as the Commission specifies. The report can also contain other information. The section sets a minimum there, but it does not set a maximum.

The purpose of the provision is to make it possible for the Commission to make all investment companies conform to the present practices of the more reputable companies.

Senator HUGHES. I suppose when we hear the opposition to the bill, one principal point will be the difficulty of making these statements and the cost and expense of them, and all that kind of thing. It always is.

Mr. HOLLANDS. A great majority of companies already send reports to stockholders. I do not think that there would be much difficulty in tying those reports into the reports they file with the Commission. Senator HUGHES. I suspect the information is meager, like most of the reports that companies send to their stockholders.

Mr. HEALY. I think it may be said that the real source of this particular provision in the bill grows out of experiences we have had under the Securities Act, where we analyzed a number of the annual reports that the corporations were sending to their stockholders, and found that there were variations and inconsistencies between the reports filed under oath, under the Securities Act, and those which were sent to the stockholders with the annual report. What we are trying to get at here is to really get rid of that kind of thing. I do not think the industry will find any fault with that general principle, although they may find fault, and perhaps with some justice, with the provision that we might ask that the reports be made too often, or something of that sort.

Mr. SCHENKER. In that connection, Senator, that is the value of the provision which gives the Commission the power to classify companies. We can say a small company shall only send out reports semiannually; that a big company shall send them quarterly. Also it indicates the value of the exempting provisions. We can say that a small company shall not be subject to these rules.

Mr. HOLLANDS. Subsection (d) makes the beneficial holders of more than 10 percent of the outstanding securities of investment companies, and the officers and directors of such companies, subject to what are substantially the reporting requirements and the liability provision of section 16 of the Securities Exchange Act of 1934. In other words, the purpose of this subjection is to make all registered investment companies subject to the same provisions regarding trading by insiders in the company's securities that the listed companies are now subject to.

I may say in that connection that the drafting of subsection (d) is defective and needs a lot of patching.

Subsection (e) deals with another problem that is peculiar to investment companies. You may have a case of officers, directors, or other insiders trading to their own advantage and to the detriment of the trust, not in the securities which the trust itself issues, but in portfolio securities of the trust.

That is not a matter that is probably of terrifically frequent occurrence, although it can be very bad when it does happen. It is also a very delicate matter to deal with. We are attempting here to reach a compromise between the various considerations by making this provision. The insider is required to report to the board of

directors of the company-and this applies only to management companies in any case-all purchases and sales which he has made during the past fiscal quarter, of securities held in the portfolio of the company; that is, securities of the same issuers. The report does not have to be made until 30 days after the end of the quarter. It is made only quarterly and is made only to the board of directors of the company, not to the Commission, to insure privacy. The practical effect of that should be that there would be no serious abuses in trading against the trust, because the person has got to disclose it to the directors.

Mr. SCHENKER. On that aspect, Senator, we have a great many instances where officers and directors will trade in the securities or buy securities a little before the investment trust does, so that the insider is getting a free ride on the purchases of the stock by the investment trust.

You see, the whole business of the investment trust is trading in securities. You may meet a situation where there may be conflicts of interest between the officer buying the stock and the investment trust buying the stock. The officer may buy his first and get the stock at a cheaper price than the investment trust does.

We say in that situation that he ought to tell his board of directors that "I was trading in or buying securities which you have in our portfolio." He does not tell it to the Commission. He tells it to his own board of directors.

The fact of the matter is that this is not a novel provision. There are several investment trusts which-after we started our investigation-voluntarily adopted that provision, and went further than we did, and said that at the time the investment trust was trading in the securities no officer, manager, or employee should trade in such securities. So it is really a requirement of a practice which has been adopted by some investment companies already.

Mr. HEALY. Section 31 of the bill deals with accounts and records; and I think enough has been said to make it plain that the matter of accounts and accounting of these companies is an extremely important matter and lies close to the heart of a great many of the difficulties.

This section requires the keeping of accounts which are made subject to the Commission's inspection at any time. The purpose is to make these companies subject to the same type of examination as are national banks, although it is hoped that such extensive and regular examination will not be necessary in actual administration. That, in general, is the import of sections (a), (b), and (c).

Paragraph (d) authorizes the Commission to prescribe uniform accounting rules; and this power extends not only to uniform methods of keeping accounts, but also to uniform methods of determining what entries should be made, and in what amount.

I would like to say that if this authority is given the Commission, it will be worked out exactly as the same authority was worked out under the Holding Company Act when we got up our uniform classification of accounts for holding companies and servicing companies. That was done in consultation with the industries and with the leaders of the accounting profession.

The lack of uniform standards and the lack of dependable standards in the accounting field has had very bad effects in many directions, and nowhere any worse than in the investment trust field.

Section (e) permits the enforcement of the uniform accounting rules by requiring by order that the company may make specific entries in specific books. Otherwise the only remedy would be the institution of punitive or injunctive proceedings for violation of the uniform accounting rules.

Section (f) is a technical qualification of the paragraphs that I have described. It permits the companies to maintain supplementary records, provided they do not impair the integrity of the accounts classified.

Section 32 is somewhat along the same line and deals with accountants and auditors. I will describe it very briefly and in very general

terms.

Subdivision (a) requires that except in emergencies any independent public accountant retained by an investment company shall be selected by the company's stockholders.

I think that the benefits that may come from that are largely psychological, but it will help to bring home to the independent public accountant that he is not any longer retained merely to find out if somebody in the office force is stealing the petty cash or merely to inform the directors as to what has happened in their company, but that under the existing statutes and existing practice that independent public accountant is really acting for the security holders rather than for the management.

Senator HUGHES. The security holders have selected him?

Mr. HEALY. If this bill is passed the stockholders are to select. the independent accountant.

Senator HUGHES. I thought I saw something in the bill about the voting securities.

Mr. HEALY. That is true. I did not realize you were making a distinction between voting securities and other securities.

Senator HUGHES. I wondered whether other securities had an interest.

Mr. HEALY. Under the terms of this bill all the holders of stock in the future will have voting rights, if the bill is passed.

There are of course some difficulties about getting the names and properties of other types of security holders, such as debenture holders. It did not seem wise to carry it that far.

Under subsection (b) the comptroller or other principal accounting officer of an investment company is to be selected by the company's voting security holders or by the board of directors, but not by the president.

Under subsection (c) the commission is authorized to prescribe the minimum scope of the procedure to be followed in audits and to require accountants and auditors to keep accounts, reports, and work sheets, and so one, and have them available for inspection.

We have had some talk with representatives of accounting societies. and, as I understand it, the one objection they make relates to subsection (c) of section 32. They have some difficulty with the proposal that the commission be authorized to prescribe the scope of procedure to be followed in audits. I am very hopeful that we can work out some substitute language for that.

The difficulty arises, according to my point of view, at least, from the fact that no two accountants ever seem to agree on what an audit is. Every one that you meet has a different definition of audit.

When I picked up the certificate that was made by the auditors and attached to the McKesson & Robbins statement, and held it up alongside of a copy of the engagement or contract between the McKesson & Robbins Co. and the auditors, taking that in one hand and their certificate in the other, I was extremely surprised. I did not see anything in the certificate that gave a security holder fair warning as to what things the auditor was responsible for and what things he was not responsible for.

It may be that there is some other way of approaching this. I despair of ever coming to an agreement as to a definition of audit. It may be that if the Commission is authorized to set some minimum standards, or if the Commission is authorized to require an auditor to disclose in some general way what he does or does not do, that will meet the problem.

If the committee is agreeable, we will continue our discussions with the accounting societies with the hope that we can bring back something that will be acceptable to them and to the proponents of this bill. Senator HUGHES (presiding). We will take a recess at this time until 2:30 this afternoon.

(Whereupon, at 12:45 p. m., a recess was taken until 2:30 p. m., of the same day.)

AFTER RECESS

The subcommittee resumed at 3 p. m.

Senator WAGNER (chairman of the subcommittee). The subcommittee will resume. I have no doubt other members of the subcommittee will be here in a few minutes.

Mr. HEALY. Mr. Chairman, might I make a brief statement at this time?

Senator WAGNER. Yes.

ADDITIONAL STATEMENT OF ROBERT E. HEALY, COMMISSIONER SECURITIES AND EXCHANGE COMMISSION, WASHINGTON, D. C.

Mr. HEALY. Before Mr. Schenker resumes his discussion of the bill I would like to offer for the record a memorandum showing the cost of the study and a description of the work completed by the investmenttrust study of the Commission. This is the expense item that Senator Townsend asked for a few days ago. If he or anyone else desires a further break-down of it we will be glad to get it.

In that connection I would like to say that each year, when the Commission has been before committees of Congress dealing with appropriations, the status of the investment-trust study has been reported, and each year additional funds have been appropriated by Congress for carrying on the investigation.

Senator WAGNER (chairman of the subcommittee). That will be made a part of the record at this point.

(The memorandum referred to, dated April 10, 1940, is made a part of the record, as follows:)

[Memorandum]

To: Senate Committee on Banking and Currency.

From: Securities and Exchange Commission.

APRIL 10, 1940.

Re: Cost of study and description of work completed by the Investment Trust Study.

I. Description of work completed by Study:

A. Public examinations:

250 companies subject of public examination.

33,000 pages of testimony taken in connection with public examina

tions.

4,800 exhibits introduced in connection with public examinations. 100 companies subject of field investigation.

B. Reports submitted to Congress:

! Includes 8 lawyers, 3 accountants, and balance includes statistical and stenographic staff.

Mr. HEALY. Next, this morning when I was testifying I expressed the idea, possibly with some reservations, that the Federal Communications Commission had the same power, to approve or disapprove reorganizations in court which is given to the Interstate Commerce Commission under the Transportation Act, and given to the Securities and Exchange Commission under the Holding Company Act. I was mistaken. I understand they do not have any such power, although they are given power to appear and be heard in 77B or the Chandler Act cases as we should call them now, involving companies subject to their jurisdiction.

One other item: This bill does not have a provision covering the matter of notice and hearing in advance of orders to be issued by the Commission. That was not an oversight. It was omitted with the