WASHINGTON, D.C. - The Securities and Exchange Commission may drop a new rule requiring funds to report after-tax performance figures if a proposal to allow investors to defer a portion of capital gains taxes on their fund investments becomes law, said Paul Roye, director of the SEC's division of investment management.

"If it turns out that the bulk of fund shareholders are able to defer paying taxes on their funds' distributions until they redeem their shares, then we will seriously consider whether there is a need for funds to provide after-tax returns," Roye said.

Roye spoke here earlier this month at the general meeting of the Investment Company Institute of Washington, D.C.

Last year, fund investors paid $345 billion in capital gains taxes, he said. Fund distributions reduce investors' returns by approximately 2.5 percent, he said.

The tax issue is especially relevant given the hit investors took last month on taxes, Roye said. The $345 billion in capital gains distributions represent a 45 percent increase over 1999, he said.

"Of course many shareholders were upset at receiving taxable distributions from a fund that was down for the year partly because many investors do not understand how fund distributions are taxed," Roye said. "Many of them got a painful lesson on the subject last month."

Two separate proposals that would allow fund investors to defer paying capital gains taxes until they redeem their shares are currently being considered by lawmakers, Roye said.

One of the proposals would allow individual investors to defer up to $3,000 in distributions and allow couples to defer $6,000. The other measure would increase the amount to $5,000 for individuals and double that amount for couples, Roye said.

Both measures are sponsored by Representative Jim Saxton (R.-N.J.), vice chairman of the Joint Economic Committee.

Currently Rep. Saxton and supporters of the bill are collecting co-sponsors and they are searching for legislation to which to attach it, said Chris Frenze, executive director of the Joint Economic Committee. There are currently 38 co-sponsors of the bill, he said.

President Bush asked supporters not to try to attach it to the tax-cut bill, he said. It will probably be voted on in the fall at the earliest, he said.

What the SEC decides to do will depend on the outcome of the proposed legislation, Roye said.

"But if such legislation is adopted, we will certainly study any changes to the way fund distributions are taxed and consider the need to revisit our after-tax rules," he said.

The after-tax rule proposal generated debate within the fund industry as to whether such a rule was necessary and if such a rule were adopted,which tax bracket should be used to calculate after-tax performance. The SEC adopted a final rule requiring fund companies to calculate their funds' after tax performance at the highest bracket, sparking protest from the ICI, according to Roye.

"We recognize that there are those of you who still disagree with the need for the requirements, or with the details of the requirements, as they were adopted,"Roye said.

If the legislation is passed, the SEC may be able to drop a rule that was adopted largely because of pressure from Capitol Hill, said Mercer Bullard, president and founder of Fund Democracy LLC of Chevy Chase, Md., and former assistant chief counsel at the SEC's division of investment management. After the "Mutual Fund Tax Awareness Act of 2000" received wide bipartisan support in the House of Representatives last year, the SEC decided to adopt an after-tax disclosure rule rather than wait for Congress to mandate it, he said.

Legislation deferring capital gains will pass only if it is voted on imminently, according to Bullard. The tax bite investors took this year has given the legislation momentum, but that momentum will slow as more attention is paid to President Bush's tax cut proposal, he said. Similar pieces of legislation have been voted down in the past, he said.

Even if investors are allowed to defer their capital gains taxes, that does not mean they should not be made aware of the taxes they will eventually pay when they decide to redeem their shares, said Barbara Roper, executive director of the Consumer Federation of America in Washington, D.C.

"It's not entirely clear that it automatically follows that if the majority of investors are deferring capital gains taxes that the rule is no longer necessary," she said.

In addition to after-tax disclosure issues, Roye discussed challenges facing the mutual fund industry and some SEC initiatives.

Many fund companies have been forced to lay off significant numbers of employees as a result of the market downturn, but firms need to exercise caution to avoid cutting their compliance departments too deeply, Roye said.

"Cutting corners in the legal and compliance area could spell disaster for some in the fund industry," he said. "Compliance problems can sink a firm. I fear that at some firms, the order is full speed ahead, creating new funds, new products without the proper controls and compliance systems in place."

The importance the SEC places on accurate pricing and securities valuation procedures is demonstrated by the commission's recent move placing three funds offered by the Heartland Group of Milwaukee in receivership, Roye said. A letter issued by the SEC three weeks ago clarifies when funds should use fair valuation procedures and highlights a fund's obligation to monitor events that might trigger the use of fair valuations, he said.

The SEC is also considering changes to advertising rules which require funds to advertise returns as of the most recently completed calendar quarter, he said.

"Should this calculation be as of the most recently completed month end, or the most current date practicable, to promote currency of the information?" he said. "Should fund advertisements be required to refer investors to this more current information? In any event, our goal will be to seek to promote in these rule amendments, balance and responsibility in fund advertising."

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