GENERAL NATURE OF ADMINISTRATIVE PROBLEMS

In part, perhaps, because the statute was the result of a compromise, but in greater measure because of the diversity of companies it covers and the intricacy of the problems they present, the Investment Company Act of 1940 is a complex and elaborate piece of legislation, calling for the use of a great variety of administrative procedures and techniques. The Act contains flat statutory prohibitions the violation of which may give rise to either injunctive or criminal proceedings in the courts; provisions which authorize the Commission to institute injunctive proceedings but the violation of which is not a criminal offense; requirements for filing financial and other data with the Commission, which is then open to public inspection; requirements for the transmission of financial and other data to security holders; provisions authorizing the Commission to render advisory reports to security holders; provisions authorizing the Commission to adopt rules and regulations in some circumstances for the purpose of giving content to statutory prohibitions which would otherwise be inoperative and in other circumstances for the purpose of relaxing statutory prohibitions which would otherwise obtain; provisions for administrative orders in proceedings initiated in some cases by the Commission and in other cases by the companies or persons affected; and provisions. for the further study of certain aspects of investment company operations. Fortunately, most of these procedures have been employed in the same or a comparable form in one or more of the statutes already administered by the Commission, so that no serious difficulties have been encountered in fitting the administration of the new Act into the framework of the Commission's previous practice.

For the purpose of administering the Investment Company Act of 1940 (together with the Investment Advisers Act of 1940), the Commission created a new division of the staff, the Investment Company Division. The organization and functions of the new division are generally similar to those of the older divisions of the Commission.

The principal problems faced by the Commission during the first eight months of its administration of the Act can conveniently be grouped into seven categories, namely, (1) determining which companies are investment companies subject to the Act and which are not investment companies or are entitled to exemption; (2) the classification of companies subject to the Act; (3) prescribing the information to be filed with the Commission and that to be transmitted to security holders; (4) the administration and enforcement of those provisions of the Act which regulate the relationships and transactions of persons who are affiliated with investment companies; (5) matters relating to the distribution, redemption, and repurchase

of securities issued by management companies; (6) reorganizations of investment companies; and (7) the treatment accorded certain special types of companies, such as unit investment trusts, periodic payment plans, and face-amount certificate companies.

THE "INVESTMENT COMPANY" CONCEPT

Although the terms "investment company" and "investment trust” have been part of the language of the financial community for some time, a definition precise enough to distinguish them sharply from holding companies on the one hand and operating companies on the other did not exist prior to the enactment of the Investment Company Act of 1940. The distinctive feature of the Act in this connection is its use of a quantitative or statistical definition, expressed in terms of the portion of a company's assets which are investment securities. Thus the statute provides, inter alia, that a company is an "investment company" if it is engaged in the business of investing, reinvesting, owning, holding, or trading in securities, and owns investment securities (defined to exclude securities of majority-owned subsidiaries and of other investment companies) exceeding 40 percent of its total assets (exclusive of Government securities and cash items).

With this quantitative test as a starting point, the statute then proceeds to carve out exceptions. Certain types of companies are excluded from the investment company category by express statutory exceptions. These types include such organizations as banks, insurance companies, savings and loan associations, small loan companies, public utility holding companies, and charitable corporations. In addition, the Act provides machinery whereby the Commission may declare by order upon application that a company, notwithstanding the quantitative definition, is nevertheless not an investment company. Thus, companies that believe that the application of the quantitative test would unreasonably cause them to be classified as investment companies are given the opportunity of obtaining administrative dispensation by showing that they are primarily engaged in a business or businesses other than that of investing, reinvesting, owning, holding, or trading in securities, either directly or through majority-owned subsidiaries or through controlled companies conducting similar types of businesses.

The experience of the Commission, during the 8 months the Act has been in effect, indicates clearly the general feasibility of working with the definitions of "investment company" contained in the Act and the administrative procedures provided in relation to them. During that time only 27 applications for declarative orders were filed. Of the applications which have so far been studied, 7 have been withdrawn by the applicants at some stage during the course of the administrative proceeding. Most of the with

drawals resulted from the informal exchange of views with representatives of the particular companies involved. Of the 4 cases which were formally decided by the Commission prior to the end of the past fiscal year, all were clear cases for administrative relief, and in each the order prayed for was granted. It is true that knotty questions have been raised by some of the applications, but those questions relate to so few companies that they do not interfere with the effective regulation of the field as a whole.

EXEMPTION OF COMPANIES FROM THE INVESTMENT COMPANY ACT OF 1940

In addition to the provisions for excluding certain types of organizations from the concept of "investment company," the Act contains certain exemptive provisions applicable to companies which, while admittedly investment companies, should for one reason or another be relieved from some or all sections of the Act. Several of these exemptive provisions are provided by the statute itself, but three subsections of the Act leave exemption in whole or in part to administrative determination.

