May I say, Mr. Chairman, that Chairman Budge has asked me to extend to you and to the members of the committee his deep regret at not being able to be here with you this morning and he has asked me to substitute in his stead and it is with your indulgence my great pleasure and honor to be here before you. The CHAIRMAN. Did you give Mr. Loomis' name and initials for the record? Mr. OWENS. I did. The CHAIRMAN. We are glad to have you. Mr. OWENS. Again I appreciate your invitation to appear here today to testify on the pending mutual fund legislation. In preparing for this appearance, I was struck by the great volume of reports, testimony and statements which have already gone into the efforts to amend the Investment Company Act of 1940. The record of testimony before this committee alone during the last session, takes up two good-sized volumes. The House hearings take an adidtional two volumes. This effort began almost a decade ago, in 1958, with the engagement of the Wharton School by the Commission to produce a study of the mutual fund industry. Their report was issued in 1962. Subsequently, the "Special Study of Securities Markets" delved into mutual fund sales practices, especially in the sale of contractual plans, and in 1963 that Study was forwarded to the Congress. Among other things, that Study found the operation of contractual plans inimical to the interests of small investors and it recommended abolition of "front-end-load" arrangements in the sale of fund shares, that is deduction of up to one half of the first year's payments for sales charges. The Special Study led to significant amendments to the Securities Exchange Act of 1934, but the legislation passed did not deal with the mutual fund industry; that was left for further study and examination by the Commission. Finally, in 1966, the Commission produced a comprehensive report"Public Policy Implications of Investment Company Growth"which made legislative recommendations designed to cope with the serious problems which had developed in the fund industry since 1940 and to deal with a large number of "technical" points which had arisen over the years. The Commission's recommendations included: the abolition of the front-end load; the reduction of fund sales charges to a maximum of 5 percent instead of the current prevailing 9.3 percent, and the establishment of a court enforced standard of reasonableness for fund management fees. Now, I realize that the members of this Committee are fully aware of the history of these efforts to achieve meaningful mutual fund legislation which finally led to passage by the Senate of S. 3724 in July 1968. I think, however, that as we renew our efforts in this session, it is worth recalling the decade of study, testimony, and consideration, by the Wharton School, by the Commission and by the Congress of the situation which has prompted these proposed amendments. As Chairman Sparkman pointed out during the floor debate last year, this has certainly been one of the most carefully studied pieces of legislation to come before Congress in recent years. This committee, in the summer of 1967, held extensive hearingsand as I have noted produced a two-volume record of testimony and statements from the Commission, the industry, the exchanges, the NASD, experts and observers. There was ample opportunity for consideration of all sides. This committee reported favorably on the bill in July of 1968, with certain fairly significant modifications S. 3724, the bill reported to the Senate, did not abolish the front-end load. Instead the Senate arrived at a formula whereby the load would not exceed 20 percent in any one year nor average more than 16 percent over the first 4 years. Instead of limiting the sales charge to a flat 5 percent, as the Commission originally proposed, S. 3724 provided for control of unreasonble sales charges by the NASD with Commission oversight. The bill adopted the Commission's recommendation that the effective standard of "waste" in regard to fund management fees be replaced by a standard of reasonableness, enforceable in the courts. Several "safeguards" were added to this section at the suggestion of the industry, including a mandatory request to the Securities and Exchange Commission to bring an action by derivative suitors and a 6-month wait for SEC action before such an action may be instituted privately. Directors' determinations of reasonableness were to be given weight by the courts, as was shareholder approval. The bill also clarified the status of bank administered collective investment funds under the Federal securities laws and the banking statutes. The bill S. 3724-contained over 40 other amendments, some "technical," others of substantive significance. Thus, the "gross abuse of trust" language of present section 36 was replaced by "breach of fiduciary duty involving personal misconduct." That bill went to the floor and the full Senate, after extensive debate, passed the bill with certain additional amendments designed to meet some of the objections of the industry. The amended bill as it finally passed the Senate provided for the following additional important changes: 1. Compensation shall be presumed reasonable if it has been approved or ratified by the affirmative vote of the owners of a majority of the outstanding voting securities and by a majority of the directors of the investment company, who are not interested persons. This presumption, may however, be rebutted by a preponderance of evidence. 2. If the court determines that the board of directors of the investment company acted with due care in approving the compensation, then there may be no monetary recovery for any period prior to the institution of the action, or, in the case of an investment advisory contract, prior to the termination date of such contract. 3. No action may be maintained by a security holder under these provisions unless the Commission refuses or fails to bring such action within six months after written request by the security holder. S. 3724, as amended and passed by the Senate, was not acted on by the House Committee on Interstate and Foreign Commerce. Of course, as I have noted, there were extensive hearings and testimony on the House side as well. The bill as it passed the Senate is now S. 34, introduced on January 15 by Chairman Sparkman in this session. Chairman Budge testified briefly on this matter before a subcommittee of this committee on March 6 of this year. He testified at that time in support of S. 35-we support S. 35 now. As he said at that time: Overall, it seems to me that the proposals which we advanced at the last session of Congress might more effectively insure fair treatment to investment company shareholders. On the other hand, enactment of S. 34 would accomplish a great improvement over the present situation and would constitute an important