during any period in which he has been in default, lowered the improvement rate so far as the company was concerned.

Furthermore, surrender values only accrued as of anniversary dates of the certificates which was yearly. Monthly payments less than a year and interest on the last attained surrender value would not increase the surrender value above the preceding anniversary date. Payments made and interest on the entire investment between anniversary dates, therefore, might be sacrificed under the terms of the contract in the event of any surrender between such dates.

As a result of the various types of regulatory provisions in the many States in which face-amount companies operate, there is presently no uniform actuarial reserve system required by law.

Another serious aspect of this type of investment company relates to the problems of the investors in these certificates in the event of the bankruptcy of such a company. Not all of these companies are at present required to deposit qualified assets with any custodian for the benefit of all their certificate holders. Some State authorities do require such deposits for the protection of certificate holders residing in the particular States and even such requirements are not on a uniform basis. In the event of bankruptcy a situation might be created where inequality of treatment might exist for certificate holders of the various States. Furthermore the problems arising out of bankruptcy would be accentuated by the fact that the assets of these companies are located in almost every State in this country.

NECESSITY FOR LEGISLATION

The committee has been greatly impressed with the sincerity and public-spirited attitude evinced by the representatives of the industry in participating in the formulation of this legislation. The committee, in recommending this regulatory legislation, does not mean to imply that most investment trusts and investment companies at present operating in this country were guilty of unfair practices or were mismanaged. Nor does it mean to indicate that in the last decade progress has not been made by the members of the industry voluntarily to eliminate some of the major abuses and deficiencies, and to improve generally standards of practice in the light of experience. However, the record does indicate that some of the grossest abuses were perpetrated in most recent years, in fact during the very course of the Commission's study. The conclusion is clear that the perpetrations of these misfeasances and the recurrence of these abuses cannot be completely abated nor the deficiencies eliminated without the enactment of adequate Federal legislation regulating these institutions. Virtually every representative of investment companies who appeared before the subcommittee conceded the necessity for, and in fact urged the immediate passage of, effective legislation to regulate investment companies. Practically no dissenting voice has been raised against any of the provisions of the substitute bill. In fact this bill has received the affirmative and unequivocal approval of the industry as a whole.

The Securities Act of 1933 and the Securities Exchange Act of 1934 have been ineffective to correct abuses and deficiencies in investment companies: first, because the record before the committee is clear that

publicity alone, which in general is the remedy provided by these acts, is insufficient to eliminate the abuses and deficiencies which exist in investment companies, and second, because a large number of such companies have never come under the purview of these acts. The representatives of the industry recognized that the protection of investors against unscrupulous management and the necessity for the prevention of the recurrence of the abuses disclosed by the Commission's study and the committee hearings made indispensable the immediate enactment of adequate legislation regulating investment companies. This is also the opinion of the committee, and the Securities and Exchange Commission concurs. Representatives of the industry have stated for the committee's record that they definitely feel that this bill (S. 4108) will materially abate, if not virtually eliminate, the malpractices and deficiencies in these organizations. They have urged that this legislation will serve the most salutary purpose of protecting small investors from breaches of trust; will afford investors a regulated and supervised institution in which to invest their savings; will act as an incentive for venture and risk capital; and will supply an intelligent and articulate group of stockholders in industrial and other public corporations. The industry asserted, and the Commission and the committee believe, that this legislation will tend to prevent those abuses which have been a stigma upon and impaired the usefulness of the investment trust industry as a whole.

Representatives of the Securities and Exchange Commission and of the industry who appeared at the hearings called the attention of the committee to the serious tax problem affecting investment companies. It appears that the nature of these companies in many respects, constituting a conduit for distribution of income to the smaller investor, is such that they should not be subjected to the same type of taxation as the ordinary business corporation. This has already been recognized in respect of certain classes of open-end companies which receive special tax treatment under existing Federal tax laws. The record before the committee indicates that the tax problem is acute with respect to closed-end companies of the type classified in this bill as "diversified". If this bill is passed, the committee believes that the tax problem of these companies should receive prompt consideration.

