Informal Matters under Other Requirements.

The Act contains a group of provisions involving various classes of persons affiliated with investment companies, which provisions, by their terms, do not take effect until some time after the effective date of the Act. The purpose of the waiting period is to give the investment companies and the classes of persons concerned an opportunity to revise their relations to comply with the respective requirements. Among other things, such revision may require amendments to charters and bylaws, special meetings of security holders, and a vote of security holders on a variety of possible matters. In this group of provisions are the following: that no more than 60 percent of the members of the board of directors of a registered company shall be investment advisers, affiliated persons of an investment adviser, or officers or employees of such company; that a registered company cannot employ as broker or principal underwriter a director or officer or a person affiliated with a director or officer, unless a majority of the board of directors are not such persons; that investment advisers shall serve as such only under a written contract with certain prescribed terms; that neither the charter, certificate of incorporation, or bylaws of any registered company shall contain provisions which purport to protect any director or officer against any liability to the company or its security holders to whieh he would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties in the conduct of his office; that investment advisers and underwriters should not be similarly protected; and that security holders shall ratify the selection of the independent public accountant.

Various problems have already been raised by companies now in the process of revising their operations to comply with these provisions when they become effective. Among those problems is the question of how far the limitations placed on charters and bylaws prevent indemnification of directors and officers for liabilities or expenses resulting from litigation arising out of their activities in connection with a registered company. The Commission has interpreted the relevant provision to prohibit such indemnification for expenses and the amount of any judgment handed down against such persons. Where suits are settled, indemnity may be offered only where the reasonable expenses of prosecuting a case to judgment would exceed the amount paid in settlement. Without such limitations, the officers and directors of investment companies would be in a position to shift from themselves to the security holders whose investments had been impaired the liability for any loss caused by their misconduct. DISTRIBUTION, REDEMPTION, AND REPURCHASE OF SECURITIES Redeemable Securities.

It is the practice of open-end investment companies to sell their urities at prices based upon the value of their underlying assets and

to agree to redeem them at prices similarly based. Prior to the enactment of the Act, almost all open-end companies determined the market value of their underlying assets at 3 p. m., the time of the closing of most stock exchanges on which their portfolios were listed. The selling price of the shares based on this computation remained fixed until 3 p. m. of the next day when a new calculation was made. The effect of this one price system was often damaging to security holders. For example, if the asset value was $10 a share at 3 p. m. on Monday and at 12 noon of the next day because of a rise in market values the asset value was $15 a share, nevertheless the public could purchase such shares at a price to net the company $10 a share. Under such circumstances the value of the existing shareholder's stock would be substantially diluted. Moreover, insiders such as directors and officers and underwriters who could obtain shares without payment of a sales load could purchase them at $10 a share and redeem them at $15 a share, since the redemption price per share was computed almost unanimously on the basis of the market value of assets at the time of the redemption.

The Act seeks to prevent these abuses by providing that any securities association registered under the Securities Exchange Act of 1934 may adopt rules setting out methods of computing prices at which their members may purchase, sell, or redeem open-end securities and the minimum time that must elapse between purchases and redemptions of such securities. Such associations may also adopt rules limiting and prescribing the method of computing the commissions their members may take on transactions in the securities in order to avoid excessive sales loads. After 1 year from the effective date of the Act, the power to make rules concerning these matters vests in the Commission. To the extent that such rules may be inconsistent with the rules of any registered securities association, the latter will be superseded. In this manner the Act in effect gave the organized security dealers a year to work out for themselves the highly complicated and technical problems involved.

The National Association of Securities Dealers, Inc., an association registered under the Securities Exchange Act of 1934, has already adopted such regulations. Among other things, the regulations provide that prices, heretofore computed generally only once a day, shall be computed twice daily. The effect of this rule is to diminish, but not to eliminate, possible dilution in the value of the shares of existing stockholders. Pursuant to the Securities Exchange Act of 1934, the rules of these associations become effective unless the Commission takes affirmative action with respect to them. In the instant case the Commission, without indicating approval, allowed the rules to become effective.

Closed-end Companies.

Registered closed-end companies are prohibited from purchasing securities of which they are the issuer, except (1) on national securities exchanges or other open markets designated by the Commission under specified circumstances, (2) pursuant to tenders, or (3) under such other circumstances as the Commission may permit by rule, regulation, or order. The primary purpose of this provision is to eliminate unfair discrimination in these transactions

The Commission has adopted a rule (Rule N-23C-1) as to repurchases of securities of closed-end companies other than on an exchange or by tender which, in effect, permits a registered investment company to purchase only its most senior security for cash under the following circumstances: the securities involved are not listed on an exchange; the seller is not an affiliated person; the purchases do not exceed more than 1 percent of such securities outstanding; the securities are bought pursuant to a firm commitment; the price paid is not above market or asset value, whichever is lower; the issuer discloses to the seller the underlying asset value of the subject secur ities; no brokerage commission is paid; the purchase is made without discrimination; and if the security is a stock, notice of intention to purchase must have been given to the stockholders at large. In any case the issuer must file reports of its repurchases with the Commission on Form N-23C-1 provided for that purpose.

