Mr. Jonathan G. Katz
Securities and Exchange Commission
Dear Mr. Katz:
Our firm, Firehouse Financial Communications LLC, develops simplified documents for financial services companies. Over the past few years, the firm and its founders have created plain English mutual fund prospectuses for numerous firms, including John Hancock Funds, The Dreyfus Corporation, Scudder Kemper Investments, Inc. and Charles Schwab Investment Management, Inc. More recently, we have also begun to develop simplified shareholder reports, application forms, proxy statements and related materials.
Our views on after-tax performance disclosure are based on two main considerations. One is our belief that disclosure of after-tax performance, while obviously valuable, is not more significant than many of the other points on which prospectuses must offer information, and therefore should not be given disproportionate space, since that would be likely to come at the expense of the reader's attention to other important matters.
The second consideration is that a number of leading mutual fund firms have already demonstrated an interest in providing good after-tax performance information, and have done so for business reasons. We believe it is inevitable that the industry will move further in this direction of its own accord, and we hope that, as with prospectus simplification, in which a great deal of progress was made (and continues to be made) for business reasons, the Commission will recognize the value to investors of allowing competition and innovation in this area to continue to flourish.
In adopting the Plain English requirements and the revisions to Form N-1A three years ago, the Commission demonstrated both leadership and wisdom. These initiatives opened the door to extensive improvements on the part of mutual fund firms who see simplification as beneficial, while still making it possible for any firm to achieve compliance with comparatively little effort. It is our hope that any after-tax disclosure requirements will, in their final form, embody this same approach by establishing sensible minimum requirements while permitting - indeed encouraging - fund groups to exceed these requirements.
General Comments on After-Tax Disclosure
We believe that providing shareholders with good disclosure about after-tax returns is a desirable goal, one that is healthy for shareholders as well as the mutual fund industry. At the same time, as the Commission acknowledges in its proposal, there is no ideal way to achieve this goal.
Providing information for every federal tax bracket would require the use of large tables, increasing the burden for readers (particularly in the case of multi-class funds) and materially reducing the communications benefits gained through the recent prospectus reforms. Nor would this level of detail, complex as it is, be enough to provide accurate numbers for most investors, because it would not consider the effects of state or local income taxes.
This particular type of information complexity is handled very easily by interactive media. It is not hard to imagine, for example, an Internet-based calculator that would let users specify the particulars of their own situations (including not only federal, state and local tax exposure but also holding period). For any given mutual fund, the calculator would be able to provide instant, "personalized" after-tax performance figures that could be more precise than those available through any other practical method.
There is no inherent reason why an electronic prospectus or shareholder report - or perhaps a new type of disclosure document combining the key elements of both - could not have such a calculator embedded within it. Until the day is at hand when this possibility is realized, however, we believe the Commission is wise to avoid requiring complex after-tax disclosure in printed documents.
Proposal for a Tax-Efficiency Spectrum
From a communications standpoint, perhaps the simplest form of disclosure would be a tax-efficiency spectrum. This could take the form of a horizontal line whose endpoints represented 0% efficiency and 100% efficiency. A mark would indicate where the fund's tax-efficiency fell on the spectrum. A percentage number would accompany the mark.
This system would have several advantages. As a visual representation its meaning would immediately be clear. Its structure would be familiar to people, being similar, for instance, to the energy efficiency spectrum displayed (by government mandate) on major appliances. It would take up little space while enhancing the readability and appeal of the prospectus. Not least, the tax-efficiency spectrum would further the Commission's goal of encouraging comparisons among funds, and it would avoid presenting investors with a specific figure that many would inevitably regard as their actual after-tax performance - when in almost all cases their actual performance would be substantially different.
Tax efficiency is, of course, not as useful a thing to know as actual after-tax performance. But because accurate after-tax performance would be so cumbersome to disclose in printed form, we believe the efficiency spectrum merits consideration. Furthermore, because the spectrum would express a percentage, investors in any tax bracket could easily estimate their own after-tax returns. If desired, some language showing how to do this could be included as part of the narrative.
