for variable insurance contracts. Moreover, 
the Commission estimates that approximately five percent of funds do 
not elect to locate the MDFP in their annual reports and therefore 
would not incur any additional burden in including the proposed 
disclosure in their annual reports. Thus, the number of investment 
companies that would be subject to the after-tax requirements is 
2,280 [(2,900-200-300) x 95%].
    \109\ This estimate is based on the staff's consultations with 
industry representatives.
    \110\ The total annual hour burden is computed by adding the 
current total annual burden (3,490 x 202.5, or 706,725) to the total 
additional annual burden imposed by the proposed amendments (2,280 x 
7.5, or 17,100).
---------------------------------------------------------------------------

    Compliance with the disclosure requirements of rule 30d-1 is 
mandatory. Responses to the disclosure requirements will not be kept 
confidential.

Rule 482

    Rule 482, including the proposed amendments, contains collection of 
information requirements. The rule is a safe harbor that permits a fund 
to advertise information the ``substance of which'' is contained in its 
statutory prospectus, subject to the requirements of the rule. Rule 482 
limits performance information to standardized quotations of yield and 
total return and other measures of performance that reflect all 
elements of return.
    The increased burden associated with the proposed amendments to 
rule 482 is included in the investment company registration statement 
forms.\111\ Thus, the proposed amendments to rule 482 will affect the 
burden hours for Form N-1A, the registration form for open-end 
investment companies that currently may advertise pursuant to rule 482. 
As described above, there are approximately 5,260 funds filing post-
effective amendments that would be affected by the proposed amendments. 
The Commission further estimates that three percent of these funds 
would elect to advertise after-tax performance and therefore be 
required to comply with the proposed amendments to rule 482.\112\ We 
estimate that the additional hour burden required to comply with the 
proposed amendments to rule 482 is .5 hours.\113\
---------------------------------------------------------------------------

    \111\ See note 100, supra.
    \112\ This estimate is based on the assumption that tax-managed 
funds and index funds would be most likely to advertise after-tax 
performance.
    \113\ This estimate is based on the staff's consultations with 
industry representatives.
---------------------------------------------------------------------------

    Compliance with Rule 482 is mandatory for every registered fund 
that issues advertisements. Responses to the disclosure requirements 
will not be kept confidential.

Rule 34b-1

    Rule 34b-1, including the proposed amendments, contains collection 
of information requirements. The rule

[[Page 15514]]

governs sales material that is accompanied or preceded by the delivery 
of a statutory prospectus and requires the inclusion of standardized 
performance data and certain legend disclosure in sales material that 
includes performance data.
    We estimate that approximately 8,495 respondents file approximately 
4.35 responses annually pursuant to rule 34b-1.\114\ Of these 
respondents, we estimate that 1,040 are money market funds that would 
be exempted from the proposed amendments and that an additional 620 
funds and unit investment trusts (``UITs'') registered on Forms N-3 and 
N-4 would not be affected by the proposed amendments. We estimate that 
an additional 1,575 funds registered on Form N-1A and subject to rule 
34b-1 are used as underlying portfolios for variable insurance 
contracts and would not advertise after-tax performance due to their 
unique tax-deferred nature. Thus, 5,260 respondents subject to rule 
34b-1 would also be subject to the proposed after-tax disclosure.\115\ 
We further estimate that three percent of respondents subject to rule 
34b-1 would elect to include after-tax performance and therefore be 
subject to the proposed amendments.\116\ The burden for rule 34b-1 
requires approximately 2.4 hours per response resulting from creating 
the information required by rule 34b-1. We estimate that rule 34b-1 
imposes a current total annual reporting burden of 88,800 hours on the 
industry.\117\ We estimate that the additional hour burden required to 
comply with the proposed amendments to rule 34b-1 is .5 hours, for a 
total burden per response of 2.9 hours and a total annual burden on the 
industry of 89,143 hours.\118\
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    \114\ These estimates are based on filings received in calendar 
year 1999. The currently approved hour burden per response for rule 
34b-1 is 2.4 hours.
    \115\ This number is computed by subtracting from the number of 
respondents filing rule 34b-1 sales material the number of money 
market funds, the number of funds and UITs registered on Forms N-3 
and N-4, and the number of funds used as underlying portfolios for 
variable insurance contracts (8,495-1,040-620-1,575, or 5,260).
    \116\ This estimate is based on the assumption that tax-managed 
funds and index funds would be most likely to advertise after-tax 
performance.
    \117\ The current total annual hour burden is computed by 
multiplying the number of responses filed annually under rule 34b-1 
by the current hour burden (37,000 x 2.4). The total annual hour 
burden for the industry has increased significantly from previous 
estimates because we have reevaluated the number of respondents 
subject to rule 34b-1.
    \118\ The total annual burden is computed by adding the current 
burden (2.4 x 37,000, or 88,800) to the additional burden imposed by 
the proposed amendments [.5 x (8,495-1,040-620-1,575) x 4.35 x 3%, 
or 343].
---------------------------------------------------------------------------

