C. Collective Funds for Self-Employed Individuals (Keogh Plans)

The Amendment provides that Keogh plans sponsored by banks should be exempt from the registration requirements of the 1933 Act unless the SEC determines that they require the protection of the Act. We agree with the SEC on the two main points at issue. First, collective trusts for Keogh plans should always be subject to the fraud provisions of the 1933 Act (accomplished by defining these interests as a security). Second, the SEC should be responsible for determining whether or not specific Keogh plans should be exempt from the registration requirements of the 1933 Act. (See discussion below under IIB.)

It should also be made plain that these collective funds are subject to the fraud provisions of the 1934 Act. This can be accomplished by defining the participations in the funds as securities for 1934 Act purposes, even if the Commission determines that Sections 12, 13, 14 and 16 of the Act need not apply.

One may also raise the question why the participants in a bank-sponsored Keogh fund should not be given the protection of the 1940 Act such as those afforded by Section 17 and other conflict of interest provisions in the same manner as these sections protect participants in a mutual fund-sponsored Keogh plan. Moreover, it is difficult to see why a statutory standard of reasonableness for management fees, if adopted, should not apply to a bank-sponsored Keogh fund which aggregates the assets of individuals in the same way as plans sponsored by mutual funds.

D. Collective Agency Accounts

The Amendment apparently intends to codify the views of the SEC in this area—namely, that these collective accounts are investment companies subject to registration under the 1940 Act and participations in such funds are considered securities for purposes of the 1933 Act and 1934 Acts.

Sections 102 (a) and 103(a) of the Amendment presumably are designed to make clear that participations in collective agency accounts are securities for purposes of the 1933 and 1934 Acts. However, there may be some confusion as to whether the exemptive provision for securities as drafted applies to these funds as well as to collective funds for self-employed individuals. The language should be rearranged to make it clear that the exemptive provision is restricted to collective funds for self-employed individuals.

II. SPECIFIC PROBLEMS

The amendment raises a number of other substantive problems with respect to dilution of investor protection and favoring the competitive position of banks. A. Banks Acting as Broker-Dealers under the 1934 Act

The Glass-Seagall Act of 1933 prohibited banks from underwriting, selling or distributing securities and thus effectively excluded them from the securities business. Consistent with this statutory prohibition, when a year later Congress enacted the Securities Exchange Act of 1934, banks were exempted from the definitions of broker and dealer contained in Section 3 of the 1934 Act. The effect of this exemption relieves banks from those provision of the 1934 Act which require the training, registration and supervision of persons dealing with the public in the retail securities business. Such provisions, together with Commission rules, also impose duties on broker-dealer and their salesmen relating to the suitability of recommended investments for customers.

Under the Amendment, banks which sponsor collective agency accounts and collective funds for self-employed individuals would be permitted to re-enter the securities business. They will naturally wish to attract assets to such funds and their personnel will solicit the investment of money in usch funds. This involves the sale of a security to the investor. The bank will have an interest in seeing the fund grow, and it is reasonable to assume that personnel of the bank who are successful in bringing assets into the fund will be rewarded by the bank in some form. Such a reward could be effected not only through bonuses or increased salary in the case of all four types of collective funds discussed in Part I above, but, as the Amendment now stands, banks would be free to place a sales load on all of these funds except the collective agency account.

Because of the definitions in Section 3 of the 1934 Act it is arguable that the personnel who sell the fund, as well as the bank, are exempt from the requirement of registration under Section 15(a) of the 1934 Act, are exempt from the requirements of training, qualification and supervision of sales personnel

noted above, and are free of all of the other rules adopted by the Commission under the 1934 Act in the public interest and for the protection of investors.

For the protection of investors the banks which sell interests in these funds and their personnel should be held to the same requirements as to record keeping and examination, training and supervision as persons who sell share of other mutual funds.

Accordingly, we believe that the definitions of broker and dealer in the 1934 Act should be modified so as to include a bank insofar as it maintains a collective agency account or a collective fund for self-employed individuals or a publicly offered common trust fund and any other bank which sells an interest or participation in any such fund.