ANALYSIS OF PROVISIONS OF TITLE I

Findings and declaration of policy.-Section 1 of the bill contains the findings of the Congress with respect to investment companies and the declaration of policy of the bill.

Definitions and exemptions of investment companies.-Investment companies within the purview of this bill are in general defined as companies which are engaged primarily in the business of investing, reinvesting, and trading in securities; and issuers which invest in or hold securities (other than securities of non-investment company subsidiaries) having a value exceeding 40 percent of the value of their total assets. A third group of investment companies covered by the bill are companies which engage in the business of issuing so-called face-amount installment certificates. Provision is made generally to exclude from the bill companies primarily engaged, directly or through subsidiaries in the operation of a business other than that of an investment company. In addition the bill specifically excludes

or

brokers, underwriters, banks, insurance companies, common commingled trust funds administered by a bank, bank holding company affiliates subject to the supervision of the Board of Governors of the Federal Reserve System, companies subject to the Interstate Commerce Act, and those of their wholly owned subsidiaries substantially all of whose assets consist of securities of companies which themselves are subject to the Interstate Commerce Act, small loan companies, factoring companies, companies dealing in mortgages or discount paper, holding companies subject to the Public Utility Holding Company Act of 1935, and certain other special types of companies (sec. 3). The bill makes provision for the exempting of employees' investment companies, and certain other persons who are not within the intent of the proposed legislation (sec. 6).

Classification and subclassification of investment companies.-Investment companies are broadly classified into three categories: management companies, unit investment trusts, and face-amount certificate companies. Management companies are divided into two types: open-end companies-companies in which the stockholder or certificate holder has a right to compel the company to redeem his shares at their asset value; and closed-end companies-companies in which the shareholders do not have such a right. Management companies, both of the open-end and closed-end type, are further subclassified upon the basis of the extent of the diversification of their investments, into diversified companies which, speaking generally, must have at least 75 percent of their assets in diversified securities and nondiversified companies which are not required so to diversify their investments (secs. 4 and 5).

Transactions by unregistered investment companies.-Investment companies, unless registered as provided in the bill, are forbidden to conduct their activities through use of the mails or instrumentalities of interstate commerce. Foreign investment companies may not register as investment companies or publicly offer securities of which they are the issuer in the United States unless the Commission finds that these foreign investment companies can be effectively subjected to the same type of regulation as domestic investment companies (sec. 7).

Registration of, disclosure of investment policy, and size of investment companies. Provision is made for the registration of investment companies with the Commission. In the main, the Commission may require the information required to register securities under the Securities Act of 1933 and the Securities Exchange Act of 1934. In addition, the registration statement must state the policy of the company as to items specifically enumerated in the bill and supply information with respect to the business affiliation and experience of the officers and directors of the company. Provision is made for the simplification of the registration procedure by permitting the filing of copies of registration statements already filed under the acts now administered by the Commission. No shift in the company's fundamental policies as stated in the registration statement may be made without the approval of a majority of the company's outstanding voting securities (secs. 8 and 13).

To put a brake on the irresponsible formation of investment companies, no investment company organized hereafter may make a public offering of its securities unless it has or is assured of having at

least $100,000 through private subscription. The bill does not contain any limitation with respect to maximum size of investment companies, but authorizes the Commission to study and report from time to time the effect of size of investment companies both on the national economy and on the trusts themselves (sec. 14).

Ineligibility of certain affiliated persons and underwriters.-Any person, who within 10 years has been convicted of a crime or is enjoined by a court in connection with a security or financial fraud is prohibited by the bill from acting as an officer, or director, of any investment company or in certain other capacities. The bill recognizes, however, that even such a person may rehabilitate himself and so the Commission is authorized to exempt persons from this prohibition where it is shown that the penalty as applied to any such person would be unduly or disproportionately severe or that the conduct of such person has been such as not to make it against the public interest or protection of investors that such exception be granted (sec. 9).

