PALM DESERT, Calif. The SEC is considering proposing that mutual funds be required to disclose more than they currently do about the effect of taxes on investment performance.

The agency is not yet sure whether and what it will propose, said Paul Roye, the director of the SEC's Division of Investment Management. But, SEC Chairman Arthur Levitt has made review of the issue a high priority for the SEC, he said.

"There is something we can do in the area," Roye said. "The question is what approach do we take."

Roye made his comments during the "Mutual Funds and Investment Management Conference" sponsored by the Investment Company Institute and the Federal Bar Association held here last week. Roye said strengthening the independence of mutual fund directors will be the agency's top priority. But, in addition to tackling the director independence and tax issues, Roye said the SEC also expects to take several other actions, including:

Issuing a final rule soon which will make it easier for mutual fund companies to send only one copy of key documents such as prospectuses to a household when several family members separately own shares of the same fund;

Conducting an examination of what fund companies receive in exchange for sending brokerage transactions to a particular broker/dealer;

Deciding how rules which limit investing by mutual fund portfolio managers should be revised; and

Examining whether Rule 12b-1 should be modified to take into account changes in distribution practices.

On the issue of the effect of taxes on performance, it may turn out that the SEC has no choice, however. Levitt said legislation introduced recently in Congress would direct the SEC to adopt rules requiring more mutual fund tax disclosure. (See related story in box, page 9)

"We look forward to working with the industry to evaluate whether and how to improve disclosure in this area," Levitt said in his speech.

The adoption of such a rule has the potential to place the interests of the mutual fund industry's two largest and most prominent firms Fidelity Investments, known for its active fund management, and the Vanguard Group, originator of the index fund at odds. Lawyers for the two firms briefly debated the issue during a panel discussion at the conference.

Vanguard has long boasted about the tax benefits of its index funds. Unless there are sustained net redemptions, the low turnover of index funds tends to reduce the capital gains which the funds distribute to shareholders. In contrast, actively- managed funds with high portfolio turnover rates can pass to shareholders substantial capital gains each year, even in years when the funds lose money.

Heidi Stam, a regulatory lawyer at Vanguard, praised the agency's attention to disclosure of the effect of taxes. Eric Roiter, vice president and general counsel at Fidelity, said any assessment of tax efficiency should take into account the effect of unrealized capital gains a fund is carrying. Some index funds, especially S&P 500 index funds, have amassed substantial unrealized capital gains in recent years as stocks have increased in value. Stam countered that the key issue was the actual effect of taxes on shareholders.

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