NEW YORK, NY 10036-6689


NEW YORK, NY 10004-2498
(212) 558-3866
FAX # (212) 558-3588

NEW YORK, NY 10004-2498
(212) 558-3188
FAX # (212) 558-3588

June 27, 2000

Mr. Jonathan G. Katz,
Securities and Exchange Commission,
450 Fifth Street, N.W.,
Washington, D.C. 20549-0609


File No. S7-09-00
Disclosure of Mutual Fund After-Tax Returns
(Release Nos. 33-7809; 34-42528; IC-24339) 

Dear Mr. Katz:

The Committee on Investment Management Regulation (the "Committee")1 of The Association of the Bar of the City of New York (the "Association") is pleased to provide its comments on the Commission's proposed rule and forms 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").

The Commission's proposals are in response to the Mutual Fund Tax Awareness Act of 1999, which directs the Commission to require "improved methods of disclosing...the after-tax effects of portfolio turnover on investment company returns to investors". In going beyond the apparently narrow directive, the Committee applauds the Commission's efforts to heighten investor awareness through prospectus disclosure that mutual fund distributions are subject to income tax whether taken in cash or additional securities. These efforts are particularly important because mutual fund investors represent virtually the entire spectrum of the nation's tax paying population and the Committee believes that there should be no ambiguity in mutual fund prospectuses about distributions being subject to income tax or the effect thereof on investors' returns.

The Committee believes, however, that (1) disclosure of after-tax returns is not compelled by the Mutual Fund Tax Awareness Act and (2) the Commission's focus on after-tax returns rather than on the components of investment performance subject to tax and the fact that taxes are payable by the shareholder have unintended and adverse consequences which are unnecessary and may possibly be confusing and harmful to mutual fund investors. These concerns are addressed in this letter. An alternative disclosure is also proposed. The Committee believes that the proposed disclosure is responsive to the Mutual Fund Tax Awareness Act but does not raise the concerns discussed in this letter.

The Committee's principal concerns with the Release and the proposed rule and form amendments are set forth below.

Investor Awareness not After-Tax Returns Should be the Focus of Disclosure. The Release is confusing as to whether the Commission's principal concern should be (a) investor awareness that fund distributions are subject to tax or (b) providing after-tax return information. We believe that investor awareness is the paramount concern and is not addressed by requiring that standardized after-tax returns be included in fund prospectuses.

Effect of Relative Cash Flows Substantially Reduces Validity of After-Tax Return Comparisons. After-tax returns tend to be higher for funds which are rapidly growing through net subscriptions than for funds with more stable or declining total assets. This is because cash flow from net subscriptions is available for investment activity and neither appreciated nor depreciated assets must be disposed of to facilitate additional purchases of portfolio securities. After-tax results then, in some cases, could have more to do with successful marketing campaigns than with investment acumen. While pretax returns may provide meaningful comparisons among different funds without regard to the effect of net cash flows, after-tax returns do not provide a reasonable basis for comparison of investment performance between and among funds with widely different rates of growth or shrinkage. This may be particularly true for new funds which are very successfully marketed.

False Expectations. The Committee expects that many funds with relatively high after-tax returns have grown rapidly in recent years and currently have a large percentage of their total assets attributable to unrealized appreciation. After-tax return comparisons will have the effect of drawing increasing numbers of shareholders into these funds, which, when net subscriptions slow or reverse, may (or will be required to) generate substantial capital gains to continue the investment program or to satisfy redemptions. As a result, disclosure of historical after-tax returns creates a sense of expectation which is false - not because the future is uncertain (which pre- and after-tax returns share in common) - but because the stage is already set (i.e., a large portion of the portfolio is already represented by unrealized appreciation). The Committee believes that the burden to be carried by any disclaimer language is very heavy, and unnecessarily so because after-tax returns are not necessarily the best means of making investors aware of the effect of taxes on investment company distributions.

