[Federal Register Volume 66, Number 24 (Monday, February 5, 2001)]
[Rules and Regulations]
[Pages 9002-9021]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-2063]



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Part II





Securities and Exchange Commission





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17 CFR Parts 230, 239, 270, and 274



Disclosure of Mutual Fund After-Tax Returns; Final Rule

  Federal Register / Vol. 66, No. 24 / Monday, February 5, 2001 / Rules 
and Regulations  

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 230, 239, 270, and 274

[Release Nos. 33-7941; 34-43857; IC-24832; File No. S7-09-00]
RIN 3235-AH77


Disclosure of Mutual Fund After-Tax Returns

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission is adopting 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''). These amendments require mutual funds 
to disclose in their prospectuses after-tax returns based on 
standardized formulas comparable to the formula currently used to 
calculate before-tax average annual total returns. The amendments also 
require certain funds to include standardized after-tax returns in 
advertisements and other sales materials. Disclosure of standardized 
mutual fund after-tax returns will help investors to understand the 
magnitude of tax costs and compare the impact of taxes on the 
performance of different funds.

EFFECTIVE DATE: April 16, 2001. Section II. J. of this document 
contains information on compliance dates.

FOR FURTHER INFORMATION CONTACT: Vincent J. Di Stefano, Senior Counsel, 
Peter M. Hong, Special 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, NW., Washington, D.C. 20549-
0506.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'') is adopting 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'' or ``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 adopting 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. Required Disclosure of After-Tax Returns
    B. Types of Return to Be Disclosed
    C. Location of Required Disclosure
    D. Format of Disclosure
    E. Exemptions from the Disclosure Requirement
    F. Advertisements and Other Sales Literature
    G. Formulas for Computing After-Tax Return
    1. Tax Bracket
    2. Capital Gains and Losses Upon a Sale of Fund Shares
    3. Other Assumptions
    H. Narrative Disclosure
    I. Technical and Conforming Amendments
    J. Effective Date; Compliance Dates
    1. Effective Date
    2. Compliance Date for Prospectuses
    3. Compliance Date for Advertisements and Other Sales Materials
III. Cost/Benefit Analysis
    A. Benefits
    B. Costs
IV. Effects on Efficiency, Competition, and Capital Formation
V. Summary of Final Regulatory Flexibility Analysis
    A. Need for the Rule and Form Amendments
    B. Significant Issues Raised by Public Comment
    C. Small Entities Subject to the Rule
    D. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements
    E. Agency Action to Minimize Effects on Small Entities
VI. Paperwork Reduction Act
VII. Statutory Authority
Text of Rules and Forms

I. Introduction

    We are adopting rule and form amendments that require a mutual fund 
to disclose after-tax returns.\1\ Taxes are one of the most significant 
costs of investing in mutual funds through taxable accounts. In 1999, 
mutual funds distributed approximately $238 billion in capital gains 
and $159 billion in taxable dividends.\2\ Shareholders investing in 
stock and bond funds paid an estimated $39 billion in taxes in 1998 on 
distributions by their funds.\3\ 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.\4\ Moreover, it is estimated 
that, between 1994 and 1999, investors in diversified U.S. stock funds 
surrendered an average of 15 percent of their annual gains to taxes.\5\
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    \1\ See Disclosure of Mutual Fund After-Tax Returns, Investment 
Company Act Release No. 24339 (Mar. 15, 2000) (65 FR 15500 (Mar. 22, 
2000)) (``Proposing Release'').
    \2\ Investment Company Institute (``ICI''), Mutual Fund Fact 
Book 56 (2000) (``2000 Mutual Fund Fact Book'') (distributions of 
taxable dividends included $95.6 billion on equity, hybrid, and bond 
funds and $63.1 billion on money market funds).
    \3\ Liberty Funds Distributor News Release, Liberty Announces 
Annual Mutual Fund Tax Pain Index (Apr. 12, 2000) http://www.libertyfunds.com/liberty/lf/scripts/ libertyNews.jsp?action= 
PressReleasesTaxPain&BV_SessionID= @@@@1948593995. 
0976289726@@@@&BV_EngineID= caljiehhgegbfdmckgcfjicil.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).
    \4\ KPMG Peat Marwick LLP, An Educational Analysis of Tax-
Managed Mutual Funds and the Taxable Investor (``KPMG Study''), at 
14.
    \5\ 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.\6\ 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.\7\ 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 fund's 
underlying portfolio securities at a gain.\8\
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    \6\ 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. 2, 2001) http://www.dreyfus.com/.
    \7\ 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 
(2000), at 2-4 (explaining tax treatment of distributions of income 
and capital gains by mutual funds to their shareholders).
    \8\ 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.\9\ 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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    \9\ KPMG study, supra note 4, 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.\10\ In 
addition, several fund groups have created new funds promoting the use 
of more tax-efficient portfolio management strategies.\11\ Moreover, in 
April 2000, a bill that would require the Commission to revise its 
regulations to require improved disclosure of mutual fund after-tax 
returns was passed by the U.S. House of Representatives and referred to 
the Senate.\12\ Many press commenters also have highlighted the need 
for improvements in mutual fund tax disclosure.\13\
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    \10\ For example, Eaton Vance Management reports after-tax 
returns and tax-efficiency ratios for certain of its tax-managed 
funds on its website. Eaton Vance, Eaton Vance Mutual Funds (visited 
December 19, 2000) http://www.eatonvance.com/mutual_funds/mutualfunds_A.asp. Online tax calculators are also available. The 
Vanguard Group, After-Tax Returns Calculator (visited December 19, 
2000) http://majestic5.vanguard.com/FP/DA/0.1.vgi_FundAfterTaxSim/079190348019134650? AFTER_TAX_CALC=SIMPLE (calculator that can be 
used to calculate after-tax returns for Vanguard funds); Andrew 
Tobias' Mutual Fund Cost Calculator (visited Dec. 22, 2000) http://www.personalfund.com/cgi-bin/cost.cgi?ticker=TWLBX (cost calculator 
includes a feature that calculates after-tax returns). Fidelity 
Investments and Charles Schwab & Co. offer Internet tools that 
feature after-tax returns of funds offered in their fund 
supermarkets. E.g., Fidelity Investments, Fidelity Funds (visited 
December 19, 2000) http://personal100.fidelity.com/gen/mflfid/0/316145200.html; About Schwab, Schwab Introduces New On-line Mutual 
Fund Selection and Screener Tools, Dec. 22, 1999 (visited Dec. 19, 
2000) http://www.prnewswire.com/cgi-bin/micro_stories.pl? 
ACCT=154881&TICK=SCH&STORY=/www/story/12-22-1999/0001102424&E 
DATE=Dec+22,+1999. Further, Morningstar, Inc., and Forbes report 
mutual fund after-tax returns. Morningstar, Mutual Fund 500 (2000 
ed.); Fund Survey, Forbes, Feb. 7, 2000, at 166.
    \11\ The fund groups offering funds labeled as ``tax-managed,'' 
``tax-efficient,'' ``tax-sensitive,'' or ``tax-aware'' include 59 
Wall Street, American Century, Bernstein, Delaware Investments, DFA 
Investment Dimensions, Dresdner RCM Global Investors, Dreyfus, Eaton 
Vance, Evergreen, Fidelity, GMO, Golden Oak, ING, J.P. Morgan, 
Liberty Financial Funds, PaineWebber, PIMCO, Prudential, Putnam, 
Russell, Standish Ayer & Wood, STI Classic, SunAmerica, T. Rowe 
Price, USAA, and Vanguard. Morningstar, Inc., currently tracks 59 
tax-managed funds, as compared to 12 such funds only four years ago. 
Morningstar, Principia Pro Plus (Dec. 2000) (reporting as of Nov. 
30, 2000).
    \12\ The Mutual Fund Tax Awareness Act of 2000, H. R. 1089, 
106th Cong., 2nd Sess. (2000) (introduced by Congressman Paul 
Gillmor, passed by the House, as amended, on Apr. 3, 2000, by a vote 
of 358 to 2, and referred to the Senate on Apr. 4, 2000.). 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).
    \13\ See, e.g., Fred Barbash, Facts Might Confuse Us? Excuse 
Me?, The Washington Post, Nov. 19, 2000, at H1; 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.\14\ While we believe 
that this disclosure is useful, we are persuaded that funds can more 
effectively communicate to investors the tax consequences of investing. 
As a result, last March we proposed 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.\15\
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    \14\ 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. 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. 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.
    \15\ Proposing Release, supra note 1.
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    Today we adopt rule and form amendments that require a fund to 
disclose its standardized after-tax returns for 1-, 5-, and 10-year 
periods. After-tax returns, which will accompany before-tax returns in 
fund prospectuses, will be presented in two ways: (i) After taxes on 
fund distributions only; and (ii) after taxes on fund distributions and 
a redemption of fund shares. Although after-tax returns will not 
generally be required in fund advertisements and sales literature, any 
fund that either includes after-tax returns in these materials or 
includes other performance information together with representations 
that the fund is managed to limit taxes will be required to include 
after-tax returns computed according to our standardized formulas.
    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''), almost forty 
percent of non-money market fund assets held by individuals are held in 
taxable accounts.\16\ 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.\17\ 
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

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selecting or evaluating a fund.\18\ 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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    \16\ As of year end 1999, eighty-one percent of mutual fund 
assets ($5.5 trillion) were held by individuals. 2000 Mutual Fund 
Fact Book, supra note 2, at 41. At the end of 1999, mutual fund 
assets held in retirement accounts stood at $2.5 trillion. 2000 
Mutual Fund Fact Book, at 49. Mutual fund assets held by individuals 
in money market funds stood at $885 billion. 2000 Mutual Fund Fact 
Book, at 103. Thus, almost 40 percent of non-money market fund 
assets held by individuals ($2.1 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).
    \17\ See Items 2, 5, 9, and 22(b)(2) of Form N-1A.
    \18\ Last year, we 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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    This is the latest Commission action in our continuing effort to 
improve fund disclosure of costs. Since 1988, we have required mutual 
funds to include a uniform fee table in the prospectus.\19\ More 
recently, we have increased our efforts to educate investors about 
mutual fund costs and how those costs affect performance.\20\ In 1999, 
we introduced a ``Mutual Fund Cost Calculator'' to assist investors in 
determining how fund fees and charges affect their mutual fund 
returns.\21\ Moreover, we are currently considering recommendations 
made in separate reports by the United States General Accounting Office 
and the Commission's Division of Investment Management on ways to 
improve fund disclosure of fees and costs.\22\
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    \19\ Item 3 of Form N-1A; Consolidated Disclosure of Mutual Fund 
Expenses, Investment Company Act Release No. 16244 (Feb. 1, 1988) 
(53 FR 3192 (Feb. 4, 1988)).
    \20\ See, e.g., Securities and Exchange Commission, Mutual Fund 
Investing: Look at More Than a Fund's Past Performance (last updated 
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 Jul. 24, 2000) http://www.sec.gov/mfcc/get-started.html.
    \22\ United States General Accounting Office, Mutual Fund Fees: 
Additional Disclosure Could Encourage Price Competition (June 2000) 
(recommending that the Commission require fund quarterly account 
statements to include the dollar amount of each investor's share of 
fund operating expenses); Division of Investment Management, 
Securities and Exchange Commission, Report on Mutual Fund Fees and 
Expenses (Dec. 2000) (recommending that the Commission consider 
requiring fund shareholder reports to include a table showing the 
cost in dollars incurred by a shareholder who invested a 
standardized amount in the fund, paid the fund's actual expenses, 
and earned the fund's actual return for the period).
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    The amendments we adopt today represent 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. Disclosure of standardized mutual fund 
after-tax returns will help investors to understand the magnitude of 
tax costs and compare the impact of taxes on the performance of 
different funds.

