with unaffiliated directors of our Funds for over two decades I think I may be permitted an appraisal of their general attitude on this matter. My remarks as a P. matter of necessity are limited to the unaffiliated directors of the Funds in our Fidelity Group, because I have had actual and continued contact of this kind only with them. Other persons would have to characterize the unaffiliated directors with whom they might have had similar extensive experience. I should like to add that in our Funds all the directors, with the single exception of myself, are unaffiliated with the Management Company.

! In the first place these directors, like the institutional and professional investors referred to above, are or were generally successful corporate or financial executives. Thus, of our unaffiliated directors, two were formerly presidents of two large Boston banks which handle trust and other fiduciary accounts. One was President from 1962 to 1966 and is now Chairman of the Executive Committee of the largest dairy company in New England. One has nearly all his life been a professional trustee, handling investments as his father was before him. Another is a professional adviser to numerous charitable and other institutions. In short, most have lived with institutional or trustee handling of accounts all their lives. I have every reason to believe that our experience here resembles that of many other investment companies.

The fee schedule is submitted each year to the shareholders of our Funds for their vote of acceptance or rejection. Before such submission they are in effect approved by these unaffiliated directors as required by the Investment Company Act of 1940. The unaffiliated directors take this responsibility seriously and are furnished with a wealth of material concerning charges made elsewhere for comparable services and other relevant data. At their request their inquiry is directed towards satisfying themselves that their shareholders, for whom as directors they are responsible, are getting good value for the money they pay in fees. They regard the management company much as they do a lawyer; are the bills reasonable with relation to the benefits received? If I read their attitude aright they feel strongly that their beneficiaries have received full and sometimes much more than full value for the money paid in fees.

II. POSSIBLE REASONING OF THE SEC

Since both of these groups of men thoroughly experienced in the handling of investment accounts (i.e., the professional type investors who are large purchasers of investment company shares and the various boards of unaffiliated directors) have in effect approved and are constantly approving our management fees, why does the SEC all of a sudden, after over twenty-five years of investment company operations under the Investment Company Act of 1940, come to the conclusion that management fees (and sales charges) are much too high? Their reasons contain various strands of thought, some possibly subconscious, and concerning them impartial observers will of course differ in analysis. I can only give you a few of my own ideas:

(a) Some Fundamental Economics

The investment company industry has grown so fast, especially in the last four years, that earnings of some management companies have risen rapidly. This often occurs in the early time phases of a business where expansion in volume exceeds temporarily the ability of the company involved to effectively expand its facilities proportionately in the time available. In our Fidelity Group we know that if we are to maintain the good (if I may say so) comparatve results we have often had in the past we must greatly increase our experimental and investigative (R & D) activities, including computer programs. Decentralized operations will likely be adopted gradually, all depending upon our judgment, as we go along, of the effectiveness of such action. To put it mildly, competition is intense in the areas of investment results, just as it is in the sale of investment company shares. Techniques, both in market operations and investment analyses and appraisals, which may have worked for some years in the past tend to become outmoded and of steadily decreasing effectiveness because of their adoption by competitors both in the United States and from all around the world. Investment funds are probably more fluid than any other type of capital and tend to flow in large amounts very quickly in the direction of apparently successful operational procedures. This automatically and of itself tends rapidly to decrease the effectiveness of these procedures. This is one of the great fundamental laws of investing in the market place.

I think the SEC, probably due to this time lag, does not appreciate the extent to which expenses of a Fund do increase as assets increase, even though of course not proportionately to the increase in size. But we cannot push this development and realinement of activities too fast; to do so would be to defeat the very goals we seek. In other words, while increasing size often does bring large economies, these are often temporarily far overestimated because of the time lag for expansion of facilities to catch up.

(b) Modern Management Techniques

I think it is fair to say that investment companies have, in the last decade and especially in the last few years, introduced new elements into the professional management of common stock accounts. These new elements include intensive study of computer applications and of the workings, both mechanical and psychological, of security markets; and do involve somewhat more activity in markets than had previously accompanied long term investment accounts. The SEC, I think, tends to regard investment company portfolio appreciation as almost solely a result of generally rising stock markets (See p. 25 of Testimony of Manuel Cohen of SEC dated July 31, 1967). If our operations were simply along so called robot or routine lines Mr. Cohen's approach is understandable; and indeed adoption of the Bill would inevitably push management companies willy-nilly in that direction.

