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Part A-Costs of Mutual Fund Investment


STANDARD OF REASONABLENESS FOR MANAGEMENT COMPENSATION This section provides a method through which a judicial determination can be made as to whether a particular fee is reasonable. While the ultimate finding as to whether a fee is reasonable is for the court, a determination by the board of directors or the shareholders is not to be ignored. This section specifically provides that a determinat on by the directors is to be given “substantial weight.” Shareholder approval is also to be given such weight as is deemed appropriate in the circumstances of a particular case. Compensation is to be presumed reasonable if it is ratified by the affirmative vote of a majority of the fund's outstanding voting securities and by a vote of a majority of the fund's uninterested directors. Such presumption may, however, be rebutted by a preponderance of the evidence.

These provisions stress the fact that the section is not designed to ignore concepts developed by the courts as to the authority and responsibility of directors in managing and controlling the everyday affairs of a corporation. The section is designed, however, to strengthen the ability of the unaffiliated directors to deal with management compensation, which raises serious conflict-of-interest problems, and to provide a method through which the Federal courts can effectively enforce the statutory provision that management compensation be reasonable. The section is in no way intended to shift the responsibility for managing a corporate enterprise from the directors of a corporation

Existing law places on the directors of a fund the responsibility for approving investment advisory contracts, and in any action a determination by the directors that compensation is reasonable shall be given substantial weight. These requirements are implemented by the amendments to sections 15 (a) and (c) of the act requiring that the investment advisory contract separately describe compensation for investment advisory service and for other services. It also requires that the directors be provided with information necessary to enable them to determine the reasonableness of the compensation paid to the investment adviser.

This section places the burden on the Commission, and on any other plaintiff, of proving to the satisfaction of a court that any fee challenged is in fact unreasonable. The court may order a reduction in the rate of compensation in any case in which it finds that the compensation is unreasonable, but it may not order the recovery of any compensation paid or accrued prior to the date on which the action was instituted or the date of termination or renewal of the management contract if it finds that the directors of the fund determined in the exercise of due care that such compensation was reasonable.

to the judiciary.

A judgment under this provision may be obtained only against the person who received the compensation, and recovery of past compensation is limited to the unreasonable portion of compensation paid or accrued within 1 year prior to the date the action was instituted, plus interest.

This section also provides that shareholder suits to enforce the standard of reasonableness may be brought only if the Commission has refused or failed to bring such suit within 6 months after a request by a shareholder.


This proposed section provides that a registered securities association may by rule prohibit its members from offering redeemable securities at a price which includes an "excessive" sales load and that the Commission may by its rules alter or supplement the rules of such association in the manner provided for by section 15A(k)(2) of the Securities Exchange Act. An underwriter of these type securities who is not a member of an association may elect to be governed either by the rules of an association or by rules prescribed by the Commission with respect to excessive sales loads.

The association and the Commission, in formulating rules as to excessive sales loads, “shall allow for reasonable compensation for sales personnel, broker-dealers, and underwriters, and for reasonable sales loads to investors." This does not mean that such rules must preserve the current level of profitability of every salesman, brokerdealer, or underwriter in the business, irrespective of efficiency. It does mean, however, that consideration must be given to the nature and quantity of services necessary to effect the proper distribution of fund shares to the public.

The provision for "reasonable loads to investors" is intended to assure that the sales loads fixed by the principal underwriters (which continue to be protected against price competition by section 22(d) of the act) will be established at levels which recognize the interests of investors. These provisions also contemplate that, if warranted, the rules might include provisions for higher sales loads in situations where relatively more selling effort is required. They will also permit flexible treatment of the problem of sales loads on automatic investment of dividends, which involve little or no new selling effort.

It is contemplated that the adoption of rules defining and prohibiting excessive sales loads will be based on a prompt study by the National Association of Securities Dealers, Inc., of all relevant factors. For this reason, the authority of the Commission to alter or supplement the rules of a securities association commences 18 months after the effective date of the act.

The provisions of this proposed section shall prevail over any conflicting provision of Federal law. This provision, which is identical to section 15A(n) of the Securities Exchange Act, is designed to make it clear that no other provision of Federal law, including the antitrust laws, prevents a registered securities association from adopting rules consistent with, and necessary to effectuate, the purposes and provisions of this section.

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This proposed section provides that not more than 20 per centum of any i year's payments may be deducted for sales load, and the entire deduction during the first 4 years may not exceed 64 per centum. This change would permit the seller of a plan to continue to collect approximately the same amount of sales load over the first 3 or 4 years (at the seller's election) as he does under present law. However, the load would be spread out more evenly over that period. For example, instead of the present situation in which typical deductions might be 50 per centum in the first year and 4.5 per centum in each of the next 3 years (averaging 15.9 per centum) a seller would be permitted to deduct 16 per centum over the entire 4-year period or 20 per centum in each of the first 3 years and 4 per centum in the fourth year (in each case averaging 16 per centum).

Under the bill, it would not be necessary that the same sales load be imposed during each of the first 4 years of the plan, but the sales load deductions from all of the monthly payments within any one of those years would have to be uniform, as would the sales load on all payments after the 48th monthly payment. This provision which corresponds to a provision found in present law, is designed to discourage unduly complicated sales load schedules which investors might have difficulty in understanding.

This proposed section does not change the provision of present law which límits the sales load on the entire plan to 9 per centum of the total payments to be made.