Difficulties in Drafting Fair Disclosure. The Committee believes that a proper understanding of after-tax returns requires substantial disclosure and that the inclusion merely of the performance percentages is inadequate. While the Committee believes that it is possible to provide disclosure that clearly identifies the components of a particular fund's after-tax returns, including growth or shrinkage of assets, portfolio turnover and other factors, it does not believe that it is reasonably practicable to provide such disclosure in succinct, plain English or that, compared to the apparent, but false, simplicity of after-tax performance percentages, any disclosure (whether a succinct or extended and detailed presentation) will mitigate the adverse consequences of meritless comparisons.

Distortion of Portfolio Management. The Committee notes that in the last few years there have been created several "tax aware" (or "tax advantaged" or "tax efficient") or similar funds expressly holding themselves out as seeking to achieve reasonably high after-tax returns. There has also been an increased level of publicity about after-tax returns. Nevertheless, relatively few preexisting funds have adopted tax aware strategies. The Committee is quite concerned that, if after-tax returns become mandated prospectus disclosure, these returns will perforce become a principal basis on which funds will compete. This will in turn cause some portfolio managers of funds not holding themselves out as tax aware to modify their behavior in an effort to enhance the after-tax returns. The Committee notes the following specific possible adverse consequences:

(a) tax exempt or tax advantaged investors will unknowingly be disadvantaged if pretax returns deteriorate,
(b) Industry and market events which would (and often should) otherwise trigger dispositions may be disregarded in order to mitigate the effect of dispositions on after-tax returns, and
(c) Portfolio imbalances arising from appreciation in assets may not be promptly addressed.

No Comparability with Market Indexes. Current Commission rules and forms require comparison of pretax returns with market indexes for most investment companies. The Committee submits that disclosure of after-tax performance to the comparison adds nothing to the investor's understanding of a particular fund's investment strategy, investment style or prospects, and that, as discussed above, it will not be practical to expect investors to understand that after-tax returns may reflect factors, such as growth in total assets, that are tangentially related to investment performance.

Inadequate Distinctions between Funds. As noted above, some funds are managed in an expressly tax-aware manner, and, also as discussed above, others, which are not so managed, have relatively high after-tax returns primarily for reasons unrelated to underlying investment performance. As a result, requiring of substantially all funds disclosure of after-tax returns does not allow for adequate distinctions to be drawn between these kinds of funds and, indeed, suggests a comparability that simply is not appropriate.

Alternative Disclosure. As noted above, the Committee believes that the principle of prospectus disclosure should be to enhance investor awareness that mutual fund distributions are generally subject to income tax. Specifically, the Committee believes that investor awareness is enhanced by presenting in a manner analogous to the expense table the following:

(a) the amounts in previous periods subject to income tax,
(b) the amounts which would be subject to tax upon a redemption, and
(c) how much of the original purchase price is attributable to unrealized appreciation (that is, the maximum amount on which the investor should be liable for gains taxes in the event that the fund's portfolio securities are sold).

The Proposed Alternative Disclosure attached to this letter provides this information based on a single class of a fund's shares, provides the context, assumptions and limitations on the information and provides an explicit example involving both federal ordinary income and capital gains tax rates. In the Committee's view this presentation expressly identifies the after-tax effects of portfolio turnover, as required by the Mutual Fund Tax Awareness Act, and at the same time does not pose the same problems or those problems to the same degree that the Committee identifies with the Commission's proposal.

The Commission's proposed disclosure does not require the information contemplated by items (b) and (c), but the Committee believes that such information is important to investor understanding of the tax effects of mutual fund investments and is "consistent with the protection of investors and the public interest" as required by the Mutual Fund Tax Awareness Act. Even if it were true, which it is not, that the taxation of mutual funds investments were comparable to investing in common stocks of noninvestment company enterprises, the Committee does not believe that such an analogy would provide useful information to mutual fund investors many of whose participation in the securities markets is limited to funds. Accordingly, the Committee believes that including the amounts subject to tax upon a redemption in the table and providing the capital gain tax calculation in the example provides valuable information to investors. Similarly, the amount of the original purchase price attributable to unrealized appreciation should be useful to investors in evaluating a fund's experience over various periods in realizing that appreciation.

