While the statements of policy which are thus required to be recited and which can only be changed with the approval of stockholders are clearly important to investors, the company's investment objectives and investment characteristics, which are also of great importance, are not expressly required to be set forth in section 8(b) and are not subject to the voting requirements of section 13. Hence, although an investment company is required, as a matter of disclosure, to set forth in its registration statement whether it intends to invest entirely in bonds or in common stocks, or in a balanced proportion of bonds, preferred stock or common stock, the management may at any time change this investment objective without the authorization or consent of shareholders. An investment company may hold itself out as an income fund with emphasis on the yield or return from its investments as its primary objective and sell its securities on the strength of such a representation and then switch its policy, without the consent of its shareholders, to that of capital appreciation as its primary objective.

To permit changes in the investment policy of a company without majority stockholder approval seems inconsistent with the purpose of the act to provide investors with a voice in the affairs of their company upon fundamental questions. Such changes are not minor matters but involve drastic alterations in the investment approach of the management. Investment companies themselves recognize the importance of these portfolio objectives or characteristics to investors and prospective purchasers and base their sales campaigns in large measure on them. Indeed, their own "tombstone" advertisements, which under the Securities Act of 1933 may do no more than identify the security being offered, generally contain a description of the investment company as a "balanced fund," a "growth fund," an "income fund" or some similar designation. Matters such as these which go to the core of the character of the company should not be subject to change without the consent of the security holders. They are of at least equal importance with the matters now required to be stated under section 8(b) and should be treated similarly.

In making this recommendation, the Commission has no desire to impede the managerial functions of the board of directors of the investment company, nor to dictate its policy. As at present, the company would be free to determine its investment objective. To assure to management adequate flexibility, the proposed amendment permits the investment company to "make appropriate reservations of freedom of action for the protection of investors." While this statement is cast in general terms, it is intended to emphasize that management may reserve full discretion to acquire so-called defensive securities. such as high-grade corporate bonds or preferred stocks or Government securities when it deems such action to be appropriate.

Experience has shown that some modification is necessary in the statutory provisions dealing with the affiliations of directors of investment companies. Section 13 of the bill would strengthen the existing provisions of section 10 of the act which have as their general purpose assurance that an investment company will have a certain minimum number of independent members on the board of directors. I used the word "independent," although it is not so expressed in the pertinent statutory provision, because the legislative history of the act, the con

gressional hearings and the committee reports repeatedly use the term and it is most descriptive of what is clearly the prime objective of these provisions of the statute. Section 10 is designed to mitigate the potential conflicts of interest among those persons who have a pecuniary stake in the investment company due to their status as manager, investment adviser, broker, investment banker or principal underwriter or who have an indirect interest because of their affiliation. In this context, sections 10(a) and 10(b) of the act should be read together. Section 10(a) requires that at least 40 percent of the members of the board be persons who are not part of the operational management of the company. Specifically, it directs that not more than 60 percent of the board may be officers, employees or investment advisers of the investment company or affiliated persons of an investment adviser of the investment company. Section 10(b) has a stricter limitation, providing that the majority of the board may not be made up of regular brokers or principal underwriters of the investment company, or investment bankers, or affiliated persons of such brokers, underwriters or investment bankers.

Despite these limitations, because sections 10(a) and 10(b) are not keyed together, it is possible to have a board of directors without any "independent" directors on the board. For example, a board of five members could consist of three officers of the investment company and two regular brokers for the company or three officers and two principal underwriters for the company. Other deviations are possible, such as the designation on the board as though he were an "independent" director, a person in control of the investment company or a stockholder of the investment adviser who would be an "affiliated person" but for the fact that instead of owning 5 percent of the stock of the investment adviser, he owns only 4.9 percent. I may add that these are not merely theoretical possibilities. They have actually been resorted to in one form or another. The employment of such loopholes by investment companies would seem to constitute a circumvention of the intention of the statute that there be a certain number of independent, disinterested directors who would act as "watch dogs" over the affairs and activities of operational management.

Section 13 of the bill reflects the Commission's view that stockholders of the investment adviser, including those with less than a 5 percent interest, regular brokers and principal underwriters for the investment company and controlling or controlled persons of the investment company, investment adviser and underwriter and their affiliates are so closely related to the management that they cannot be deemed to be truly disinterested representatives of the public investor interest. They would normally have a pecuniary stake in the management and could not be considered to be "independent" directors in any true sense of the word. A director cannot properly be designated as "independent" so long as he owes allegiance to management from whom he derives pecuniary benefit.