(c) Unaffiliated Director Arrangement Sound and Very Adaptable

The SEC apparently discounts the approval of the management fee by unaffiliated directors as ineffective both because of lack of any practical alternative and because of the relationship between a Fund and its adviser (See p. 18 of said Testimony of Mr. Cohen dated July 31, 1967). Also it has been suggested that since persons who are interested in the Management Company are often influential in the choice of directors, the latter would tend to follow the wishes of the Management Company and therefore not be impartial. This I think is an understandable thought by someone who has not really lived for some time with a situation of this sort.

It has been my experience that these unaffiliated directors are possessed of an intense loyalty towards their Fund shareholders, for whom they act in a fiduciary capacity. If any director felt that their shareholders, to use Mr. Cohen's expression, were not getting a "fair shake" in the management fees paid the Funds, one may be sure he would be on the war path at once for the reduction of these fees, even though, as the SEC points out, his main influence may be moral suasion rather than the possibly arguable practicability of power to depose management. The Management Company would most certainly give great weight to any such directorial protest regardless of any legal or practical power which might exist. See article by Prof. Mundheim in The Institutional Investor, June 1967, p. 48, where he points out strong reasons why unaffiliated directors will and do try to do a good job, and also that they have an "effective bargaining weapon" in their power to express with weight their dissenting views.

It must be remembered that an unaffiliated director has also the responsibility for not setting fees so low as to interfere with management incentive to do the very best job of which it is capable. This is a hard and exacting job which can't be realized by anyone who has not actually had a similar problem himself. These directors are looking far ahead, as well as at the immediate situation, and have to endeavor as best they can to keep fees as low as possible and yet to steer wide of fees which would tend to turn the investment management into a robot or routine operation of the kind noted above. I believe thousands of shareholders have reason to thank these directors for firmly turning their backs on fee levels which would tend to create or foster procedures similar to the so called "random" or "dart” approach of which we have heard lately. Again, the suggestion that men of the caliber I mentioned above are the type to "go along" with the Management Company against their own convictions is to anyone who knows these men completely fantastic. That suggestion does not square with the general experience of corporate life where men of ability. high standing and reputation are involved. No one suggests in corporate affairs that a director is automatically "in the pocket" of the person or persons who might have been responsible for his appointment.

So I believe the SEC attitude here simply reflects the standpoint of theoretical outside observations, and is unrealistic from a practical standpoint.

I would like to stress again that there is no conflict of interest where the unaffiliated directors approve a management contract in which is set forth the method of determining the management fee. They have just one loyalty, which is to their shareholders' long run interests, and thus their dealings with the Management Company are at arms length.

III. EFFECT OF RECENT CURRENT BROAD PUBLIC DISCUSSIONS

I believe that the Testimony of Mr. Cohen of the SEC dated July 31, 1967, and the testimony of other persons will be carefully studied and evaluated by I know our own unaffiliated directors and I believe by all such directors. Also, discussions in this area such as took place at the University of Pennsylvania Conference on Mutual Funds reported in Volume 115, Number 5, March 1967, issue of the University of Pennsylvania Law Review, cannot help but be informative and enlightening to these directors. If they have erred in the past in this respect, although in good faith and not from any lack of effort, they are the first to want to know; and they are eager to have fresh points of view expressed to them.

IV. SERVICES OFFERED TO PUBLIC BY INDUSTRY

A multitude of facts relating to performance, costs and other phases of investment companies are appearing in the public press, due to the greatly increasing interest of the general public in all phases of the industry. All this tends to inform the public thoroughly concerning the many facets of industry operation. One of the major services the industry presents to the nation is the great diversity of Funds which may be purchased by the public. There are small, medium sized and large Funds. Some have maximum sales "load", some small or none at all. There are even Funds at a discount from asset value. There are Funds aiming mainly at capital performance, or income, or the so called balanced approach, mixtures of these, specialty Funds, and others. Each needs its own environment to develop to its maximum efficiency. Shareholders generally can shift from one Fund to another. To try to press the rigid hand of conformity on all these variegated Funds might be the death of this spontaneous and live quality which has attracted so many persons as shareholders.