II. Discussion

    The Commission received 235 letters commenting on the Proposing 
Release.\23\ One hundred ninety-five of the letters were from 
individual investors or investor advocacy groups. The individual 
investors and investor advocacy groups overwhelmingly supported the 
Commission's proposal to require disclosure of after-tax returns. The 
remaining 40 letters were from industry participants, who were divided 
in their views. Many generally supported the proposal, while expressing 
concerns regarding specific disclosure requirements. Others opposed the 
proposal. Many commenters offered recommendations for improving 
portions of the proposal. The Commission is adopting the proposed rule 
and form amendments with the modifications described below that address 
commenters' concerns.
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    \23\ The comment letters and a summary of the comments prepared 
by the Commission staff are available for public inspection and 
copying in the Commission's Public Reference Room, 450 Fifth Street, 
NW., Washington, DC (File No. S7-09-00).
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A. Required Disclosure of After-Tax Returns

    The Commission is adopting, with modifications, the requirement 
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. As discussed more fully below, funds will be required to 
include after-tax return information in the risk/return summary of the 
prospectus.\24\ Funds will not generally be required to include after-
tax returns in advertisements or other sales materials. Funds will, 
however, be required to include after-tax returns computed according to 
a standardized formula in sales materials that either include after-tax 
returns or include any other performance information together with 
representations that the fund is managed to limit taxes.\25\
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    \24\ Items 2(c)(2)(i) and (iii) of Form N-1A.
    \25\ Rule 482(e)(4) and (5)(iii); rule 482(f); rule 34b-
1(b)(1)(iii)(B) and (C).
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    Individual commenters overwhelmingly supported the required 
disclosure of after-tax returns. Many of these individuals stated that 
after-tax returns would help them compare funds and make better-
informed investment decisions. Industry comments, however, were mixed 
regarding whether funds should be required to disclose this 
information. Industry commenters supporting after-tax return disclosure 
noted that the disclosure would give investors a clearer understanding 
of fund performance and assist them in evaluating the impact of taxes 
on the performance of various funds. Industry commenters opposing 
after-tax return disclosure argued, among other things, that the 
disclosure would overwhelm investors, be irrelevant to investors in 
tax-deferred accounts such as 401(k) plans, be inaccurate because the 
returns are not tailored to individual investors' specific tax 
situation, place funds at a competitive disadvantage, and be unduly 
burdensome to compute. A few of these commenters suggested that, 
instead of requiring the disclosure of after-tax returns, the 
Commission should encourage the development of web-based personalized 
after-tax return calculators.
    After careful consideration of these comments, we continue to 
believe that requiring funds to provide standardized after-tax returns 
will be beneficial to investors, allowing them to make better-informed 
investment decisions. We believe that after-tax return disclosure is 
useful to, and understandable by, investors, as evidenced by the 
overwhelming support of individual commenters. Moreover, in recognition 
of the fact that after-tax returns would not be relevant for investors 
who hold fund shares through tax-deferred arrangements, we are 
requiring that after-tax returns be accompanied by narrative disclosure 
to that effect, and we are exempting prospectuses used exclusively to 
offer fund shares as investment options for tax-deferred arrangements 
from the after-tax return disclosure requirement.\26\
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    \26\ General Instruction C.3(d)(iii) and Item 2(c)(2)(iv)(B) of 
Form N-1A.
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    We recognize that the computation of after-tax return depends on 
assumed tax rates, which vary from investor to investor. Standardized 
after-tax returns will, however, serve as useful guides to

[[Page 9005]]

understanding the effect of taxes on a fund's performance and allow 
investors to compare funds' after-tax returns. The presentation of 
standardized after-tax returns, coupled with the presentation of 
before-tax returns, will provide investors with a more complete and 
accurate picture of a fund's performance than before-tax returns 
standing alone.
    We strongly encourage funds to develop web-based calculators and 
other tools that investors may use to compute their individualized 
after-tax return for a fund. This information will be very useful to 
investors in assessing how a particular fund has performed for them. We 
believe, however, that after-tax returns should be made available to 
all investors, not only to those who have the ability to access and use 
these web-based programs. In addition, personalized after-tax 
calculators often do not facilitate ready comparisons of different 
funds' after-tax performance.
    We do not believe that requiring funds to disclose after-tax 
returns will place them at a competitive disadvantage vis-a-vis other 
investments. Investors choose funds over other investment products 
because they offer advantages unavailable with most other investment 
products, e.g., access to professional portfolio management and 
diversification with a relatively small investment. In addition, we are 
exempting money market funds from the after-tax return disclosure 
requirement, in part because of our concern that they would be 
disadvantaged vis-a-vis very similar, competing products.
    Finally, we believe that the burden to funds of computing and 
disclosing after-tax returns is justified by the benefits to investors 
from receiving this information. While we acknowledge that funds will 
incur a one-time cost to modify their systems to compute after-tax 
returns, the computation thereafter should be straightforward to 
perform using readily available data.

B. Types of Return To Be Disclosed

    As proposed, funds will be required to calculate after-tax returns 
using a standardized formula similar to the formula presently used to 
calculate before-tax average annual total return.\27\ We proposed to 
require funds to disclose after-tax return for 1-, 5-, and 10-year 
periods on both a ``pre-liquidation'' and ``post-liquidation'' basis, 
and we are adopting that requirement. Pre-liquidation after-tax return 
assumes that the investor continued 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 have been realized by a shareholder upon the 
sale of fund shares.\28\ Post-liquidation after-tax return assumes that 
the investor sold 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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    Most commenters addressing the issue of whether we should require 
pre- and post-liquidation after-tax returns supported disclosure of 
both types of after-tax returns. A few commenters argued that pre-
liquidation after-tax return should be eliminated because the addition 
of another performance figure could overwhelm and confuse investors 
and, if provided without post-liquidation after-tax return, would tend 
to suggest to shareholders that taxation could be deferred 
indefinitely. A few commenters recommended that only pre-liquidation 
after-tax returns be required because post-liquidation returns reflect 
the action of a specific shareholder (i.e., the decision to sell fund 
shares), rather than the tax-efficiency of the fund's portfolio 
management.
    The Commission is adopting, as proposed, the requirement that funds 
present both pre- and post-liquidation after-tax returns in order to 
provide investors with a more complete understanding of the impact of 
taxes on a fund's performance.\30\ 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.\31\
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    \30\ Items 21(b)(2) and (3) of Form N-1A.
    \31\ 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.
---------------------------------------------------------------------------

    In response to commenters' concerns about investor confusion, we 
are streamlining the returns required to be disclosed. Most commenters 
recommended that we revise the proposed pre-liquidation after-tax 
return figure to deduct fees and charges payable upon a redemption of 
fund shares, such as sales charges or redemption fees. This would make 
the pre-liquidation after-tax return figure comparable to currently 
required standardized before-tax returns, which also deduct fees and 
charges payable upon sale, and would result in comparable disclosure by 
funds that impose sales charges upon purchase and those that impose 
sales charges upon redemption.\32\ Commenters also argued that this 
modification would eliminate the need for the proposed pre-liquidation 
before-tax return figure with no deduction of fees and charges payable 
upon sale, thereby simplifying the presentation of before- and after-
tax returns.
---------------------------------------------------------------------------

    \32\ Instruction 4 to Item 21(b)(1) of Form N-1A.
---------------------------------------------------------------------------

    We agree and have eliminated pre-liquidation before-tax returns. 
This will result in three, rather than four, types of return, all of 
which are net of all fees and charges: before-tax return; return after 
taxes on distributions (pre-liquidation); and return after taxes on 
distributions and redemption (post-liquidation).\33\ To address 
concerns that investors could be confused by a pre-liquidation after-
tax return measure that assumes no sale of fund shares for purposes of 
computing tax consequences but nonetheless reflects fees and charges 
payable upon a sale of fund shares, we have modified the captions in 
the performance table to focus investor attention on the taxes that are 
deducted, rather than whether or not the shareholder held or sold his 
shares.\34\
---------------------------------------------------------------------------

    \33\ Items 2(c)(2)(i) and (iii) and 21(b)(1)-(3) of Form N-1A.
    \34\ See Section II.D., infra, regarding modifications to the 
format of disclosure.
---------------------------------------------------------------------------

C. Location of Required Disclosure

    We are requiring, as proposed, that funds disclose after-tax 
returns in the performance table contained in the risk/return summary 
of the prospectus.\35\ The amendments also will have the effect of 
requiring that after-tax returns be included in any fund profile 
because a profile must include the prospectus risk/return summary.\36\ 
We proposed,

[[Page 9006]]

but are not adopting, a requirement that after-tax returns be included 
in Management's Discussion of Fund Performance (``MDFP''), which is 
typically contained in the annual report.\37\ Funds will, however, be 
required to state in the MDFP that the performance table and graph do 
not reflect the deduction of taxes that a shareholder would pay on fund 
distributions or the redemption of fund shares.\38\
---------------------------------------------------------------------------

    \35\ Item 2(c)(2)(iii) of Form N-1A.
    \36\ 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 Item 5(a) of Form N-14 (cross-
referencing Item 2 of Form N-1A).
    \37\ See Proposing Release, supra note , at nn. 36-41, and 
accompanying text.
    \38\ Item 5(b)(2) of Form N-1A.
---------------------------------------------------------------------------

    We are requiring that after-tax returns be included in the 
prospectus and profile 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.\39\ Most commenters that addressed the issue of the 
appropriate location for after-tax return disclosure supported 
requiring disclosure of after-tax returns in fund prospectuses.
---------------------------------------------------------------------------

    \39\ 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, supra 
note 18, at 21.
---------------------------------------------------------------------------

    Several commenters recommended that after-tax returns not be 
included in fund profiles. Commenters were concerned that the length 
and complexity of the disclosure could overwhelm the remaining 
information in the profile, defeating the purpose of the summary 
disclosure document. We continue to believe, however, that after-tax 
returns should be included in the fund profile because of the 
importance of past performance in many investors' investment decisions. 
We have, however, addressed the concerns expressed by commenters by 
simplifying the presentation of required after-tax returns.\40\
---------------------------------------------------------------------------

    \40\ See Section II.B., supra, regarding modifications to the 
types of returns required; Section II.D., infra, regarding 
modifications to the format of disclosure, including simplification 
of presentation for funds offering more than one class of shares in 
the prospectus; Section II.H., infra, regarding the narrative 
accompanying the performance table.
---------------------------------------------------------------------------

    Some commenters supported inclusion of after-tax returns in the 
risk/return summary, but others recommended that after-tax returns be 
disclosed in the section of the prospectus describing the tax 
consequences to investors of buying, holding, exchanging, and selling 
fund shares.\41\ These commenters argued that the required disclosure 
is too lengthy and technical for inclusion in the risk/return summary. 
We believe that it is critical that after-tax returns be disclosed in 
the same location as before-tax returns, so that after-tax returns will 
be easy for investors to find and compare with before-tax returns. 
Therefore, we are adopting, as proposed, the requirement that after-tax 
returns be presented in the risk/return summary. In addition, in 
response to commenters' concerns that the proposed disclosure would be 
too lengthy or complex for inclusion in the risk/return summary, we 
have simplified the presentation of returns in the table, as well as 
the accompanying narrative.\42\
---------------------------------------------------------------------------

    \41\ Item 7(e) of Form N-1A.
    \42\ See discussion in note 40, supra.
---------------------------------------------------------------------------

    We have decided not to require funds to include after-tax returns 
in the MDFP, which is typically contained in the annual report. Many 
commenters who addressed the issue of the appropriate location for 
disclosing after-tax returns recommended that after-tax returns not be 
included in the MDFP. As commenters observed, existing shareholders 
already receive detailed information that allows them to determine the 
tax impact of their investment in the fund.\43\ They also typically 
receive on an annual basis an updated prospectus that will contain 
after-tax performance information.\44\ Moreover, commenters pointed out 
that, because after-tax returns in the MDFP would have been calculated 
on a fiscal year basis, they would not be comparable from fund to fund, 
and use of fiscal year results could enable funds to time distributions 
in order to artificially enhance after-tax returns. We have therefore 
decided not to require disclosure of after-tax returns in the MDFP.
---------------------------------------------------------------------------

    \43\ Annually, funds are required to send Form 1099-DIV or a 
similar statement to any shareholder receiving $10 or more in 
taxable income. I.R.C. 6042. Form 1099-DIV reports the amount and 
character of fund distributions (e.g., ordinary dividends, capital 
gain distributions, and non-taxable distributions) received by 
shareholders during the year. Funds also are required to send Form 
1099-B or a similar statement to any shareholder who sells, 
exchanges, or redeems fund shares during the year. I.R.C. 6045. Form 
1099-B reports the proceeds from the sale of fund shares.
    \44\ The Securities Act requires mutual funds to send updated 
prospectuses only to those existing shareholders who make additional 
purchases. In practice, many mutual funds send an updated prospectus 
annually to all of their shareholders.
---------------------------------------------------------------------------

    We are concerned, however, that investors may be confused about 
whether the returns included in the performance table and graph in the 
MDFP have been calculated on a before-or after-tax basis. Therefore, 
funds will be required to include a statement in the MDFP that 
accompanies the performance table and graph to the effect that the 
returns shown do not reflect the deduction of taxes that a shareholder 
would pay on fund distributions or the redemption of fund shares.\45\
---------------------------------------------------------------------------

    \45\ Item 5(b)(2) of Form N-1A.
---------------------------------------------------------------------------

D. Format of Disclosure

    We are requiring, as proposed, that before and after-tax returns be 
presented in a standardized tabular format. Consistent with the 
modifications to the types of returns required, funds must present 
before- and after-tax returns as follows: \46\
---------------------------------------------------------------------------

    \46\ Item 2(c)(2)(iii) of Form N-1A.