    Compliance with rule 34b-1 is mandatory for every registered 
investment company that issues sales literature. Responses to the 
disclosure requirements will not be kept confidential.

Request for Comments

    We request your comments on the accuracy of our estimates. Pursuant 
to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments to: (i) 
Evaluate whether the proposed collection of information is necessary 
for the proper performance of the functions of the agency, including 
whether the information will have practical utility; (ii) evaluate the 
accuracy of the Commission's estimate of burden of the proposed 
collection of information; (iii) determine whether there are ways to 
enhance the quality, utility, and clarity of the information to be 
collected; and (iv) evaluate whether there are ways to minimize the 
burden of the collection of information on those who are to respond, 
including through the use of automated collection techniques or other 
forms of information technology.
    Persons submitting comments on the collection of information 
requirements should direct the comments to the Office of Management and 
Budget, Attention: Desk Officer for the Securities and Exchange 
Commission, Office of Information and Regulatory Affairs, Room 3208, 
New Executive Office Building, Washington, D.C. 20503, and should send 
a copy to Jonathan G. Katz, Secretary, Securities and Exchange 
Commission, 450 5th Street, N.W., Washington, D.C. 20549-0609, with 
reference to File No. S7-09-00. OMB is required to make a decision 
concerning the collection of information between 30 and 60 days after 
publication of this release. Consequently, a comment to OMB is best 
assured of having its full effect if OMB receives it within 30 days 
after publication of this Release.

VII. Statutory Authority

    The Commission is proposing amendments to Form N-1A pursuant to 
authority set forth in sections 5, 6, 7, 10, and 19(a) of the 
Securities Act [15 U.S.C. 77e, 77f, 77g, 77j, 77s(a)] and sections 8, 
24(a), 30, and 38 of the Investment Company Act [15 U.S.C. 80a-8, 80a-
24(a), 80a-29, 80a-37]. The Commission is proposing amendments to rule 
482 pursuant to authority set forth in sections 5, 10(b), and 19(a) of 
the Securities Act [15 U.S.C. 77e, 77j(b), and 77s(a)]. The Commission 
is proposing amendments to rule 34b-1 pursuant to authority set forth 
in sections 34(b) and 38(a) of the Investment Company Act [15 U.S.C. 
80a-33(b) and 80a-37(a)].

List of Subjects

17 CFR Part 230

    Advertising, Investment companies, Reporting and recordkeeping 
requirements, Securities.

17 CFR Part 239

    Reporting and recordkeeping requirements, Securities.

17 CFR Parts 270 and 274

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

Text of Proposed Rules and Forms

    For the reasons set out in the preamble, Title 17, Chapter II of 
the Code of Federal Regulations is proposed to be amended as follows:

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

    1. The authority citation for part 230 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77b, 77f, 77g, 77h, 77j, 77r, 77s, 77z-3, 
77sss, 78c, 78d, 78l, 78m, 78n, 78o, 78w, 78ll(d), 79t, 80a-8, 80a-
24, 80a-28, 80a-29, 80a-30, and 80a-37, unless otherwise noted.
* * * * *
    2. Section 230.482 is amended by:
    a. revising the introductory text of paragraph (e)(3);
    b. removing ``; and'' at the end of paragraph (e)(3)(iv) and in its 
place adding a period;
    c. redesignating paragraph (e)(4) as paragraph (e)(5);
    d. adding new paragraph (e)(4); and
    e. revising newly redesignated paragraph (e)(5) to read as follows:


Sec. 230.482  Advertising by an investment company as satisfying 
requirements of section 10.

