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potential, including some loans now classified as "nonpurpose." Unless the Board of Governors itself feels that further studies are necessary before requesting such authority, section 7 of the Exchange Act should be amended to authorize the Board of Governors to establish initial margin requirements on loans collateralized by securities, irrespective of their purpose, for banks and those lenders encompassed in paragraph 5 as well as brokerdealers. The authority should be sufficiently flexible so that the Board may take into account both the general economic and credit needs of the country and the immediate needs of the securities markets, enabling it to establish separate initial margin requirements adapted to those separate purposes. Pursuant to such authority, the Board should appropriately amend Regulations T and U to encompass such specific categories of “nonpurpose” loans collateralized by securities and establish such margin levels as may seem appropriate to it.

2. Section 7 of the Exchange Act should be amended to give the Board of Governors of the Federal Reserve System authority to permit broker-dealers to extend credit on such over-the-counter securities or classes thereof as it may from time to time designate, with such advice or assistance as it may request of the Commission. The Board's authority should permit it, in establishing initial margin requirements, to differentiate between listed securities and some or all over-the-counter securities and among various classes of over-the-counter securities. Pursuant to such authority, and assuming implementation of recommendations in chapter IX.B. for extension of investor protections (financial reporting and proxy and insider-trading controls) to certain overthe-counter securities, the Board should appropriately amend Regulation T to permit broker-dealers to extend credit on specified classes of stocks and convertible bonds included within the “OTC-listed” category referred to in chapter IX.B. for which reliable, current information is available.

3. Section 7 of the Exchange Act should be amended to empower the Board of Governors of the Federal Reserve System to impose initial margin requirements on actively traded over-the-counter stocks and convertible bonds used as collateral for loans by banks. This power should extend both to loans for purchasing or carrying securities and also for other purposes. The Board's authority should permit it to designate from time to time the classes of overthe-counter stocks and convertible bonds to be deemed actively traded for this purpose, with such advice or assistance as it may request of the Commission. Pursuant to such authority, the Board should amend Regulation U to extend margin controls to bank loans on those categories of over-the-counter stocks and convertible bonds so designated, which might coincide with, or differ from, the categories designated in respect of extension of credit by broker-dealers. It is not intended that such a requirement restrict banks from lending at their discretion, as at present, on inactively traded over-the-counter stocks, convertible bonds, or nonequity securities.

4. Whether or not the other recommendations herein are adopted, Regulation U should be amended so that loans collateralized by, or to purchase or carry, listed convertible bonds are subject to margin requirements similar to those on loans collateralized by stock to purchase or carry listed stocks, with appropriate exceptions or differentiation for convertible bonds whose market prices do not primarily reflect the availability of the conversion privilege.

5. Under the authority now provided by section 7 of the Exchange Act, the Board of Governors should subject "all persons" who make loans to U.S. residents, on the collateral of securities traded in U.S. markets, to the same requirements as are applicable to domestic bank loans collateralized by such securities, subject to appropriate exclusions for lenders in specified categories such as those not engaged in a business of lending or those never having aggregate outstanding security loans of more than a specified amount, say, $100,000. To aid in enforcement, domestic lenders should be required to keep specified records and file periodic reports, and domestic banks should be prohibited from furnishing any form of assistance or service to any foreign lender in connection with any loan not in conformity with such requirements.



[Part A (Introduction) briefly describes the structure of the mutual fund industry, outlines the growth of the industry since the enactment of the Investment Company Act of 1940, and delineates the area of inquiry of the chapter.]


