THE INVESTMENT COMPANY AMENDMENTS ACT

OF 1969

U.S. SENATE,

COMMITTEE ON BANKING AND CURRENCY,

Washington, D.C.

The committee met at 10 a.m. in room 5302, New Senate Office Building, Senator John Sparkman, chairman of the committee, presiding.

Present: Senators Sparkman, Proxmire, and McIntyre.

The CHAIRMAN. Let the committee come to order please.

We expect other Senators in. Unfortunately, Senator Bennett, ranking minority member, is not able to be here today. We do expect Senator Tower later, but it has been suggested that we proceed with the hearings.

As you know, the committee today begins hearings on S. 34 and S. 296, both of which are, in effect, amendments to the Investment Company Act.

(Copies of the bills and a letter from the Federal Reserve System regarding S. 34 may be found at p. 215.)

The CHAIRMAN. These bills are not technical financial matters. They do not, as has been alleged, "provide for wide-sweeping new regulatory powers over the mutual fund industry, which powers would be tantamount to ratefixing in a highly competitive industry.

Their sole purpose is to provide adequate consumer protection for the 5 million Americans, the majority of whom are of modest means, who have invested their savings in mutual fund shares.

During the last Congress this committee held extensive hearings, review, and executive sessions on this subject matter. Legislation identical to S. 34 was passed by the Senate, but unfortunately the House failed to act.

I may say that the legislation reported out of this committee last year was passed by the Senate by a voice vote. No one demanded a rollcall.

Senator MCINTYRE. There was a motion to recommit. We had a rollcall on the motion to recommit.

The CHAIRMAN. That was earlier. Not on final passage.

After we finished hammering the legislation out on the Senate floor it was passed by a voice vote without a request for a rollcall. As I say, the House failed to act. As a result of last year's deliberations, only two areas of controversy seem to remain. The first concerns mutual fund management fees.

The bills before us today state that management fees should be reasonable. They allow mutual funds shareholders the right to sue in court in order to challenge the reasonableness of a particular fee.

A right which, in my opinion, is inherent under our American system of jurisprudence but which is not available under current law.

Suits under this bill, as under any other law, require the plaintiff to prove his case by a fair preponderance of the evidence.

All agree that management fees should be reasonable, and the entire mutual fund industry insists that its fees are reasonable. However, this industry, for over 2 years, has remained intransient in its opposition to allowing shareholders to sue in court to determine whether or not a particular fee is reasonable.

I sincerely hope that before these hearings are concluded this industry will at long last reconsider its position on this matter.

The second area of disagreement concerns the so-called front end load. Many investors of relatively modest means purchase mutual fund shares by investing small amounts of money at monthly intervals. These investors pay the same sales commissions as purchasers of ordinary mutual funds except for one significant factor. In almost all cases, half of their first year's payments are deducted for sales commissions.

Obviously, this type of arrangement is detrimental to the investor, particularly if he discontinues his payments at an early date, as many of them find it necessary to do.

Even after 5 years of payments, unless the stock market rises rapidly, the investor is certain to lose money.

The original legislation considered by this committee would have abolished the front-end, load-sales charge.

S. 34 does not follow that recommendation. Its provisions represent, in my opinion, a reasonable compromise. Under S. 34 the front-end load would be spread out over 4 years with no more than 20 percent of any one year's payments being deductible for sales charges.

In addition, total commissions paid to salesmen would not be reduced. This provision is of the utmost importance, if this bill is to provide adequate consumer protection.

The front-end load is found only in installment plans. Studies by the Wharton School of the University of Pennsylvania, and by the SEC show that these plans are sold mainly to people who have little accumulated capital reserves. They are, in most cases, the least sophisticated of our Nation's investors. These are the people whom this bill is intended to protect. Present law, which permits the deduction of half of the investor's money for sales charges, unfortunately does not afford such protection.

Five million Americans own mutual fund shares. I am confident that as a result of this legislation, more and more Americans will gain confidence in the mutual fund industry and will seek to provide for their personal future by investing in the future of their country's security.

