June 30, 2000

By E-Mail and Overnight Delivery

Mr. Jonathan G. Katz
Secretary
Securities and Exchange Commission
450 Fifth Street, NW
Washington, D.C. 20549-0609

Re: Disclosure of Mutual Fund After-Tax Returns, File No. S7-09-00

Dear Mr. Katz:

Charles Schwab Investment Management, Inc. ("CSIM") and Charles Schwab & Co., Inc. ("Schwab" ) are pleased to comment on the Securities and Exchange Commission's (the "Commission") proposed rule and form amendments under the Securities Act of 1933 and the Investment Company Act of 1940 requiring mutual funds to disclose after-tax returns based on standardized formulas (the "Proposed Amendments").¹

CSIM is the investment adviser and administrator for 43 mutual funds with more than $116 billion in assets and 5 million accounts (the "SchwabFunds^®"). Some SchwabFunds are actively managed, while other SchwabFunds are index funds. Schwab maintains the Mutual Fund Marketplace^®, through which Schwab's customers have access to over 3,000 non-proprietary mutual funds and the SchwabFunds. Schwab serves over 1.5 million households that own more than $311 billion in mutual fund assets.

As stated in the Proposing Release, the Proposed Amendments are designed to require funds to "more effectively communicate to investors the tax consequences of investing."² Like the Commission, we have noted that investors do not always understand that a fund's after-tax performance can vary significantly from its pre-tax performance, and that a shareholder should consider the impact of taxes when determining which funds to purchase. In its role as distributor for the SchwabFunds and separately in its role of providing educational information to all Schwab customers, Schwab has produced several customer communications designed to explain the impact of taxes on mutual fund performance. Schwab also provides after-tax returns for all of the funds sold through its Mutual Fund Marketplace.

We are writing this letter in support of the Commission's decision to require the disclosure of after-tax performance for all variable net asset value funds. We agree with the Commission's decision to require after-tax performance numbers in prospectuses and shareholder reports, but not in advertisements or other sales literature. We also concur with the Commission's proposal to allow each fund to determine how best to disclose the assumptions made in calculating after-tax performance. In addition, we have several recommendations with respect to certain mechanics, which we have set out below.

Requiring Disclosure of After-Tax Returns For All Variable Net Asset Value Funds

The Proposing Release seeks comment on whether disclosure of after-tax returns should be required and whether this information is useful to, and understandable by, investors. The Proposing Release asks whether specific types of funds should be exempted from the requirements. Comment is also sought on the relative merits of requiring disclosure of after-tax returns or simply standardizing the computation of after-tax returns for funds that choose to disclose these numbers.

We concur with the Commission's decision to require after-tax disclosure for all variable net asset value funds. As the Commission points out on page 9 of the Proposing Release, the Proposed Amendments are designed to "help investors to understand the magnitude of tax costs and compare the impact of taxes on the performance of different funds." We believe that tax costs are an important issue for bond fund investors as well as equity fund investors, and that bond fund investors deserve the same opportunity to comparison-shop that equity fund investors do.

It has been our experience that bond fund after-tax performance can vary significantly from bond fund to bond fund and even from year to year within a particular fund. We also point out that while bond funds generally have not paid out capital gains distributions in the past few years, they are much more likely to do so in a declining interest rate environment.³ A capital gains distribution could come as an unpleasant surprise to bond fund shareholders, many of whom only expect to receive current income. This is particularly true with respect to municipal bond funds, since investors specifically choose these funds to minimize their tax liability and generally hold these funds in their taxable accounts. In our opinion, the receipt of a taxable capital gain distribution by a municipal bond fund investor is likely to be as unwelcome as it would be to an equity investor, if not more so. While we believe that all bond funds should be subject to the Proposed Amendments, we strongly believe that municipal bond funds in particular should report their after-tax performance.