The extraordinary growth of the mutual fund industry in the 23 years since the adoption of the Investment Company Act has raised a group of problems seemingly not contemplated by its framers. The very structure of the industry, unique as it is in the securities industry, creates special problems of concern for the adequate protection of investors. Mutual fund shares, alone among securities offered to the public, are constantly redeemable and continuously offered by their V issuers. Their statutorily required redeemability has been taken by most funds and their sponsors to justify, if not require, the creation of retail sales forces to facilitate the constant offering of shares. The growth of these sales forces is further stimulated by the frequently close relationship of the principal underwriters of mutual funds to their investment advisers, whose compensation is geared to the total net asset value of the fund and is increased as sales increase the size of the funds. Since generally the entire burden of the selling cost of mutual funds is borne by the purchasers of new shares (unlike the usual corporate offering at the market in which the issuer itself absorbs the cost of offering new shares), the funds' sales organizations are not restrained in their selling operations by considerations of costs to the funds. The sales organizations are also protected by the "fair trade” aspects of the Investment Company Act, the NASD rules, and the private sales agreements of the underwriters governing the prices and spreads at which shares can be sold.

Mutual funds and contractual plans are sold to investors by securities salesmen employed by a wide variety of firms, including firms engaged in the general securities business such as stock exchange member firms. The standards of selection, training, and supervision of salesmen for such firms have been described in chapters II and III, where it is noted that in some cases the requirements for salesmen v restricted to sales of mutual funds are lower than those for general securities salesmen. Sales of no-load funds are handled without the use of such sales organizations as are described below. However, a substantial proportion of all mutual fund shares and a very large proportion of contractual plans are sold by salesmen of large- or medium-sized firms specializing in the sale of mutual funds, some of the largest of which are affiliated with particular funds, their investment advisers and principal underwriters, and a few of which are not

members of the NASD or other self-regulatory organizations. The report's description in this chapter of selling organizations, selling practices, and training and supervision of salesmen applies principally, although with significant exceptions, to the sales organizations specializing in mutual fund shares.

The large- and medium-sized retail sales organizations which have grown up in the mutual fund industry are characterized by a particularly high turnover of salesmen. The heavy turnover requires them to engage in a continuous program of extensive recruiting, and recruits are overwhelmingly persons totally inexperienced in the securities business. Most sales organizations in fact prefer inexperienced recruits, though they look with favor on sales experience in other fields. The emphasis on inexperienced recruits in turn requires the sales organizations to supply them with such training as will be sufficient to enable them to pass qualifying examinations, where applicable, and to impart to them the tested techniques of mutual fund selling. Sales trainees are almost never paid during their training period, and their training is generally brief and conducted in the evenings on a parttime basis, sometimes in formal classroom-type programs but more often in informal discussions with a sales supervisor. The limited curriculum consists of two parts. The first part primarily provides such rudimentary introduction to the securities business, the Federal and State securities laws, the rules of the NASD and the Federal tax laws as will enable the trainee to pass the NASD examination (except for the large nonmember organizations) and such State examinations as may be required. The balance of training aims largely at acquainting the recruit with the product he will sell and instilling in him effective methods of prospecting, making presentations, and closing.

The mutual fund salesman, thus briefly trained, is then sent out to the public to sell mutual fund shares and contractual plans. He sells almost exclusively on straight-commission compensation arrangement, rarely with a draw against commissions, and often with the commission schedule weighted to favor sales of the shares of the fund or funds sponsored by his employer. His first sales, apart from those made to himself, are generally made to prospects from his personal circle of acquaintances. To be successful, however, the fund salesman must constantly enlarge his circle of prospects. This enlargement is accomplished through various standard prospecting techniques: Requests for referrals of names from persons to whom he has made sales, “radiation,” mailings, telephone calls, and the "cold turkey” call.

In his prospecting and presentations the mutual fund salesman is generally approaching a person who has not previously evinced an interest in buying mutual funds, and he often does not reveal at the outset that he is selling them. He frequently represents himself as an expert in financial planning, but the extent of financial planning performed by most fund salesmen is largely limited to persuading a prospect to invest a portion of his assets or earnings in equity investments. In many organizations the sales presentation is expected to be highly emotional and dramatic in tone, playing on such factors as fear, pride, and patriotism. As one industry representative has said of the mutual fund salesman:

He must do the approaching. Nor can he succeed in the effort of claiming attention with cold recitations of facts, figures, and legalistic jargon. He must be imaginative. He must color his approaches with excitement and drama.

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