NEW YORK - A rule proposal outlining how mutual funds should report their after-tax returns should be revised to make it less confusing to investors, said Joel M. Dickson, a principal with The Vanguard Group of Malvern, Pa.

The proposed rule would require funds to report one-, five- and 10-year pre- and post-liquidation tax returns in their prospectuses and annual reports. When calculating after-tax returns, funds would be required to assume that taxes are charged at the maximum income-tax rate and taxes on fund distributions are charged at the time the distributions are made, said Susan Nash, a senior assistant director in the SEC's division of investment management. Money market funds, 401(k) plans, variable annuities and other tax-deferred funds are exempt from providing after-tax performance figures in the proposal, she said.

The SEC felt compelled to issue a rule proposal on the matter because in many cases taxes on mutual funds exceed the fees that they charge and most investors do not have a good understanding of the impact taxes have on their investments, Nash said. Also, the SEC felt that since some funds are more tax efficient than others, it had to try to offer a standard investors could use to measure after-tax performance, she said.

Nash and Dickson made their comments at a conference here last week on current SEC initiatives in fund advertising and after-tax reporting, sponsored by The National Investment Company Service Association of Wellesley, Mass.

"The SEC is hesitant to plow too deeply in the micro management of advertisements," Nash said. But if a company does advertise after-tax performance, it will be required to post the standard number, she said. "We did conclude that it's important for ads that have after-tax returns to use SEC standards."

But the after-tax performance should be included in all fund advertisements, said Dickson. Vanguard will request that the SEC revise the proposal to require after-tax performance figures in all fund advertisements because advertisements are directed towards retail investors who are affected the most by taxes, he said.

While Vanguard agrees with the rule's intentions, its scope may be too broad and as a result could be confusing for investors, Dickson said. A fund's after-tax performance is affected by its objective, its fiscal year, its expense ratios and unrealized gains and losses, he said.

"What happens when you get negative returns?" he said. " Explaining the nuances of all of these numbers gets to be very difficult."

Another controversial aspect of the rule proposal is the tax rate it will use, Nash said. The SEC decided to use the highest tax rate possible because an average investor tax bracket would present too many logistic challenges, she said.

"Good policy arguments can be made not to use the highest rate, but if you go that way, you have the challenge of inflation and each year you have to figure out the average investor's rate," she said.

The SEC's rule should be designed to allow greater flexibility in determining each fund's tax consequences for each individual, said David Gottstein, president of an advisory firm, Dynamic Capital Management of Anchorage, Ala.

"We believe that the only way for accurate after-tax results to be represented is either to have an investor's tax rates inputted into a system before performance numbers are presented, or that a table, or set of tables, be presented whereby investors could match their respective short- and long-term tax rates and identify their appropriate respective performance," Gottstein wrote in a letter to the SEC.

While the numbers may confuse investors initially, the SEC will try to make the after-tax return numbers as easy to understand as possible, Nash said.

"We will be adding a new row of numbers and there is a start up learning period for investors," she said. Also, the SEC will require that fund companies use a plain English narrative when presenting after-tax performance, she said. For instance, the number that refers to the pre-liquidation figures will be referred to in prospectuses and annual reports as, "If you hold on to your shares," she said.

The comment period for the SEC's proposal ends June 30.

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