in some quarters and criticism in others. We want to be fair and reasonable to the industry; we also want to be fair to investors.

In general, various commentators, without approving of all the details of the bill, have said that it gives the general impression of a mild and well-considered measure. Among these may be noted the New York Times, the Christian Science Monitor, and the St. Louis Post Dispatch.

Before I point out some of the things that this bill does, I should like to point out some of the things it does not do.

In the first place, the bill does not attempt to set up an ideal form of investment company and then compel all companies to conform to the ideal. Its provisions have been scrupulously adapted to the existing diversities of investment company organizations and functions. In order that the committee may fully appreciate the varying forms which investment trusts and companies take, let me briefly describe the various types. And I think when you listen to the description of the various types you will realize why it has been difficult to draw a bill, there are such variations.

First, there are the management investment companies. The distinctive feature of these companies is that no restrictions, or only limited restrictions, are imposed with respect to the nature, type, and amounts of investment which their managements may make.

Management investment companies fall into two broad classes, the open-end and the closed-end type. The peculiarity of open-end companies is that they issue so-called redeemable securities-that is, as security which provides that the holder may tender it to the company at any time and receive a sum of money roughly proportionate to the current market value of his share of the company's assets. Because of the exercise of this redemption feature, the assets of most open-end companies would constantly be shrinking if they did not constantly sell new securities to new investors. It is because of this constant sales activity that these companies are called open-end companies. Presumably, the name was suggested by the familiar term "open-end mortgage." Closed-end companies are management investment companies which do not have this redemption feature. They do not distribute their securities continuously but only from time to time as they need new capital. Up to 1929 nearly all investment companies were of the closed-end type. However, the openend companies, though a relatively recent development, have expanded rapidly and now have total assets whose value is approximately two-thirds of the value of closed-end assets.

Then there are the fixed or semifixed investment trusts. In this type management discretion is completely or almost completely eliminated. The investor is sold an undivided interest in a specified package or unit of securities which are deposited with a trustee. The underlying securities cannot be changed at all, or can be eliminated only upon the happening of certain specified contingencies, such as the passing of a dividend on any security in the package for a prescribed period of time, the reduction in the investment rating of the security by a prescribed statistical service, and similar reasons. Another type of investment company is the so-called installment investment or periodic payment plan, which is in essence a device to sell investment trust or investment company shares to the public on the installment plan. These plans were designed to tap the savings

of individuals in the lowest economic and income strata of the population for investment in common stocks. Some plans provide for installments as low as $5 a month but the usual payment is $10 a a month, and the period of payment is generally 10 years.

The final variant of investment enterprise studied by the Commission is the so-called face-amount certificate company. Although these companies have been in existence in this country since 1894, the greater portion of their certificates have been sold since 1929. In essence the certificates sold by those companies are contracts between the corporation which issue them and the purchaser, whereby in consideration of the payment of certain specified installments the corporation agrees to pay to the purchaser at maturity a definite sum, the "face amount" of the certificate; or to pay prior to maturity a specified surrender value of the certificate. As in the case of installment investment plan, the selling commissions or "load" on the face amount certificate are taken out of the installments paid within the first and second years. As a consequence, the surrender value of the certificate during the early years is small and the investor who defaults or permits his certificate to lapse sustains a substantial loss. Though there are relatively few companies in this field, they are quite large. The two largest companies and their subsidiaries have aggregate assets in the neighborhood of $190,000,000 and have outstanding certificates with a face amount of over $1,000,000,000-the amount which these companies will have to pay if all investors make the required payments in the meantime.

The bill does not attempt to tell investment trusts that they can or cannot engage in this or that activity. There is not the slightest. conscious effort to circumscribe or restrict the initiative or the enterprise of managers. The bill does not attempt to say to the investment trust, "You cannot make this or that kind of investment." It does attempt to say, "If you regularly make this or that kind of an investment you must make disclosure and obtain your stockholders' consent to this fundamental business; you must wear the label appropriate to your business; and you must conform to the type of regulation that is most appropriate for your kind of a company."

