principal underwriter, controlling persons of the investment adviser or principal underwriter, or the principal executive officer of such investment companies, and the principal executive officer of the investment adviser or principal underwriter of an investment company.

Under this proposed section, a person would be deemed an interested person because of a business or professional relationship only if the Commission, by order, determines that he has, at any time during the prior 2 fiscal years, had a material business or professional relationship with persons specified in the statute. Such order would not be retroactive. It would take effect 60 days after the entry thereof and would not affect the status of a person for the purpose of the act or for any other purpose for any period prior to the effective date of the order. The Commission could issue an order under the proposed amendment determining that a director of an investment company is an interested person if it should find that a business or professional relationship was material in the sense that it might tend to impair the independence of such director. Ordinarily, a business or professional relationship would not be deemed to impair independence where the benefits flow from the director of an investment company to the other party to the relationship. In such instances the relationship is not likely to make the director beholden to that party. For example, a director ordinarily would not be considered to have a material business relationship with the investment adviser simply because he is a brokerage customer who is not accorded special treatment. A business relationship arising solely from the fact that the chief executive officer of an investment adviser to an investment company and a director of that investment company are directors of another company, whether that company is an investment company managed by the same investment adviser or a separate industrial corporation ordinarily would not be deemed material. Similarly, a director of one investment company would not ordinarily be deemed an interested person of that company by reason of being a director of another investment company with the same adviser. This case-by-case method of implementing the material business and professional relationship test would eliminate any danger of inadvertent violations of the requirements of the act and adequately implement your committee's basic intent in proposing this section.

Finally, the section provides that no person is to be deemed to be an interested person of an investment company solely by reason of his being a member of its board of directors, advisory board, an owner of its securities or a member of the immediate family of such a person.

Part F-Administrative and Other Proceedings

SECTION 4, AMENDING SECTION 9-PROVIDING FOR ADMINISTRATIVE ACTION AGAINST CERTAIN PERSONS SERVING INVESTMENT COMPANIES

Section 4(b) of the bill would add a new subsection (b) to section 9 of the act to empower the Commission, after notice and opportunity for hearing, to bar an individual, either permanently or for such time as may be appropriate, from serving an investment company in the capacities now enumerated in section 9 or as an employee of an investment company or as an affiliated person of its investment adviser,

depositor, or principal underwriter. The Commission could take such action only if it found (1) that the individual in question had willfully violated, or had willfully participated in a violation of any provision of the Securities Act, the Securities Exchange Act, the Investment Company Act or the Investment Advisers Act or any rule or regulation under those statutes; and (2) that the action was in the public interest. The proposed amendment would supplement the existing provisions of section 9. It would provide grounds and procedures for disqualification from affiliation with an investment company of persons willfully violating the Federal securities laws.

Under the proposed amendment if the Commission finds that an investment adviser or broker dealer or an associated person thereof has violated the antifraud or other provisions of the Investment Advisers Act or the Exchange Act and has barred or suspended him from serving as an investment adviser or broker-dealer or from association with a broker-dealer, it can also prevent him from being associated with an investment company, its adviser or its principal underwriter.

Like the provisions of section 15(b) of the Securities Exchange Act and section 203 (d) of the Investment Advisers Act, the proposed amendment would provide for an administrative proceeding to determine whether persons have engaged in willful misconduct and whether the public interest requires that such persons be barred from serving an investment company.

The proposed amendment will correct another deficiency of section 9 which bars a person convicted of certain crimes or enjoined on the basis of misconduct specified in that section from serving as an officer, director, or investment adviser of an investment company, but permits such a person to be an employee of an investment company.

Further, under the proposed amendment, in appropriate cases, the Commission could proceed against an individual affiliated with a company's investment adviser, principal underwriter, depositor, or sponsor without naming or joining the individual's employer as a party in such proceeding. Moreoever, the Commission could, where appropriate, institute private proceedings which would not be made public unless and until the parties so request or adverse findings are made against the individual or company involved.