* * * * *
    (e) * * *
    (3) Before-tax average annual total return (with redemption) for 
one, five, and ten year periods; Provided, That if the company's 
registration statement under the Securities Act of 1933 (15 U.S.C. 77a 
et seq.) has been in effect for less than one, five, or ten years, the 
time period during which the registration statement was in effect is 
substituted for the period(s) otherwise prescribed; and Provided 
further, That such quotations:
* * * * *
    (4) For an open-end management investment company, after-tax 
average annual total return (with and without redemption) for one, 
five, and ten year periods; Provided, That if the company's 
registration statement under the Securities Act of 1933 (15 U.S.C. 77a 
et seq.) has been in effect for less than one,

[[Page 15515]]

five, or ten years, the time period during which the registration 
statement was in effect is substituted for the period(s) otherwise 
prescribed; and Provided further, That such quotations:
    (i) Are based on the methods of computation prescribed in Form N-
1A;
    (ii) Are current to the most recent calendar quarter ended prior to 
the submission of the advertisement for publication;
    (iii) Are accompanied by quotations of total return as provided for 
in paragraph (e)(3) of this section;
    (iv) Include both after-tax average annual total return (with 
redemption) and after-tax average annual total return (without 
redemption);
    (v) Are set out with equal prominence and are set out in no greater 
prominence than the required quotations of total return; and
    (vi) Identify the length of and the last day of the one, five, and 
ten year periods; and
    (5) Any other historical measure of company performance (not 
subject to any prescribed method of computation) if such measurement:
    (i) Reflects all elements of return;
    (ii) Is accompanied by quotations of total return as provided for 
in paragraph (e)(3) of this section;
    (iii) In the case of any measure of performance adjusted to reflect 
the effect of taxes, is accompanied by quotations of total return as 
provided for in paragraph (e)(4) of this section;
    (iv) Is set out in no greater prominence than the required 
quotations of total return; and
    (v) Identifies the length of and the last day of the period for 
which performance is measured.
* * * * *

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

    3. The authority citation for part 270 continues to read in part as 
follows:

    Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39 
unless otherwise noted:
* * * * *
    4. Section 270.34b-1 is amended by:
    a. redesignating paragraphs (b)(1)(iii) (B) and (C) as paragraphs 
(b)(1)(iii) (C) and (D);
    b. adding new paragraph (b)(1)(iii)(B); and
    c. revising paragraph (b)(3) to read as follows:


Sec. 270.34b-1  Sales literature deemed to be misleading.

* * * * *
    (b)(1) * * *
    (iii) * * *
    (B) Accompany any quotation of performance adjusted to reflect the 
effect of taxes with the quotations of total return specified by 
paragraph (e)(4) of Sec. 230.482 of this chapter;
* * * * *
    (3) The requirements specified in paragraph (b)(1) of this section 
shall not apply to any quarterly, semi-annual, or annual report to 
shareholders under Section 30 of the Act (15 U.S.C. 80a-29) containing 
performance data for a period commencing no earlier than the first day 
of the period covered by the report; nor shall the requirements of 
paragraphs (e)(3)(ii), (e)(4)(ii), and (f) of Sec. 230.482 of this 
chapter apply to any such periodic report containing any other 
performance data.
* * * * *

PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933

    5. The authority citation for part 239 continues to read, in part, 
as follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77sss, 78c, 
78l, 78m, 78n, 78o(d), 78u-5, 78w(a), 78ll(d), 79e, 79f, 79g, 79j, 
79l, 79m, 79n, 79q, 79t, 80a-8, 80a-24, 80a-29, 80a-30 and 80a-37, 
unless otherwise noted.
* * * * *

PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940

    6. The authority citation for part 274 continues to read as 
follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m, 
78n, 78o(d), 80a-8, 80a-24, and 80a-29, unless otherwise noted.

    Note: The text of Form N-1A does not and these amendments will 
not appear in the Code of Federal Regulations.