V. SUGGESTED CONTROL BY COURTS

I therefore think that at this point it would be most unfortunate for the industry and its shareholders to have a rule of management fees by court decisions established which clearly would take years of confusion and uncertainty to develop. Judge Friendly himself refers to "years" of litigation (See p. 14 of the Friendly Statement). Principles that could be readily applied to the multitudinous diverse situations of various Funds would be most difficult to formulate. In view of the apparent prejudice against the principle of so called incentive fees (as exemplified, by Section 205 (1) of the Investment Advisers Act, apparently designed to remove incentives to take "undue risks"), I think it is plain that it would be very difficult to devise a fee structure to reflect unusually good investment results. Hence the obtaining and retaining of individuals gifted with a flair for operations in securities, and giving them the long term incentives to develop their capabilities to the greatest extent, would be impeded. I think it is clear from the history of such individuals (and Funds as well) that good years have to be offset against bad years over often a considerable length of time to reach a fair appraisal of practical results. Let us say a lawsuit is started under the proposed Bill covering fees paid during a period of two years preceding the filing of the suit. The determination of this suit might well take several years, or more. Presumably the judge's inquiry would be to determine whether the fee paid during each of the two years under examination was "reasonable". What fee would be "reasonable"? If cost of operation is not taken as a base, where would it start? It is suggested that fees in the highly competitive investment counsel areas could be used as a guide with "allowance for differences". But I believe, in this area, one would not find fees providing incentives for superior performance (see reference to Section 205 of the Invesmtent Advisers Act above). So free competitive fees in this area wouldn't be of any use in trying to establish how good performance might be allowed for. In short, it seems probable that courts wold have to fall back on cost of operation as a base, resulting in something similar to a "cost plus" operation. This would almost surely lead to close examination of costs, including salaries, personnel, etc. which would 82-865 0-67-pt. 238

involve great complexity in any large organization of the Investment Company type. Even though the SEC in its "Technical Statement" (p. 4) states that "Advisers would be free to remunerate their officers, directors and employees in such fashion as they wish" it would appear that this might not in substance be the case.

VI. CONCLUSION

In conclusion, I submit that Shareholders of Mutual Funds are being, and have been, properly protected by presently existing legislation with its requirements of

(a) Disclosure of financial and other data relating to the Funds:

(b) Scrutiny and approval by Shareholders and Unaffiliated Directors of contracts with the Funds; and

(c) Scrutiny and supervision of investment company matters by the SEC. I point out that under present legislation, the unaffiliated directors of many Funds (including the larger Funds in the Fidelity Group of Funds) have already negotiated reductions in their management fee. Rather than legislative action I would suggest that experience over the next few years may be particularly helpful. The unaffiliated directors are now definitely on notice that the SEC considers fees set by them in general to be frequently too high. The renewed efforts and experiences of these directors will I think be enlightening both to the public and to all persons interested in the rapidly evolving affairs of the investment companies. I am sure we will see very painstaking efforts by these directors to conduct a full study of the various points of view expressed to your Committee in the recent hearings to assist them in their examination of management fees to be submitted to the shareholders of our Funds in coming months. It is the essence of the American system that many organizations trying to reach certain results have a way of hammering out practical methods. Each watches and studies what others in a similar position are doing, and from this come natural and realistic adjustments. I strongly believe the unaffiliated director arrangement is basically a sound one; and maybe one reason it has been attacked has been the lack of general understanding of its true fiduciary character and effectiveness as well as very little general understanding of the difficult problems that have to be worked out. It would seem that in coming years individual actions and the natural play of economic forces will bring far better long term results for investment company shareholders than would legislative fiat or threats of law suits.

LIBERAL, KANS., August 25, 1967.

Senator JOHN SPARKMAN,
U.S. Senate,

Washington, D.C.

DEAR SIR: I have just finished reading the article, “Funds on the Defensive," in the August 15th issue of FORBES. I enjoyed reading the article, but I would like to express my opinion as an investor.