In Section 6 (b) the Commission is directed to exempt by order any employees' securities company from the provisions of the Act, to the extent that such exemption is consistent with certain specified standards. To date, 7 companies have filed applications for exemption under this section. The most important are those applications filed. by 4 investment companies holding funds for the benefit of more than 40,000 employees of General Electric Company. The total assets of these 4 companies amount to more than $200,000,000.

The disposition of such applications presents many difficult problems and requires constant use of the Commission's informal conference procedure, for Section 6 (b), in effect, directs the Commission to study in detail the history and operations of each such company and to determine the effect which each section of the Act will have on one or more aspects of the applicant's business. After this is done, the Commission must, in effect, accommodate the Act to the particular circumstances of the employees' securities company involved, in the light of the considerations enumerated in Section 6 (b). This process, in relation to the applications of the four companies affiliated with General Electric Company, has almost run its course. Formal hearings have been set, and opinions and orders should be issued in the near future. The other applications under Section 6 (b) are in some stage of the same process.

? These do not include employees' stock bonus, pension, or profit-sharing trusts which meet the conditions of Section 165 of the Internal Revenue Code, since such trusts are excluded from the definition of "investment company" by Section 3 (c) (13).

Section 6 (d) of the Act directs the exemption by rule or order, to the extent consistent with the public interest and the protection of investors, of certain small closed-end investment companies whose securities are offered intrastate. At the end of the fiscal year the three applications filed under this section were pending.

The remaining exemptive provision, and in many ways the most important, is Section 6 (c) which reads as follows:

"The Commission, by rules and regulations upon its own motion, or by order upon application, may conditionally or unconditionally exempt any person, security, or transaction, or any class or classes of persons, securities, or transactions, from any provision or provisions of this title or of any rule or regulation thereunder, if and to the extent that such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of this title."

Sixty-two applications have been filed seeking orders under this section, of which 20 had been disposed of at the close of the fiscal year ended June 30, 1941. Many of the applications requested orders which amounted to little more than the formal expression of minor administrative determinations. For instance, requests were made for additional time in which to file with the Commission or to transmit to security holders documents and other forms of information; requests, in effect, for stays pending the outcome of proceedings instituted under other provisions of the Act; and requests for temporary exemption from specified provisions because of a variety of circumstances. For the purposes of such applications, the exemptive power vested in the Commission has helped to eliminate many small but irritating inconveniences, particularly those which inevitably occur during the period of adjustment to new regulatory law, without sacrificing substance or principle.

Some of the applications filed under Section 6 (c), however, have requested sweeping substantive exemptions. Such applications involve considerations in many respects similar to those discussed in relation to applications filed by employees' securities companies under Section 6 (b). During the period between the effective date of the Act and the close of the fiscal year, only one application for complete exemption from the Act was granted under Section 6 (c). This order related to an unusual situation-an investment company created to hold the assets of the New York agency of a European bank with no known American investor interest in either the investment company, the agency, or the bank. The exemption, however, was granted for only 1 year.

It will be noted that the exemptive function of the Commission may be exercised not only by order on application but also by rule on the Commission's own motion. No rules have been adopted under this

section giving complete exemption to any class of companies. The few rules which have been adopted are principally of two types: procedural rules and rules de minimis:

A typical example of a procedural rule is Rule N-6C-3, which provides, in effect, that any employees' securities company which filed an application under Section 6 (b) of the Act prior to November 15, 1940, is exempt from the provisions of the Act applicable to investment companies until the Commission has finally determined the application. Such a rule is, in effect, a stay pendente lite and is comparable to the procedural orders of exemption to which reference has already been made.

An example of a rule de minimis is Rule N-15A-1. The Act contains a number of provisions regulating investment advisers of investment companies and the contracts pursuant to which they give their advice. Among these provisions is a requirement that investment advisory contracts be approved by the shareholders of the investment company concerned. Since the remuneration under such contracts commonly is as high as one-half of 1 percent of the value of the assets of the investment company per year, the essential soundness of this requirement of shareholder approval is obvious. An occasional company, however, may retain an investment adviser for special purposes under an arrangement providing for such small compensation that to require shareholder approval of the contract would be an unnecessarily cumbersome procedure which, instead of protecting the shareholders in any substantial sense, would merely distract their attention from more important aspects of the investment company's operations.

Rule N-15A-1 was therefore adopted. It provides, in effect, that an investment adviser of a registered investment company may act under a contract which has not been approved by the voting securities of the registered company in accordance with the provisions of Sections 15 (a) and (e) if such adviser is not otherwise affiliated either with the registered company or with a principal underwriter thereof; if his compensation either is not more than $100 a year or is not more than $2,500 a year and one-fortieth of 1 percent of the company's net assets as determined in accordance with the rule; and if the aggregate compensation of all investment advisers of such registered company either is not more than $200 a year or is not more than one-twentieth of 1 percent of the company's net assets.

CLASSIFICATION OF INVESTMENT COMPANIES

Investment companies are divided by the statute into three classes, namely, management companies, unit investment trusts, and faceamount certificate companies.