    7. General Instruction C to Form N-1A (referenced in Secs. 239.15A 
and 274.11A) is amended by:
    a. revising the introductory text of paragraph 3.(d)(i);
    b. republishing paragraph 3.(d)(i)(A);
    c. republishing paragraph 3.(d)(i)(B) except for removing ``and'' 
at the end of the paragraph;
    d. republishing paragraph 3.(d)(i)(C) except for removing the 
period at the end of the paragraph and adding in its place ``; and''; 
and
    e. adding paragraph 3.(d)(i)(D) to read as follows:
    Form N-1A
* * * * *
    General Instructions
* * * * *
    C. Preparation of the Registration Statement
* * * * *
    3. Additional Matters:
* * * * *
    (d) Modified Prospectuses for Certain Funds.
    (i) A Fund may omit the information required by Items 
2(c)(2)(iii)(A), (B), and (D), 2(c)(2)(iv), 5(b)(2)(i), (ii), and (iv), 
and 5(b)(3), and a Fund may modify or omit, if inapplicable, the 
information required by Items 7(b)-(d) and 8(a)(2), if the Fund's 
prospectus will be used exclusively to offer Fund shares as investment 
options for:
    (A) A defined contribution plan that meets the requirements for 
qualification under section 401(k) of the Internal Revenue Code (26 
U.S.C. 401(k));
    (B) A tax-deferred arrangement under sections 403(b) or 457 of the 
Internal Revenue Code (26 U.S.C. 403(b) and 457);
    (C) A variable contract as defined in section 817(d) of the 
Internal Revenue Code (26 U.S.C. 817(d)), if covered in a separate 
account prospectus; and
    (D) A similar plan or arrangement pursuant to which an investor is 
not taxed on his or her investment in the Fund until the investment is 
sold.
* * * * *
    8. Item 2 of Form N-1A (referenced in Secs. 239.15A and 274.11A) is 
amended by:
    a. revising paragraph (c)(2)(iii);
    b. adding paragraph (c)(2)(iv);
    c. revising paragraph (a) of Instruction 2; and
    d. revising paragraph (c) of Instruction 3 to read as follows:
Form N-1A
* * * * *
Item 2. Risk/Return Summary: Investments, Risks, and Performance
* * * * *
    (c) * * *
    (2) * * *
    (iii) If the Fund has annual returns for at least one calendar 
year, provide a table showing the Fund's (A) before-tax average annual 
total return (without redemption); (B) after-tax average annual total 
return (without redemption); (C) before-tax average annual total return 
(with redemption); and (D) after-tax average annual total return (with 
redemption). A Money Market Fund should show only the returns described 
in clause (C) of the preceding sentence. All returns should be shown 
for 1-, 5-, and 10-calendar year periods ending on the date of the most 
recently completed calendar year (or for the life of the Fund, if 
shorter), but only for periods subsequent to the effective date of the 
Fund's registration statement. The table also should show

[[Page 15516]]

the returns of an appropriate broad-based securities market index as 
defined in Instruction 5 to Item 5(b) for the same periods. A Fund that 
has been in existence for more than 10 years also may include average 
annual total returns for the life of the Fund. A Money Market Fund may 
provide the Fund's 7-day yield ending on the date of the most recent 
calendar year or disclose a toll-free (or collect) telephone number 
that investors can use to obtain the Fund's current 7-day yield. For a 
Fund (other than a Money Market Fund or a Fund described in General 
Instruction C.3.(d)(i)), provide the information in the following table 
with the specified captions:

                      Average Annual Total Returns
                [For the periods ended December 31, ----]
------------------------------------------------------------------------
                                      1 year      5 years      10 years
------------------------------------------------------------------------
If You Continue to Hold Your
 Shares at End of Period:
    Before-Tax Return............          __%          __%          __%
    After-Tax Return.............          __%          __%          __%
If You Sell Your Shares at End of
 Period:
    Before-Tax Return............          __%          __%          __%
    After-Tax Return.............          __%          __%          __%
Index (reflects no deduction for           __%          __%          __%
 fees, expenses, or taxes).......
------------------------------------------------------------------------

    (iv) Adjacent to the table required by paragraph (c)(2)(iii) of 
this Item, provide a brief explanation of the following:
    (A) The differences among the four types of return presented, 
including whether the returns reflect redemption and the charges and 
taxes associated with redemption;
    (B) That before-tax returns assume that all distributions are 
reinvested;
    (C) The assumptions used in calculating after-tax returns, 
including (1) the use of the historical highest individual federal 
marginal income tax rates; (2) the assumption that taxes are paid out 
of fund distributions and that distributions, less taxes, are 
reinvested; (3) the exclusion of state and local taxes; and (4) if 
after-tax returns (with redemption) are higher than before-tax returns 
(with redemption), explain the reason for this result, including the 
assumption that a shareholder has sufficient gains from other sources 
to offset all losses from the redemption of fund shares;
    (D) Actual after-tax returns depend on an investor's tax situation 
and may differ from those shown;
    (E) The after-tax returns shown are not relevant to investors who 
hold their Fund shares through tax-deferred arrangements, such as 
401(k) plans or individual retirement accounts; and
    (F) After-tax returns reflect past tax effects and are not 
predictive of future tax effects.

