governing trading by insiders of investment companies and with the authority to prevent such practices.

SECTION 11, ADDING NEW SECTION 19(b)—DISTRIBUTIONS OF LONG

TERM CAPITAL GAINS

Section 11 of the bill would amend section 19 of the Investment Company Act by adding a new subsection (b), which would prohibit registered investment companies from distributing realized long-term capital gains more frequently than once every 12 months except as the Commission may permit by rule, regulation, or order in the public interest and for the protection of investors.

Part D-Fund Holding Companies

SECTION 7, AMENDING SECTION 12(d) (1)—PREVENTING THE CREATION AND ENLARGEMENT OF FUNDHOLDING COMPANIES

Section 7 of the bill would amend section 12(d)(1) of the act to limit the creation and operation of new fundholding companies and the further enlargement of existing companies of this type.

The proposed amendment to section 12(d) (1) would permit investment company securities to be purchased by other investment companies but only within specified limits and subject to the detailed restrictions spelled out in the section.

Under the proposed amendment to section 12(d)(1) of the act, subparagraph (A) would make it unlawful for a registered investment company and any company or companies controlled by such registered investment company to purchase or otherwise acquire securities issued by another investment company if, as a result of such transaction, the limitations contained in that subparagraph would be exceeded. It also places similar limitations on acquisitions of securities of registered investment companies by unregistered companies.

Subparagraph (B) would make it unlawful for a registered open end company, its principal underwriter or any broker-dealer registered under the Securities Exchange Act of 1934 to sell or otherwise dispose of a security issued by a registered investment company to any other investment company if, as a result of such transaction and to the knowledge of the seller, the limitations contained in that subparagraph would be exceeded.

Subparagraph (C) would make it unlawful for an investment company to purchase or otherwise acquire the securities of a registered closed-end investment company if, as a result of such transaction, the limitations with respect to ownership of voting securities contained in that subparagraph would be exceeded. The stock of closed-end companies is usually bought and sold in the secondary trading markets rather than through the issuance of new shares as in the case of openend companies. Because of this fact, it would be much more difficult for a buyer or a seller to know how much of a closed-end company's stock was owned by investment companies generally. Therefore, in this case, it is appropriate to have the prohibition apply to the buyer (rather than the seller as in the case of open-end companies) and to apply the 10-percent test only to the holdings of the acquiring company, other investment companies with the same investment adviser, and companies controlled by such investment companies.

Subparagraph (D) would retain existing exceptions from the prohibitions against the transfer of investment company interests to other investment companies for securities received because of: (a) dividends: (b) exchange offers that have been approved by the Commission under section 11 of the act: and (c) plans of reorganization. None of these three items involve a new commitment by an investment company. The first item, the exception for dividends, covers only those which the issuer declares in terms of stock and not in terms of money. Dividends and capital gain distributions declared in terms of money, which the recipient may elect to apply to the purchase of additional shares, are not within this exception.

Subparagraph (E) would continue the present exception for acquisitions of interests in investment companies by unit trusts. This exception covers contractual plan companies which invest in a specific mutual fund. This subparagraph would also extend the exception to a security purchased by an investment company, the depositor of or principal underwriter for which is a broker-dealer registered under the Securities Exchange Act of 1934 or a controlled person of such a broker-dealer and the investment portfolio of which consists only of that security. In the case of a purchase or acquisition by a nonregistered investment company, the recommended changes also would condition the availability of the exemption upon the existence of an agreement with the registered investment company or its principal underwriter governing (a) the voting of proxies and (b) the substitution of other securities for the underlying securities.

Subparagraph (F) would exempt from the provisions of paragraph (1) securities purchased or otherwise acquired by a registered investment company where immediately after the purchase or acquisition the registered investment company and all of its affiliated persons own not more than 3 percent of the total outstanding stock of the acquired company and neither the acquiring company nor its principal underwriter or other distributors charge a sales load of more than 121⁄2 percent. In order to provide protection for open-end companies and their shareholders where such companies' securities are acquired within the limitations of subparagraph (F), the subparagraph also provides that no issuer of any security purchased or acquired by a registered investment company under the subparagraph shall be obligated to redeem such securities in an amount exceeding 1 percent of the issuer's total outstanding securities during any period of less than 30 days. In addition, the restrictions on voting rights prescribed by this section would be applicable to the acquiring company.

