(January 19 – 17:40 ET) – The U.S. Securities and Exchange Commission is adopting rules requiring mutual funds to disclose standardized after-tax returns.

The SEC says the new rules are “designed to help investors understand the magnitude of tax costs and compare the impact of taxes on the performance of different funds. The move by the SEC follows a bill passed last April by the U.S. House of Representatives, known as the “Mutual Fund Tax Awareness Act of 2000,” a bill introduced by congressman Paul Gillmor to enhance the information that mutual fund shareholders receive about after-tax returns.

Paul Roye, director of the SEC’s Division of Investment Management, said, “Taxes can be the most significant cost of investing in a mutual fund. Today’s action addresses the gap between the importance of taxes to mutual fund investors and the knowledge that investors have about taxes.”

According to the SEC, recent estimates suggest that more than 2.5% of the average stock fund’s total return is lost each year to taxes, and that varies widely from fund to fund. The size of the tax-bite depends on several factors, including the level of portfolio trading and the amount of gains realized on trades, as well as the degree to which the manager uses portfolio losses to offset realized gains.

The SEC will require disclosure of after-tax returns for 1, 5, and 10-year periods in its prospectus. After-tax returns will be presented in two ways — after taxes on fund distributions, and after taxes on fund distributions and the sale of fund shares. These returns will have to be presented in a standardized table to help investors compare the returns of different funds.

After-tax returns will be computed assuming that taxes are imposed at the maximum individual federal income tax rate, and distributions are taxed at historical tax rates in effect when the distributions were made rather than rates in effect when the calculation is performed.

Funds will be required to include standardized after-tax returns in any advertisement that includes any after-tax performance information, or any other performance information together with claims that the fund is managed to limit or control the effect of taxes.

After-tax returns are not required for money market funds, or funds using prospectuses exclusively for investors in tax-deferred plans.
-IE Staff