                                          Average Annual Total Returns
                                   [For the periods ended December 31,------]
----------------------------------------------------------------------------------------------------------------
                                                                     5 years  [or life of  10 years  [or life of
                                                     1 year                 fund]                  fund]
----------------------------------------------------------------------------------------------------------------
Return Before Taxes........................               ______%                ______%                ______%
Return After Taxes on Distributions........               ______%                ______%                ______%
Return After Taxes on Distributions and                   ______%                ______%                ______%
 Sale of Fund Shares.......................
    Index (reflects no deduction for [fees,               ______%                ______%                ______%
     expenses, or taxes])..................
----------------------------------------------------------------------------------------------------------------


[[Page 9007]]

    Before- and after-tax returns must be presented in the order 
specified, using the captions provided by Form N-1A. When more than one 
fund or series is offered in a prospectus, the before- and after-tax 
returns of each fund or series must be adjacent to one another. A 
prospectus may not, for example, present the before-tax returns for all 
funds, followed by the after-tax returns for all funds.\47\ We believe 
that this presentation will help investors to compare funds and to 
understand the differences among the different measures of return for 
any particular fund.
---------------------------------------------------------------------------

    \47\ Item 2(c)(2)(iii) of Form N-1A; Instruction 2(e) to Item 2 
of Form N-1A.
---------------------------------------------------------------------------

    We have modified the captions in the performance table to focus 
investor attention on the taxes that are deducted, rather than whether 
or not the shareholder held or sold his shares. We have also modified 
the captions to clarify that returns are shown for the life of the 
fund, if shorter than the 5- or 10-year measurement periods, and that 
the language following the caption for the index may be modified, as 
appropriate, to be consistent with the index selected by the fund.
    We have also simplified the presentation for funds that offer 
multiple classes of a fund in a single prospectus. We were persuaded by 
several commenters who argued that requiring after-tax returns for all 
classes of a fund, as proposed, could result in overwhelming or 
confusing disclosure to investors, and that, with the exception of 
expense ratio differences, which affect the level of dividend 
distributions, the tax burden of the various share classes will be 
similar. We have modified the amendments to require that a fund 
offering multiple classes in a single prospectus present the after-tax 
returns of only one class.\48\ The class selected must be offered to 
investors who hold their shares through taxable accounts and have 
returns for at least 10 years, or, if no such class has 10 years of 
return, be the class with the returns for the longest period.
---------------------------------------------------------------------------

    \48\ Instruction 3(c)(ii) to Item 2 of Form N-1A.
---------------------------------------------------------------------------

    A fund that offers multiple classes in a single prospectus must 
explain in the narrative that accompanies the performance table that 
the after-tax returns are for only one class offered by the prospectus 
and that the after-tax returns for other classes will vary.\49\ In 
addition, in order to facilitate comparisons among the returns shown, 
after-tax returns for the one class presented must be adjacent to the 
before-tax returns for that class and not interspersed with the before-
tax returns of the other classes, returns of other funds, or with the 
return of the broad-based securities market index.\50\ The return of 
the broad-based securities index may either precede or follow the 
returns for the fund.\51\
---------------------------------------------------------------------------

    \49\ Item 2(c)(2)(iv)(C) of Form N-1A.
    \50\ Instructions 2(e) and 3(c)(iii) to Item 2 of Form N-1A.
    \51\ Instruction 2(e) to Item 2 of Form N-1A.
---------------------------------------------------------------------------

E. Exemptions From the Disclosure Requirement

    We are exempting money market funds from the requirement to 
disclose after-tax returns, as proposed.\52\ We are also adopting, with 
modifications, our proposal to permit a fund to omit the after-tax 
return information in a prospectus used exclusively to offer fund 
shares as investment options for defined contribution plans and similar 
arrangements.\53\
---------------------------------------------------------------------------

    \52\ Item 2(c)(2)(iii) of Form N-1A.
    \53\ General Instruction C.3(d)(iii) of Form N-1A
---------------------------------------------------------------------------

    Specifically, we are permitting a fund to omit the after-tax return 
information in a prospectus used exclusively to offer fund shares as 
investment options to one or more of the following:
     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 contract as defined in section 817(d) of the 
Code;
     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;\54\ or
---------------------------------------------------------------------------

    \54\ These similar plans or arrangements may include those 
existing under current tax law or new types of plans or arrangements 
permitted by future changes in the tax law.
---------------------------------------------------------------------------

     Entities that are not subject to the individual federal 
income tax.
    The proposed after-tax return information would largely be 
irrelevant in these circumstances because the affected investors either 
are not subject to current taxation on fund distributions or are not 
subject to current taxation at the individual federal income tax rates, 
and their tax consequences on a sale of fund shares are different from 
those experienced by individual investors in taxable accounts.\55\
---------------------------------------------------------------------------

    \55\ See IRS Publication 575, Pension and Annuity Income (2000), 
at 4 (explaining tax treatment of earnings under a variable annuity 
contract) and 7-19 (explaining tax treatment of distributions from 
retirement plans); IRS Publication 525, Taxable and Non-Taxable 
Income (2000), at 6 (explaining tax treatment of contributions to a 
retirement plan) and 15 (explaining tax treatment of proceeds of a 
life insurance contract); IRS Publication 575, Pension and Annuity 
Income (2000), at 5 (tax treatment of Section 457 Deferrred 
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).
---------------------------------------------------------------------------

    In response to the recommendations of several commenters, we have 
expanded the exemption to include prospectuses used to offer fund 
shares to entities that are not subject to individual taxation (e.g., 
tax-exempt foundations, colleges, and corporations). We agree that the 
after-tax return information is not relevant to these investors. A fund 
may not, however, rely on this exemption if the prospectus is used 
indirectly to offer shares to persons that are subject to individual 
taxation, such as an offer to a partnership whose individual partners 
are taxed on a pass-through basis.\56\
---------------------------------------------------------------------------

    \56\ I.R.C. 702 (regarding taxation of partners).
---------------------------------------------------------------------------

    The Commission carefully considered whether to exclude bond funds, 
generally, or tax-exempt funds, specifically, from the requirement to 
disclose after-tax returns. A number of commenters argued that bond 
funds should be exempt from disclosing after-tax returns because 
investors in bond funds are generally aware of the tax consequences of 
investing in these funds, the funds do not usually make unexpected 
distributions of capital gains, and the funds are bought for their 
yield and not their growth potential. Other commenters argued that bond 
funds should not be exempt because such funds may have significant 
capital gains or losses in volatile markets, certain types of bond 
funds commonly realize significant capital gains, and some managers of 
bond funds seek to avoid making capital gains distributions by using 
various tax management strategies.
    Having considered the views expressed by commenters, we have 
decided not to exempt bond funds from disclosing after-tax returns. 
While investors may more readily understand the tax impact of owning a 
bond fund that makes few, if any, capital gains distributions, than the 
tax impact of owning other funds, bond funds may have significant 
capital gains or losses, and we believe that it is important for after-
tax return information to be available to their shareholders.
    Similarly, 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 taxed on gains from the sale of fund shares.\57\

[[Page 9008]]

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 decided not to exempt tax-exempt funds 
from the required disclosure.\58\
---------------------------------------------------------------------------

    \57\ 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 (2000), at 2 (describing tax treatment of 
tax-exempt mutual funds).
    \58\ 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(a) to Item 21(b)(2) and Instruction 
3(a) to Item 21(b)(3) of Form N-1A.
---------------------------------------------------------------------------

F. Advertisements and Other Sales Literature

    We are adopting, with modifications, amendments that require 
certain fund advertisements and sales literature to include after-tax 
performance that is calculated according to the standardized formulas 
prescribed in Form N-1A for computation of after-tax returns in the 
risk/return summary. As proposed, all fund advertisements and sales 
literature that include after-tax performance information will be 
required to include after-tax returns computed according to the 
standardized formulas.\59\ Any quotation of non-standardized after-tax 
return also will be subject to the same conditions currently applicable 
to quotations of non-standardized performance that are included in fund 
advertisements and sales literature.\60\ Requiring advertisements and 
sales literature that include after-tax performance information to 
include standardized after-tax returns will help to prevent misleading 
advertisements and sales literature and permit shareholders to compare 
claims about after-tax performance.
---------------------------------------------------------------------------

    \59\ Rule 482(e)(4) permits 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 
measures of standardized after-tax return; (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 measure of after-tax return could be included in 
advertisements if accompanied by the standardized measures of after-
tax return. Rule 482(e)(5)(iii). Similarly, measures of after-tax 
return may be included in other sales materials if accompanied by 
the standardized measures of after-tax return. Rule 34b-
1(b)(1)(iii)(B).
    A quotation of standardized tax equivalent yield in an 
advertisement or other sales literature need not be accompanied by 
standardized after-tax returns. Rules 482(e)(2) and 34b-
1(b)(iii)(B).
    \60\ Specifically, any measure of after-tax return in a rule 482 
advertisement will be required to reflect all elements of return and 
be set out in no greater prominence than the required quotations of 
standardized before-tax and after-tax returns. The advertisement 
will be required to identify the length of and the last day of the 
period for which performance is measured. Rule 482(e)(5)(i), (iv), 
and (v).
    Likewise, any sales literature that contains a quotation of 
performance that has been adjusted to reflect the effect of taxes 
remain subject to the other requirements of rule 34b-1.
---------------------------------------------------------------------------

    Commenters generally supported the proposal to require fund 
advertisements and sales literature that include after-tax performance 
information to include standardized after-tax returns, but several 
commenters recommended that we extend the requirement to advertisements 
and sales literature that claim that a fund is ``tax-managed'' or 
``tax-efficient'' and that include any performance information. As 
noted by one commenter, a fund advertising 20 percent before-tax return 
and claiming 100 percent tax-efficiency could have significant 
unrealized gains that would result in tax liabilities when a 
shareholder redeems his or her shares. We are persuaded that, to help 
prevent such tax-efficiency claims from being misleading, such 
advertisements should include standardized after-tax returns, which 
will help an investor to assess the tax-efficiency of the fund more 
accurately. Therefore, we have modified the proposal to require the 
inclusion of standardized after-tax returns in any advertisement or 
sales literature that includes a quotation of performance and that 
represents or implies that the fund is managed to limit or control the 
effect of taxes on performance.\61\
---------------------------------------------------------------------------

    \61\ We believe that any fund that uses terms such as tax-
managed, tax-efficient, tax-sensitive, or tax-aware in its name is 
representing or implying that the fund is managed to limit or 
control the effect of taxes on performance. Therefore, a fund using 
these terms in its name will be required to include standardized 
after-tax returns in any advertisement or sales literature that 
includes a quotation of performance.
---------------------------------------------------------------------------

    This requirement does not apply to advertisements or sales 
literature for a fund that is eligible to use a name suggesting that 
the fund's distributions are exempt from federal income tax or from 
both federal and state income tax under our recently-adopted fund names 
rule.\62\ Because these funds meet the strict standards of the names 
rule, we have concluded that the additional requirement for including 
standardized after-tax returns in advertisements or sales literature 
should not apply to them unless they voluntarily choose to include 
after-tax performance information.
---------------------------------------------------------------------------