SECTION 20, AMENDING SECTION 36-ENJOINING BREACH OF FIDUCIARY DUTY INVOLVING PERSONAL MISCONDUCT

Section 36 of the act presently authorizes the Commission to bring an action in the U.S. district courts to enjoin persons from acting in relation to an investment company if such a person has been guilty of gross misconduct or gross abuse of trust.

The highly punitive overtones of the existing section, together with the injunctive penalty, seriously impairs the ability of the courts to deal flexibly and adequately with wrongdoing by certain affiliated persons of investment companies. Therefore, this proposed section would authorize actions to enjoin breaches of fiduciary duty involving personal misconduct. It also empowers the courts to grant such relief as it finds necessary or appropriate. The amended section will enable the Commission to move against officers, directors and advisory board members of an investment company and its investment advisers

or principal underwriters if they engage or are about to engage in conduct which violates prevailing standards of fiduciary duty involving personal misconduct.

This section is intended to deal only with such violations committed by individuals. It is not intended to provide a basis for the Commission to undertake a general revision of the practices or structures of the investment company industry. In appropriate cases, nonfeasance of duty or abdication of responsibility would constitute a breach of fiduciary duty involving personal misconduct.

Part G-Coverage

SECTION 3(a), AMENDING SECTION 3(b)(2)—REQUIREMENT OF GOOD

FAITH

Under section 3 (b) (2) of the act any issuer, other than a registered investment company, may file an application for an order of the Commission declaring it to be exempt from regulation under the act in accordance with the standards of that section. The filing of such application provides an automatic 60-day exemption from all provisions of the act; during this 60-day period, an applicant may engage in activities prohibited under the act even though the Commission may ultimately deny the application.

Section 3(a) of the bill would amend section 3(b) (2) to specify that this automatic 60-day exemption is available only if the application is filed in "good faith."

While a requirement of "good faith" is implicit in the statute, the existing statutory language does not so provide. By making the requirement an explicit one, companies would be placed on notice that an automatic exemption cannot be obtained by the filing of a frivolous application not presenting a colorable claim to the exemption from regulation provided for by section 3(b)(2).

SECTION 3(b)(2) AMENDING SECTION 3(c) (8)—-DELETION OF EXCLUSION

FOR COMPANY 90 PERCENT OR MORE OF WHOSE SECURITIES ARE THOSE OF CERTAIN SINGLE ISSUERS

Section 3(c) (8) excludes from the statutory definition of an investment company a company 90 percent or more of the value of whose investment securities are those of any single bank, insurance company, or other financial institutions of the types enumerated in sections 3(c), (5), (6), and (7) of the act. Section 3(b) (3) of the bill would delete this paragraph from the act.

The availability of the section 3(c) (8) exemption to companies which hold, solely as an investment, securities of certain types of financial institutions appears to be wholly inconsistent with the statutory policy of the coverage of the act and should be removed. Its deletion from the act will not affect existing exclusions for companies which control or manage the enterprises whose securities they hold.

SECTION 3(b)(3) AMENDING SECTION 3(c)(6)—MODIFICATION OF EXCLUSION FOR COMPANIES ENGAGED IN FACTORING, DISCOUNTING, AND REAL ESTATE BUSINESSES

Under the existing provisions of section 3(c) (6) companies engaged primarily in factoring, discounting, and real estate are excluded from

the definition of an investment company unless they are engaged in the business of issuing face-amount certificates of the installment type or periodic payment plan certificates.

Section 3(b)(3) of the bill would amend section 3(c)(6) of the act to provide that, in addition to existing limitations, the exclusion from the definition of an investment company provided by that section would be unavailable to any such company issuing a security redeemable at the election of the holder.

Although the companies enumerated in section 3(c) (6) have portfolios of securities in the form of notes, commercial paper, or mortgages and other liens on and interests in real estate, they are excluded from the act's coverage because they do not come within the generally understood concept of a conventional investment company investing in stocks and bonds of corporate issuers. The proposed amendment would have the effect of extending the regulatory provisions of the act to certain of these companies which in recent years have attempted to capitalize on the popularity of open end companies by issuing reedemable securities.

