June 30, 2000
VIA E-MAIL (email@example.com)
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Disclosure of Mutual Fund After Tax Returns (File No. S7-09-00)
Dear Mr. Katz:
On behalf of MFS Investment Management ("MFS"), I appreciate the opportunity to express MFS' views on the proposal to require mutual funds to disclose their after-tax returns (the "Proposal").
MFS and its affiliates manage a broad variety of open-end and closed-end investment companies, variable annuity products, institutional funds, offshore funds and accounts for large institutional clients. The history of the MFS organization dates to 1924 and the founding of America's first mutual fund, Massachusetts Investors Trust. MFS currently manages over $150 billion on behalf of over 4 million investors worldwide.
The purpose of this letter is to express MFS' opposition to the Proposal and to recommend two alternative approaches. We have reviewed a draft of the Investment Company Institute's (ICI) letter on the Proposal (the "ICI Letter"). In the event that the Commission proceeds to adopt the Proposal, we support the specific comments expressed in the ICI Letter, with one exception discussed below.
Insufficient Evidence of Need
The House of Representatives, in adopting the Mutual Fund Tax Awareness Act of 1999, H.R. 1089, 106th Cong., 1st Sess. (1999), and the Commission, in advancing the Proposal, have assumed that the provision of after-tax performance information by mutual funds is sufficiently important to investors to overcome the costs (including the potential investor confusion) of requiring this disclosure. This presumption has little factual support in the congressional record.
The Subcommittee on Finance and Hazardous Materials held a hearing on increasing disclosures to benefit investors on October 29, 1999. The Subcommittee received testimony from Joel M. Dickson, Ph.D, Senior Investment Analyst, The Vanguard Group, Inc.; Mr. David B. Jones, Vice President, Fidelity Management and Research Company; and Mr. Matthew P. Fink, President, Investment Company Institute. In addition, the Commission submitted written testimony for the record.
Absent from the record for this hearing is evidence that investors have expressed a significant demand for after-tax performance information. Rather, statements in the record reflect the views of the proponents of this disclosure that investors need to better understand the impact of taxes. Also absent from the record is any discussion of the costs of providing this information. Likewise, the Commission cites little evidence of investor demand for after-tax performance information in its proposing release. In over 10 years as Secretary of the Funds in the MFS Family, I have not received a single letter or phone call from a shareholder requesting this sort of disclosure.
The Proposal would mandate a costly solution to a problem that may not exist. Assuming that after-tax performance information is in fact important to investors, then mandatory disclosure of this information by mutual funds may be an appropriate response. However, mandating this disclosure when investor interest is untested and uncertain is unneccessary and costly.
Every new rule has associated costs, and the Proposal is no exception. The costs of the Proposal are at least:
In the face of uncertain investor interest in the Proposal, its associated costs and limitations, MFS believes that the Commission should consider alternatives to the Proposal, as discussed below.
Alternative #1 - Let the Market Decide
Rather than mandate after-tax return disclosure for all mutual funds, the Commission should adopt a rule that would permit investors to decide the importance of this information. This alternative proposal would contain the following elements:
This approach lets the market (i.e., investors) decide the importance of this information. If investors believe that this information is in fact important, they will demand that their funds provide it to them, and in order to remain competitive in a highly competitive environment, funds will respond or risk losing market share. Such choices already exist and show no evidence of strong investor support. If investors do not make this demand, then the information is not sufficiently important to investors and funds should be entitled to decide that the costs discussed above are not warranted in the best interests of their shareholders. MFS does not believe a governmental mandate is necessary or appropriate where investors are well suited, through the mechanism of market pressure, to express their preferences and achieve results acceptable to them.
Alternative #2 - Eliminate Pre-Liquidation After Tax Returns
The goal of providing pre-liquidation after tax returns, according to the Congressional record and the Commission's proposing release, is to demonstrate how effectively a fund is tax managed by its portfolio manager(s). However, a fund's cash flows are often the single largest factor in determining its pre-liquidation after tax performance regardless of the degree to which tax advantaged policies are utilized by the portfolio manager. Accordingly, the use of a pre-liquidation after tax return in an attempt to measure the effective tax management by the portfolio manager will be misleading and make comparisons among funds meaningless.
For example, two funds with exactly the same pre-tax performance over a given period may have very different pre-liquidation after-tax returns if one is growing and the other is shrinking. This is due to the fact that the growing fund may not be under pressure to sell portfolio holdings and may therefore generate less capital gains; while conversely the shrinking fund may need to sell portfolio holdings to raise cash to satisfy redemption requests and by doing so may generate capital gains. While each fund's portfolio manager may either (i) be highly effective in managing his or her fund for maximum tax efficiency or (ii) have generated performance results without any regard for tax efficiency, the pre-liquidation after tax returns may be sharply higher for the growing fund. The fact that one fund is growing and other is shrinking may have nothing to do with the manner in which the funds are being managed, but may be attributable to the relative success of the funds' distribution efforts, sales and redemption activity by large shareholders1 (e.g., market timers) and the overall performance of the market in which the funds focus their investments. An investor reviewing the pre-liquidation after tax returns of these funds could be easily misled by the performance differential into believing that the growing fund is effectively tax managed, while the shrinking fund is not, when the reverse may in fact be the case.
MFS does not believe that it is possible, from a practical standpoint, to adjust pre-liquidation after tax returns to negate the effects of purchase and redemption activity on these returns. Without adjusting these returns in this manner, the goal of demonstrating how effectively a fund is tax managed through the use of these returns will not be satisfied, and the use of these returns will be misleading and make comparisons among funds meaningless. For these reasons, MFS recommends the elimination of the requirement to disclose pre-liquidation after tax returns.
Specific Comments on ICI Letter
In the event that the Commission proceeds to adopt the Proposal, MFS supports the specific comments expressed in the ICI Letter, with one exception. The ICI Letter recommends that pre-liquidation after tax returns reflect the deduction of any applicable contingent deferred sales charge ("CDSC") and that the disclosure of before-tax returns that do not reflect the deduction of the CDSC be eliminated. While this recommendation would result in the presentation of three, as opposed to four, performance numbers, MFS believes the result would be confusing to investors because it is counterintuitive to deduct the CDSC in a presentation of a pre-liquidation return number. The benefit of disclosing fewer numbers is far outweighed by the resulting confusion.
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MFS' appreciates the opportunity to comment on the Proposal, and would be pleased to discuss its views with the Commission staff.
Stephen E. Cavan
Senior Vice President
and General Counsel
1 In an extreme case, two funds that make annual distributions could have the exact same total returns and distribution amounts, but if one fund experienced a large redemption the day before the distribution record date, its after tax performance could be significantly worse than the other fund's after tax performance because the distribution amount for the fund with the large redemption will be spread over a smaller shareholder base (thereby increasing the distribution amount per share). This is only one example of factors which are not related to the investment decision making process, but which can exert a material impact on after tax performance, as contemplated by the Proposal.