SEC Passes Rule Forcing Funds to Disclose After-Tax Returns

The Securities and Exchange Commission passed a rule Friday that will require mutual fund companies to include the after-tax returns for the one-, five- and 10-year time periods in their prospectuses.

The SEC said the new rules are designed to help investors understand the impact that taxes can have on their mutual fund returns. Mutual funds distributed around $238 billion in capital gains and $159 billion in taxable dividends in 1999, while recent research suggests that over 2 1/2 percentage points of the average stock fund's total return each year is lost to taxes, the SEC said.

The after-tax returns must be presented in two ways. One example will show the effect of taxable distributions resulting from the portfolio manager's purchases and sales of securities in the fund. The other will show the effect of taxable distributions along with the shareholder's tax hit if he or she sold the fund.

These after-tax returns will be calculated using the maximum income tax rate in order to provide investors with the "worst-case" scenario, the SEC said. Illustrations of a fund's past distributions will be shown using the fund's historical tax rate that was in effect when those distributions were made.

In fund advertisements, funds will be required to include standardized after-tax returns in any advertisement that includes after-tax performance information or any ad that claims the fund is managed to control the effect of taxes.

The SEC said that money market funds and funds that have been set up exclusively for investors in tax-deferred arrangements such as 401K plans or variable annuities will be exempt from the rule.

"Today's action addresses the gap between the importance of taxes to mutual fund investors and the knowledge that investors have about taxes," said Paul Roye, the director of the SEC's Division of Investment Management.

The SEC cited a recent survey that showed that while 85% of fund investors said that taxes play an important role in their investment decisions, only 33% felt that they were knowledgeable about the tax implications of investing. Only 18% were able to identify the maximum rate for long-term capital gains.

>To order reprints of this article, click here: Reprints