For example, the bill does not prohibit investment companies from actively trading in securities or engaging in underwritings. However, we feel very definitely that a company which risks a substantial part of its capital in underwriting, or a company whose principal business is to speculate actively, should be clearly labeled as such a company and should have the consent of its security holders to engage in these activities.

The bill does not attempt to compel investment companies to change their existing outstanding capital structures, or to simplify their existing pyramided investment company systems. It does provide, however, that in the future these companies shall issue only common stock, except in connection with consolidation, mergers, and reorganizations.

Nor does the bill require the segregation of investment bankers, brokers, and distributors from the management of investment companies, a step which various officials of investment companies themselves advocated in the hearings before the Commission. However, to prevent the evils which may result from the divided loyalties,

certain specific restrictions are imposed on affiliations involving conflicts of interest.

The bill does not prohibit management contracts although there was expressed by many officials the opinion that they should be abolished. It does require that management contracts meet certain specified conditions. Now I move to a slightly different topic connected with the bill.

Undoubtedly, before the hearings are over, there will be considerable discussion, and properly so, as to the amount of discretion which should be given to the Commission. My immediate observation is about as follows:

First of all, it seems to me that the greatest virtue of the administrative process is flexibility. I think it would be unfortunate to throw it away. A good deal of the criticism of it is based upon the false idea that the rule-making power is the power to make laws. We do not have the power to make laws. No one has the power to make laws except Congress. The Schechter decision by the Supreme Court reminded us of that fundamental principle. Congress may lawfully, however, authorize us to make rules to implement already existing laws according to prescribed standards. Despite the views that I have expressed, if Congress believes that it can write flat prohibitions into this statute which will stamp out abuses and which will not do injustice to the honest persons in the industry, that's all right with us. The fewer discretionary decisions we have to make, the easier our administrative job is. I shall not be surprised, however, if as the hearing develops you find situations where rigid prohibitions cannot be drawn and where the industry and the Senators will find that it is necessary to put a little rubber into the bill for the exceptional, unforeseeable and unpredictable cases. For example, I doubt the wisdom of undertaking to write into the bill itself uniform accounting standards for all investment trusts. It isn't a job that I would relish very much. There is, it seems to me, but one senible way to approach problems of that nature. Give the power to the Commission and then let the Commission work it out in conference as a joint enterprise with the industry and the representative accounting firms and societies of the country. I assume, of course, that the Commission should be given the power to promulgate rules relating to its own practice and procedure.

It seems to me that in the face of problems of that kind and of practical necessities that it is unwise to take all flexibility out of the act. I doubt whether the committee can solve these difficult problems by the rigid rules of statute. I doubt whether the industry believes it can be done. By way of illustration, I would like to say from actual experience that if the Securities Exchange Act of 1934 had not given us very flexible powers of exemption, the utmost confusion would have existed in the early days of registering stock exchanges and the thousands of listed securities traded on those exchanges. We had to resort to this exemptive power for a temporary period in order not to interrupt trading and in order finally to reach the statutory objective of registration, and I think it is highly significant, and I would like to emphasize at this time, that much of the flexibility of the Exchange Act of 1934 is due to the insistence of the exchanges themselves, expressed before the committees of Congress, as the reports of the congressional committees clearly show at the pages which are specified

221147-40-pt. 1-4

in my printed copy of this statement. (H. Rep. No. 1383; 73d Cong., 2d sess, pp. 6-7).

Further, with respect to the substantive provisions of this bill, I do not propose to discuss these in detail, but I do wish to make two or three general observations about them.

In general, everyone seems to be pretty much agreed that the functions of the investment trusts should be to afford the small investor an opportunity to spread his investment risks by a diversification of security holdings, to furnish competent and continuing investment supervision, and to assist in making capital available for industry. In a great many instances these objectives have not been realized. The failure may be attributed to certain fundamental causes.

