PART VIII

ADMINISTRATION OF THE TRUST INDENTURE ACT OF 1939

Bonds, notes, debentures, and similar securities publicly offered for sale, except as specifically exempted by the Trust Indenture Act of 1939, must be issued under an indenture which meets the requirements of the act and has been duly qualified with the Commission. Indentures to be qualified are required to include specified provisions which provide means by which the rights of holders of securities issued under such indentures may be protected and enforced. These provisions relate to designated standards of eligibility and qualification of the corporate trustee to provide reasonable financial responsibility and to minimize conflicting interests. The act imposes on the trustee, after default, the duty to use the same degree of care and skill "in the exercise of the rights and powers invested in it by the indenture" as a prudent man would use in the conduct of his own affairs. Exculpatory provisions formerly used to eliminate all liability of the indenture trustee are outlawed.

The provisions of the Trust Indenture Act are closely integrated with the requirements of the Securities Act. Registration pursuant to the Securities Act of securities to be issued under a trust indenture subject to the Trust Indenture Act is not permitted to become effective unless the indenture conforms to the requirements of the latter act, and necessary information as to the trustee and the indenture must be contained in the registration statement. In the case of securities issued in exchange for other securities of the same issuer and securities issued under a plan approved by a court or other proper authority which, although exempted from the registration requirements of the Securities Act, are not exempted from the requirements of the Trust Indenture Act, the obligor must file an application for the qualification of the indenture, including a statement of the required information concerning the eligibility and qualification of the trustee.

Indentures filed under the Trust Indenture Act of 1939 during the fiscal year ended June 30, 1959

PART IX

ADMINISTRATION OF THE INVESTMENT COMPANY ACT OF

1940

Companies engaged primarily in the business of investing, reinvesting, holding and trading in securities are subject to registration and regulation under the Investment Company Act of 1940. This act, among other things, prohibits such companies from changing the nature of their business or their investment policies without the approval of their stockholders, requires disclosure of the finances and investment policies of these companies, regulates the means of custody of the companies' assets, requires management contracts to be submitted to security holders for their approval, prohibits underwriters, investment bankers and brokers from constituting more than a minority of the directors of such companies, and prohibits transactions between such companies and their officers, directors and affiliates except with the approval of the Commission. The act also regulates the issuance of senior securities and requires face-amount certificate companies to maintain reserves adequate to meet maturity payments upon their certificates.

Investment companies which offer securities to the public must file appropriate registration statements under the Securities Act. Registered investment companies must also file periodic reports and are subject to the Commission's proxy and insider trading rules. Both the Division of Corporation Finance and the Division of Corporate Regulation assist the Commission in the administration of this statute, the former being concerned with the disclosure provisions and the latter with the regulatory provisions.

COMPANIES REGISTERED UNDER THE ACT

During the fiscal year ending June 30, 1959, 70 new companies registered under the act while the registrations of 11 companies were terminated. The following classes of companies were involved:

None of the 70 new registered companies were deregistered during the year. Eight of the new registrations were filed by small business investment companies which had received from the Small Business Administration notice to proceed to qualify for a license under the Small Business Investment Act of 1958.

As of June 30, 1959, there were 512 investment companies registered under the act, and the estimated aggregate market value of their assets on that date was $20 billion. These figures represent an overall increase of 59 registered companies and an increase of roughly $3 billion in the market value of assets over the corresponding totals as of June 30, 1958. The total registered companies by classification are as follows:

The following table illustrates the striking growth of registered investment company assets during the past 18 years, and particularly in recent years:

Number of investment companies registered under the Investment Company Act and the estimated aggregate assets at the end of each fiscal year, 1941 through 1959

*The increase in aggregate assets reflects the sale of new securities as well as capital appreciation. By way of llustration, the National Association of Investment Companies reported that during the calendar year 1958 its open-end investment company members, numbering 151 and representing the bulk of the industry, had net sales of their securities amounting to $1.1 billion.