    \62\ Rules 482(e)(6) and 34b-1(b)(1)(iii)(C). The fund names 
rule, rule 35d-1(a)(4), requires a fund that uses a name suggesting 
that a fund's distributions are exempt from federal income tax or 
from both federal and state income tax to adopt a fundamental policy 
under section 8(b)(3) of the Investment Company Act: (i) To invest 
at least 80 percent of its assets in investments the income from 
which is exempt, as applicable, from federal income tax or from both 
federal and state income tax; or (ii) to invest its assets so at 
least 80 percent of the income that it distributes will be exempt, 
as applicable, from federal income tax or from both federal and 
state income tax. See Investment Company Names, Investment Company 
Act Release No. 24828 (Jan. 17, 2001).
---------------------------------------------------------------------------

    One commenter recommended that we prohibit funds from publishing 
after-tax returns for periods of less than one year. The commenter 
argued that this would prevent funds from reporting year-to-date after-
tax returns just before a large taxable distribution, wrongly 
suggesting to shareholders that the fund had been tax-efficient. While 
we have decided not to prohibit funds from publishing after-tax returns 
for periods of less than one year in all cases, we remind funds that 
sales materials are subject to the antifraud provisions of the federal 
securities laws and that compliance with the terms of rule 482 under 
the Securities Act or rule 34b-1 under the Investment Company Act is 
not a safe harbor from liability for fraud.\63\ Therefore, any fund 
that publishes after-tax returns for periods shorter than one year 
should be extremely careful to ensure that the returns are not 
materially misleading, e.g., because the returns incorrectly suggest 
that a fund has been more tax-efficient than has, in fact, been the 
case.
---------------------------------------------------------------------------

    \63\ See, e.g., Advertising by Investment Companies, Investment 
Company Act Release No. 16245 (Feb. 2, 1988) [53 FR 3868 (Feb. 10, 
1988)], at n.51. See also section 17(a) of the Securities Act [15 
U.S.C. 77q]; section 10(b) of the Exchange Act [15 U.S.C. 78j(b); 
section 34(b) of the Investment Company Act [15 U.S.C. 80a-33]; 
section 206 of the Investment Advisers Act of 1940 [15 U.S.C. 80b-
6].
---------------------------------------------------------------------------

G. Formulas for Computing After-Tax Return

    We are adopting, with the modifications discussed below, the 
requirement 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.\64\ After-tax returns 
will 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.\65\ Also, after-tax returns 
will be calculated for 1-, 5-, and 10-year periods.\66\
---------------------------------------------------------------------------

    \64\ Items 21(b)(2) and (3) of Form N-1A.
    \65\ Items 21(b)(2) and (3) of Form N-1A; Instruction 1 to Item 
21(b)(2) and Instruction 1 to Item 21(b)(3) of Form N-1A.
    \66\ Items 21(b)(2) and (3) of Form N-1A.
---------------------------------------------------------------------------

1. Tax Bracket
    We are requiring, as proposed, that standardized after-tax returns 
be calculated assuming that distributions

[[Page 9009]]

by the fund and gains on a sale of fund shares are taxed at the highest 
applicable individual federal income tax rate.\67\ Comment was divided 
on this issue. Some commeters supported the highest tax rate as 
providing investors with the full range of historical after-tax 
returns, as well as being the simplest rate to use to compute after-tax 
returns. Other commenters, however, recommended that we require funds 
to calculate after-tax returns using an intermediate tax rate in 
addition to, or in lieu of, the highest tax rate. These commenters 
observed that the typical mutual fund investor is not in the highest 
tax bracket, and argued that after-tax returns calculated using tax 
rates to which the typical mutual fund investor is subject would be 
more useful.
---------------------------------------------------------------------------

    \67\ Instruction 4 to Item 21(b)(2) of Form N-1A; Instruction 4 
to Item 21(b)(3) 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).
---------------------------------------------------------------------------

    After careful consideration of these comments, we continue to 
believe that it is most appropriate to use the highest tax rate, rather 
than an intermediate rate. Computing after-tax returns with maximum tax 
rates will provide investors with the ``worst-case'' federal income tax 
scenario. Coupled with before-tax return, which reflects the imposition 
of taxes at a 0 percent rate, this ``worst-case'' scenario will 
effectively provide investors with the full range of historical after-
tax returns. We believe that providing the full range of federal income 
tax outcomes provides investors the most complete information.
    In addition, we concluded that any benefits of using an 
intermediate tax rate would be outweighed by the complexity of 
determining the appropriate intermediate rate from one year to the next 
as tax rates and the income of a typical mutual fund investor change. 
Most of the commenters who recommended that after-tax returns be 
calculated using an intermediate rate suggested that we either use a 
specific rate (e.g., 28 percent) or select a specific income level 
(e.g., $55,000) that would be used to identify the appropriate tax 
rate. If we were to adopt either of these approaches, we would be 
required to make ongoing modifications to respond to changes in tax 
rates and income levels. One commenter suggested that we determine the 
intermediate rate by reference to the median United States household 
income reported by the U.S. Census Bureau. This approach would be 
predicated on assumptions about the ``typical'' mutual fund investor 
and the past, present, and future income of that investor.
    In any case, a requirement that funds calculate after-tax returns 
using an intermediate rate would effectively require that we 
continually monitor the changing demographics of mutual fund investors, 
as well as changing tax laws, and update our rules accordingly. The use 
of an intermediate rate also would require that funds include complex 
narrative disclosure in the risk/return summary about how the 
intermediate rate had been selected or what intermediate rate had been 
used from year to year.\68\
---------------------------------------------------------------------------

    \68\ The concerns expressed by the commenters are, in any event, 
mitigated by the fact that after-tax returns will not reflect state 
and local taxes, which are often quite significant.
    State income tax rates can be as high as 12%; and a rate of 6%-
7%, or higher, is common on taxable income of $55,000, the income 
level suggested by commenters as representative of a typical mutual 
fund investor. See The World Almanac and Book of Facts 161 (2000) 
(state income tax rates).
---------------------------------------------------------------------------

    While we are not adopting a requirement that funds calculate after-
tax returns using an intermediate rate, we encourage funds to provide 
their investors with additional information that is tailored to a 
particular fund's typical investor, or to make available to investors 
after-tax returns calculated using multiple tax rate assumptions. Funds 
can supply this information in a variety of ways (e.g., calculators on 
their websites or disclosure elsewhere in the prospectus of returns 
calculated based on different tax rate assumptions).
2. Capital Gains and Losses Upon a Sale of Fund Shares
    We are adopting, substantially as proposed, amendments requiring 
that return, after taxes on distributions and redemption, 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.\69\ As proposed, a fund will 
be required to track the actual holding periods of reinvested 
distributions and may not assume that they have the same holding period 
as the initial $1,000 investment.\70\ We have made technical changes to 
clarify that applicable federal tax law should be used to determine 
whether and how gains and losses from the sale of shares with different 
holding periods should be netted, as well as the tax character (e.g., 
short-term or long-term) of any resulting gains or losses.\71\
---------------------------------------------------------------------------

    \69\ Instructions 6 and 7 to Item 21(b)(3) of Form N-1A. In 
order to simplify the computation of returns after taxes on 
distributions and sale of fund shares, funds may assume that a 
taxpayer has sufficient capital gains of the same character to 
offset any capital losses on a sale of fund shares and therefore 
that the taxpayer may deduct the entire capital loss. Instruction 
7(d) to Item 21(b)(3) of Form N-1A.
    \70\ Instruction 7(c) to Item 21(b)(3) of Form N-1A.
    A fund would also be required to separately track the basis of 
shares acquired though the $1,000 initial investment and each 
subsequent purchase through reinvested distributions. We wish to 
clarify that a distribution representing a return of capital will 
reduce the basis of an existing lot of shares and be included in the 
basis of the shares acquired upon reinvestment, which may have the 
effect of shifting the amount of basis allocated to shares with 
various holding periods.
    \71\ Instruction 7(d) to Item 21(b)(3) of Form N-1A.
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    Several commenters suggested that we permit funds to calculate 
taxes on gains realized upon a sale of shares at the end of the one-
year period (i.e., short-term capital gains) as if the shares had been 
held for one year and one day (i.e., long-term capital gains).\72\ 
These commenters argued that a reasonable shareholder would hold the 
shares for the extra day in order to qualify for the more advantageous 
tax treatment, and that it is inappropriate to assume that shares would 
be sold at the end of the one-year period. We are not modifying the 
proposal to reflect this comment. A shareholder who redeems his or her 
shares at any time during the one-year period is subject to taxation of 
gains at short-term rates. We believe that it is important for the 
after-tax return calculation to accurately reflect the fact that 
redeeming shares within the one-year period may have significant 
adverse tax consequences. In addition, we are providing that the tax 
consequences of a sale of fund shares should be determined in 
accordance with applicable federal tax law on the redemption date. If 
we were, instead, to prescribe a special rule for one-year returns, we 
would have to reevaluate this special rule in light of subsequent 
changes in tax law, such as increases to the holding period required 
for long-term gain treatment.
---------------------------------------------------------------------------

    \72\ I.R.C. 1222(1) provides 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.''
---------------------------------------------------------------------------

    A number of commenters suggested other modifications to the 
proposal regarding the tracking of holding periods, such as treating 
the holding period of all reinvested distributions as beginning on the 
date of the original investment, and treating all gains on redemption 
as qualifying for long-term capital gains treatment. We are not 
adopting these recommended modifications, each of which would have the 
effect of reclassifying short-term gains as long-term gains, as they 
would minimize the impact of short-term gains on fund returns, in a 
manner

[[Page 9010]]

inconsistent with federal tax law. One of our purposes in requiring the 
disclosure of after-tax returns is to provide investors with 
information about the differential impact that taxes have on the 
before-tax returns of various funds, and we believe that ignoring the 
effect of short-term gains would tend to minimize these differences 
inappropriately.
3. Other Assumptions
    Commenters generally supported the other assumptions that the 
Commission proposed to require in the computation of after-tax returns, 
and we are adopting those requirements as proposed. Specifically, 
after-tax returns:
     Will be calculated using historical tax rates; \73\
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    \73\ Instruction 4 to Item 21(b)(2) of Form N-1A; Instruction 4 
to Item 21(b)(3) of Form N-1A. The Proposing Release sets forth the 
maximum federal income tax rates for the years 1990-2000. Proposing 
Release, supra note , at n.66, and accompanying text.
---------------------------------------------------------------------------

     Will be based on calendar-year periods, consistent with 
the before-tax return disclosure that currently appears in the risk/
return summary; \74\
---------------------------------------------------------------------------

    \74\ Item 2(c)(iii) of Form N-1A.
---------------------------------------------------------------------------

     Will exclude state and local tax liability; \75\
---------------------------------------------------------------------------

    \75\ Instruction 4 to Item 21(b)(2) of Form N-1A; Instruction 4 
to Item 21(b)(3) of Form N-1A.
---------------------------------------------------------------------------

     Will not take into account the effect of either the 
alternative minimum tax or phaseouts of certain tax credits, 
exemptions, and deductions for taxpayers whose adjusted gross income is 
above a specified amount; \76\
---------------------------------------------------------------------------

    \76\ Id.
---------------------------------------------------------------------------

     Will assume that any taxes due on a distribution are paid 
out of that distribution at the time the distribution is reinvested and 
reduce the amount reinvested; \77\ and
---------------------------------------------------------------------------

    \77\ Instruction 3 to Item 21(b)(2) of Form N-1A; Instruction 3 
to Item 21(b)(3) of Form N-1A.
---------------------------------------------------------------------------

     Will be calculated assuming that the taxable amount and 
tax character (e.g., ordinary income, short-term capital gain, long-
term capital gain) of each distribution are as specified by the fund on 
the dividend declaration date, adjusted to reflect subsequent 
recharacterizations.\78\
---------------------------------------------------------------------------

    \78\ Id.
---------------------------------------------------------------------------

    Tax treatment of distributions. As proposed, we are not specifying 
in detail the tax consequences of fund distributions. Funds generally 
should determine the tax consequences of distributions by applying the 
tax law in effect on the date the distribution is reinvested. However, 
because a number of commenters expressed concern about whether a fund 
that has elected to pass through foreign tax credits to its 
shareholders may reflect the foreign tax credit in after-tax returns, 
we are providing that the effect of applicable tax credits, such as the 
foreign tax credit, should be taken into account in accordance with 
federal tax law.\79\
---------------------------------------------------------------------------