The Committee recognizes that more information, such as the existence of tax loss carryforwards, could be useful to the more sophisticated investor, but believes that the Proposed Alternative Disclosure strikes a nice balance between too little and problematic disclosure (after tax returns) and too much and confusing disclosure.

* * * * * *

Members of the Committee would be delighted to discuss with members of the Commission staff any or all aspects of this letter and the Proposed Alternative Disclosure. Questions or comments may be directed to John E. Baumgardner, Jr. or Marina Pearlman at the address and telephone numbers above.


John E. Baumgardner, Jr.

John E. Baumgardner, Jr., Esq., Chair2

Margaret A. Bancroft, Esq.

Edmund P. Bergan, Jr., Esq.

Cynthia G. Cobden, Esq.

Stuart H. Coleman, Esq.

Frank W. Giordano, Esq.

Joel H. Goldberg, Esq.

William V. Healey, Esq.

Lisa M. Hurley, Esq.

Brian M. Kaplowitz, Esq.

Philip L. Kirstein, Esq.

Burton M. Leibert, Esq.

Leonard B. Mackey, Jr., Esq.

Frank J. Nasta, Esq.

Dana L. Platt, Esq.

Kathryn L. Quirk, Esq.

Jean Margot Reid, Esq.

Michael R. Rosella, Esq.

Michael Rosenbaum, Esq.

Victoria E. Schonfeld, Esq.

Nina O. Shenker, Esq.

Sharon J. Weinberg, Esq.

Proposed Alternative Disclosure

Mutual funds generally do not pay federal, state or local income taxes. However, distributions to you of net investment income and net realized capital gains generally are subject to income taxes, which you must pay, whether or not you receive your distribution in cash or in additional shares of the Fund. Gains realized by you upon sale or redemption of Fund shares are also generally subject to income tax. The effect of income taxes on your investment in the Fund is determined by a variety of factors, many of which have little to do with the Fund's actual investment performance. These factors include your actual federal, and, if applicable, state and local tax rates, and your other sources of income, gains and losses. In addition, some shareholders, such as IRAs, pension funds and charitable organizations, may not be subject to income tax.

The table below and the example which follows make certain simplifying assumptions in order to help you compare with distributions of other mutual funds the amount of distributions (both capital gain and net investment income) paid by the Fund which are subject to personal income taxes. It assumes (1) you have invested $10,000 (net of all front-end sales charges) in the Fund at the beginning of each period, (2) you reinvested all distributions in additional shares and paid applicable taxes from other resources and (3) you redeemed all of your shares at the end of each period. The information in this table is included in or derived from the Fund's financial statements included or incorporated by reference in this Prospectus.

The actual performance of your investment in the Fund, the distributions that you actually receive and the taxes that you will be required to pay, may differ substantially from those set forth in the table and the example, depending on the dates you actually invested or redeemed shares and your actual federal, state and local tax rates.


(1 year)


(3 years)


(5 years)


(10 years)


Class A

Class A

Class A

Class A

Increase in Net Asset Value





Distributions subject to tax, whether taken in cash or additional shares:





     Net investment income





     Net long-term capital gain





Gain (loss) on redemption of shares at end of period





Amount of initial investment attributable to unrealized appreciation





For example, if you owned Class A shares and were subject only to the highest marginal federal income tax rate applicable to individuals (39.6%), and redeemed your shares after three years, you would have been subject to a total of $                      in federal income taxes as follows: 39.6% times $xx.xx (the net investment income) ($                   ), 20% times $xx.xx (the net long-term capital gain) ($                        ) and 20% times $xx.xx (the gain on redemption) ($                   ). Of course, this example does not take into effect any other expenses, gains or losses that you may have which may increase or offset the distributions you have received from the Fund or the proceeds upon a redemption, or any taxes payable thereon.

If you did not sell your shares at the end of each period, you would not realize the foregoing gain (or loss) on redemption, but you would have the same cumulative net investment income and net long-term capital gains which may be subject to income taxes.

1 The Committee is composed of lawyers with diverse perspectives on investment management issues, including members of law firms, counsel to financial services firms, investment company complexes and investment advisers. A list of our members is enclosed.

2 Marina Pearlman, Esq., Secretary