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instituted by the Commission to liquidate so-called orphan trusts (sec. 26).
Periodic payment plans.-The bill contains additional provisions which relate specifically to companies issuing periodic payment plan certificates. These provisions fall roughly into three classes: provisions relative to sales load; provisions regulating the incidents and denominations of the certificates, and provisions regarding custodianship. The sales load is limited to 9 percent. Recognizing the heavier initial expense, due primarily to sales commissions, the bill permits half of the sales load to be taken out during the first year of the plan; the balance is to be spread equally over the subsequent years. To prevent evasion of these restrictions on sales load by the imposition of so-called management fees, the Commission is authorized to prescribe maximum management fees. The provision relating to sales load may be modified by the Commission to meet the problems of small companies. Periodic payment plan certificates must be redeemable securities; and the initial payment under any plan must be at least $20, with each subsequent payment at least $10 (sec. 27).
Face-amount certificate companies.—Companies which sell faceamount certificates are generally subject to the provisions of the bill but must comply with certain provisions which are specifically applicable to that type of company. The bill contains provisions with respect to minimum capitalization of face-amount certificate companies. All companies which in the future sell these certificates must at all times maintain reserves, which, accumulated at a rate not to exceed 3% percent compounded annually, must provide an amount sufficient to meet at all times all the liabilities and obligations of the company to all its certificate holders. The companies must have cash or qualified investments (investments which are qualified under the Code for the District of Columbia for life insurance companies) of a value not less than the aggregate of their capital and reserve requirements. The bill makes provision to require deposit with certain qualified banks all or any part of the investments maintained by such company as certificate reserve requirements except that the company may be credited with deposits made pursuant to law or regulation with State authorities in respect to liabilities of the certificates sold to the residents of such States The bill makes provision for the distribution of the loading charge (the maximum amount of which charge is fixed by the bill) over the life of the certificate. In essence, no more than 50 percent of the load may be taken out the first year, no more than 7 percent in each of the following 4 years, and not more than 4 percent the remaining years. The surrender value of the certificate for the first year must be equal to at least 50 percent of the gross annual payment made on the certificate and for any subsequent time must be the amount of reserve of such certificate less a prescribed surrender charge. A certificate may not contain a provision making the holder liable for any unpaid balance on the certificate and must provide for the issuance to the certificate holder upon the happening of certain contingencies of a so-called paid-up certificate.
The obligations of the company to a certificate holder, who has defaulted, are specifically enumerated in the bill (sec. 28). If a face-amount company does not maintain the minimum certificate
reserve on all its outstanding face-amount certificates issued prior to the effective date of the bill then the company cannot make any distribution or pay any dividend on any senior capital security which exceeds a prescribed percentage of its earnings or which the Commission determines might impair the financial integrity of the company or its ability to meet its liabilities on the outstanding certificates. În the future, face-amount certificate companies cannot issue senior capital securities in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate for the protection of investors, or if such company has such senior capital securities outstanding to make any distribution or pay any dividend in contravention of such rules and regulations as the Commission may prescribe to insure the financial integrity of the company and to prevent the impairment of the company's abilities to meet its obligations on its face-amount certificates (sec. 18). A face-amount company can acquire the securities of another face-amount company only upon certain prescribed conditions (sec. 12). The bill makes provision to obtain equality of treatment of certificate holders who are residents of various States in the event of bankruptcy of a face-amount company. The bill preserves the rights of residents in those States which require specific deposits with their State officials but makes provision for equalization of treatment of all certificate holders, by providing that residents of other States must receive an amount equal to that reccived by the residents of States with deposits, before the latter can share in the general assets of the bankrupt company (sec. 29).
Unlawful representations.—The bill contains the usual provisions prohibiting misrepresentations and half-truths in registration statements, reports and other documents filed with the Commission, and prohibiting the misrepresentation of the effect of registration with the Commission. In addition, the use of misleading names by registered investment companies is specifically prohibited. The latter provisions may be enforced by order of the Commission when the name is adopted after the effective date of the bill, and by a court at the suit of the Commission as to names theretofore adopted (secs. 34 (b), 35).
Administrative and enforcement machinery.---The bill contains ample provisions, but appropriately circumscribed, for the enforcement of its provisions; for the carrying out of the powers and duties vested in the Commission, and for court review of the Commission's action (secs. 38 to 46, 49).
Formal provisions.-The bill contains the usual provisions regarding validity of contracts, liability of controlling persons, the effect of the bill on existing law, and separability of provisions. The effective date of title I is November 1, 1940, as to all companies except face-amount certificate companies, as to which the bill does not become effective until January 1, 1941. The short title of the bill is the “Investment Company Act of 1940” (secs. 47, 48, 50 to 53).
TITLE II. INVESTMENT ADVISERS
Title II, which deals with investment advisory services, is an outgrowth of the Commission's survey of these organizations in connection with its study of investment trusts and investment companies. The subcommittee held hearings on the original provisions of title II as they were included in S. 3580. At these hearings representatives of the larger investment adviser firms and representatives of a voluntary association of investment advisers opposed that title. However, at the conclusion of the hearings, much as in the case of the investment trusts and investment companies, representatives of the investment adviser organizations and the Securities and Exchange Commission, at the suggestion of the chairman of the subcommittee, conferred with a view to drafting proposals which would have the support of the investment advisers and the Commission. As a result, title II of S. 4108 was prepared. This title has the affirmative support of virtually all investment advisers, both the members of the association and those who are not members, wḥo appeared before the committee.
