1 STATEMENT OF THE U.S. SECURITIES AND EXCHANGE COMMISSION CONCERNING DISCLOSURE OF THE TAX CONSEQUENCES OF MUTUAL FUND INVESTMENTS AND CHARITABLE CONTRIBUTIONS TO THE SUBCOMMITTEE ON FINANCE AND HAZARDOUS MATERIALS THE COMMITTEE ON COMMERCE UNITED STATES HOUSE OF REPRESENTATIVES OCTOBER 29, 1999 Thank you for giving the Securities and Exchange Commission (SEC or Commission) the opportunity to present this statement concerning the disclosure of tax consequences of mutual fund investments and charitable contributions. The Commission fully supports the important goal of full disclosure, and welcomes this dialogue on these issues. I. The Tax Consequences of Mutual Fund Investments One of the Commission’s primary goals with respect to mutual fund disclosure is ensuring that funds clearly present their performance and costs to investors. H.R. 1089, the Mutual Fund Tax Awareness Act of 1999, would address an important aspect of this issue, the effect of taxes on mutual fund performance. H. R. 1089 would require the Commission to revise its regulations to improve methods of disclosing to investors in mutual fund prospectuses and annual reports the after-tax effects of portfolio turnover on mutual fund returns. In fact, as more fully described below, the Commission staff is already working on improving disclosure in this area. Current Disclosure Requirements Mutual funds currently are required to disclose the following information about taxes in their prospectuses and annual reports: * Tax Consequences. A fund must disclose in its prospectus the tax consequences to shareholders of buying, holding, exchanging, and selling the fund’s shares, including the tax consequences of fund distributions. * Portfolio Turnover. A fund must disclose in its prospectus whether the fund may engage in active and frequent portfolio trading to achieve its principal investment strategies and, if so, the tax consequences to investors of increased portfolio turnover and how this may affect fund performance. A fund also must disclose in its prospectus and annual reports the portfolio turnover rate for each of the last 5 fiscal years. * Distributions. A fund must disclose dividends from net investment income and capital gains distributions per share for each of the last 5 fiscal years in its prospectus and annual reports. Staff Consideration of Mutual Fund Tax Disclosure The Commission staff has been considering whether mutual fund disclosure requirements could be revised to provide investors with a better understanding of the tax consequences of holding and disposing of a fund, the relative tax efficiencies of different funds, and how much of a fund’s reported pre-tax return will be paid out by an investor in taxes. There is no direct correlation between the portfolio turnover rate, which currently is disclosed, and shareholder tax consequences. For example, a fund with high portfolio turnover may produce relatively low taxable gain to investors if it offsets realized gains with realized losses. The Commission staff is considering whether there are other measures that could be used to convey mutual fund tax consequences that are understandable to investors and not unduly burdensome for funds to compute. Standardizing disclosure of the tax consequences of a mutual fund investment is complicated because different fund investors are in different tax situations and, therefore, may experience different tax consequences from the same fund investment. The Commission staff’s considerations have focused on after-tax return, a measure of a mutual fund’s performance, adjusted to illustrate how taxes could affect an investor. (The calculation of after-tax return requires a number of assumptions about the investor’s tax situation, such as his or her tax bracket.) The staff is considering two separate measures of after-tax return: * Pre-Liquidation After-Tax Return. This measure assumes that an investor continues to hold the fund at the end of the period for which the return is computed. It measures only the taxes resulting to the investor from the portfolio manager’s purchase and sale of portfolio securities. * Post-Liquidation After-Tax Return. This measure assumes that an investor sells the fund at the end of the period for which the return is computed and pays taxes on any appreciation (or realizes losses). It measures both the taxes resulting from the portfolio manager’s purchase and sale of portfolio securities and the taxes incurred by shareholders on a sale of fund shares. These measures of after-tax return could help investors compare the after-tax returns of different funds and gain an understanding of the impact of taxes on a fund’s reported pre-tax return. Anticipated Commission Action The Commission staff currently is preparing a recommendation to the Commission that it issue proposed rule amendments intended to improve the disclosure of the tax consequences of mutual fund investments. The proposed rule amendments, if issued, would be promulgated pursuant to the Commission’s existing authority and would be the subject of public notice and comment. II. Disclosure of Charitable Contributions by Public Companies and Mutual Funds H. R. 887 is a bill that would require public companies and mutual funds to disclose information about certain of their contributions to non-profit organizations where an insider of the company, or a spouse, is a director or trustee of the organization. In addition, public companies would be required to make available disclosure of the total value of contributions made and identify the donees and amounts contributed if they exceed a dollar threshold established by the Commission. SEC Staff Study At Representative Gillmor’s request, the Commission staff has studied H. R. 887 and previous versions of the legislation. In fact, the staff requested comment from the public concerning the costs and benefits of the earlier legislation (H. R. 944 and 945). Nearly 200 persons commented. The vast majority of the commenters opposed the previous legislation. The commenters supporting disclosure argued that improved disclosure would reduce abuse, improve accountability, reduce shareholder distrust, provide another basis on which to assess the judgment of management, and build goodwill with the companies’ customers and community. Opponents of disclosure argued that it would be costly to track small contributions, especially for large companies. They believed that companies would reduce the amount of gifts to avoid disclosure or avoid giving to controversial charities. There was concern this disclosure could be used for political or personal agendas. After studying the issue, the Commission staff concluded that imposing the corporate charitable contributions disclosure requirements in H. R. 887 would be feasible in that public companies are capable of tracking and disclosing this information to investors. Many companies currently collect charitable contribution information for tax purposes, and a small number already voluntarily disclose this information to the public. Current Disclosure Requirements Currently, shareholders have a right to make proposals in the company’s proxy statement to provide disclosure of charitable contributions. Those proposals have not attracted substantial support from shareholders. The Business Roundtable has commented that few shareholders request information regarding charitable contributions from companies that provide this information voluntarily. This leads us to believe that a significant majority of shareholders may not consider this information to be important. In recent years, the Commission has been focusing much of its efforts on streamlining disclosure and mandating plain English. Charitable contributions account for a small portion of most companies’ financial activities. We are cautious about adding disclosure that would add to the volume of detail given to investors without providing material information. In the course of reviewing H. R. 887, the Commission staff identified additional practical issues that may affect the implementation of disclosure requirements for corporate charitable giving. Although companies already track the amount of their charitable contributions and to whom they are made for tax purposes, they may not have in place mechanisms to identify gifts to organizations affiliated with corporate insiders and their spouses, in part because they are not currently required to do so. Also, depending upon the dollar thresholds for disclosure, the amount of disclosure and the corresponding cost burden will vary significantly. Finally, there are other technical issues that the staff would be pleased to discuss. III. Conclusion The Commission supports the goals of H.R. 1089, the Mutual Fund Tax Awareness Act of 1999. Taxes have a significant effect on mutual fund performance, and the Commission and its staff are already working hard to improve the disclosure that funds make to investors in this area. The Commission remains concerned about H. R. 887. The Commission looks forward to working with the Subcommittee on these important issues. 1