    \79\ Instruction 3 to Item 21(b)(2) of Form N-1A; Instruction 3 
to Item 21(b)(3) of Form N-1A. A fund may elect to pass through to 
shareholders foreign tax credits if more than 50 percent of the 
value of the fund's total assets at the close of the taxable year 
consists of stock or securities in foreign corporations and the fund 
otherwise qualifies for favorable tax treatment as a regulated 
investment company for the taxable year. I.R.C. 853. In computing 
after-tax returns, a fund that elects to pass foreign tax credits 
through to shareholders may assume that the shareholders use those 
credits. We would not object if a fund adjusts after-tax returns to 
reflect the impact of distributions of up to $600 of foreign tax 
credits, the amount of credit that may be taken by a married couple 
filing jointly without regard to limits on the foreign tax credit. 
I.R.C. 904(a) and (j)(2). If a fund makes distributions of foreign 
tax credits in excess of $600, the fund must take into account the 
limits in the federal tax law on the ability of shareholders to use 
foreign tax credits.
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H. Narrative Disclosure

    We are adopting, with modifications, the requirement that funds 
include a short, explanatory narrative adjacent to the performance 
table in the risk/return summary.\80\ This is intended to facilitate 
investor understanding of the table. We are not mandating specific 
language for the narrative, but it must be in plain English.\81\
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    \80\ Item 2(c)(2)(iv) of Form N-1A.
    \81\ 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).
---------------------------------------------------------------------------

    Commenters generally agreed that the proposed narrative disclosure 
would help investors understand information in the performance table. 
Several commenters, however, recommended streamlining the narrative by 
combining some of the proposed items with the narrative currently 
required for before-tax returns and by eliminating technical items 
unnecessary for investor understanding of performance information. We 
agree and have modified the narrative disclosure to require the 
following information: \82\
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    \82\ We eliminated the proposed requirement that funds explain 
the differences between the types of returns presented, which is 
unnecessary in light of our reduction of the returns from four to 
three and our revision of the table captions. We also eliminated the 
proposed requirement that funds disclose that before-tax returns 
assume all distributions are reinvested. As commenters noted, funds 
are not currently required to include this technical information 
with before-tax returns. We also eliminated the similar proposed 
requirement that funds disclose that after-tax returns assume that 
taxes are paid out of fund distributions and that distributions, 
less taxes, are reinvested. Finally, we eliminated the proposed 
requirement that funds, whose after-tax returns exceed before-tax 
returns, explain the reason for this result. Funds, however, will 
have the option of including this explanatory material. Item 
2(c)(2)(iv)(D) of Form N-1A.
---------------------------------------------------------------------------

     After-tax returns are calculated using the historical 
highest individual federal marginal income tax rates, and do not 
reflect the impact of state and local taxes; and
     Actual after-tax returns depend on the investor's tax 
situation and may differ from those shown, and 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.\83\
---------------------------------------------------------------------------

    \83\ As discussed above, we have simplified the proposal to 
require a fund offering more than one class of shares in its 
prospectus to show after-tax returns for one class only. See Section 
II.D., supra notes 48-50 and accompanying text. Consistent with this 
modification, such funds will be required to include disclosure that 
after-tax returns are shown for only one class and that after-tax 
returns for other classes will vary. Item 2(c)(2)(iv)(C) of Form N-
1A.
---------------------------------------------------------------------------

    In addition, a fund will be required to provide a statement to the 
effect that the fund's past performance, before and after taxes, is not 
necessarily an indication of how the fund will perform in the 
future.\84\
---------------------------------------------------------------------------

    \84\ Item 2(c)(2)(i) of Form N-1A.
---------------------------------------------------------------------------

I. Technical and Conforming Amendments

    We proposed 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. 
This technical change is no longer necessary due to modifications we 
have made to the types of returns required. We are adopting, as 
proposed, amendments to rule 34b-1(b)(3) under the Investment Company 
Act to exclude after-tax performance information contained in periodic 
reports to shareholders from the updating requirements of the rule.
    We proposed 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 
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. We have decided not to delete 
this instruction because it applies to returns that are not

[[Page 9011]]

required by specific items of Form N-1A.\85\
---------------------------------------------------------------------------

    \85\ Instruction 6 to Item 21(b)(1) of Form N-1A.
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J. Effective Date; Compliance Dates

1. Effective Date
    The rule and form amendments that the Commission is adopting today 
will be effective April 16, 2001.
2. Compliance Date for Prospectuses
    February 15, 2002. All post-effective amendments that are annual 
updates to effective registration statements and profiles filed on or 
after February 15, 2002, must comply with the amendments to Form N-1A. 
Based on the comments, we believe that this will provide funds with 
sufficient time to make the necessary changes to existing software and 
internal systems in order to compile after-tax returns and incorporate 
the new disclosure in their prospectuses. We would not object if 
existing funds file their first annual update complying with the 
amendments pursuant to rule 485(b), provided that the post-effective 
amendment otherwise meets the conditions for immediate effectiveness 
under the rule.\86\
---------------------------------------------------------------------------

    \86\ 17 CFR 230.485(b).
---------------------------------------------------------------------------

3. Compliance Date for Advertisements and Other Sales Materials
    October 1, 2001. All fund advertisements and sales materials must 
comply with the amendments to rules 482 and 34b-1 no later than October 
1, 2001. These amendments apply only to those funds voluntarily 
choosing to include after-tax returns in advertisements or sales 
literature, or claiming to be managed to limit or control the effect of 
taxes on performance and including performance information in these 
materials. As these funds have made the decision to market themselves 
in this manner, we believe that they should be required to do so in a 
standardized fashion as soon as practicable.

III. Cost/Benefit Analysis

    In the Proposing Release, we analyzed the costs and benefits of our 
proposals and requested comments and data regarding the costs and 
benefits of the rule and form amendments. In response to our request 
for comments, a few commenters generally argued that the proposed 
amendments would increase costs for the funds and that such costs will 
be passed on to investors. None of the commenters, however, provided 
specific data quantifying additional costs.
    The rule and form changes will require a fund to disclose its 
standardized after-tax returns for 1-, 5-, and 10-year periods. After-
tax returns, which will accompany before-tax returns in fund 
prospectuses, will be presented in two ways: (i) After taxes on fund 
distributions only; and (ii) after taxes on fund distributions and a 
redemption of fund shares.\87\ The before- and after-tax returns would 
be required to be presented in a standardized tabular format. Although 
after-tax returns will not generally be required in fund advertisements 
and sales literature, any fund that either includes after-tax returns 
in these materials or includes other performance information together 
with representations that the fund is managed to limit taxes will be 
required to include after-tax returns computed according to our 
standardized formulas.
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    \87\ As discussed above, we have modified the proposal by 
eliminating the proposed requirement to include after-tax returns in 
the MDFP, which is typically contained in the annual report. 
Accordingly, the hour burden for preparing and filing annual reports 
in compliance with rule 30d-1 will be reduced by 7.5 hours. See 
Proposing Release, supra note 1, at nn. 107-110, and accompanying 
text (discussing the estimated hour burden for proposal requiring 
after-tax return disclosure in annual reports). Funds will be 
required to include a statement in the MDFP that accompanies the 
performance table and graph to the effect that the returns shown do 
not reflect the deduction of taxes that a shareholder would pay on 
fund distributions or the redemption of fund shares. Item 5(b)(2) of 
Form N-1A. We believe that the hour burden for the required 
statement in the MDFP will be negligible and will not result in a 
change to the current hour burden for preparing and filing annual 
reports.
---------------------------------------------------------------------------

A. Benefits

    As discussed above, taxes are one of the most significant costs of 
investing in mutual funds through taxable accounts. In 1999, mutual 
funds distributed approximately $238 billion in capital gains and $159 
billion in taxable dividends.\88\ Shareholders investing in stock and 
bond funds paid an estimated $39 billion in taxes in 1998 on 
distributions by their funds.\89\ 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.\90\ Moreover, it is estimated 
that, between 1994 and 1999, investors in diversified U.S. stock funds 
surrendered an average of 15 percent of their annual gains to 
taxes.\91\
---------------------------------------------------------------------------

    \88\ 2000 Mutual Fund Fact Book, supra note 2, at 56.
    \89\ Liberty Funds Release, supra note 3.
    \90\ KPMG study, supra note 4, at 14.
    \91\ Clements, supra note 5, at C1.
---------------------------------------------------------------------------

    Despite the tax dollars at stake, many investors lack a clear 
understanding of the impact of taxes on their mutual fund 
investments.\92\ 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 
fund's underlying portfolio securities at a gain.
---------------------------------------------------------------------------

    \92\ Dreyfus Corporation, supra note 6.
---------------------------------------------------------------------------

    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.\93\ Indeed, all 
but a few of the comment letters we received from individual investors 
supported the Commission's proposal to require standardized after-tax 
returns.
---------------------------------------------------------------------------

    \93\ See supra note 10 and accompanying text.
---------------------------------------------------------------------------

    Currently, the Commission requires mutual funds to disclose 
significant information about taxes to investors.\94\ While this 
disclosure is useful, we believe funds can more effectively communicate 
to investors the tax consequences of investing. Therefore, the 
Commission is adopting amendments to Form N-1A and rules 482 and 34b-1 
that will require disclosure of standardized mutual fund after-tax 
returns.
---------------------------------------------------------------------------

    \94\ 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 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 amendments will allow investors to compare 
after-tax performance among funds, which is likely to affect investor 
decisions relating to the purchase or sale of fund shares. This could 
have indirect 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. The 
changes in fund investment

[[Page 9012]]

strategies and investor behavior resulting from this disclosure may 
also result in higher average after-tax returns for investors.\95\
---------------------------------------------------------------------------

    \95\ Given the $2.1 trillion of assets held in individual non-
money market fund taxable accounts, even a small change in relative 
after-tax returns affecting only a small portion of those assets can 
lead to significant benefits to investors.
---------------------------------------------------------------------------

    Requiring standardized after-tax performance in the prospectus, 
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 amendments will 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, information regarding a fund's after-tax performance 
helps 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

    The changes in fund investment strategies and investor behavior 
resulting from the after-tax requirements may have distributional 
effects among funds depending on their relative after-tax returns. 
Funds that have lower after-tax returns relative to other funds may 
experience loss of market share. We expect, however, that any reduction 
of market share for funds with lower after-tax returns will be offset 
by a commensurate increase in market share for funds with higher after-
tax returns.
    Funds affected by the after-tax requirements will incur costs in 
complying with the new disclosure. Funds will have to compute the 
after-tax returns using a standardized method prescribed by Form N-1A. 
The costs associated with computing the new after-tax performance will 
include the costs of purchasing or developing software, implementing a 
new system for computing the returns, analyzing data for inclusion in 
the standardized formula, and training fund employees. In addition, 
funds will incur costs in incorporating the new disclosure in their 
prospectuses, advertisements, and sales literature. Funds could also 
incur costs in responding to questions from investors regarding the 
after-tax returns.
    We expect that the costs of implementing new systems to compute the 
standardized after-tax performance will largely consist of initial, 
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 standardized after-tax 
performance data.\96\ Also, the costs of analyzing data for inclusion 
in the standardized formula will be substantially greater in connection 
with a fund's first-time compliance with the amendments than it will be 
in subsequent disclosures. Likewise, the costs of revising fund 
prospectuses, advertisements, and sales literature to incorporate the 
new disclosure should decrease after the first disclosures complying 
with the amendments have been made. We note that in response to 
concerns expressed by certain commenters regarding the burdens imposed 
on funds by the new requirements, we have simplified the presentation 
of after-tax returns.\97\ Although the costs of updating the disclosure 
in fund prospectuses, advertisements, and sales literature will 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 will change from year to year.
---------------------------------------------------------------------------

    \96\ 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/.
    \97\ As discussed above, we have modified the proposal by: 
eliminating the proposed requirement to disclose pre-liquidation 
before-tax returns; eliminating after-tax returns in annual reports; 
streamlining the required narrative disclosure; and simplifying the 
presentation for funds that offer multiple classes in a single 
prospectus.
---------------------------------------------------------------------------