We started investing in November, 1960, and have been investing since then as it is possible. We have also established an account for our son which we feel will help him with his college education.

Many of Mr. Cohen's statements are true, but I feel he fails to consider that the average investor does not have the facilities nor the time to intelligently invest in individual stocks.

I feel that I am in this category. I am a schoolteacher and although I keep as well-informed as I can, I feel that the management company looking after our funds is much more qualified than I to know when to buy or sell.

Most of our shares are in Affiliated Fund, Inc. and we also have an account with Investment Company of America.

I do not feel that the acquisition cost is too high. After all we recently purchased a new car, and I'm sure the dealer had a greater per cent of mark-up than the acquisition cost of my shares. And the car depreciated the minute we drove away from the garage.

Nor do I object to paying the sales cost on my reinvestment. This is one facet of a mutual fund which I appreciate very much, the dividend reinvestment privilege.

I am opposed to contractual plans or front-end loads as they call them. T feel these are unfair to the investor.

A voluntary reinvestment plan is to the investor's advantage. It helps him to plan for his future without the penalty of a contractual if he finds he cannot complete his plan.

In the 61⁄2 years we have been investing in Affiliated Fund, our investment, by reinvesting our dividends, has practically doubled in value and we have been investing over the years so some of it has not been in over a few years and some of it only a few months.

Our son's account has been in 41⁄2 years and is already over 11⁄2 times its original value.

I feel you will look into every angle before making the laws necessary to protect the investors. But I do feel Mr. Cohen and also the Wharton School do not take the average investor into consideration in saying we could do as well or better buying individual stocks.

Very sincerely,

Mrs. CHET KEESLING.

MANHATTAN FUND INC.,
New York, July 19, 1967.

Hon. WALLACE F. BENNETT,
Senate Office Building,

Washington, D.C.

DEAR SENATOR BENNETT: You wrote to me in May concerning the then scheduled hearing in June before the Senate Banking and Currency Committee on S. 1659. I appreciate your suggestion that you would be interested in having my views on the proposed legislation.

I understand that the Committee will be fully informed as to the views of the industry as a whole, including the anticipated effect upon small securities dealers. Accordingly, I will confine my remarks to some of the broad aspects of the legislation which I think should concern the Senate.

The effect of a proposal, however phrased, which purports to regulate investment company management compensation, moves voluntary arrangements between competent persons into the area of regulated rates which may be expected to affect also all bank, insurance company, individual trustee, pension fund and other fiduciaries who have agreed to manage someone's money, notwithstanding the agreement they are willing to make. I consider the ultimate effect of the proposed legislation to be a drastic incursion into the right of private agreement, and justifiable only if demanded by an overriding public interest based on findings that the public requires such protection in this competitive area. I believe there is no such present interest.

As you know, not only is there strong competition among the various modes of investment management, all now subject to substantive regulation, but competition is particularly active even within each mode. There is considerable variance in management fees, for example, where investment advisers are employed by mutual funds, as well as in the services for which the fees are charged by the advisers. The individual investor always can secure information, as required by law, as to investment objectives of a fund, the management fees being paid by the fund, and sales charges, if any, on the purchase of the fund's shares.

Sales charges and contractual plans are by no means universal and, where plans exist, there is no uniformity as to the so-called "front-end load". Sales charges on direct purchases of fund shares range from no charge at all to the maximum now permitted by law. Competition in this area is active and effective, and the proposed legislation would have the adverse effect of attempting to establish the lowest common denominator.

Investors in mutual funds are, I believe, first concerned with the objective of the fund in terms of their personal requirements. Having determined which funds meet their objectives, they choose the management they desire among those funds. I believe that, in making such choice, the investor is less concerned with cost of management or sales charges than with historical or anticipated management results. If he is concerned with fees and sales charges, his present freedom of choice is extensive and appropriate and permits him to weigh his preferred management against such costs.

In my opinion, the proposed legislation will have a depressant effect upon the growth of mutual funds as a widespread investment medium. I consider that such a result would be contrary to the public interest.

Sincerely yours,

GERALD TSAI, Jr.