First, there has been no regulation with respect to the individuals who may organize and operate these companies. The bill provides for the registration of officers, directors, managers, and underwriters of investment trusts and companies. That does not mean that no one can occupy one of these positions unless his qualifications are approved by the S. E. C. The Commission would only have the authority to deny registration or revoke registration for certain specific causes, viz: (1) That the man had been convicted of a crime within 10 years; (2) that he is under injunction by a court of competent jurisdiction because of some wrongdoing in connection with security transactions; (3) that in his registration he makes a material misrepresentation to the Commission. The purpose of this provision is to prevent persons with unsavory records from occupying these positions where they have so much power and where faithfulness to the fiduciary obligation is so important.

Second, it is perhaps not too much to say that the disregard of fiduciary standards lies at the root of many investment-company problems. The fiduciary obligation of the management to stockholders is too often violated or disregarded. The bill undertakes to impose specific conditions which will insure the observance of this fundamental obligation.

Third, many investment companies have adopted complicated and precarious forms of capital structure. Under this bill they will be required to follow more conservative standards. In view of the nature and functions of these companies, I believe that there is no excuse for pyramiding or for more than one class of securities in their capital structures.

Fourth, adequate accounting regulation is in my opinion fundamental, if these companies are ever to serve the purposes for which they should be designed.

Fifth, some public supervision over mergers, consolidations, and other reorganizations is necessary for the protection of investors. The investor is singularly helpless under such circumstances. Every time, for example, there is a merger of the sort recently proposed between Atlas and Curtiss-Wright, we have a flock of letters from security holders who cannot analyze the exchange offers and do not know what to do. I think it is extremely helpful if some impartial body which has no money stake whatever in the outcome, but is in a completely impartial position, can write an objective, scientific analysis of those offers and put them in the hands of the stockholders, who will thereby, I hope, get some basis for making an intelligent decision.

This bill will, I believe, promote the dignity of investment trusts. The management of these institutions is worthy of being a separate profession and a separate charge in itself, instead of being a mere adjunct to some other line of business. What we ought to develop is a group of expert investment trust managers who do not make their profits from originating and distributing types of securities, styled principally for their sales appeal, but from wise and careful management of the funds entrusted to them.

I believe that a true mutual investment company subject to governmental supervision may be entitled to special tax consideration. At the present time, only open-end companies are the beneficiaries of this consideration. I feel that the basis of granting this favorable tax treatment should not depend upon the right of a security holder to compel the company to redeem his security but rather upon the more fundamental aspects of mutuality and regulation.

Finally, intelligent regulation is in the interest of the investment trusts and companies themselves, as well as the people who put their money into these organizations. I believe this bill will tend to restore public confidence in these institutions. These organizations could then perform the vital functions of furnishing honest and unbiased investment management to the large group of small investors who require this service. These organizations might then become a vital factor in furnishing capital for industry and the stimulation of national

recovery.

Senator WAGNER. Thank you very much, Judge. Are there any questions?

Senator TOWNSEND. The Judge will be available in case we care to ask questions after we have had a chance to study this?

Mr. HEALY. I hope to be able to answer all the questions. Senator WAGNER (chairman of the subcommittee). Mr. David Schenker, chief counsel for the S. E. C. Investment Trust Study.

STATEMENT OF DAVID SCHENKER, CHIEF COUNSEL, SECURITIES AND EXCHANGE COMMISSION INVESTMENT TRUST STUDY

Mr. SCHENKER. Senators, the Judge's talk was entirely devoted to title 1, which deals with investment trust, and investment companies. Senator WAGNER. Will you keep your voice up please?

Mr. SCHENKER. Yes. The proposed bill also contains a short title relating to investment advisers, which encompasses that broad category ranging from people who are engaged in the profession of furnishing disinterested, impartial advice to a certain economic stratum of our population to the other extreme, individuals engaged in running tipster organizations, or sending through the mails stock market letters.

Now, you may ask, "Where does the S. E. C. fit into this investment counsel picture? How did you come to make the study?"

Section 30. specifically directed us to make a study of the influence exerted by people affiliated with investment trusts and investment companies upon their investment policies. It became quite obvious to us that there were a great many of them and we felt duty bound to make that study.

Of course, our jurisdiction was limited to that peculiar phase. However, we did succeed in getting certain fundamental data, mostly