In order to effectuate fully the policy of section 10, the abovementioned classes and their affiliated persons should be placed in the same category as officers, employees and the investment adviser of the investment company. The proposed amendment places in the 60percent category of section 10(a), along with officers, employees and

the investment adviser, all the persons just described, except the regular brokers of the company and their affiliated persons. In recognition of the view that such regular brokers may not be as closely related to management, the amendment provides that officers, employees and the other persons I have mentioned, together with regular brokers, may not exceed 80 percent of the membership of the board. Thus, where a broker is a director, at least 1 member of a board of 5 or less and at least 2 members of a board of from 6 to 10 would have to be truly independent directors.

The Commission has grown somewhat concerned with the provisions of the act governing the portfolio requirements of face-amount certificate companies. Briefly, a face-amount certificate company may be described as an investment company engaged in the business of selling its own unsecured debt obligations on an installment basis. The proceeds are invested and used, together with increments, to pay the obligations at maturity. Section 24 of the proposed bill would limit the proportion of common or preferred stock that may be acquired by such companies in order that face-amount certificates, which are essentially fixed debt obligations, may not have an unduly speculative character.

Section 28(b) of the act now requires a face-amount certificate company to have cash or qualified investments equal to its capital stock and certificate reserves. Qualified investments are defined as investments permitted under the District of Columbia Code for life insurance companies together with such other investments as we may authorize. Since insurance companies, although they do not actually do so to any great extent, may, under the District Code, purchase unlimited amounts of common and preferred stocks, face-amount certificate companies may also purchase such securities to any extent they may wish.

The face-amount certificate companies studied by the Commission in the investigation that led to the passage of the Investment Company Act invested in real estate mortgage and senior corporate securities in order to meet the fixed obligations they undertook to pay at maturity. The failure of the act to place a limitation on the amount of common stock or preferred stock that such companies may acquire seems to have been unintentional. The entire thrust of the provisions of section 28 of the act is to make sure that the company will be in position to meet its fixed liabilities. Not only is this shown by the legislative history of the act, but it is also evident from the very elaborate provisions of section 28 itself governing the maintenance of reserves and requiring their computation on the basis of a rate of accumulation limited to not more than 32 percent per annum. On the face of it, it would be contrary to the purpose of the act to permit face-amount companies to invest to any appreciable extent in the more speculative types of securities such as common stocks. Accordingly, our proposal sets up a formula designed to provide reasonable limitations upon investments in preferred and common stocks. (See p. 150.)

Section 3(c) (9) of the act now excludes from regulation as an investment company, a company subject to regulation under the Interstate Commerce Act. Section 7 of the bill would eliminate this exception if our Commission finds and by order declares that such company is primarily an investment company.

It was intended by section 3 (c) (9) to avoid subjecting a railroad or a railroad holding company to dual regulation. However, as the section is written it provides an excuse for corporations which are essentially investment companies rather than holding companies to escape regulation under the Investment Company Act by subjecting themselves to regulation under the Interstate Commerce Act.

Senator JAVITS. Mr. Woodle, do you mind a question at this point? I notice in the statement that you use as examples the Alleghany Corp. and the American-Hawaiian Steamship Co.

Mr. WOODLE. Yes, sir.

Senator JAVITS. I notice also a letter from the Chairman of the ICC, who does not entirely agree with you. The point at issue seems to be whether, instead of putting a company under both the ICC law and the SEC law, and then giving SEC the authority to exempt as much as it might like to exempt, it should be written in the law that a company shall be under only one jurisdiction for each of various functions. In other words, the ICC does not desire to have jurisdiction over the investment functions of a company that comes under its jurisdiction in transportation matters provided that we do not give dual jurisdiction or authority by this bill, both to SEC and to ICC, over transactions over which ICC has jurisdiction.

The argument is that when you exempt a function from the control of an agency-you have done it before this should be written expressly in the law.