B. Delegation of Regulatory Powers to SEC with respect to Bank-sponsored Collective Funds for Self-employed Individuals

Under Sections 102(a) and 103 (a) of the Amendment it is clear that interests in collective funds for self-employed individuals are securities within the definition of "securities" under the 1933 Act and the 1934 Act, provided that the Commission determines that protection for investors requires that the provisions of the respective Acts be applicable. Section 102 (c) of the Amendment would insert a new Section 25 (b) which would transfer to the respective bank regulatory agency all the powers, functions and duties of the SEC with respect to such funds and would give such agency the power in its discretion to exempt any class of interests or participations in such funds from all the provisions of and regulations under the 1933 Act. Similarly, Sections 103 (c) (1) and (2) would amend Section 12(i) of the 1934 Act to effect the same transfer with respect to specified sections of the 1934 Act. Section 103 (c) (3) would give the respective bank regulatory agency the power to exempt any securities issued by banks and interests and participations in collective funds for self-employed individuals from all provisions of and regulations under the 1934 Act.

In his testimony on S. 2704 last year the Chairman of the Securities and Exchange Commission noted that Keogh plans, because of the complexity of the arrangements involved, posed “a particular need for adequate and understandable disclosure concerning the risks, obligations, rights and costs which are involved" [Hearings, p. 137]. He also noted that the Commission regarded Keogh plans as being within the 1933 and 1934 Acts [Hearings, p. 134]. The proposed Amendment is plainly inconsistent with the approach indicated in Chairman Cohen's testimony at that time as well as his testimony on the Amendment.

We believe that the amendments to the 1933 Act proposed in Section 102 (c) of the Amendment and to the 1934 Act proposed in Section 103 (c) (2) and (3) of the Amendment should be rejected because they discriminate unfairly against financial institutions which will be competing directly with the banks who are selling interests and participations in such collective funds. Even assuming that the banking authorities would not totally exempt Keogh plans from the 1933 Act, the disclosure standards for all Keogh plans, whether sponsored by a bank or others, should be uniform. Moreover, the protections for investors in such securities should be regulated by the agency (the SEC) which has so long been charged with this type of duty. The bank regulatory agencies are primarily concerned with maintaining the strength of the banking system and not with the protection of investors.

C. The Amendments to Section 10 of the 1940 Act

Section 101 (c) (1) of the Amendment would, in its effect, undercut the investor protections of Section 10 (c) and Section 10 (b) (3) of the 1940 Act. Section 10 (c) provides that a majority of the directors of an investment company may not be made up of officers and directors of any one bank. It was adopted as a response to the SEC's finding in 1940 that bank control of investment companies was inconsistent with the effective protection of investors. Section 10(b) (3) requires that a majority of the directors of an investment company shall not be investment bankers or affiliated persons of any investment banker. This too was adopted on the recommendation of the SEC in 1940 as being necessary to protect investors. There has been no showing that the policy of assuring the independence of investment companies from such other financial institutions is irrelevant today or that it should be abrogated.

This appears to be an inadvertent grant of power since the Amendment does not seem intended to deal with equity or debt securities of the bank itself.

Although the SEC has granted an exemption from the prohibitions of Section 10(c) in the case of First National City Bank, its decision to do so was based on the specific characteristics of the FNCB's Account such as, for example, its policy of investing for long-term growth, its stated brokerage policy, and the $10,000 minimum investment. There is nothing in the Commission's opinion to suggest that it would be appropriate to grant similar exemptions to all bank mutual funds in all circumstances.

Furthermore, Section 101 (c) (2) would amend Section 10(d) of the 1940 Act which allows a fund which meets precise requirements to operate with only one independent director, freeing it from the requirement of Section 10 (a) that 40% of the directors must be independent. The provision of Section 10 (d) for only one independent director was specifically tailored to the investment counsel who sponsored an investment company as an adjunct to his investment counseling business. Yet, the Amendment would permit bank collective agency accounts to operate with only one indepenent director. Even no-load funds which come within the terms of Section 10 (d) do not receive this type of preferential treatment. They cannot have a board of directors with a majority of commercial or investment bankers.

It might be noted that the SEC rejected the application of the First National City Bank for an exemption to permit it to have only one independent director. Chairman Cohen now accepts this statutory proposal without assigning any particular reason for so doing.

Moreover, in granting the exemption involving the composition f the Board of the First National City Bank mutual fund, the SEC imposed a condition on the bank in recognition of one of the conflict of interest situations in which a sponsor bank could be found. The FNCB mutual fund was prohibited from buying securities underwritten by a syndicate including FNCB so long as any member of the syndicate has not fully disposed of its allotment of securities. The Amendment contains no such safeguard against this particular conflict of interest. There is no showing that investor protection does not require such a condition.