Subparagraph (G) specifies that for the purposes of paragraph (1) of the section, the value of an investment company's total assets shall be computed as of the time of purchase or acquisition or as close thereto as is reasonably possible. Under the act as presently written, the Commission has the authority to institute actions in the proper U.S. district courts to seek injunctions against violations of the act and to enforce compliance with its provisions. It is contemplated that in a proper case the court would direct divestiture of securities acquired in a transaction which violated the act. Subparagraph (H) specifies that (a) the Commission may join as a party to an enforcement action under this section, the issuer of the security involved and (b) a court may issue such orders with respect to the issuer as may he necessary or appropriate for the enforcement of the statute. For

example, if the court issues an order requiring divestiture, it might order, if appropriate, the issuer to withhold distribution of dividends and capital gains with respect to the securities acquired in the unlawful transaction pending compliance with the court's divestiture order. The amendment would not require any investment company to divest itself of any existing holding. Only in the case of an illegal acquisistion resulting in new holdings or additions to preexisting holdings would the court have the power to direct divestiture. It will be able to do so under the proposed amendment in a flexible fashion that takes into account the varying circumstances of particular cases.

Section 7 of the bill would also make technical changes in sections 12(d) (1) and 12(d) (2) of the act to take into account the changed format of that section.

Part E-Strengthening Independent Checks on Investment Company Management

SECTIONS 2(3), 5, 8(c), 8(d) AND 18, AMENDING SECTIONS 2(a), 10, 15 AND 32(a)-ADDING THE TERM "INTERESTED PERSON"

Section 2(3) of the bill would add a new section 2(a) (19) to the Investment Company Act defining the term "interested person" to include persons who have close family or substantial financial or professional relationships with investment companies, their investment advisers, principal underwriters, officers, and employees.

Proposed section 2(3) of this bill adds a new section 2(a) (19) to the act which would define the term "interested person." Other sections of the bill would substitute that new term for the present term "affiliated person" in the following sections of the act: (1) section 10, relating to the composition of boards of directors (amended by sec. 5 of the bill); (2) section 15, relating to the approval of advisory and underwriting contracts (amended by secs. 8(c) and 8(d) of the bill); and (3) section 32(a), relating to the selection of independent public accountants (amended by sec. 18 of the bill). The new "interested person" concept will not widen the scope of sections 10(f) and 17 of the act, which prohibits transactions between investment companies, on the one hand, and the companies' affiliated persons as well as the affiliated person of such affiliated persons on the other, absent prior Commission approval. These sections remain unchanged.

Under the bill the new term "interested person" would include affiliated persons of an investment company, its investment adviser and principal underwriter, as well as members of the immediate family of such affiliated persons and persons who have beneficial interests or legal interests as fiduciaries in securities issued by the investment adviser, principal underwriter, and their controlling persons. The term would also include any broker-dealer registered under the Securities Exchange Act of 1934, and affiliated persons of any such broker-dealer. In additon, the definition would classify as an interested person legal counsel for an investment company, its investment adviser and principal underwriter and partners and employees of such legal counsel.

Interested person would also include persons who have any material business or professional relationships with an investment company, or another investment company having the same investment adviser or

principal underwriter, controlling persons of the investment adviser or principal underwriter, or the principal executive officer of such investment companies, and the principal executive officer of the investment adviser or principal underwriter of an investment company.