Investment advisers are persons who for compensation engage in the business of advising others, either directly or through publication or writings as to the value of securities, or as to the advisability of investing in, purchasing, or selling securities or who for compensation and as part of a regular business issue or promulgate analyses or reports concerning securities.
The emergence of the investment adviser as an important occupation or profession did not occur until the World War. However, it was not until after 1929 that the investment adviser firms organized and increased rapidly. The number of investment advisers presently functioning has been difficult to ascertain. The Commission reported to the Congress that in connection with its study of these firms, it obtained replies to questionnaires from only 394 persons or firms which administer funds or give investment advice.
Similarly, it is difficult definitely to estimate the amount of funds under the influence or control of investment advisers. However, some idea of the size of the funds administered by investment advisers may be deduced from the fact that 51 firms for which information was obtainable by the Commission managed, supervised, and gave investment advice with respect to funds aggregating approximately $4,000,000,000.
The nature of the functions of investment advisers, their increasing widespread activities, their potential influence on security markets and the dangerous potentialities of stock market tipsters imposing upon unsophisticated investors, convinces this committee that protection of investors requires the regulation of investment advisers on a national scale.
The report of the Commission to the Congress and the record before the committee is clear that the solution of the problems and abuses of investment advisory services-individuals and companies which either handle pools of liquid funds of the public or give advice with respect to security transactions cannot be effected without Federal legislation.
Not only must the public be protected from the frauds and misrepresentations of unscrupulous tipsters and touts, but the bona fide investment counsel must be safeguarded against the stigma of the activities of these individuals. Virtually no limitations or restrictions exist with respect to the honesty and integrity of individuals who may solicit funds to be controlled, managed, and supervised. Persons who may have been convicted or enjoined by courts because of perpetration of securities fraud are able to assume the role of investment advisers. Individuals assuming to act as investment advisers at present can enter profit-sharing contracts which are nothing more than "heads I win, tails you lose" arrangements. Contracts with investment advisers which are of a personal nature may be assigned and the control of funds of investors may be transferred to others without the knowledge or consent of the client.
Title II recognizes that with respect to a certain class of investment advisers, a type of personalized relationship may exist with their clients. As a consequence, this relationship is a factor which should be considered in connection with the enforcement by the Commission of the provisions of this bill.
ANALYSIS OF PROVISIONS OF TITLE II
Findings and definitions.-Sections 201 and 202 contain, respectively, the findings of the Congress with respect to investment advisers nd the definitions of various terms used in title II. The term “investment adviser" is so defined as specifically to exclude banks, bank holding company affiliates, lawyers, accountants, engineers, teachers, brokers (insofar as their advice is merely incidental to brokerage transactions for which they receive only brokerage commissions), publishers of bona fide newspapers, news magazines, or financial publications of general and regular circulation, and persons whose advice is limited to securities issued by the United States and certain instrumentalities of the United States. In addition, the Commission is authorized by rules and regulations or order, to make certain further exceptions according to prescribed statutory standards.
Registration of investment advisers.-Investment advisers who make use of the mails or instrumentalities of interstate commerce in connection with their investment advisory business, unless they fall within one of the specific exemptions provided in section 203 (b), are required to register by filing with the Commission an application for registration containing certain information, the character of which is specified in the bill. The administrative machinery for registration is similar to that provided in the Securities Exchange Act of 1934 for the registration of over-the-counter brokers and dealers. Registration may be denied or revoked if the registrant has within 10 years been convicted of a crime or is enjoined by a court in connection with a security or financial fraud, or if his application for registration is materially misleading. The data contained in the application for registration must be kept reasonably current by such annual and special reports as the Commission may require for that purpose (secs. 203, 204).
Investment advisory contracts.-Contracts or agreements between an investment adviser and a client may not provide for compensation to the investment adviser based upon capital gains or capital appreciation. Each such contract must be non-assignable, and must provide, if the investment adviser is a partnership, that the client will be notified of any change in the membership of the firm, so that he will be in a position, if he so desires, to disaffirm the contract (sec. 205).
Certain prohibited transactions.- Transactions and practices which defraud or operate as a fraud or deceit upon clients or prospective clients are prohibited. Registered investment advisers are also forbidden to purchase securities from or sell securities to any client, either as principal or in connection with a brokerage business, without first advising the client of the transaction and obtaining his consent thereto (sec. 206).
Unlawful representations, administrative and enforcement machinery, and formal provisions. In these respects title II contains provisions generally comparable to those of title I (sec. 207 to 221, inclusive). Section 210, which relates to publicity, recognizes that in many instances the adviser-client relationship has a confidential basis, and provides for confidential treatment of information obtained in the administration and enforcement of the title, to the extent that such treatment is consistent with efficient enforcement.