TABLE 1 ASSETS AND OPERATING EARNINGS OF THE 25 LARGEST BANKS, 1968

Source: "Moody's Bank & Finance 1968" by Moody's Investors Service, Inc."

TABLE 2.-ASSETS AND OPERATING EARNINGS OF THE 25 LARGEST STOCK LIFE INSURANCE COMPANIES, 1968

Source: "Moody's Bank & Finance 1968", by Moody's Investors Service, Inc.

TABLE 3.-MUTUAL FUNDS ASSETS AND EARNINGS OF MANAGEMENT COMPANIES, 1968

TABLE 4.-MUTUAL FUND PORTFOLIO ACTIVITY AND INVESTORS PURCHASES AND REDEMPTIONS DURING PERIODS OF MARKET DECLINE (IN MILLIONS OF DOLLARS]

Note: The preceding studies constitute coverage of all periods of important market decline since the end of World War II. The studies were based, in each case, on reports received from substantial portions of the industry with the following percentages of assets of Investment Company Institute's open-end members represented: (1) 74.3 percent; (2) 96.5 per cent; (3) 82.5 percent; (4) 79.0 percent; (5) 98.4 percent; (6) 100.0 percent; (7) 100.0 percent; (8) 100.0 percent; (9)75.0 percent; (10) 82.2 percent; (11) 77.7 percent; (12) 83.0 percent; (13) 83.9 percent.

Senator PROXMIRE. Thank you, sir, for a very competent presentation.

Mr. Augenblick, in the case of Sachs v. Brady, the landmark case in the area of management fees, the Court said, under the doctrine of corporate waste, and I quote:

The compensation received must be so inadequate in value that no person of any sound business judgment would deem it worth what the corporation is paid. Does that standard effectively preclude any mutual fund shareholder from suing in court in order to reduce the management fee? For example, one mutual fund with $2.4 billion in assets still charges a flat advisory fee rate of one-half of 1 percent. Could this fee be challenged under Sachs v. Brady?

Mr. AUGENBLICK. Yes. I think a plaintiff would have his right to come into court and make the challenge. In these cases which involve

Senator PROXMIRE. Could the plaintiff ever win under these circumstances?

Mr. AUGENBLICK. This would be up to the judge.

Senator PROXMIRE. Well

Mr. AUGENBLICK. But may I point out, Senator Proxmire, that a variety of language is used in various cases involving the standards which govern the obligation of directors in their conduct with respect to the affairs of the corporation. You have just quoted certain language. In other courts they prefer to say directors may not act beyond standards of business judgment. Some other courts will say directors, no matter what a majority of the shareholders do, may not engage in conduct which constitutes corporate waste.

So that there is a variety of expressions on the part of courts which governs the standard of conduct in this area.

Senator PROXMIRE. Can you give me an example of any instance at all in history in which a plaintiff has ever won a suit to reduce management fees?

Mr. AUGENBLICK. So far as I know, there have been three litigated cases, and in none of these cases was the plaintiff successful.

Senator PROXMIRE. So it has never been done? Under present law, with all the mutual funds and all the investors, none of them have ever succeeded in reducing a management fee based on the present opportunities given by law?

Mr. AUGENBLICK. That is correct. But the same standards have been applied by courts to the action of the directors in connection with management fees that have been applied by courts to the action of directors of any other type of corporation. The standard has been no different.

Senator PROXMIRE. But isn't it true under the provisions of this legislation all that is being done is to allow the mutual fund shareholder the right to have the same determination by a disinterested party-that is, a Federal judge-as to the reasonableness of the fee?

Mr. AUGENBLICK. I think it's quite the converse. In my testimony, I used the word "novel." I know of no competitive industry today where the law provides that a court shall determine what are reasonable fees in that industry. This is quite a novel approach.

In all of the other cases, what courts do is give credence to the action of a majority of the shareholders and of the board of directors, assuming, of course, that the board of directors is not dominated. And they require a dissenting shareholder who is in the minority to establish that what the directors did was a waste of the company's money.

Senator PROXMIRE. Now, as I understand, the members of the mutual fund industry have repeatedly stated that a court's determination of the reasonableness of a fee is a new concept. However, Judge Henry J. Friendly, of the Second Circuit Court of Appeals, in a statement submitted to the committee last year stated, and I quote:

There are many instances in which courts now have to decide what constitutes reasonable compensation. One is in passing on the fairness of arrangements between a fiduciary and his beneficiaries, a standard that might well be applicable to this very problem but for the effect given to ratification by stockholders or unaffiliated directors.

In addition, Judge Friendly addressed himself to the problems of uniform court decisions as follows, and I quote:

*** I would suppose that the courts would develop intelligible guidelines within a relatively short time. This result would be aided by the fact that since actions to recover unreasonable fees are equitable in nature, they would be tried to judges and not to juries.