Under this proposed section, a person would be deemed an interested person because of a business or professional relationship only if the Commission, by order, determines that he has, at any time during the prior 2 fiscal years, had a material business or professional relationship with persons specified in the statute. Such order would not be retroactive. It would take effect 60 days after the entry thereof and would not affect the status of a person for the purpose of the act or for any other purpose for any period prior to the effective date of the order. The Commission could issue an order under the proposed amendment determining that a director of an investment company is an interested person if it should find that a business or professional relationship was material in the sense that it might tend to impair the independence of such director. Ordinarily, a business or professional relationship would not be deemed to impair independence where the benefits flow from the director of an investment company to the other party to the relationship. In such instances the relationship is not likely to make the director beholden to that party. For example, a director ordinarily would not be considered to have a material business relationship with the investment adviser simply because he is a brokerage customer who is not accorded special treatment. A business relationship arising solely from the fact that the chief executive officer of an investment adviser to an investment company and a director of that investment company are directors of another company, whether that company is an investment company managed by the same investment adviser or a separate industrial corporation ordinarily would not be deemed material. Similarly, a director of one investment company would not ordinarily be deemed an interested person of that company by reason of being a director of another investment company with the same adviser. This case-by-case method of implementing the material business and professional relationship test would eliminate any danger of inadvertent violations of the requirements of the act and adequately implement your committee's basic intent in proposing this section.

Finally, the section provides that no person is to be deemed to be an interested person of an investment company solely by reason of his being a member of its board of directors, advisory board, an owner of its securities or a member of the immediate family of such a person.

Part F-Administrative and Other Proceedings

SECTION 4, AMENDING SECTION 9-PROVIDING FOR ADMINISTRATIVE ACTION AGAINST CERTAIN PERSONS SERVING INVESTMENT COMPANIES

Section 4(b) of the bill would add a new subsection (b) to section 9 of the act to empower the Commission, after notice and opportunity for hearing, to bar an individual, either permanently or for such time as may be appropriate, from serving an investment company in the capacities now enumerated in section 9 or as an employee of an investment company or as an affiliated person of its investment adviser,

depositor, or principal underwriter. The Commission could take such action only if it found (1) that the individual in question had willfully violated, or had willfully participated in a violation of any provision of the Securities Act, the Securities Exchange Act, the Investment Company Act or the Investment Advisers Act or any rule or regulation under those statutes; and (2) that the action was in the public interest. The proposed amendment would supplement the existing provisions of section 9. It would provide grounds and procedures for disqualification from affiliation with an investment company of persons willfully violating the Federal securities laws.

Under the proposed amendment if the Commission finds that an investment adviser or broker dealer or an associated person thereof has violated the antifraud or other provisions of the Investment Advisers Act or the Exchange Act and has barred or suspended him from serving as an investment adviser or broker-dealer or from association with a broker-dealer, it can also prevent him from being associated with an investment company, its adviser or its principal underwriter.

Like the provisions of section 15(b) of the Securities Exchange Act and section 203 (d) of the Investment Advisers Act, the proposed amendment would provide for an administrative proceeding to determine whether persons have engaged in willful misconduct and whether the public interest requires that such persons be barred from serving an investment company.

The proposed amendment will correct another deficiency of section 9 which bars a person convicted of certain crimes or enjoined on the basis of misconduct specified in that section from serving as an officer, director, or investment adviser of an investment company, but permits such a person to be an employee of an investment company.

Further, under the proposed amendment, in appropriate cases, the Commission could proceed against an individual affiliated with a company's investment adviser, principal underwriter, depositor, or sponsor without naming or joining the individual's employer as a party in such proceeding. Moreoever, the Commission could, where appropriate, institute private proceedings which would not be made public unless and until the parties so request or adverse findings are made against the individual or company involved.

SECTION 20, AMENDING SECTION 36-ENJOINING BREACH OF FIDUCIARY DUTY INVOLVING PERSONAL MISCONDUCT

Section 36 of the act presently authorizes the Commission to bring an action in the U.S. district courts to enjoin persons from acting in relation to an investment company if such a person has been guilty of gross misconduct or gross abuse of trust.

The highly punitive overtones of the existing section, together with the injunctive penalty, seriously impairs the ability of the courts to deal flexibly and adequately with wrongdoing by certain affiliated persons of investment companies. Therefore, this proposed section would authorize actions to enjoin breaches of fiduciary duty involving personal misconduct. It also empowers the courts to grant such relief as it finds necessary or appropriate. The amended section will enable the Commission to move against officers, directors and advisory board members of an investment company and its investment advisers