Instructions

* * * * *
    2. Table.
    (a) Calculate a Money Market Fund's 7-day yield under Item 21(a); 
the Fund's before-tax average annual total return (without redemption) 
and before-tax average annual total return (with redemption) under 
Items 21(b)(1) and (2), respectively; and the Fund's after-tax average 
annual total return (without redemption) and after-tax average annual 
total return (with redemption) under Items 21(b)(3) and (4), 
respectively.
* * * * *
    3. Multiple Class Funds.
* * * * *
    (c) Provide average annual total returns in the table for each 
Class offered in the prospectus. The four types of return for each 
Class required under Item 2(c)(2)(iii)(A), (B), (C), and (D) should be 
adjacent and should not be interspersed with the returns of other 
Classes.
* * * * *
    9. Item 5 of Form N-1A (referenced in Secs. 239.15A and 274.11A) is 
amended by:
    a. revising paragraph (b)(2);
    b. adding paragraph (b)(3); and
    c. adding Instruction 12 to read as follows:
Form N-1A
* * * * *
    Item 5. Management's Discussion of Fund Performance
* * * * *
    (b)(1) * * *
    (2) Include a statement accompanying the graph to the effect that 
past performance does not predict future performance and that account 
value does not reflect the taxes that a shareholder would pay on fund 
distributions or the redemption of fund shares. In a table placed 
within or next to the graph, provide the Fund's (i) before-tax average 
annual total return (without redemption); (ii) after-tax average annual 
total return (without redemption); (iii) before-tax average annual 
total return (with redemption); and (iv) after-tax average annual total 
return (with redemption). All returns should be shown for the 1-, 5-, 
and 10-year periods as of the end of the last day of the most recent 
fiscal year (or for the life of the Fund, if shorter), but only for 
periods subsequent to the effective date of the Fund's registration 
statement. All returns should be computed in accordance with Items 
21(b)(1), (b)(2), (b)(3), and (b)(4). For a Fund other than a Fund 
described in General Instruction C.3.(d)(i), provide the information in 
the following table with the specified captions:

                      Average Annual Total Returns
                       [For the Fiscal Year ended]
------------------------------------------------------------------------
                                      1 year      5 years      10 years
------------------------------------------------------------------------
If You Continue to Hold Your
 Shares at End of Period:
    Before-Tax Return............          __%          __%          __%
    After-Tax Return.............          __%          __%          __%
If You Sell Your Shares at End of
 Period:

[[Page 15517]]

 
    Before-Tax Return............          __%          __%          __%
    After-Tax Return.............          __%          __%          __%
------------------------------------------------------------------------

    (3) Adjacent to the table required by paragraph (b)(2) of this 
Item, provide a brief explanation of the following:
    (i) The differences among the four types of return presented, 
including whether the returns reflect redemption and the charges and 
taxes associated with redemption;
    (ii) That before-tax returns assume that all distributions are 
reinvested;
    (iii) The assumptions used in calculating after-tax returns, 
including (A) the use of the historical highest individual federal 
marginal income tax rates; (B) the assumption that taxes are paid out 
of fund distributions and that distributions, less taxes, are 
reinvested; (C) the exclusion of state and local taxes; and (D) if 
after-tax returns (with redemption) are higher than before-tax returns 
(with redemption), explain the reason for this result, including the 
assumption that a shareholder has sufficient gains from other sources 
to offset all losses from the redemption of fund shares;
    (iv) Actual after-tax returns depend on an investor's tax situation 
and may differ from those shown;
    (v) The after-tax returns shown are not relevant to investors who 
hold their Fund shares through tax-deferred arrangements, such as 
401(k) plans or individual retirement accounts; and
    (vi) After-tax returns reflect past tax effects and are not 
predictive of future tax effects.