PROGRAM FOR INSPECTION OF INVESTMENT COMPANIES

The Commission, as indicated in its 23d and 24th Annual Reports, has initiated a program for the periodic inspection of investment companies pursuant to the statutory authority under section 31 of the Investment Company Act. Up to the fiscal year 1958, 16 companies had been inspected. Fourteen companies were inspected in fiscal 1959, the third year of the inspection program. These inspections were undertaken by staff teams usually consisting of one attorney or analyst from the Division of Corporate Regulation and one securities investigator from the appropriate field office in order to combine the specialized training and knowledge of the staff concerning the regulatory requirements of the Investment Company Act with the field experience and investigative expertness of field office personnel.

Inspections made in the past 3 years indicated, in some instances, noncompliance with regulatory provisions of the Investment Company Act. For example: (1) improper selling practices by salesmen who promoted the sale of mutual fund shares just prior to dividend payment dates without explaining that the amount of dividend to be paid was included in the purchase price of the shares on which a salesload was paid and that receipt of the dividend would represent a return of capital on which the shareholder would be liable for income taxes; (2) deviations from fundamental policy without approval of stockholders; (3) improper composition of boards of directors because of the affiliation of directors; (4) acquisition of securities during an underwriting where an affiliated relationship existed between underwriter and company; (5) sale of securities to a company by an affiliated person acting as a principal; (6) failure to file appropriate fidelity bond; (7) noncompliance with the requirements for the custody of the portfolio securities of a company under section 17 of the act; and (8) failure to obtain approval of stockholders or the Board of Directors for an investment advisory contract.

In addition to noncompliance with various regulations and standards required under the act, there were instances where books and records of the companies were inadequate or lacking. For example: (1) failure to record the date and time of requests for redemption, thus making it impossible to determine whether the investors received their correct net asset value; (2) failure to maintain purchase and sales journals; failure to maintain ledger accounts for broker-dealers used by the company for its portfolio security transactions; and (3) failure to keep proper vouchers for out-of-pocket expenses. In addition, the staff noted instances where the custodian did not adhere to the terms of the custodianship agreement, or the Commission's regulations on the safekeeping of portfolio securities of the company. In some instances, there was a considerable delay in the transmission

to the investment companies of funds received by dealers selling mutual fund shares.

In cases where deficiencies are noted, unless other action is indicated, they are brought to the attention of the investment companies involved so that corrective steps may be taken. The Commission's experience to date shows that this aspect of the inspection program will prove to be particularly helpful to the newly organized or the smaller investment company, and of benefit to the investing public.

STUDY OF SIZE OF INVESTMENT COMPANIES

On behalf of the Commission, the Securities Research Unit of the Wharton School of Finance and Commerce of the University of Pennsylvania is now conducting a fact-finding survey in connection with a study of the problems created by the growth in size of investment companies (see 24th Annual Report, p. 148). This inquiry, made pursuant to the direction contained in section 14(b) of the Investment Company Act, is being conducted, at present, through the use of a questionnaire directed to the various investment companies. The questionnaire was prepared by the staff of the Wharton School after discussion with the Commission and representatives of the investment company industry and was distributed by the Commission early this year. Shortly before the close of the past fiscal year the Wharton School submitted to the Commission a progress report on its size and study activities.

The report indicates that substantial data in reply to the early phases of the questionnaire have been obtained and are being processed. In the initial stage of the work, detailed processing is being concentrated on the replies of open-end companies. A preliminary report on certain phases of the size study is planned early in the next fiscal year. It is anticipated that later other preliminary reports covering other aspects of the study will be available.

When it receives the full report from the Wharton School on the size study survey, it is expected that the Commission will be in a position to determine whether the increased size of investment companies has created any problems which require specific remedial legislative recommendations by the Commission to the Congress.

CURRENT INFORMATION

The Commission's rules promulgated under the act require that the basic information contained in notifications of registration and in registration statements of investment companies be kept up-todate, through periodic and other reports, except in cases of certain inactive unit trusts and face-amount companies. The following current reports and documents were filed during the 1958 fiscal year: