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PART VIII

ADMINISTRATION OF THE INVESTMENT COMPANY ACT

OF 1940

The Investment Company Act of 1940 provides for the registration and regulation of companies primarily engaged in the business of investing, reinvesting, owning, holding, or trading in securities. The Act, among other things, requires disclosure of the financial and investment policies of such companies; prohibits changing the nature of their business or their investment policies without shareholder approval; regulates the means of custody of the companies' assets; requires management contracts to be submitted to security holders for 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 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 the certificates.

The securities of investment companies which are offered to the public are also required to be registered under the Securities Act of 1933 and the companies must file periodic reports. Such companies are also subject to the Commission's proxy rules and certain “insiders” of closed-end companies are subject to reporting and "short swing" trading rules. In November 1964, certain functions relating to investment companies were reallocated from the Division of Corporation Finance to the Division of Corporate Regulation, including the administration of the disclosure requirements with respect to registration statements filed by such companies under the Securities Act of 1933 and the administration of the periodic reporting, proxy solicitation and other provisions of the Securities Exchange Act of 1934 with respect to registered investment companies. On the basis of the experience since the transfer of functions, the resulting concentration of responsibility in the Division of Corporate Regulation for the administration of the securities laws as they apply to investment companies has been of material convenience to registrants and other persons concerned with investment companies.

COMPANIES REGISTERED UNDER THE ACT As of June 30, 1965, there were 727 investment companies registered under the Act, including 69 small business investment companies. Of this total, 616 were "active" companies, whose assets had an aggregate market value of approximately $44.6 billion. Compared with the corresponding totals at June 30, 1964, these figures represent an overall increase of approximately $3 billion in the market value of assets, while the number of registered companies decreased by four. The classification of the registered companies and the approximate market value of the assets in each category as of June 30, 1965, are shown in the following table:

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• "Inactive,” as used herein, refers to registered companies which, as of June 30, 1965, were in the process of being liquidated or merged, or which have otherwise gone out of existence and remain registered only until such time as the Commission issues orders under Section 8(1) of the Investment Company Act termi. nating their registration.

The approximately $3.3 billion of assets of the "active” registered unit investment trusts includes approximately $2.8 billion of assets of registered unit investment trusts which invest in securities of other registered investment companies, substantially all of them management open-end companies.

During the fiscal year, 50 new companies, including 3 small business investment companies, registered under the Act while the registrations of 54 companies, including 7 small business investment companies, were terminated. The classification of these companies is as follows:

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GROWTH OF INVESTMENT COMPANY ASSETS The following table illustrates the striking growth of assets of investment companies over the years since the enactment of the Investment Company Act: Number of investment companies registered under the Investment Company Act

and their estimated aggregate assets, in round amounts, at the end of each fiscal year, 1941 through 1965

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. The increase in aggregate assets reflects the sale of new securities as well as capital appreciation.

INSPECTION AND INVESTIGATION PROGRAM During fiscal year 1965, a total of 146 investment company inspections was completed pursuant to the statutory authority conferred on the Commission by Section 31(b) of the Investment Company Act. A large number of the inspections disclosed violations not only of the Investment Company Act but also of other statutes administered by the Commission. A number of the violations uncovered during the course of routine inspections were serious in character. These included inadequate arrangements for safekeeping of the investment company's portfolio securities or failure to observe the safekeeping procedures which had been established. The inspections also disclosed several situations in which the procedures for pricing shares for purposes of purchase or redemption were not in conformity with the statute or the investment company's prospectus. Several instances were found in which the investment company failed to redeem shares within the required statutory period. The inspections further uncovered a number of instances in which transactions violating Section 17 of the Act had been effected by affiliated persons.

Largely as an outgrowth of information obtained during these inspections, 23 private investigations were commenced during the fiscal year. On the basis of the facts obtained in the investigations, two civil actions were instituted by the Commission. One of the actions (S.E.C. v. Capital Funds, Inc., et al.) 1 sought to enforce compliance with the proxy solicitation requirements of the Investment Company Act and the Securities Exchange Act of 1934 in connection with a proxy solicitation of shareholders of Modern American Mortgage Corporation, a then registered investment company. In that civil action, the Commission also sought to enjoin the defendants from offering to purchase the securities of Modern American Mortgage Corporation by means of allegedly fraudulent statements concerning, among other things, the net worth, earnings, assets and future market value of the securities of that company.

As a result of the Commission's inspection and investigation program, a total of $1,541,000 was returned during fiscal 1965 to investment companies for the benefit of shareholders or to the shareholders directly. Following one inspection, a court-ordered liquidation of an unregistered investment company resulted in a distribution of assets totalling $1,287,170 to that company's shareholders. In another instance, the Commission's staff, during a routine examination, discovered that an investment company officer had been converting funds by causing the company to purchase worthless short-term notes of a fictitious enterprise. Following this discovery, the investment company was fully indemnified for its losses, which aggregated $195,000. In a third instance, through the efforts of the Commission's staff, $39,441 was returned to an investment company in settlement of that company's claims against an affiliated broker-dealer firm arising from excessive brokerage commissions and trading profits and from the broker-dealer's activities in causing the company to engage in certain unauthorized principal trades with another affiliated business entity. REVISION OF ANNUAL REPORT FORM FOR MANAGEMENT

INVESTMENT COMPANIES Even under an expanded inspection program, such as has been pursued by the Division of Corporate Regulation in the past few years, certain investment companies inevitably require closer or prompter scrutiny. Because of this and the continued growth in the number and size of investment companies, the Commission considered that the public interest and the protection of investors would be served by strengthening the annual report filed by investment companies, and

* No. LR-64C-123, E.D. Ark. (April 20, 1965).

* S.E.C. v. Max J. Royer, Business Development Corp. et al., Civ. Act. IP 63-C334 S.D. Ind. (Order dismissing action, August 28, 1964).

adopted a revised form, captioned Form N-1R, effective for all fiscal years ending on and after December 31, 1964.3

In adopting Form N-1R the Commission determined to amend the reporting requirements in two major respects. First, the previous form was revised to provide for additional information in the public reports filed by registered management investment companies. Second, a new nonpublic report is provided as a part of the form. The data in both reports will materially assist the Commission in its inspection program. In addition, the reports will serve the purpose of bringing to the attention of the persons responsible for the management and operations of investment companies information which will assist them to determine more readily whether the statutory standards and requirements are, in fact, being complied with, and thus contribute to the achievement of a substantial degree of selfinspection.

FILINGS REVIEWED Investment companies offering their shares for sale to the public must file a registration statement for their securities under the Securities Act of 1933 as well as register under the Investment Company Act. The registration statements and revised prospectuses of investment companies filed pursuant to the Securities Act are reviewed for compliance with that Act and the Investment Company Act. The Commission's rules promulgated under the Investment Company Act generally require that the basic information contained in notifications of registration and in registration statements of investment companies be kept current through periodic and other reports. In addition, proxy soliciting material filed by investment companies is reviewed for compliance with the Commission's proxy rules. The following table sets forth the volume of filings processed during the past fiscal year:

* Investment Company Act Release No. 4151 (January 25, 1965). Because of the increased scope of this form, the due date of the first annual report filed by a registered company on the form was extended, from not more than 120 days as previously required for the filing of annual reports, to not more than 180 days after the close of the fiscal year covered by the report. For companies whose fiscal year ended on December 31, 1964, the first report on Form N-1R was thus required to be filed not later than June 29, 1965.

* As noted at p. 116, infra, the proposal to amend Rule 20a-2 with respect to information to be disclosed in proxy statements was withdrawn. In connection with the withdrawal the Commission indicated that further consideration of an amendment of Rule 20a-2 will be undertaken, including the extent to which the information called for by certain items of Form N-1R should be disclosed in proxy statements, prospectuses and reports to shareholders of registered investment companies.

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