Instructions

* * * * *
    12. Table for Multiple Class Funds.
    Provide average annual total returns in the table for each Class of 
a Multiple Class Fund that is offered in the prospectus or covered by 
the annual report. The four types of return for each Class required 
under Item 5(b)(2)(i), (ii), (iii), and (iv) should be adjacent and 
should not be interspersed with the returns of other Classes.
* * * * *
    10. Item 21 of Form N-1A (referenced in Secs. 239.15A and 274.11A) 
is amended by:
    a. revising the phrase ``(b)(1)-(4)'' to read ``(b)(1)-(7)'' in the 
introductory text of paragraph (b);
    b. redesignating paragraphs (b)(1), (2), (3), (4), and (5) as 
paragraphs (b)(2), (5), (6), (7), and (8), respectively;
    c. adding new paragraphs (b)(1), (b)(3), and (b)(4); and
    d. revising newly redesignated paragraph (b)(2) to read as follows:
Form N-1A
* * * * *
Item 21. Calculation of Performance Data
* * * * *
    (b) * * *
    (1) Before-Tax Average Annual Total Return (Without Redemption) 
Quotation. For the 1-, 5-, and 10-year periods ended on the date of the 
most recent balance sheet included in the registration statement (or 
for the periods the Fund has been in operation), calculate the Fund's 
before-tax average annual total return (without redemption) by finding 
the average annual compounded rates of return over the 1-, 5-, and 10-
year periods (or for the periods of the Fund's operations) that would 
equate the initial amount invested to the ending redeemable value, 
according to the following formula:

P(1+T) \n\ = ERVNR

Where:

P = a hypothetical initial payment of $1,000.
T = before-tax average annual total return (without redemption).
n = number of years.
ERVNR = ending redeemable value of a hypothetical $1,000 
payment made at the beginning of the 1-, 5-, or 10-year periods at the 
end of the 1-, 
5-, or 10-year periods (or fractional portion) assuming no redemption 
of the account.

Instructions

    1. Assume the maximum sales load (or other charges deducted from 
payments) is deducted from the initial $1,000 payment.
    2. Assume all distributions by the Fund are reinvested at the price 
stated in the prospectus (including any sales load imposed upon 
reinvestment of dividends) on the reinvestment dates during the period.
    3. Include all recurring fees that are charged to all shareholder 
accounts. For any account fees that vary with the size of the account, 
assume an account size equal to the Fund's mean (or median) account 
size. Reflect, as appropriate, any recurring fees charged to 
shareholder accounts that are paid other than by redemption of the 
Fund's shares.
    4. Determine the ending redeemable value by assuming no redemption 
at the end of the 1-, 5-, or 10-year periods. Deduct any charges that 
are deducted at the end of each period assuming no redemption. Do not 
deduct nonrecurring charges deducted only on redemption, such as 
deferred sales loads or redemption fees.
    5. State the before-tax average annual total return (without 
redemption) quotation to the nearest hundredth of one percent.
    (2) Before-Tax Average Annual Total Return (With Redemption) 
Quotation. For the 1-, 5-, and 10-year periods ended on the date of the 
most recent balance sheet included in the registration statement (or 
for the periods the Fund has been in operation), calculate the Fund's 
before-tax average annual total return (with redemption) by finding the 
average annual compounded rates of return over the 1-, 5-, and 10-year 
periods (or for the periods of the Fund's operations) that would equate 
the initial amount invested to the ending redeemable value, according 
to the following formula:

P(1+T) \n\ = ERVR

    Where:
P = a hypothetical initial payment of $1,000.
T = before-tax average annual total return (with redemption).
n = number of years.
ERVR = ending redeemable value of a hypothetical $1,000 
payment made at the beginning of the 1-, 5-, or 10-year periods at the 
end of the 1-, 
5-, or 10-year periods at the end of the 1-, 5-, or 10-year periods (or 
fractional portion), assuming the account is redeemed at the end of the 
last day of the measurement period.

Instructions

    1. Assume the maximum sales load (or other charges deducted from 
payments) is deducted from the initial $1,000 payment.
    2. Assume all distributions by the Fund are reinvested at the price 
stated