We believe that the reasons for restrictions in Section 10(b) (2) and 10 (c) are just as valid today as in 1940. Moreover, we consider the requirement of Section 10(a) one of the essential features of the 1940 Act which should not be weakened. Accordingly we urge that the amendments in Section 101 (c) (1) and (2) should not be adopted.

APPENDIX

INTEGRATION OF SUGGESTED COLLECTIVE FUND DEFINITIONS INTO THE SECURITIES ACTS 1

1940 Act

All four definitions of collective funds suggested in the text would be added as definitions to Section 2(a) of the Act. Section 2(a)(35) defining a “security” could then be amended to add "interest or participation in a common trust fund, a collective fund for pension trusts, a collective fund for self-employed individuals, or a collective agency account." Participations in all types of collective funds should be included in the definition of a security for the purpose of uniformity with the other acts.

A collective agency account is considered to be an investment company for purposes of the 1940 Act, but the other three types of funds are not. Thus, the exemption for common trust funds contained in Section 3(c)(3) of the 1940 Act should be shortened to read "any common trust fund." Similarly, the exemp tion for collective funds for pension trusts and collective funds for self-employed individuals would be incorporated into Section 3(c) (13).

This exemption should also make clear that the funds contributed to a bank as custodian under Section 401 (f) of the Internal Revenue Code would not be considered an investment company whether or not the bank is acting as custodian for numerous identical plans which have qualified under Section 401 as a prototype plan.

1933 Act

The four definitions of collective funds would be included as definitions in Section 2 of the Act. These definitions would then be used in Section 2(1) of the 1933 Act defining securities. Similarly, the definition for a collective fund for self

1 If the Committee believes that legislation along these lines is appropriate, the Institute would be glad to suggest appropriate statutory language.

employed individuals would be used to shorten the amendment to Section 25, if that is to be adopted.

We agree with the SEC that there is no reason why any of these securities should be exempt from the fraud provisions of the 1933 Act. Thus each of them should be included in the definition of a security.

1934 Act

The four definitions of collective funds would be added to the 1934 Act in Section 3. Section 3(a)(10) defining securities for the purposes of the Act should include participations in all four types of funds in the same way as the 1933 Act. To the extent it is appropriate to exempt any of these four types of funds from the 1934 Act, Section 12(g) (2) could be shortened by using these definitions. As in the case of the 1933 Act we agree with the Commission that it would be inappropriate to exempt these securities from the fraud provisions of the 1934 Act. Thus, each of them should be included in the definition of a security.

STATEMENT OF EUGENE V. ROSTOW, STERLING PROFESSOR OF LAW AND PUBLIC AFFAIRS, YALE UNIVERSITY

The Investment Company Intitute has asked for my opinion as to those portions of S. 2704 which authorize qualified banks to pool managing agency accounts into "collective investment funds."

These "collective investment funds" would be exempted by S. 2704 from the provisions of the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Company Act of 1940. The banks establishing such funds would, however, be required to file written "plans" with the appropriate supervisory agency as defined in the bill. These plans would set forth the character of the banks' investment funds, and the supervisory agency would approve such plans as in compliance with the statute, or allow them to become effective without specific approval. Regular financial reports would be required of the bank for each fund it maintains. And prescribed financial information would be furnished to investors, and to persons responsible for participation in a collective investment fund. The Comptroller of the Currency would be given power to make rules and regulations under the act, and to make exemptions as well.

The McIntyre bill contemplates that each bank manage its own collective investment fund or funds. (Sec. 4(a) (1).) No provision is made for investor election of directors of the fund, or for the duration or review of management contracts. The bill would thus give the banks considerable, although not unlimited, authority to establish and conduct open-end investment funds, by pooling managing agency accounts. Such funds would not be regulated by the Securities and Exchange Commission under the Investment Company Act, but by the Comptroller of the Currency under the McIntyre bill, on a different footing, and pursuant to different policies.