This section would also provide that the sales load on the excess paid by an investor in any month over the minimum monthly payment called for by the plan may not exceed the sales load applicable to payments subsequent to the first 48 monthly payments under the plan. For example, if an investor bought a 10-year $50-a-month plan with a sales load of 16 per centum on the first 48 monthly payments and 4 per centum on subsequent payments, and made an initial payment of $600, the sales load would be $30, obtained by adding $8, or 16 per centum of the first $50, to $22, or 4 per centum of the remaining $550. Of course, plan sellers are not required to accept prepayments.

This provision is not intended to apply to normal and minor variations, such as payment on a quarterly, rather than monthly, basis, or the payment of arrears by an investor who is delinquent in his scheduled payments.

Section 16(b) of this bill would repeal subsection (b) of section 27 of the Investment Company Act. That subsection authorizes the Commission to "relax” the requirements of section 27(a) for "smaller companies—subjected to higher operating costs." Applications for relief under this subsection have been extremely rare, and the Commission has never granted any of them. Many years have elapsed since the last such application was made. Since there is no evidence that the operating costs of the smaller contractual plan sponsors are any higher than those of their larger competitors, it is hard to see how the Commission could ever properly grant a 27(b) application for permission to charge higher loads. If in an unusual case such an application were to be supported by a substantial showing of merit, the Commission may still grant such application by exercising its general exemptive authority under section 6(c) of the act. Section 27(b) is therefore surplusage and is deleted.



Section 17 of the bill would add a new subsection (i) to section 28 under which:

(1) The existing provisions of section 28 will continue to apply in all respects to all face-amount certificates issued prior to the subsection's effective date as well as to new certificates issued pursuant to the terms of such outstanding certificates.

(2) With respect to certificates issued after the effective date of the subsection

(a) The reserve payment or payments for the first 3 certificate years must amount to at least 80 percent of the required gross annual payment for those years, instead of the present 50 percent in the first year, with 93 percent in the second to the fifth years, inclusive.

(6) The reserve payment or payments for the fourth certificate year must amount to at least 90 percent of the gross annual payment required in the fourth year.

(c) The reserve payment or payments for the fifth certificate year must amount to at least 93 percent of the gross annual payment required in this year.

(d) Reserve payments for years subsequent to the fifth certificate year must amount to at least 96 percent of the required gross annual payments. This new section 28(i) would substantially conform the law relating to face-amount certificates to that which the amendments to section 27 apply to contractual plans. The existing limit on the total charge paid by a completing certificate holder remains unchanged.



Section 6 would delete from the Investment Company Act section 11(b)(2) which permits series companies or their principal underwriters to charge an additional sales load when shareholders in one series exchange their shares for shares in another series. Section 11(a) of the act specifically prevents the imposition of sales charges when shareholders are induced to exchange their certificates for new certificates in the same or another investment company.

Part B~Banks and Insurance Companies

SEPARATE ACCOUNT Section 2(4) of the bill would add to the Investment Company Act a new subsection 2(a)(37) which defines the term "separato account” established and maintained by an insurance company. The purpose of adding this new subsection is to provide a definitional base for the


exclusion from the act of certain separate accounts provided for in section 3(b) (5) of the bill.

The definition in the new subsection is based on the definition in Commission rule 3c-3 promulgated under the act which, in turn, is based on the definitions in separate account legislation of certain States, including New York. The definition expressly includes separate accounts established and maintained pursuant to the laws of Canada or any Province thereof, but includes such separate accounts of Canadian insurance companies only if such companies are subject to supervision by State insurance officials as provided in section 2(a)(17) of the act.



Section 3(b)(5) of the bill would expand a present exclusion from the definition of “investment company" in section 3(c)(13), redesignated section 3(c)(11), of the Investment Company Act to cover certain bank collective trust funds and certain insurance company separate accounts funding pension or profit-sharing plans which meet the requirements of section 401(a) of the Internal Revenue Code. As a purely technical matter the amendment would also delete the reference to section 165 of the code and substitute a reference to section 401(a) of the code which replaced it.

The amendment in section 3(b) (5) of the bill would codify the Commission's current basic position that bank collective trust funds, which consist solely of assets of employees' plans and which meet the conditions of section 401(a) of the code, are entitled to the exclusion which the act presently provides for “[a]ny employees' stock bonus, pension, or profit-sharing trust which meets the conditions of section 165 (now, 401(a)] of the Internal Revenue Code, as amended.”'

The amendment would exclude only those bank collective trust funds which are maintained solely for the funding of employees' stock bonus, pension or profit-sharing plans including so-called H.R. 10 plans, and which are not used as a vehicle for direct investment by individual members of the public. For example, the amendment would not exclude a bank collective fund maintained for the collective, investment and reinvestment of assets contr buted thereto by such bank in its capacity as managing agent.

The amendment in section 3(b)(5) of the bill would also exclude from the definition of “investment company's under the act certain insurance company separate accounts, as defined in section 2(4) of the bill. The purpose of this amendment is to give life insurance companies the same treatment with respect to employees' pensions and profit-sharing plans, which meet the requirements of section 401(a) of the code as is provided for banks.



Section 5(d) of the bill would amend section 10(d) of the Investment Company Act to exempt bank collective funds for managing agency accounts from the provisions of sections (10a), 10(b)(2), 10(b)(3), and

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