During the past year, 17 applications for orders involving special situations were filed with the Commission. Many of them were with respect to purchases by investment companies of their own securities from the British Government. Of the 17 applications filed, 11 were granted and 6 were pending at the close of the fiscal year.

Although the Act does not expressly impose limitations on repurchases by closed-end companies of their own securities except for a requirement of prior notice to shareholders of the company's intention to repurchase, such repurchases may be of advantage to the management and detrimental to public shareholders. However, it has already been pointed out that the Act confers upon the Commission the power to seek an injunction of gross abuse of trust by managements. The existence of this power has enabled the Commission to prevail upon the management of one investment company to circumscribe repurchase of the company's preferred stock on a stock exchange so as to prevent the management from gaining an advantage at the expense of selling shareholders.

In this case the management held a substantial block of the company's common stock which had no asset value. Dividends on the company's preferred stock were passed although the company legally was in a financial position to meet the dividend requirements. Instead, the management caused the company to buy substantial blocks

of the preferred stock on the stock exchange at prices substantially less than the liquidating value of such stock. This practice tended to build up value in the common stock and thus served the interest of the management. On the other hand, to prevent the company from repurchasing the preferred stock would result in a substantial decline in the market value of the stock since the company was virtually the only buyer. After several conferences with the management, a plan was worked out which permitted repurchases in sufficient amount to maintain a satisfactory market for such stock but which prevented the management from profiting on the repurchases through an enhancement in the asset value of the common stock held by the management. The plan also required the company to pay out all current earnings as dividends on the preferrred stock.

PLANS OF REORGANIZATION

In connection with any reorganization 10 involving a registered investment company, the Act provides that copies of all the documents relevant to the solicitation of proxies, consents, and other type of action of security holders be filed with or mailed to the Commission. The Act also vests in the Commission two functions with reference to reorganizations. First, the Commission is authorized, if requested by any participating registered investment company or the holders of 25 percent of any class of its outstanding securities, to render an advisory report in respect of the fairness of any plan of reorganization and its effect upon any class or classes of security holders. Second, it may seek to enjoin the consummation of any such plan in the courts on the ground that it is grossly unfair or constitutes gross misconduct or gross abuse of trust on the part of officers, directors, or other specified persons sponsoring the plan.

With respect to the first-the power to render advisory reports on request-two such requests have been received. In both cases advisory reports were prepared and distributed to the interested security holders.

The first case involved a plan of reorganization proposing the consolidation of two investment companies followed by offers of the consolidated company to exchange its securities for outstanding securities of three other investment companies which were thereafter to dissolve. The companies involved were Standard Investing Corporation, International Equities Corporation, Central Capital Corporation, Atlantic Securities Company of Boston, and Beacon Participations, Inc. All of these companies were affiliated and were component companies in a system of investment companies known as the Henderson Group. Standard Investing Corporation and

the

10 The term includes among other things a dissolution, merger, consolidation, a sale of a substantial portion of assets, and recapitalizations.

International Equities Corporation were the consolidating companies, the other three the dissolving companies.

The complicated issues presented by this reorganization can be indicated merely by pointing out the complex capital structures of the companies (which created sharp conflicts of interest among the holders of the various classes of securities) and the types of assets which had to be valued (as a basis for determining the fairness of the treatment accorded by the plan to the various security holders). As to capital structure, Beacon Participations, Inc., had outstanding two classes of preferred stock and common stock; Atlantic Securities Company of Boston had outstanding debentures, a preferred stock, and a common stock; Central Capital Corporation had outstanding only common stock; Standard Investing Corporation had outstanding debentures, preferred stock, and common stock; International Equities Corporation had outstanding two classes of stock with different claims against the company's assets and profits. Various degrees of cross-ownership and circular-ownership existed among the companies and all of the companies were controlled by another company which was not being reorganized.

The underlying assets of these companies, upon the valuation of which depended in a large measure the fairness of the treatment accorded to all the classes of security holders involved, were as follows: real estate and hotel companies, service companies, a company manufacturing fiber containers, an aviation accessory company, and diversified investment securities.

After numerous conferences between the management of these companies and members of the Commission's staff some features of the original tentative plan desired by the management were altered. In the report of the Commission addressed to the security holders, the plan was carefully explained; the capital structures were outlined; the methods of evaluating the assets, particularly the assets having no quoted market values, were discussed; and the effect of the plan on the existing rights and privileges of each of the outstanding classes of securities were analyzed and defined.

It was indicated to the security holders that the Commission did not recommend or approve the plan. The stated purpose of the Commission was to assist security holders in exercising their judgment whether or not to accept the plan of reorganization. It was, however, the opinion of the Commission that the plan, on the basis of certain specified assumptions, was sufficiently within the limits of fairness to justify its submission to the security holders for their consideration.

The second case involved the proposed consolidation of Liberty Share Corporation and Western New York Securities Corporation. The situation in this case was simpler. Liberty Share Corporation had outstanding only one class of stock and its assets consisted chiefly