    Because funds filing initial registration statements will not have 
any performance information to report, the new after-tax performance 
requirements will not impose any additional costs on the preparation 
and filing of an initial registration statement on Form N-1A. The 
disclosure required by the amendments will appear in the first post-
effective amendment that is required to include the after-tax return 
disclosure. The costs associated with including the disclosure in this 
first post-effective amendment will 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. 
The costs incurred by funds choosing to include after-tax returns in 
fund advertisements and sales literature will be limited to the cost of 
revising the advertisements and sales literature to incorporate the 
same standardized after-tax returns that will be required to appear in 
fund prospectuses.
    Form N-1A. The primary cost of complying with the amendments to 
Form N-1A is the cost of preparing and filing post-effective amendments 
to registration statements. We estimate that 4,500 post-effective 
amendments to registration statements are filed annually on Form N-1A, 
for 7,875 portfolios.
    These post-effective amendments will contain performance figures 
and thus be affected by the amendments. For purposes of the Paperwork 
Reduction Act (``PRA''), we have estimated that the amendments will 
increase the hour burden per portfolio per filing of a post-effective 
amendment by 18 hours.\98\ Of the 7,875 funds referenced in post-
effective amendments, 1,040 are money market funds, which will be 
exempted from the after-tax disclosure requirements. An additional 
1,575 funds are used as investment vehicles for variable insurance 
contracts, which will be permitted to omit the after-tax information. 
Thus, approximately 5,260 of the 7,875 funds referenced in post-
effective amendments will be affected by the amendments.\99\ We 
estimate that the cost for all funds to comply with the amendments 
discussed above is $6,059,520.\100\
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    \98\ This estimate is based on the staff's consultations with 
industry representatives.
    \99\ The number of funds referenced in post-effective amendments 
that will be affected by the amendments is computed by subtracting 
those funds that are exempt from or permitted to omit the 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 will be 
permitted to omit the after-tax return disclosure in prospectuses 
distributed to investors in these tax-deferred arrangements, they 
will still incur a burden from including the disclosure in 
prospectuses distributed to other investors.
    \100\ This cost estimate is calculated by multiplying the 
estimated number of hours to comply with the requirements (94,680 
hours) by the weighted average hourly wage ($64). The Commission's 
estimate concerning the burden hours is based on the staff's 
consultation with industry representatives. The Commission's 
estimate concerning the wage rate is based on salary information for 
the securities industry compiled by the Securities Industry 
Association. See Securities Industry Association, Report on 
Management & Professional Earnings in the Securities Industry 1999 
(Sept. 1999).

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[[Page 9013]]

    The amendments to Form N-1A will impose other related costs on 
funds. Our current estimated cost of preparing a post-effective 
amendment to a previously effective registration statement is $7,500. 
We estimate that the additional cost imposed by the amendments to Form 
N-1A is $1,860 per portfolio/fund or a total cost of $9,783,600.\101\ 
This estimate represents the cost of developing and implementing a 
computerized system for compiling tax data and computing after-tax 
returns and the costs of hiring outside counsel to assist in revising 
the prospectus to incorporate the new after-tax return disclosure.\102\ 
Again, a portion of this cost burden will be comprised largely of 
initial, one-time costs.
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    \101\ The estimate is based on the staff's consultation with 
industry representatives.
    \102\ Software-related costs may decrease as vendors offering 
services for computing the new standardized after-tax returns enter 
the market. See Daly, Program Lets Fund Companies Offer After-Tax 
Returns (Dec. 29, 1999) (visited Feb. 9, 2000) http://www.ignites.com/.
---------------------------------------------------------------------------

    Rule 482. Rule 482 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.
    Because rule 482 does not require funds to perform any computations 
not required by the amendments for Form N-1A, the primary cost of 
complying with the amendments is the cost of the additional hour burden 
that is outlined in our PRA analysis. As described above, there are 
approximately 5,260 funds filing post-effective amendments that will be 
affected by the amendments. The Commission further estimates that three 
percent of these funds will elect to use advertisements or sales 
literature that either include after-tax returns or include other 
performance information together with representations that the fund is 
managed to limit or control the effect of taxes on performance and 
therefore be required to comply with the amendments to rule 482.\103\ 
For purposes of the PRA, we have estimated that the additional hour 
burden required to comply with the amendments to rule 482 is .5 
hours.\104\ The amendments to rule 482 will thus impose additional 
estimated costs of $5,506.\105\
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    \103\ This estimate is based on the assumption that tax-managed 
funds and index funds would be most likely to use advertisements 
that either include after-tax returns or include other performance 
information together with representations that the fund is managed 
to limit or control the effect of taxes on performance.
    \104\ This estimate is based on the staff's consultations with 
industry representatives.
    \105\ The total cost of the annual hour burden is calculated by 
multiplying the annual hour burden (79) by the weighted average 
hourly wage ($64). See supra note 100.
---------------------------------------------------------------------------

    Rule 34b-1. Rule 34b-1 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. As with 
the amendments to rule 482, these amendments will not require funds to 
perform any computations not required by the amendments to Form N-1A. 
Hence, the cost of complying with these amendments is primarily the 
cost associated with the burden estimate in our PRA analysis.
    We estimate that approximately 8,495 respondents file approximately 
4.35 responses annually pursuant to rule 34b-1.\106\ Of these 
respondents, we estimate that 1,040 are money market funds that will be 
exempt from the amendments and that an additional 620 funds and unit 
investment trusts (``UITs'') registered on Forms N-3 and N-4 will not 
be affected by the 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 will not use 
advertisements or sales literature that include after-tax returns or 
include other performance information together with representations 
that the fund is managed to limit or control the effect of taxes on 
performance. Thus, 5,260 respondents subject to rule 34b-1 will also be 
subject to the after-tax disclosure.\107\ We further estimate that 
three percent of respondents subject to rule 34b-1 or 157.8 respondents 
will elect to use advertisements or sales literature that either 
include after-tax returns or include other performance information 
together with representations that the fund is managed to limit or 
control the effect of taxes on performance and therefore be subject to 
the amendments.\108\ For purposes of the PRA, we have estimated that 
the additional hour burden attributable to the amendments to rule 34b-1 
is .5 hours, for a total of 78.9 annual burden hours or $5,049.60.\109\
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    \106\ These estimates are based on filings received in calendar 
year 1999.
    \107\ 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).
    \108\ This estimate is based on the assumption that tax-managed 
funds and index funds would be most likely to advertise after-tax 
performance.
    \109\ The total annual burden for the amendments is computed by 
multiplying the estimated number of respondents (157.8) subject to 
rule 34b-1 by the additional burden imposed by the amendments (.5). 
The total cost of the annul burden attributable to the amendments is 
calculated by multiplying the total burden hours (78.9) by the 
weighted average hourly rate of $64.
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IV. Effects on Efficiency, Competition, and Capital Formation

    Section 2(c) of the Investment Company Act, section 2(b) of the 
Securities Act, and section 3(f) of the Exchange Act require the 
Commission, when engaging in rulemaking that requires it to consider or 
determine whether an action 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.\110\ The Commission has considered these factors.
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    \110\ 15 U.S.C. 77(b), 78c(f), and 80a-2(c).
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    The Commission believes that the after-tax return requirements will 
help to increase investor understanding of a fund's after-tax 
performance. Increased understanding should enable investors to better 
evaluate various funds in determining which funds are most suitable for 
their investment needs. More educated investors should promote 
competition among funds as they seek to attract those investors 
interested in the impact of taxes on fund investments. On balance, the 
Commission believes that the after-tax return requirements will benefit 
investors, foster efficiency, and promote competition among mutual 
funds. While investors will be better equipped to make investment 
decisions, it is unclear whether these amendments will result in an 
increase in capital formation.

V. Summary of Final Regulatory Flexibility Analysis

    A Final Regulatory Flexibility Analysis (``FRFA'') has been 
prepared in accordance with 5 U.S.C. 604. The Commission proposed 
amendments to Form N-1A (17 CFR 239.15A and 274.11A), the registration 
form used by mutual funds to register under the Act and to offer their 
shares under the Securities Act, and amendments to rule 482 under the 
Securities Act and rule

[[Page 9014]]

34b-1 under the Act in the Proposing Release. The Commission prepared 
an Initial Regulatory Flexibility Analysis (``IRFA'') in accordance 
with 5 U.S.C. 603 in conjunction with the Proposing Release, which was 
made available to the public. The Proposing Release summarized the IRFA 
and solicited comments on it. No comments specifically addressed the 
IRFA.

A. Need for the Rule and Form Amendments

    As discussed above, taxes are one of the most significant costs of 
investing in mutual funds through taxable accounts. Despite the tax 
dollars at stake, many investors lack a clear understanding of the 
impact of taxes on their mutual fund investments.\111\
---------------------------------------------------------------------------

    \111\ See supra notes 2-6 and accompanying text.
---------------------------------------------------------------------------

    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.\112\ In addition, 
several fund groups have created new funds promoting the use of more 
tax-efficient portfolio management strategies.\113\ Moreover, in April 
2000, a bill that would require the Commission to revise its 
regulations to require improved disclosure of mutual fund after-tax 
returns was passed by the U.S. House of Representatives and was 
referred to the Senate.\114\
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    \112\ See supra note 10 and accompanying text.
    \113\ See supra note 11 and accompanying text.
    \114\ See supra note 12 and accompanying text.
---------------------------------------------------------------------------

B. Significant Issues Raised by Public Comment

    The Commission requested comment on the IRFA, but we received no 
comments specifically addressing the analysis. One commenter, however, 
argued that the proposed amendments would have a greater impact on 
smaller entities while another commenter suggested a longer phase-in 
period for smaller funds to comply with the new requirements. Neither 
of the commenters provided any specific or quantifiable data.

C. Small Entities Subject to the Rule

    For purposes of the Regulatory Flexibility Act, a fund is 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.\115\ As of December 1999, there were 
approximately 2,900 investment companies registered on Form N-1A that 
may be affected by the proposed amendments.\116\ Of these 2,900, 
approximately 150 are investment companies that meet the Commission's 
definition of small entity for purposes of the Investment Company 
Act.\117\ The amendments that require funds to provide after-tax 
returns in registration statements, advertisements, and sales 
literature will affect those small entities.
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    \115\ 17 CFR 270.0-10.
    \116\ This estimate is based on statistics compiled by the 
Commission's Division of Investment Management staff from January 1, 
1999, through December 31, 1999.
    \117\ This estimate is based on statistics compiled by the 
Commission's Division of Investment Management staff from January 1, 
1999, through December 31, 1999.
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D. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements

    The amendments will require all funds subject to the amendments to 
provide after-tax return information in their prospectuses. Although 
after-tax returns will not generally be required in fund advertisements 
and sales literature, any fund that either includes after-tax returns 
in these materials or includes other performance information together 
with representations that the fund is managed to limit taxes will be 
required to include after-tax returns computed according to our 
standardized formulas.
    After assessing the amendments in light of the current reporting 
requirements and consulting with representatives in the industry, the 
Commission has considered the potential effect that the amendments will 
have on the preparation of registration statements, advertisements, and 
sales literature. The Commission estimates that, as a result of the 
amendments, it will take approximately 18 additional hours per 
portfolio to prepare the first post-effective amendment to the 
registration statement on Form N-1A that is required to include the 
proposed after-tax return disclosure.\118\ The Commission believes that 
this estimate represents an initial, one-time burden and that the hour 
burden will be reduced for subsequent post-effective amendments. For 
purposes of calculating the rule 482 hour burden relating to 
advertisements, the Commission estimates that the proposed amendments 
will impose approximately .5 additional hours per portfolio.\119\ The 
Commission also estimates that the proposed amendments will impose 
approximately .5 additional hours per response for sales literature 
subject to rule 34b-1.\120\
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    \118\ This estimate is based on the staff's consultation with 
industry representatives. 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.
    \119\ This estimate is based on the staff's consultation with 
industry representatives.
    \120\ This estimate is based on the staff's consultation with 
industry representatives.
---------------------------------------------------------------------------