Requiring standardized after-tax performance disclosure across all variable net asset value funds allows investors to fairly evaluate the impact of taxes on their investments regardless of category or style of fund. If uniform disclosure were not required, we believe that only those funds with exemplary after-tax performance would provide that performance to the public, thereby leaving investors without a basis for comparing the majority of funds. For all of these reasons, we support the Commission's decision to apply the Proposed Amendments across all variable net asset value funds.

Provision of Pre- and Post-Liquidation Information

The Proposed Amendments require that funds provide both pre- and post-liquidation after-tax returns. The Proposing Release seeks comment on whether both of these returns should be required, or whether just one type of return is sufficient.

We support the Commission's decision to require the inclusion of both pre-liquidation and post-liquidation after-tax performance information. Each calculation provides valuable information that an investor can use in determining whether to buy or hold a particular fund.

Pre-liquidation returns highlight the tax implications associated with owning fund shares. By comparing pre-tax returns to pre-liquidation after-tax returns, investors can evaluate the effect that a portfolio manager's decisions has on the returns of a particular fund. Post-liquidation after-tax numbers highlight the tax consequences associated with selling fund shares. Though the inclusion of both sets of data results in more lengthy regulatory documents, we believe that the benefits of having this information available to all investors outweigh the burdens of the additional disclosure. In addition, we believe that the availability of this information allows independent third parties to analyze and synthesize this data into other formats for investors to use in making their investment decisions.

Format of Disclosure

The Proposed Amendments require that after-tax returns be presented in a tabular format that includes four sets of returns: before-tax and after-tax returns when shares are held at the end of the period (and no redemption fees and sales charges are deducted), and before-tax and after-tax returns when shares are sold at the end of the period (and redemption fees and sales charges are deducted). The Proposing Release requests comment on whether the format is clear and understandable, or whether an alternative format might be more appropriate.

We agree with the Commission's decision to present after-tax numbers in a tabular format, but we request that the Commission consider the approach described by the Investment Company Institute ("ICI"). The ICI's proposal requires just two calculations: one that includes the impact of taxes on fund distributions, and one that includes the impact of taxes on fund distributions and the sale of fund shares. The ICI also recommends that a multiple class fund only be required to provide after-tax returns for one class. We believe that the ICI's proposal focuses the investor's attention on the impact of taxes in a clear and concise format. We also believe that the after-tax information presented in the ICI's proposed format could be added to fund disclosure documents with relatively minimal revision of those documents. For these reasons, we recommend that the Commission adopt the ICI's approach.

Location of Disclosure

The Proposed Amendments require after-tax performance information in a fund's prospectus and shareholder reports. The Proposing Release requests comment on the appropriateness of requiring after-tax disclosure in these documents and their specific locations within these documents.

We believe that the best practice would be to require after-tax performance numbers in both prospectuses and shareholder reports. The prospectus disclosure affords prospective shareholders an opportunity to evaluate fund after-tax performance, while the shareholder report disclosure provides this information to existing shareholders. We also agree that this information belongs in the management's discussion of fund performance section of the shareholder reports.

We strongly believe that after-tax performance numbers belong in the prospectus, but we request that the Commission reconsider its location. Like the ICI, we recommend that it be included in the taxation section rather than the risk/return summary as stated in the Proposed Amendments. We believe that this information is too technical and lengthy compared to the other items in the risk/return summary, and therefore the taxation section is more appropriate.

Formulas for Calculating After-Tax Return

The Proposed Amendments articulate the specific assumptions to be used in calculating after-tax returns, and the Proposing Release requests comment on the propriety of those assumptions. We generally concur with the Commission's decisions, but we feel it is important to discuss a few of the mechanics in more detail, as we explain below.