[[Page 15518]]

in the prospectus (including any sales load imposed upon reinvestment 
of dividends) on the reinvestment dates during the period.
    3. Include all recurring fees that are charged to all shareholder 
accounts. For any account fees that vary with the size of the account, 
assume an account size equal to the Fund's mean (or median) account 
size. Reflect, as appropriate, any recurring fees charged to 
shareholder accounts that are paid other than by redemption of the 
Fund's shares.
    4. Determine the ending redeemable value by assuming a complete 
redemption at the end of the 1-, 5-, or 10-year periods and the 
deduction of all nonrecurring charges deducted at the end of each 
period. If shareholders are assessed a deferred sales load, assume the 
maximum deferred sales load is deducted at the times, in the amounts, 
and under the terms disclosed in the prospectus.
    5. State the before-tax average annual total return (with 
redemption) quotation to the nearest hundredth of one percent.
    (3) After-Tax Average Annual Total Return (Without Redemption) 
Quotation. For the 1-, 5-, and 10-year periods ended on the date of the 
most recent balance sheet included in the registration statement (or 
for the periods the Fund has been in operation), calculate the Fund's 
after-tax average annual total return (without redemption) by finding 
the average annual compounded rates of return over the 1-, 5-, and 10-
year periods (or for the periods of the Fund's operations) that would 
equate the initial amount invested to the after-tax ending value, 
according to the following formula:

P(1+T) \n\ = ATVNR

Where:
P = a hypothetical initial payment of $1,000.
T = after-tax average annual total return (without redemption).
n = number of years.
    ATVNR = ending after-tax value of a hypothetical $1,000 
payment made at the beginning of the 1-, 5-, or 10-year periods at the 
end of the 1-, 5-, or 10-year periods (or fractional portion), assuming 
no redemption of the account.

Instructions

    1. Assume the maximum sales load (or other charges deducted from 
payments) is deducted from the initial $1,000 payment.
    2. Assume all distributions by the Fund, less the taxes due on such 
distributions, are reinvested at the price stated in the prospectus 
(including any sales load imposed upon reinvestment of dividends) on 
the reinvestment dates during the period.
    3. Calculate the taxes due on any distributions by the Fund by 
applying the tax rate specified in Instruction 4 to each component of 
the distributions on the reinvestment date (e.g., ordinary income, 
short-term capital gain, long-term capital gain). The taxable amount 
and tax character of each distribution should be as specified by the 
Fund on the dividend declaration date, but may be adjusted to reflect 
subsequent recharacterizations of distributions. Distributions should 
be adjusted to reflect the federal tax impact the distribution would 
have on an individual taxpayer on the reinvestment date. For example, 
assume no taxes are due on the portions of any distribution that would 
not result in federal income tax on an individual, e.g., tax-exempt 
interest or non-taxable returns of capital.
    4. Calculate the taxes due using the highest individual marginal 
federal income tax rate in effect on the reinvestment date. The rate 
used should correspond to the tax character of each component of the 
distributions (e.g., ordinary income rates for ordinary income 
distributions, short-term capital gain rates for short-term capital 
gain distributions, long-term capital gain rates for long-term capital 
gain distributions). Note that the required tax rates may vary over the 
measurement period. Disregard any potential tax liabilities other than 
federal tax liabilities (e.g., state and local taxes); the effect of 
phaseouts of certain exemptions, deductions, and credits at various 
income levels; and the impact of the federal alternative minimum tax.
    5. Include all recurring fees that are charged to all shareholder 
accounts. For any account fees that vary with the size of the account, 
assume an account size equal to the Fund's mean (or median) account 
size. Assume that no additional taxes or tax credits result from any 
redemption of shares required to pay such fees. Reflect, as 
appropriate, any recurring fees charged to shareholder accounts that 
are paid other than by redemption of the Fund's shares.
    6. Determine the ending after-tax value by assuming no redemption 
at the end of the 1-, 5-, or 10-year periods. Deduct any charges that 
are deducted at the end of each period assuming no redemption. Do not 
deduct nonrecurring charges deducted only on redemption, such as 
deferred sales loads or redemption fees.
    7. State the after-tax average annual total return (without 
redemption) quotation to the nearest hundredth of one percent.
    (4) After-Tax Average Annual Total Return (With Redemption) 
Quotation. For the 1-, 5-, and 10-year periods ended on the date of the 
most recent balance sheet included in the registration statement (or 
for the periods the Fund has been in operation), calculate the Fund's 
after-tax average annual total return (with redemption) by finding the 
average annual compounded rates of return over the 1-, 5-, and 10-year 
periods (or for the periods of the Fund's operations) that would equate 
the initial amount invested to the after-tax ending value, according to 
the following formula:
P(1 + T)n = ATVR

Where:

P = a hypothetical initial payment of $1,000.
T = after-tax average annual total return (with redemption).
n = number of years.
ATVR = ending after-tax value of a hypothetical $1,000 
payment made at the beginning of the 1-, 
5-, or 10-year periods at the end of the 1-, 5-, or 10-year periods (or 
fractional portion), assuming the account is redeemed at the end of the 
last day of the measurement period.