S. 2704 raises a number of legal and economic problems. This statement is confined to one: Whether it would be sound public policy to shift the present boundary between mutual funds and banks, as S. 2704 proposes, so as to allow the banks to compete directly with mutual funds, insurance companies, and other financial institutions for a somewhat larger part of the flow of private savings. The appeal of such a step is that it would encourage more competition among financial institutions for the saver's dollar. But the proposal would also weaken the protections afforded to bank depositors and to the entire financial system by the Glass-Steagall Act of 1933, and the legislation which has followed it. In view of the variety of investment programs now open to the saver, and the extent of competition among mutual funds, brokerage firms, insurance companies, savings banks, building and loan associations, and other financial intermediaries, I conclude on the basis of information presently available that the adverse effect of S. 2704 on the sfety of the banking system would outweigh its probable impact in increasing the degree of competition in a market which is already quite actively competitive.

The McIntyre bill is an effort to resolve a controversy between the Securities and Exchange Commission and the Comptroller of the Currency over their respective regulatory jurisdictions. The solution it offers for this administrative problem arises far-reaching issues of policy, however, which in my opinion should not be decided inadvertently, or without benefit of full hearings.

The Glass-Steagall Act of 1933 is a declaration of policy, based on an extended congressional inquiry, and highlighted by the vivid experience of the great depression. It undertakes the statutory divorcement of commercial banking from investment banking, and from many other aspects of the securities business as well. In this respect it is like several statutes basic to the structure of the economy-the commodities clause of the Hepburn Act, for example, prohibiting railroads from engaging in most other forms of business, or the laws requiring a separation between shipping and air transport, between air transport and the manufacture of planes, and the like.

The Glass-Steagall Act, the Supreme Court remarked, is "a preventive or prophylactic measure," designed "to remove tempting opportunities from the management and personnel of member banks." Board of Governors v. Agnew, 329 U.S. 441, 449 (1947). It includes provisions dealing with a number of specific practices. But its broad remedial purposes are simpler and more comprehensive than the particular means chosen to carry them out.

The Federal Reserve System is the central nervous system of the economy. The possibility of distortion or disturbance in the flow of credit is a matter of absolutely fundamental importance to all aspects of economic life, and to the authorities charged with responsibility for governing it.

I propose to examine S. 2704 in the prospective of this concern.

One should consider the question from the point of view of the investor in a bank's collective investment fund, of the depositor in a bank conducting such a fund, and of the economy at large.

Chairman William L. Cary of the Securities and Exchange Commission discussed the problem definitely from the standpoint of an investor in a bank's collective investment fund before a subcommittee of the House Committee on Government Operations on May 30, 1963. His comments on the Comptroller's Regulation 9, which broadly parallels S. 2704, are cogent and persuasive to me. and I fully concur in them. At the least, Chairman Cary's views require. I conclude, that investors in bank-managed investment pools be protected by the substantive and adjective law of the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Company Act of 1940.

The problem raised by S. 2704 is quite as serious, however, if examined as a factor in the health of the banking system.

The proponents of the bill point out, quite correctly, that banks have always acted as trustees, and that law and custom have long accepted the propriety of such fiduciary activities on the part of commercial banks. The principle of pooling or commingling trust assets became popular some 40 years ago. Under proper safeguards, there is no objection to the practice, which enables banks to offer fiduciary services to relatively small estates and trusts.

The present proposal is justified as a modest enlargement of existing practice and the "common trust fund" exemption of the securities statutes. But the "collective investment fund" proposals represent something quite different, and quite new. They would permit the banks to act as investment advisers and managers on a novel scale, going far beyond the historic limits of their fiduciary services. Here, as is often the case, differences of degree become differences in kind.

The trust business of bank, in the nature of things, derives from the banks* relationships with its customers, with lawyers, and with insurance agents. While a bank's trust accounts hardly come to it from the skies, they do not, on the other hand, normally involve the active daily battle for business characteristic of the work of brokers and dealers. One of the purposes of the GlassSteagall Act was to keep the banks out of this market, with its built-in and inescapable conflicts of interest. As the House Committee report on the 1935 amendments of the Banking Act makes clear, the policy of Glass-Steagall was not only to divorce commercial from investment banking, but from "the securities business" more generally (H. Rept. 742, 74th Cong., 1st sess. 17 (1935)). That policy stands out strongly in sections 16, 20, 21, and particularly 32 of the Glass-Steagall Act, 12 U.S.C. 24, 377, 378, and 78.

In the conduct of a trust department of the classical kind, a bank is under no pressure to sell interests in its own "collective investment trusts." Its fees and commissions as trustee, guardian, or executor do not depend on whether trust assets are managed in the common trust fund, or in a separate account. But if the law develops as S. 2704 proposes, the banks would have a pecuniary interest in advising their customers to purchase interests in their own collective