Maximum Federal Tax Bracket. We concur with the Commission's decision to calculate after-tax returns using the maximum federal tax bracket rather than an average shareholder tax rate. As the Commission mentions in the Proposing Release, the maximum rate shows the "worst case" impact that federal taxes would have on a shareholder's investment. The maximum rate is also easily identifiable and does not require review by the Commission, unlike the average tax rate. Further, because so many factors need to be assessed in determining the actual tax costs of an investment to a particular shareholder, applying an average rate would result in numbers that are only slightly more useful to some shareholders than those calculated using the maximum tax rate, and not worth the complexity of monitoring and recalculating the average rate on a periodic basis. For these reasons, we concur with the Commission's decision to use the maximum federal tax rate.

Calendar Year Periods. We recommend that the Commission reconsider its decision to require returns based on the calendar year in prospectuses and the fiscal year end in shareholder reports. Instead, we advocate calculating all after-tax returns based on the calendar year. Our recommendation is based on our belief that presenting returns for two different periods is too confusing to investors. We believe investors may look at the prospectus in conjunction with the shareholder reports and fail to understand why the numbers are different. We are also concerned that they may compare the information in a prospectus or shareholder report to that presented by an independent third party and not realize that the numbers are based on different fiscal periods.

We recommend that returns be calculated as of the calendar year end instead of fiscal year end for two reasons. First, most individual investors pay taxes based on a calendar year end. Calendar year end numbers are therefore more meaningful to these investors. Second, if all funds are required to report after-tax numbers based on a calendar year end, investors can easily compare their funds' after-tax returns to those of their competitors.

We realize that pre-tax return information in the annual reports is based on fiscal periods, and that the purpose of these reports is to provide investors with interim data regarding the performance of their investments. It is our opinion, however, that it is more important to provide the same after-tax return information to investors across regulatory documents than it is to provide pre-tax and after-tax return information based on the same period within the shareholder reports. For these reasons, we ask that the Commission consider requiring that all after-tax return information be calculated as of the calendar year end.

Advertisements and Sales Literature

The Commission notes in the Proposing Release that advertising and sales literature ("marketing materials") will not be required to contain after-tax performance information unless they specifically mention after-tax performance numbers. Comment is requested regarding the inclusion of after-tax returns in these materials and the proposed standardization of after-tax performance information.

We strongly support the Commission's decision to only require standardization of after-tax performance information when such information is specifically included in marketing materials. Many marketing materials are concise, providing a brief informative synopsis of the characteristics of a fund. We believe that, for these types of materials, requiring inclusion of after-tax return information would detract from the clarity of the message being presented and would contribute to investor confusion about the potential advantages of investing in mutual funds.

We also concur with the Commission's view that any after-tax returns quoted in marketing materials be calculated as described in the Proposed Amendments. This standardization will ensure that any numbers quoted in these materials can be compared accurately to those of other funds. We think that the Proposed Amendments are clear that the mere mention of tax-efficient strategies of a fund in marketing materials, without reference to actual after-tax performance information, would not trigger the requirement to provide standardized after-tax performance information.

Disclosure of Assumptions Used in Calculations

We agree with the Commission's decision to require that the assumptions used in the various calculations be explained, but that funds be allowed to determine how to disclose this information. Because there are so many assumptions that need to be stated for these after-tax returns, each fund will need to devise disclosure language that fits the style and format of its prospectus and shareholder report. This is equally true for marketing materials that include any after-tax return numbers. We believe that this flexibility will result in more coherent materials than might be the case if specific disclosure were mandated.

Compliance Date

The Commission proposes that compliance with the Proposed Amendments be mandatory for all regulatory documents filed within six months of the Proposed Amendments' effective date. Because the calculations required by the Proposed Amendments will require the purchase, integration and testing of additional software and redesign of our regulatory documents, we request that this compliance date be extended to one year from the Proposed Amendments' effective date. We believe that the additional six months will allow us sufficient time to ensure that our systems and materials are thoroughly tested and complete.

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We appreciate the opportunity to comment on the Proposing Release. If you have any questions or would like to discuss the comments in this letter, please do not hesitate to give me a call at (415) 636-5495.

Very truly yours,

J.H. Chafkin
President and Chief Operating Officer of CSIM
Executive Vice President of Schwab