E. Agency Action To Minimize Effects on Small Entities

    The Commission believes that special compliance or reporting 
requirements for small entities would not be appropriate or consistent 
with investor protection. The disclosure amendments we are adopting 
will give prospective and existing shareholders greater access to 
information about the after-tax returns of mutual funds. Different 
disclosure requirements for small entities, such as reducing the level 
of disclosure that small entities would have to provide, would create 
the risk that investors would not receive adequate information about a 
fund's after-tax returns or would receive confusing, false, or 
misleading information. In addition, investors would not be able to 
easily compare each fund when making an investment decision if there 
were no uniform disclosure standards for after-tax performance 
information applicable to all funds. The Commission believes it is 
important for prospective and existing shareholders to receive this 
information about after-tax returns for all funds, not just for funds 
that are not considered small entities.
    Investors in small funds should have information about the funds' 
after-tax returns and would benefit from this information as much as 
investors in larger funds. If we do not require certain information for 
small entities, this could create the risk that investors in small 
funds might not receive important information about a fund's after-tax 
returns. The Commission also notes that current disclosure requirements 
in registration statements do not distinguish between small entities 
and other funds. In addition, the Commission believes it would be 
inappropriate to impose a different timetable on small entities for 
complying with the requirements because investors would not have the 
ability to compare the after-tax returns of all funds when making an 
investment decision.
    Further clarification, consolidation, or simplification of the 
proposals for funds that are small entities would be inconsistent with 
concerns for investor protection. Simplifying or otherwise

[[Page 9015]]

reducing the regulatory requirements of the proposals for small 
entities could undercut the purpose of these proposals: 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. For the same reasons, using performance standards to specify 
the requirements for small entities also would not be appropriate.
    We note, however, that in response to concerns expressed by certain 
commenters regarding the burdens imposed on funds by the new 
requirements, we have simplified the presentation of after-tax 
returns.\121\ We have also extended the date by which all post-
effective amendments that are annual updates to effective registration 
statements and profiles must comply with the amendments to Form N-1A 
from the proposed six-month period to February 15, 2002, which will 
provide funds an additional four months to comply with the amendments. 
Overall, these amendments will not adversely affect small entities. We 
believe that the burden on funds of computing and disclosing after-tax 
returns is justified by the benefits to investors from receiving this 
information. While we acknowledge that funds will incur a one-time cost 
to modify their systems to compute after-tax returns, the computation 
thereafter should be straightforward to perform using readily available 
data.
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    \121\ As discussed above, we have modified the proposal by: 
eliminating the proposed requirement to disclose pre-liquidation 
before-tax returns; eliminating after-tax returns in annual reports; 
streamlining the required narrative disclosure; and simplifying the 
presentation for funds that offer multiple classes in a single 
prospectus.
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    The FRFA is available for public inspection in File No. S7-23-99, 
and a copy may be obtained by contacting Peter M. Hong, Special 
Counsel, at (202) 942-0721, Office of Disclosure Regulation, Division 
of Investment Management, Securities and Exchange Commission, 450 5th 
Street, NW., Washington, DC 20549-0506.

VI. Paperwork Reduction Act

    As explained in the Proposing Release, certain provisions of the 
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: (i) ``Form N-1A under the 
Investment Company Act of 1940 and Securities Act of 1933, Registration 
Statement of Open-End Management Investment Companies''; (ii) 
``Registration Statements--Regulation C'';\122\ and (iii) ``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.\123\
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    \122\ The amendments 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 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.
    \123\ As discussed above, we have modified the proposal by 
eliminating the proposed requirement to include after-tax returns in 
the MDFP, which is typically contained in the annual report. 
Accordingly, the hour burden for preparing and filing annual reports 
in compliance with rule 30d-1 will be reduced by 7.5 hours. See 
Proposing Release, supra note 1, at nn. 107-110, and accompanying 
text (discussing the estimated hour burden for proposal requiring 
after-tax return disclosure in shareholder reports). Funds will be 
required to include a statement in the MDFP that accompanies the 
performance table and graph to the effect that the returns shown do 
not reflect the deduction of taxes that a shareholder would pay on 
fund distributions or the redemption of fund shares. Item 5(b)(2) of 
Form N-1A. We believe that the hour burden for the required 
statement in the MDFP will be negligible and will not result in a 
change to the current hour burden for preparing and filing annual 
reports.
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    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-2). 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)).
    As discussed above, the amendments will require a fund to disclose 
its standardized after-tax returns for 1-, 5-, and 10-year periods. 
After-tax return information is to be included in the risk/return 
summary of the prospectus. Funds are required to include a short, 
explanatory narrative adjacent to the performance table in the risk/
return summary. After-tax returns, which will accompany before-tax 
returns in fund prospectuses, will be presented in two ways: (i) After 
taxes on fund distributions only; and (ii) after taxes on fund 
distributions and a redemption of fund shares. The before- and after-
tax returns will be required to be presented in a standardized tabular 
format. Although after-tax returns will not generally be required in 
fund advertisements and sales literature, any fund that either includes 
after-tax returns in these materials or includes other performance 
information together with representations that the fund is managed to 
limit taxes will be required to include after-tax returns computed 
according to our standardized formulas.
    The information required by the 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.
    In the Proposing Release, the Commission estimated the burden hours 
that would be necessary for the collection of information requirements 
under the proposed amendments. Although no commenters specifically 
addressed the burden estimates for the collection of information 
requirements, a few commenters raised concerns regarding the costs 
involved in complying with the disclosure requirements of the 
amendments. These commenters, however, did not provide an estimate of 
the burden hours associated with the proposed rule changes. We continue 
to believe that the estimates of the burden hours contained in the 
Proposing Release are appropriate.\124\
---------------------------------------------------------------------------

    \124\ As discussed above, we have modified the proposal by: 
Eliminating the proposed requirement to disclose pre-liquidation 
before-tax returns; eliminating after-tax returns in annual reports; 
streamlining the required narrative disclosure; and simplifying the 
presentation for funds that offer multiple classes in a single 
prospectus. The elimination of after-tax returns in annual reports 
will reduce the hour burden for preparing and filing annual reports 
in compliance with rule 30d-1 by 7.5 hours. See Proposing Release, 
supra note 1, at nn. 107-110, and accompanying text (discussing the 
estimated hour burden for proposal requiring after-tax return 
disclosure in annual reports). We do not believe, however, that the 
other three modifications will affect the estimated burden hours 
overall.

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[[Page 9016]]

    Form N-1A. Form N-1A, including the 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.\125\ We estimate that 4,500 post-
effective amendments to registration statements are filed 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.\126\ 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.
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    \125\ These estimates are based on filings received in calendar 
year 1999. The current approved hour burden per portfolio for an 
initial Form N-1A is 824 hours.
    \126\ These estimates are based on filings received in calendar 
year 1999. The current approved hour burden per portfolio for post-
effective amendments to Form N-1A is 104 hours.
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    The proposed amendments will 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 will have no performance 
history to disclose. Post-effective amendments to such registration 
statements, however, will contain performance figures and thus be 
affected by the amendments. We estimate that the amendments will 
increase the hour burden per portfolio per filing of a post-effective 
amendment by 18 hours.\127\ Of the 7,875 funds referenced in post-
effective amendments, 1,040 are money market funds, which will be 
exempted from the after-tax return disclosure requirements. An 
additional 1,575 funds are used as investment vehicles for variable 
insurance contracts, which will be permitted to omit the after-tax 
information. Thus, approximately 5,260 of the 7,875 funds referenced in 
post-effective amendments will be affected by the proposed 
amendments.\128\ The Commission estimates the total annual hour burden 
for all funds for preparation and filing of initial registration 
statements and post-effective amendments on Form N-1A will be 1,159,311 
hours.\129\
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    \127\ This estimate is based on the staff's consultations with 
industry representatives.
    \128\ The number of funds referenced in post-effective 
amendments that will be affected by the amendments is computed by 
subtracting those funds that are exempt from or permitted to omit 
the after-tax return 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 will 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.
    \129\ 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 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 will 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 122, supra), the Form N-1A burden will include the estimated 
rule 482 burden of .5 hours (the rule 482 burden is discussed below) 
that will be imposed on the three percent of funds that we estimate 
would use advertisements or sales literature that either include 
after-tax returns or include other performance information together 
with representations that the fund is managed to limit or control 
the effect of taxes on performance (.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 will be 1,159,311 hours (245,552 + 819,000 + 
94,680 + 79).
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    Compliance with the disclosure requirements of Form N-1A is 
mandatory. Responses to the disclosure requirements will not be kept 
confidential.
    Rule 482. Rule 482, including the amendments, contains collection 
of information requirements. The rule 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 amendments to rule 482 is 
included in Form N-1A.\130\ Thus, the 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 will be affected by the proposed 
amendments. The Commission further estimates that three percent of 
these funds will elect to use advertisements or sales literature that 
either include after-tax returns or include other performance 
information together with representations that the fund is managed to 
limit or control the effect of taxes on performance and therefore be 
required to comply with the proposed amendments to rule 482.\131\ We 
estimate that the additional hour burden required to comply with the 
proposed amendments to rule 482 is .5 hours.\132\
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    \130\ See supra note 122.
    \131\ This estimate is based on the assumption that tax-managed 
funds and index funds would be most likely to advertise after-tax 
performance or use advertisements that include other performance 
information together with representations that the fund is managed 
to limit or control the effect of taxes on performance.
    \132\ This estimate is based on the staff's consultations with 
industry representatives.
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    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 amendments, contains 
collection of information requirements. The rule 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.\133\ Of these 
respondents, we estimate that 1,040 are money market funds that will be 
exempt from the amendments and that an additional 620 funds and unit 
investment trusts (``UITs'') registered on Forms N-3 and N-4 will not 
be affected by the 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 will not 
advertise after-tax returns or use

[[Page 9017]]

advertisements that either include other performance information 
together with representations that the fund is managed to limit or 
control the effect of taxes on performance due to their unique tax-
deferred nature. Thus, 5,260 respondents subject to rule 34b-1 will 
also be subject to the after-tax return disclosure.\134\ We further 
estimate that three percent of respondents subject to rule 34b-1 will 
elect to use advertisements or sales literature that either include 
after-tax returns or include other performance information together 
with representations that the fund is managed to limit or control the 
effect of taxes on performance and therefore be subject to the proposed 
amendments.\135\ 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.\136\ 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.\137\
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    \133\ These estimates are based on filings received in calendar 
year 1999. The current approved hour burden per response for rule 
34b-1 is 2.4 hours.
    \134\ 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).
    \135\ This estimate is based on the assumption that tax-managed 
funds and index funds would be most likely to advertise after-tax 
performance or use advertisements that include other performance 
information together with representations that the fund is managed 
to limit or control the effect of taxes on performance.
    \136\ 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.
    \137\ 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).
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    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.