Instructions

    1. Assume the maximum sales load (or other charges deducted from 
payments) is deducted from the initial $1,000 payment.
    2. Assume all distributions by the Fund, less the taxes due on such 
distributions, are reinvested at the price stated in the prospectus 
(including any sales load imposed upon reinvestment of dividends) on 
the reinvestment dates during the period.
    3. Calculate the taxes due on any distributions by the Fund by 
applying the tax rate specified in Instruction 4 to each component of 
the distributions on the reinvestment date (e.g., ordinary income, 
short-term capital gain, long-term capital gain). The taxable amount 
and tax character of each distribution should be as specified by the 
Fund on the dividend declaration date, but may be adjusted to reflect 
subsequent recharacterizations of distributions. Distributions should 
be adjusted to reflect the federal tax impact the distribution would 
have on an individual taxpayer on the reinvestment date. For example, 
assume no taxes are due on the portions of any distributions that would 
not result in federal income tax on an individual, e.g., tax-exempt 
interest or non-taxable returns of capital.
    4. Calculate the taxes due using the highest individual marginal 
federal

[[Page 15519]]

income tax rate in effect on the reinvestment date. The rate used 
should correspond to the tax character of each component of the 
distributions (e.g., ordinary income rates for ordinary income 
distributions, short-term capital gain rates for short-term capital 
gain distributions, long-term capital gain rates for long-term capital 
gain distributions). Note that the required tax rates may vary over the 
measurement period. Disregard any potential tax liabilities other than 
federal tax liabilities (e.g., state and local taxes); the effect of 
phaseouts of certain exemptions, deductions, and credits at various 
income levels; and the impact of the federal alternative minimum tax.
    5. Include all recurring fees that are charged to all shareholder 
accounts. For any account fees that vary with the size of the account, 
assume an account size equal to the Fund's mean (or median) account 
size. Assume that no additional taxes or tax credits result from any 
redemption of shares required to pay such fees. Reflect, as 
appropriate, any recurring fees charged to shareholder accounts that 
are paid other than by redemption of the Fund's shares.
    6. Determine the ending after-tax value by assuming a complete 
redemption at the end of the 1-, 5-, or 10-year periods and the 
deduction of all nonrecurring charges deducted at the end of each 
period. If shareholders are assessed a deferred sales load, assume the 
maximum deferred sales load is deducted at the times, in the amounts, 
and under the terms disclosed in the prospectus.
    7. Determine ending after-tax value by subtracting capital gains 
taxes resulting from the redemption and adding the tax benefit from 
capital losses resulting from the redemption.
    (a) Calculate the capital gain or loss upon redemption by 
subtracting the tax basis from the redemption proceeds (after deducting 
any nonrecurring charges as specified by Instruction 6).
    (b) In determining the tax basis, include the initial $1,000 
payment and reinvested distributions (net of taxes assumed paid from 
the distributions, but not net of any sales loads imposed upon 
reinvestment). Also, adjust the tax basis for any distributions 
representing returns of capital and any other tax basis adjustments 
that would apply to an individual taxpayer.
    (c) When determining the character of capital gain or loss upon 
redemption, the Fund should track the actual holding periods of 
reinvested distributions. That is, the Fund should not assume that 
shares acquired through reinvestment of distributions have the same 
holding period as the initial $1,000 investment.
    (d) Calculate the capital gains taxes (or the benefit resulting 
from tax losses) by multiplying the amount of the capital gain (loss) 
by the highest federal individual capital gains tax rate in effect on 
the redemption date. The rate used should correspond to the tax 
character of the capital gains (e.g., short-term or long-term), which 
is determined by the length of the measurement period in the case of 
the initial $1,000 investment and the length of the period between 
reinvestment and the end of the measurement period in the case of 
reinvested distributions.
    8. State the after-tax average annual total return quotation (with 
redemption) to the nearest hundredth of one percent.
* * * * *

    By the Commission.
    Dated: March 15, 2000.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-6948 Filed 3-21-00; 8:45 am]
BILLING CODE 8010-01-P