SECTION 3(b)(4), AMENDING SECTION 3(c) (10)—CLARIFICATION

OF

EXEMPTION FOR HOLDING COMPANY REGISTERED UNDER PUBLIC UTILITY HOLDING COMPANY ACT OF 1935

Section 3(c) (10) now excludes from the coverage of the act any company "with a registration statement in effect as a holding company under the Public Utility Holding Company Act of 1935." Section 3(b)(4) of the bill would amend section 3(c) (10) of the act to make the exclusion provided by that section available to companies "subject to regulation under the Public Utility Holding Company Act of 1935."

SECTION 10, AMENDING SECTION 18(f) (2)—MODIFICATION OF DEFINITION

OF SENIOR SECURITY

Section 18(f) of the act makes it unlawful for any registered open end investment company to issue or sell any senior security. The term "senior security" does not, under section 18(f) (2), include shares of a particular "series" the holders of which are preferred over the holders of all other series in respect of assets specifically allocated to that series.

Section 10 of the bill would amend section 18(f) (2) to give the Commission specific power by rule, regulation, or order to require that any matter affecting shareholders of any series of shares issued by such companies, including the election of directors, be voted upon separately by such series.

Although it is contemplated that any such rule may provide that approval of stockholders holding a certain percentage of stock is necessary for the election of directors, it is not intended that the authority granted by this amendment would be used to require that a company set up groups of individuals for each series with functions similar to those of the company's overall board of directors. Similarly, it is not intended that any rule would relieve the company of any requirements with respect to voting that may be applicable under State law. A majority of the outstanding voting securities of a class or series would be computed in the manner set forth in section 2(a) (40) of the act.

Part H-Management-Shareholder Relationships

SECTIONS 8(c) AND 18, AMENDING SECTIONS 15(c) AND 32(a)—ATTENDANCE AT DIRECTORS' MEETINGS

Sections 15(a), 15(b), 15(c), and 32(a) of the act provide for (a) renewal of advisory contracts; (b) approval and renewal of underwriting contracts; and (c) the selection of independent auditors by the board of directors of an investment company, including a majority of the unaffiliated directors. These sections do not require the attendance in person of the members of the board of directors at meetings where required action is taken, even though their vote is necessary to meet the statutory requirements.

Sections 8(c) and 18 of the bill would amend sections 15(c) and 32(a) of the act to provide that the voting requirements of sections 15 and 32 can be satisfied only by directors who are personally present at a meeting at which their votes are taken. The proposed amendment is intended to assure informed voting on matters which require action by the board of directors of registered investment companies.

SECTION 8(a) AND 8(b), AMENDING SECTIONS 15(a) (4) AND 15(b)(2)— ASSIGNMENT OF ADVISORY AND UNDERWRITING CONTRACTS

Section 15(a) (4) of the act requires that an investment advisory contract provide for automatic termination upon its "assignment by the investment adviser." Similarly, section 15(b) (2) requires that underwriting contracts provide for automatic termination upon their "assignment by such underwriter."

Section 8(a) of the bill would amend section 15(a) (4) of the act to delete the words "by the investment adviser" and section 8(b) of the bill would amend section 15(b)(2) to delete the words "by such underwriter."

Section 2(a) (4) defines the term "assignment," among other things as occurring when some action is taken by persons other than the investment adviser or underwriter. Thus, under the definition, assignment includes any direct or indirect transfer of a controlling block of outstanding voting securities by a security holder of the adviser or underwriter. Section 15, however, introduces an ambiguity into the act because it refers only to an "assignment" by the adviser or underwriter itself and not by a person holding a controlling block of stock of the adviser or underwriter. The proposed amendment will remove this possible ambiguity without making a substantive change in the existing law.

SECTION 9(a), AMENDING SECTION 17(f)—CASH ASSETS INCLUDED

UNDER BANK CUSTODY

Under section 17(f), an investment company of the management type must place "its securities and similar investments" in the custody of (1) a bank, (2) a stock exchange firm subject to rules prescribed by the Commission or (3) itself, subject to rules or orders prescribed by the Commission. If a company chooses to retain the custody of its securities, it must deposit them with certain specified institutions for safekeeping, subject to certain rules as to access, earmarking, and inspection.