Senator MCINTYRE. Mr. Chairman, I have a very brief statement. First, I would like to go on record now at the commencement of these hearings, to express my deep appreciation of the chairman's efforts to move forward on this legislation which will benefit the shareholders, particularly the small shareholders of American mutual funds. The fact that we are holding these hearings at all, and particularly the fact that one of the bills before us already received approval of the full Senate is clear proof of the goals to which this committee,

under leadership of the chairman, can aspire. I believe the chairman already knows how important to investors I think these hearings are, and I want to go on the record and express my appreciation to him. The committee has before it two bills-S. 34 and S. 296.

The first of these, S. 34, is identical to the bill we passed in the Senate last year, S. 3724 of the 90th Congress. I supported that bill vigorously. I felt at the time it was the best possible piece of legislation which could be passed considering the powerful and well-financed opposition thrown up by the lobbyists of the mutual fund industry. Nevertheless, I stated on the floor last July 24, that this bill "while a definite improvement in the protection offered investors, is in many respects a bare and watered-down version of an ideal regulatory instrument for mutual funds."

Accordingly, this year, I introduced S. 296, which makes three basic changes from last year's bill. The committee staff prepared an analysis of the differences between these two bills, and I ask that it be placed in the record at this time.

The CHAIRMAN. Without objection that will be done. (The analysis follows:)

ANALYSIS OF S. 296

(Investment Company Amendments Act, by Senator McIntyre)

[This bill is identical in its provisions to S. 34, the Investment Company Amendments Act as introduced by Senator Sparkman, an explanation of which is contained in the committee print, except for the following]

Senator MCINTYRE. I would like to state as simply as possible what these changes are.

First, I would like to see the level of commissions completely removed from regulations by either the Federal Government or industry body.

At present commission levels are regulated by the Federal Government under section 22(d) of the act, which makes it a Federal crime for salesmen to offer shares with commissions different from those established by the fund's underwriter.

S. 34 keeps this Federal regulation and adds to it a layer of regulations as to commission levels by the National Association of Security Dealers, NASD.

My bill removes all of these regulations and would permit commission levels to be established by the free interplay of competitive forces in the open market.

Second, I would like to see the Congress carry out the recommendation of the Securities and Exchange Commission that the front-end load be abolished. The law of contract long recognized that unjust enrichment forms an appropriate ground for denying to one contracting party certain financial advantages conferred upon him by another.

I believe that the retention of a front-end load by contractual plans sponsors which is unearned because the plan holder drops out or redeems his share before conclusion of the plan represents unjust enrichment, and the best way to remedy this is follow the SEC recommendations and abolish front-end loads.

Finally, I don't believe the SEC should be limited in any way in its right to go to court to enjoin breaches of fiduciary duty on the part of the fund managers. If a fund manager acts in an untrustworthy manner as measured by traditional standards of what our laws expect of one who acts in a position of trust, the SEC, as public watchdog over this industry, should be able to prevent further breaches.

Thank you.

The CHAIRMAN. Thank you, Senator McIntyre.

The Chairman of the Securities Exchange Commission had planned to be here this morning. Unfortunately Judge Budge's mother is quite ill and he felt it was necessary for him to return to Idaho. We all extend our hopes that the Judge's mother may have a quick recovery. In any event we extend our sympathy to him in her illness. Judge Budge has been very much interested in and concerned with this legislation. In his stead, Commissioner Hugh F. Owens of the Securities and Exchange Commission is with us this morning.

Mr. Owens, we are very glad to have you here this morning. We are glad to hear from you. We have your statement. It will be printed in full in the record (see p. 27). You may treat it as you see fit.

For the benefit of the record will you give the name and position of the gentleman who accompanies you.

STATEMENT OF HUGH F. OWENS, COMMISSIONER, SECURITIES AND EXCHANGE COMMISSION, ACCOMPANIED BY PHILIP A. LOOMIS, JR., GENERAL COUNSEL

Mr. OWENS. Thank you, Mr. Chairman.

I am accompanied this morning by our very able General Counsel of the Commission, Mr. Philip A. Loomis, Jr., who will assist me in the presentation before you all this morning.