Comments on the Proposed Disclosure
While our enthusiasm for the Commission's proposed after-tax disclosure is tempered by the issues discussed above, we believe the proposed disclosure has many merits, and we respectfully offer the following comments, which we hope the Commission will find useful should it move forward with the disclosure substantially as proposed.
We strongly support the Commission's recommendation that any information on after-tax performance be located in the risk/return summary. We believe the Commission is correct in thinking that investors would be less likely to find after-tax information if it were separated from the performance information in the summary. In addition, for those fund companies that have chosen the option of combining their summary with their Item 4 disclosure, any other location would compromise the simple and logical organization these prospectuses now have.
We wholeheartedly agree with the Commission's view that any disclosure be limited to one tax bracket at most. As noted above, any greater disclosure could have the effect of giving after-tax performance more prominence than pre-tax performance, simply because the after-tax information would occupy more space. Logic suggests this would not be desirable unless most investors held their fund shares in taxable accounts, which is not likely to be the case anytime soon.
In addition, the mere presence of additional numbers (such as for different federal tax brackets) would inevitably raise expectations for accuracy and applicability. As soon as numbers are provided for more than one tax bracket, the reader is engaged in determining which numbers most closely apply to his or her own situation. This encourages readers to focus on the absolute values of these numbers and discourages their use as an example and a tool for comparison. This could in some cases prove quite misleading to investors, because the nature of the presentation, with its many tabular entries, would suggest a degree of accuracy that no general disclosure could actually provide.
We note that several commenters to date have asked for multiple tax bracket information, which we interpret as a sign of mutual fund investors' interest in accurate after-tax performance for particular cases. We agree with the Commission's view that showing the maximum federal tax bracket is a logical choice, as it can best serve both as a benchmark and a "worst-case" estimate. However, in view of investor interest in an accurate number, it is possible that using a median tax bracket rather than the higher tax bracket would produce a result that is ultimately more meaningful to the bulk of mutual fund investors. Consistent with the views stated earlier, we believe the most efficient way for investors of all circumstances to obtain reasonably accurate approximations will be through interactive calculators, which competitive pressures may compel fund groups to offer as a feature of their Web sites.
We are aware of at least one fund company that will soon present after-tax information graphically (as well as in a table) in its shareholder reports. We believe this type of presentation is valuable to investors, and we urge the Commission to allow the addition of graphic elements in the presentation of pre- and post-tax returns in shareholder reports. In particular, we ask that the Commission allow for a presentation that shows total returns for each required period as a vertical bar, with a segment at the top end, differentiated by color or shading, that indicates the portion of total returns lost to taxes.
Comments on Wording
We support the Commission's intent to allow flexibility in the wording of the narrative that accompanies the after-tax returns. As with the new N-1A, this flexibility would permit those firms that are most interested in clear communication to use the plainest language possible, and to present the required information in a style that is consistent with the rest of their prospectus language. At the same time, it would not affect the Staff's ability to object to versions of the narrative that appear misleading or incomplete.
With regard to the performance table, we likewise hope that the Commission will permit some degree of flexibility in the wording of the captions. However, should the Commission decide to stipulate a particular wording, we would like to suggest the following versions of the main captions in the performance table (keeping the same subcaptions as currently proposed):
If you continued to hold your shares
If you sold your shares
After 1 year
After 5 years
In addition to being shorter, these versions use the past tense in order to remind readers that the information shown is historical.
In closing, we ask you to note that the views expressed in this letter are those of our company, and may or may not be shared by those mutual fund firms with which we have done business.
We are pleased to have the opportunity to comment on this proposal, and look forward to any future initiatives the Commission may make toward the improving the user-friendliness of disclosure documents.
Very truly yours,
Firehouse Financial Communications, LLC
22 Mountain Avenue
Malden, MA 02148