Provisions relating to directors, officers, and certain affiliated persons.In the future, no person shall serve as a director of an investment company unless elected by the holders of its outstanding voting securities, except that, in effect, vacancies not exceeding one-third of the board occurring between meetings of stockholders may be filled in any otherwise legal manner. However, with respect to existing strict trusts, where no provision is made for election of trustees, the bill does not require an affirmative election of trustees but provides a procedure for their removal by certificate holders (sec. 16).

The bill provides that at least 40 percent of the board of directors of an investment company shall be "independent"; that is, no more than 60 percent may consist of investment advisers to the company or affiliated persons of such an adviser or officers or employees of the company. Moreover, a majority of the board of directors of an investment company must be composed of persons who are not regular brokers for the company or principal underwriters of its securities, or investment bankers, or in each case persons affiliated with them. An exception is made to take care of certain types of investment companies which are closely affiliated with investment advisers and which are designed primarily to make available this medium of diversification of investment to the smaller customers of these advisers. This exception is carefully safeguarded by specific conditions. Hereafter the majority of the board of directors of an investment company may not consist of persons who are officers or directors of any one bank, except that any investment company which, on March 15, 1940, shall have had a majority of its directors consisting of such persons may continue to do so (sec. 10).

In the future, persons who are officers, directors, investment advisers, etc., or persons affiliated with such persons may not, as principal, knowingly sell to or purchase from any investment company any securities or other property or borrow from any such investment company. Provision is made for certain exceptions with respect to transactions involving the company's own security issues and for transactions exempted by the Commission (sec. 17).

In general, agency transactions are not affected by the bill, but brokerage commissions are limited in the main to standard rates

with provision for special exemptions. Provision is made that those officers and employees who have access to securities or funds of investment companies may be required to be bonded. Securities of investment companies must be placed in the custody either of banks, or with stock exchange firms subject to supervision by the Commission as to methods of safekeeping (sec. 17).

Investment companies may not purchase securities underwritten by persons affiliated with the investment company, unless the investment company itself is a principal underwriter of such securities, until after the termination of the underwriting syndicate (sec. 10). Officers and directors of investment companies and certain other persons are not allowed to exculpate themselves from liability for any wilful misfeasance, bad faith, gross negligence, or reckless disregard of their duties (sec. 17). The provisions of section 16 of the Securities Exchange Act of 1934 relating to transactions of officers, directors, and controlling persons which now apply to equity securities of investment companies whose securities are listed on a national securities exchange are made applicable to all securities of all registered closedend companies (sec. 30). Gross misconduct or gross abuse of trust by directors, officers, investment advisers, principal underwriters, etc., is made a basis for injunctive proceedings in a Federal court to be instituted by the Commission (sec. 36). Larceny or embezzlement of property of investment companies is made a Federal crime (sec. 37). Provisions with respect to certain activities of investment companies.Investment companies, generally speaking, may not trade on margin, participate in joint trading accounts, or effect short sales in portfolio securities in contravention of rules and regulations which may be prescribed. Investment companies may engage in underwriting activities if consistent with their declared investment policies (sec. 12). Upstream loans to investment companies, except by wholly owned subsidiaries, are prohibited (sec. 21).

Hereafter, an investment company or group of controlled companies may not purchase securities issued by another investment company if as a result of such acquisition such group will have more than 3 percent of the outstanding voting securities of such other investment company, or 5 percent of a specialized investment company. Investment companies, however, may increase their holdings in other investment companies of which they already hold 25 percent of the voting stock, since such holdings constitute presumptive control. A similar provision limits the acquisition by investment companies of an insurance company's stock to 10 percent, with additional exceptions relating to the organization of new insurance companies and the purchase of stock of insurance companies from other investment companies cr where it is found that such acquisition is in the public interest because the financial condition of such insurance company will be improved as a result of such acquisition or any plan contemplated as a result thereof (sec. 12).

Cross and circular ownership as defined are prohibited in the future and existing cross and circular ownership must be eliminated within 5 years (sec. 20).

Although investment companies are in general prohibited from acquiring securities of persons engaged in the brokerage business or in the business of underwriting and dealing in securities, provision is made to permit investment companies, either alone or jointly with other investment companies, to purchase stock of a company engaged