reform. Consequently, if this Committee prefers to accept S. 34, I would gladly accept that decision and support that bill. As this committee is well aware, the Commission has bent every effort to reach an agreement with the industry. We and our staff have recently met several times with representatives of the Investment Company Institute. Their major concern at this point seems to be the management fee provisions of the bill. I think that it is appropriate to point out that although S. 3724 and the present S. 34 contain significant modifications of the Commission's original proposals, this committee's report makes it clear that there remains a real need for congressional action in the areas of advisory fees and management compensation, sales loads, and contractual plan loads. That need was not only expressed in your report, but was also set forth in the floor debates. We have exhibited, I think, a willingness to meet industry objections. I regret that we cannot come to this committee with full agreement. On management fees, which as I have said now seem to be the sticking point, as your report points out, mutual funds, with rare exception, are managed by external organizations which obrain fees calculated on a percentage of net assets of the funds. The mutual fund industry has grown from one-half billion dollars in net assets in 1940 to over $50 billion today. Much of this growth has been over the past 5 years. It appears that the industry is now growing at the rate of nearly $10 billion a year. This annual rate of growth is almost as large as the entire industry just 15 years ago. We now have billion-dollar funds and monthly fund sales of over $600 million. Management fees have been reduced in recent years by adoption of sliding scales or by the triggering of existing scaled down schedulesbut these reductions have in many cases been less than significant. That is not to say that some funds have not benefited appreciably from fee reductions-whether caused by shareholders' actions or the attention given to the problem by the Commission and the Congress. Nevertheless, it is clear that a significant problem still exists and that legislative action remains appropriate. On March 17, 1969, Chairman Budge wrote to Senators Bennett, Williams, and McIntyre providing figures as to net asset and advisory fee rates for the 57 externally managed funds, identified in our 1966 report, having net assets over $100 million. We have since obtained such data for the 87 funds which had over $100 million in net assets at June 30, 1968 and I would like to introduce that tabulation for the record. It is appended to this statement. The CHAIRMAN. Without objection we are very glad to have it in the record. I know you have two different groups there. Does the larger group in any way include what you have in the smaller group? Mr. OWENS. Yes. It is just more that have gone over the $100 million mark. The CHAIRMAN. The second group includes the first group? The CHAIRMAN. Very well, we are glad to have it. Mr. OWENS. It shows that 68 of the 87 funds had effective management fees of 0.40 percent or over, 59 funds-well over half-had effective rates of 0.45 percent or over, and 46, again over half, had rates of 0.50 percent or more. Now, it is clear that it does not cost 10 times as much to manage a $1 billion fund as it costs to manage a $100 million fund. Fund investors have not benefited adequately from the savings in management costs per dollar managed which result from fund growth. I think that it is not seriously disputed that, with infrequent exceptions, fund directors have not been very effective in bargaining with fund managers for reduced fees. Their position in so bargaining with their fellow directors is, of course, a difficult one. It is also difficult to test these fees in the courts. Under the general rule of common law, advisory contracts ratified by shareholders or approved by a vote of disinterested directors may not be upset unless there is a showing of corporate "waste" or "gross abuse of trust." I think the statement in the Report of this committee summed the situation up very well: Because of the unique structure of this industry, the relationships between mutual funds and their advisers are not the same as those that usually exist between buyers and sellers or in conventional corporate relationships. The forces of price competition or arm's-length bargaining do not work as effectively in the mutual fund industry as they do in other sectors of the American economy. At the same time, it is difficult to test these fees in the courts. Under the general rule of law, advisory contracts which are ratified by the shareholders or approved by a vote of the disinterested directors may not be upset in the courts except upon a showing of "corporate waste." The fee must "shock the conscience of the court." Such a rule may not be an undue one when the protection of competition and hard bargaining is effective. But in the mutual fund industry where these marketplace forces do not operate as effectively, your committee believes that the standard of "corporate waste" is unduly restrictive and it should be changed. One more item on this area. It is true that advisory fees are disclosed to the shareholder. This, however, is a federally regulated industry and that regulation goes beyond disclosure. That policy decision was made by the Congress in 1940-and with ample basis. The question now is what must be done, after almost 30 years of extraordinary growth and no new legislation, to make the existing regulatory scheme more effective. I have not extensively discussed here the sales load or the frontend load proposals. This whole area has already been discussed before you at great length and there seems, at least at this point, to be no great industry opposition to the proposals in S. 34 on these matters although the people who sell contractual plans are concerned. I think that I can fairly represent to this committee that we have made every reasonable effort to reach an agreement on outstanding differences. We have been helped immeasurably by the efforts of chairman and the members of this committee. As I have said, Š. 34 contains significant compromises-I respectfully submit that no further compromises in S. 34 are necessary. We have considered S. 296 which would substitute complete repeal of section 22(d), the act's retail price maintenance provision, for the proposed NASD jurisdiction over sales loads. It would also eliminate the front-end load. It is somewhat inconsistent for the industry to favor governmental interference in maintaining sales loads, while On elimination of the front-end load, the Commission supports the I would like to close by thanking this committee for its great patience ADVISORY FEE RATES AND EXPENSE RATIOS OF EXTERNALLY MANAGED MUTUAL FUNDS WITH JUNE 30, 1968 |