And one other quotation from Judge Friendly:

There remains the claim that section 15 (d) would be a litigation breeder. But it is not a valid objection that a statute may lead to the bringing of lawsuits; what would matter would be unjustified lawsuits. While some derivative actions are brought simply for harassment, we have become increasingly aware that others serve a most useful purpose in policing directors and officers who otherwise would be laws unto themselves.

Would you care to comment on Judge Friendly's opinions?

Mr. AUGENBLICK. It is certainly true that the determination of what are reasonable fees is not novel for courts in certain instances such as Judge Friendly cited.

For example, where you have trust fees, where you have attorneys' fees, fees in bankruptcy, courts have an obligation to determine the reasonableness of the fees which are requested.

But when I and others have used the word "novel," what we were referring to was the determination of reasonable fees in a competitive industry, and this I respect fully submit would be quite different.

Senator PROXMIRE. In your testimony and during the mutual fund industry's testimony last year, great faith was placed upon the judgment of independent directors. However, at the committee's hearings last year, one mutual fund director stated:

How can an independent director come along later on and say we are going to fire that particular management company, replace them with somebody else? I don't believe it is the function of the director to put his judgment in replacing the judgment exercised by the man the day he bought the shares. He didn't buy it because I am on the board. He bought it because a company is doing the managing.

Except for the question of management fees, and I would say the independent directors I have had the privilege of serving with do an alert and intense job . . . In light of this comment, can independent directors truly negotiate at arm's length with a management company over the advisory fee? Mr. AUGENBLICK. If I understand correctly what you have just quoted, Senator, let me say first that I believe I disagree with some of the testimony you just quoted. This represents the testimony of one director, one fund, and there are over 500 active funds, and we have 254 members, larger funds possibly, in our Institute.

my

I have never been an independent director. I cannot speak from personal experience. But all I have to do is to take a look at the list of independent directors that was submitted to this committee in connection with the hearing last year, and these cannot be described as "patsies" in any way. These are independent, successful people.

And I do believe that the independent directors exercise a very important function in seeing to it, after examination, that the management fee is reasonable and that the management of the mutual fund is doing a good job.

And I'm told this has been very effective, and I think there was testimony last year by John Haire with respect to the effectiveness in his own fund.

Senator PROXMIRE. Let me ask you about some other observations by independent directors. These were made by independent directors when asked why they became directors of a particular fund. One was this:

Well, I think-I don't know, I'm not a mindreader, but I have known (the investment adviser) since 1940, and he was in college at the same time with my wife and she had known him ten or more years before that. We used to know them very well when we lived in Winnetka before, which was in the early 1940's. The director of a different fund said of his selection:

Well, I knew the (adviser) personally. My wife's father had been formerly associated with (the advisory company), and I had met (the adviser) through him.

Another director gave this account of being chosen as a director: (The investment adviser) called me. (He) is a cousin of mine, and I have known him, of course, for a few years and he called me and told me that they were organizing a fund which was to invest in some special situations to be a growth fund for those who were particularly interested in capital advancement rather than income, and wanted to know if I would help them out by being on the Board.

And I told (the adviser) that I didn't know the first thing about the funds or really investments at all, that I didn't see what I could contribute to the Board.

And he said, Well, I could be of some help to them because I had just the general background that they wanted to get a varied Board put together and I could be of some help to them.

I said, "What you really want to do is use my name."

And he said, "Well, if you want to put it that way, I suppose that is it."

What is your reaction to that?

Mr. AUGENBLICK. Senator, may I first ask what was the date of those comments?

Senator PROXMIRE. These were taken from the court cases. These were in the Congressional Record last year. We can supply the names of the funds and directors at a later time.

Mr. AUGENBLICK. My point is I think they go back a number of years. And since that time, there has been an increasing awareness on the part of directors in this industry, stimulated if you like in some part by litigation. But, certainly, an increasing awareness of the strict nature of their obligations.

Senator PROXMIRE. Well, at your request, we will put those dates in the record.

(The information referred to follows:)

MEMORANDUM

To: Senate Committee on Banking and Currency.
From: The Securities and Exchange Commission.

APRIL 28, 1969.

Re: Sources of unaffiliated directors' statements referred to during testimony on S. 34 and S. 296.

On April 17, 1969, during the testimony concerning S. 34 and S. 296, Senator Proxmire questioned Robert Augenblick, Esquire, President of the Investment Company Institute, with regard to the role of unaffiliated directors and particularly with respect to some statements of independent directors which had appeared in the Congressional Record on July 26, 1968 (S9494-6). Mr. Augenblick requested that the sources and dates of the quoted materials be supplied.

Most of the statements were taken in 1963 in connection with the Report of the Securities and Exchange Commission, Public Policy Implications of Investment Company Growth, which was issued in 1966, and a few were derived from depositions taken by counsel for private litigants in connection with derivative actions.