Do you see any real objection to writing the law so that company A, the Alleghany Corp., will be regulated by SEC and by SEC only as to its investment policy, and will be regulated by ICC and by ICC only as to its carrier functions. If the company has 16 percent of its assets in New York Central, SEC will not regulate that, the ICC will. So you answer Alleghany's argument that there is going to be dual control, and at the same time you do not deprive SEC of what it claims is a gap in the law, where Alleghany is engaged in investment functions, and being regulated by a commission which is not specializing in that line of business. Is there any real objection to writing it right in the law?

Mr. ORRICK. If I may answer that for the Commission, your proposal sounds very reasonable, sir. We received the letter from the Chairman of the Interstate Commerce Commission yesterday, the first time we saw it, so the Commission has not been able to formulate an agency position on the suggestion of Mr. Tuggle, and I wonder if we could amplify a response to your question in the hearing which we understand will be held on the 24th of this month, next Wednesday. (See p. 518.)

(The following was received for the record :)

PROPOSED MODIFICATIONS RELATING TO AMENDMENT OF SECTION 3(c) (9) OF INVESTMENT COMPANY ACT OF 1940

1. Section 7 of S. 1181 would be modified to read as follows: "(9) Any company (A) which is subject to regulation under the Interstate Commerce Act: Provided, That this exception shall not apply to a company which the Commission finds and by order declares to be primarily engaged, directly or indirectly, in the business of investing, reinvesting, owning, holding, or trading in securities; or (B) whose entire outstanding stock is owned or controlled by a company excepted under clause (A) hereof: Provided, That the assets of the controlled company consist substantially of securities issued

by companies which are subject to regulation under the Interstate Commerce Act; or (C) which is subject to regulation under the Interstate Commerce Act and substantially all of whose investment securities are issued by controlled companies subject to regulation under the Interstate Commerce Act."

2. The following new section would be added to the Investment Company Act: "Section 6(f). The following transactions shall be exempt from the provisions of this title:

"(1) Any transaction of a registered investment company which is also a carrier as defined in section 5(13) of the Interstate Commerce Act, or which, pursuant to section 5(3) of that act, has been ordered to be considered a carrier and subject to any of the provisions therein specified, involving (i) the acquisition of control of a carrier or carriers or (ii) the issuance of securities or assumption of any obligation or liability for purposes of financing the acquisition of control of a carrier or carriers or financing of a carrier business or a business incidental thereto, provided such transaction is subject to approval by the Interstate Commerce Commission.

"(2) Any transaction between a registered investment company of the character described in subparagraph (1) of this subsection and an affiliated person or persons of such a registered investment company or an affiliated person or persons of such a person, or between any of such persons, provided the transaction is connected with the operation of the carrier business, or a business incidental thereto, in which any party to the transaction is engaged. "(3) Any transaction between an affiliated person of a registered investment company of the character described in subparagraph (1) of this subsection, which affiliated person is primarily engaged in the business of a carrier, and any controlled companies of such affiliated person, and any transaction between such controlled companies."

(For an explanation of the amendment and letters discussing it see appendix, p. 518.)

Senator JAVITS. Certainly, Commissioner.

May I make the following suggestions to our chairman: (1) That if you do agree, that you submit a form of amendment, and, second, that the Interstate Commerce Commission be invited to submit a form of amendment and to support it by testimony before us. I make that request, Mr. Chairman.

Senator WILLIAMS. Very well, we will do that, Senator Javits. It will be understood that we will make time available on June 24 for this.

Mr. WOODLE. Do you wish me to continue, Mr. Chairman?

Senator JAVITS. Thank you for allowing me to interrupt you.
Senator WILLIAMS. Yes, proceed.

Mr. WOODLE. In this way, investors in such corporations are deprived of the more pertinent and appropriate supervision provided by the Investment Company Act, since the companies need comply only with a more limited type of regulation under the Interstate Commerce Act which is not designed primarily for the same purposes. In fact, the additional regulation involved if both the SEC and the Interstate Commerce Commission were to have jurisdiction in such a case, would involve little, if any, duplication or conflict and the burden imposed thereby would not be substantial. Duplication now exists in other areas and in such instances the Commission has been careful to mitigate so far as it can the burdens imposed on industry by such overlapping jurisdiction. To this end, the Commission can avail itself of the broad exemptive authority under section 6(c) of the act to exempt transactions and persons from the provisions of the act to the extent that such exemption is consistent with proper standards of investor protection and public interest. In any event, it is inappropriate for a corporation which is primarily engaged in