VII. Statutory Authority

    The Commission is adopting 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), and 38 of the Investment Company Act (15 U.S.C. 80a-8, 80a-
24(a), 80a-37). The Commission is adopting 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 
adopting 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 Rules and Forms

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

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

    1. The general authority citation for part 230 is revised as 
follows:


    Authority: 15 U.S.C. 77b, 77c, 77d, 77f, 77g, 77h, 77j, 77r, 
77sss, 77z-3, 78c, 78d, 78l, 78m, 78n, 78o, 78t, 78w, 78ll(d), 78mm, 
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. Removing ``; and'' at the end of paragraph (e)(3)(iv) and in its 
place adding a period;
    b. Redesignating paragraph (e)(4) as paragraph (e)(5) and paragraph 
(f) as paragraph (g);
    c. Adding new paragraphs (e)(4) and (f); and
    d. 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) * * *
    (4) For an open-end management investment company, average annual 
total return (after taxes on distributions) and average annual total 
return (after taxes on distributions and 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:
    (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 average annual total return (after taxes on 
distributions) and average annual total return (after taxes on 
distributions and 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.
    (f) An advertisement for an open-end management investment company 
(other than a company that is permitted under Sec. 270.35d-1(a)(4) of 
this chapter to use a name suggesting that the company's distributions 
are exempt from federal income tax or from both federal and state 
income tax) that represents or implies that the company is managed to 
limit or control the effect of taxes on company performance shall 
accompany any quotation of the company's performance permitted by 
paragraph (e) of this section with quotations of total return as 
provided for in paragraph (e)(4) of this section.
* * * * *

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

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



[[Page 9018]]


    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)(D) and (E);
    b. Adding new paragraphs (b)(1)(iii)(B) and (C); and
    c. Revising paragraph (b)(3) before the note 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 (not including a quotation of tax equivalent yield or 
other similar quotation purporting to demonstrate the tax equivalent 
yield earned or distributions made by the company) with the quotations 
of total return specified by paragraph (e)(4) of Sec. 230.482 of this 
chapter;
    (C) If the sales literature (other than sales literature for a 
company that is permitted under Sec. 270.35d-1(a)(4) to use a name 
suggesting that the company's distributions are exempt from federal 
income tax or from both federal and state income tax) represents or 
implies that the company is managed to limit or control the effect of 
taxes on company performance, include 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 (g) 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 adding paragraphs 3.(d)(iii) and (iv) to 
read as follows:

Form N-1A

* * * * *

General Instructions

* * * * *

C. Preparation of the Registration Statement

* * * * *

3. Additional Matters

* * * * *
    (d) * * *
    (iii) A Fund may omit the information required by Items 
2(c)(2)(iii)(B) and (C) and 2(c)(2)(iv) if the Fund's prospectus will 
be used exclusively to offer Fund shares as investment options for one 
or more of the following:
    (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)), a tax-deferred arrangement under section 403(b) or 457 
of the Internal Revenue Code (26 U.S.C. 403(b) or 457), a variable 
contract as defined in section 817(d) of the Internal Revenue Code (26 
U.S.C. 817(d)), 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; or
    (B) persons that are not subject to the federal income tax imposed 
under section 1 of the Internal Revenue Code (26 U.S.C. 1), or any 
successor to that section.
    (iv) A Fund that omits information under Instruction (d)(iii) may 
alter the legend required on the back cover page by Item 1(b)(1) to 
state, as applicable, that the prospectus is intended for use in 
connection with a defined contribution plan, tax-deferred arrangement, 
variable contract, or similar plan or arrangement, or persons described 
in Instruction (d)(iii)(B).
* * * * *

    8. Item 2 of Form N-1A (referenced in Secs. 239.15A and 274.11A) is 
amended by:
    a. Revising paragraphs (c)(2)(i) and (c)(2)(iii);
    b. Adding paragraph (c)(2)(iv);
    c. Revising paragraph (a) of Instruction 2;
    d. Adding paragraph (e) to Instruction 2; and
    e. Revising paragraph (c) of Instruction 3 to read as follows:

Form N-1A

* * * * *

Item 2. Risk/Return Summary: Investments, Risks, and Performance

* * * * *
    (c) * * *
    (2) * * *
    (i) Include the bar chart and table required by paragraphs 
(c)(2)(ii) and (iii) of this section. Provide a brief explanation of 
how the information illustrates the variability of the Fund's returns 
(e.g., by stating that the information provides some indication of the 
risks of investing in the Fund by showing changes in the Fund's 
performance from year to year and by showing how the Fund's average 
annual returns for 1, 5, and 10 years compare with those of a broad 
measure of market performance). Provide a statement to the effect that 
the Fund's past performance (before and after taxes) is not necessarily 
an indication of how the Fund will perform in the future.
* * * * *
    (iii) If the Fund has annual returns for at least one calendar 
year, provide a table showing the Fund's (A) average annual total 
return; (B) average annual total return (after taxes on distributions); 
and (C) average annual total return (after taxes on distributions and 
redemption). A Money Market Fund should show only the returns described 
in clause (A) 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 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 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

[[Page 9019]]

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)(iii)), provide 
the information in the following table with the specified captions:

                                          Average Annual Total Returns
                                   [For the periods ended December 31,------]
----------------------------------------------------------------------------------------------------------------
                                                                     5 years  [or life of  10 years  [or life of
                                                     1 year                 fund]                  fund]
----------------------------------------------------------------------------------------------------------------
Return Before Taxes........................               ______%                ______%                ______%
Return After Taxes on Distributions........               ______%                ______%                ______%
Return After Taxes on Distributions and                   ______%                ______%                ______%
 Sale of Fund Shares.......................
Index (reflects no deduction for [fees,                   ______%                ______%                ______%
 expenses, or taxes])......................
----------------------------------------------------------------------------------------------------------------

    (iv) Adjacent to the table required by paragraph 2(c)(2)(iii), 
provide a brief explanation that:
    (A) After-tax returns are calculated using the historical highest 
individual federal marginal income tax rates and do not reflect the 
impact of state and local taxes;
    (B) Actual after-tax returns depend on an investor's tax situation 
and may differ from those shown, and 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;
    (C) If the Fund is a Multiple Class Fund that offers more than one 
Class in the prospectus, after-tax returns are shown for only one Class 
and after-tax returns for other Classes will vary; and
    (D) If average annual total return (after taxes on distributions 
and redemption) is higher than average annual total return, the reason 
for this result may be explained.
    Instructions.
* * * * *
    2. Table.
    (a) Calculate a Money Market Fund's 7-day yield under Item 21(a); 
the Fund's average annual total return under Item 21(b)(1); and the 
Fund's average annual total return (after taxes on distributions) and 
average annual total return (after taxes on distributions and 
redemption) under Items 21(b)(2) and (3), respectively.
* * * * *
    (e) Returns required by paragraphs 2(c)(2)(iii)(A), (B), and (C) 
for a Fund or Series must be adjacent to one another and appear in that 
order. When more than one Fund or Series is offered in the prospectus, 
do not intersperse returns of one Fund or Series with returns of 
another Fund or Series. The returns for a broad-based securities market 
index, as required by paragraph 2(c)(2)(iii), must precede or follow 
all of the returns for a Fund or Series rather than be interspersed 
with the returns of the Fund or Series.
* * * * *
    3. Multiple Class Funds.
* * * * *
    (c) When a Multiple Class Fund offers more than one Class in the 
prospectus:
    (i) Provide the returns required by paragraph 2(c)(2)(iii)(A) of 
this Item for each Class offered in the prospectus;
    (ii) Provide the returns required by paragraphs 2(c)(2)(iii)(B) and 
(C) of this Item for only one of those Classes. The Fund may select the 
Class for which it provides the returns required by paragraphs 
2(c)(2)(iii)(B) and (C) of this Item, provided that the Fund:
    (A) Selects a Class that has been offered for use as an investment 
option for accounts other than those described in General Instruction 
C.3.(d)(iii)(A);
    (B) Selects a Class described in paragraph (c)(ii)(A) of this 
instruction with 10 or more years of annual returns if other Classes 
described in paragraph (c)(ii)(A) of this instruction have fewer than 
10 years of annual returns;
    (C) Selects the Class described in paragraph (c)(ii)(A) of this 
instruction with the longest period of annual returns if the Classes 
described in paragraph (c)(ii)(A) of this instruction all have fewer 
than 10 years of returns; and
    (D) If the Fund provides the returns required by paragraphs 
2(c)(2)(iii)(B) and (C) of this Item for a Class that is different from 
the Class selected for the most immediately preceding period, explain 
in a footnote to the table the reasons for the selection of a different 
Class;
    (iii) The returns required by paragraphs 2(c)(2)(iii)(A), (B), and 
(C) of this Item for the Class described in paragraph (c)(ii) of this 
instruction should be adjacent and should not be interspersed with the 
returns of other Classes; and
    (iv) All returns shown should be identified by Class.
* * * * *

    9. Item 5 of Form N-1A (referenced in Secs. 239.15A and 274.11A) is 
amended by revising paragraph (b)(2) to read as follows:

Form N-1A

* * * * *

Item 5. Management's Discussion of Fund Performance

* * * * *
    (b)(1) * * *
    (2) In a table placed within or next to the graph, provide the 
Fund's average annual total returns 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. Average annual 
total returns should be computed in accordance with Item 21(b)(1). 
Include a statement accompanying the graph and table to the effect that 
past performance does not predict future performance and that the graph 
and table do not reflect the deduction of taxes that a shareholder 
would pay on fund distributions or the redemption of fund shares.
* * * * *

    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)-(6)'' in the 
introductory text of paragraph (b);
    b. Redesignating paragraphs (b)(2), (3), (4), and (5) as paragraphs 
(b)(4), (5), (6), and (7), respectively;
    c. Adding new paragraphs (b)(2) and (b)(3); and
    d. Revising paragraph (b)(1) to read as follows:

Form N-1A

* * * * *

Item 21. Calculation of Performance Data

* * * * *
    (b) * * *
    (1) Average Annual Total Return 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 average annual

[[Page 9020]]

total return 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=ERV

Where:

P=a hypothetical initial payment of $1,000.
T=average annual total return.
n=number of years.
ERV=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).

    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 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 average annual total return quotation to the nearest 
hundredth of one percent.
    6. Total return information in the prospectus need only be current 
to the end of the Fund's most recent fiscal year.
    (2) Average Annual Total Return (After Taxes on Distributions) 
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 
average annual total return (after taxes on distributions) 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 value, according to 
the following formula:

P(1+T)n=ATVD

Where:

P=a hypothetical initial payment of $1,000.
T=average annual total return (after taxes on distributions).
n=number of years.
ATVD=ending 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), after taxes on 
fund distributions but not after taxes on redemption.

    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 rates 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 portion 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. The effect of applicable 
tax credits, such as the foreign tax credit, should be taken into 
account in accordance with federal tax law.
    4. Calculate the taxes due using the highest individual marginal 
federal income tax rates in effect on the reinvestment date. The rates 
used should correspond to the tax character of each component of the 
distributions (e.g., ordinary income rate for ordinary income 
distributions, short-term capital gain rate for short-term capital gain 
distributions, long-term capital gain rate 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 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. Assume that the redemption has 
no tax consequences.
    7. State the average annual total return (after taxes on 
distributions) quotation to the nearest hundredth of one percent.
    (3) Average Annual Total Return (After Taxes on Distributions and 
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 average annual total return (after taxes on 
distributions and 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 value, according to the following formula:

P(1+T)n=ATVDR

Where:

P=a hypothetical initial payment of $1,000.
T=average annual total return (after taxes on distributions and 
redemption).
n=number of years.
ATVDR=ending 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

[[Page 9021]]

portion), after taxes on fund distributions and redemption.

    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 rates 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 portion 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. The effect of applicable 
tax credits, such as the foreign tax credit, should be taken into 
account in accordance with federal tax law.
    4. Calculate the taxes due using the highest individual marginal 
federal income tax rates in effect on the reinvestment date. The rates 
used should correspond to the tax character of each component of the 
distributions (e.g., ordinary income rate for ordinary income 
distributions, short-term capital gain rate for short-term capital gain 
distributions, long-term capital gain rate 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 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 the ending 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) The Fund should separately track the basis of shares acquired 
through the $1,000 initial investment and each subsequent purchase 
through reinvested distributions. In determining the basis for a 
reinvested distribution, include the distribution net of taxes assumed 
paid from the distribution, but not net of any sales loads imposed upon 
reinvestment. Tax basis should be adjusted for any distributions 
representing returns of capital and any other tax basis adjustments 
that would apply to an individual taxpayer, as permitted by applicable 
federal tax law.
    (c) The amount and character (e.g., short-term or long-term) of 
capital gain or loss upon redemption should be separately determined 
for shares acquired through the $1,000 initial investment and each 
subsequent purchase through reinvested distributions. The Fund should 
not assume that shares acquired through reinvestment of distributions 
have the same holding period as the initial $1,000 investment. The tax 
character should be 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.
    (d) Calculate the capital gains taxes (or the benefit resulting 
from tax losses) using the highest federal individual capital gains tax 
rate for gains of the appropriate character in effect on the redemption 
date and in accordance with federal tax law applicable on the 
redemption date. For example, applicable federal tax law should be used 
to determine whether and how gains and losses from the sale of shares 
with different holding periods should be netted, as well as the tax 
character (e.g., short-term or long-term) of any resulting gains or 
losses. Assume that a shareholder has sufficient capital gains of the 
same character from other investments to offset any capital losses from 
the redemption so that the taxpayer may deduct the capital losses in 
full.
    8. State the average annual total return (after taxes on 
distributions and redemption) quotation to the nearest hundredth of one 
percent.
* * * * *

    By the Commission.
    Dated: January 18, 2001.

Jonathan G. Katz,
Secretary.
[FR Doc. 01-2063 Filed 2-2-01; 8:45 am]
BILLING CODE 8010-01-U