which the Securities and Exchange Commission recognized in 1958 when it adopted Rule 22(d)-1 under the Investment Company Act of 1940. At that time the Commission said: "The purposes of this section (Section 22(d)) are to prevent discrimination among purchasers and to provide for orderly distribution of such shares by preventing their sale at a price less than that fixed in the prospectus." [Emphasis supplied.]

In considering the role of Section 22(d), it is essential that one distinguish between the relationship among the purchaser-owners of the shares of a mutual fund and the purchaser-owners of other products.

On the one hand, the continued ability of the owner of mutual fund shares to enjoy his redemption privilege, which was an essential part of the productservice he has bought, is enhanced by the maximum possible retention of shares by other shareholders and the sale of new shares either to existing investors in the fund or to new shareholders-in order to offset the continuing flow of redemptions. In turn, the degree to which shareholders retain their shares depends to an important extent upon the quality of the selling which led to their present ownership. Thus, there are qualitative, as well as quantitative factors involved. There are several ways in which existing shareholders may suffer from largescale net redemptions. There is no question that the economic benefits of largescale operations have been reflected in a decline in expense ratios of funds as their size has increased.

Any large-scale net redemptions and the resulting sale of portfolio securities, moreover, could have a substantial impact on the market for particular issues held by the fund or on the entire equity market. One merely has to look at the experience of the savings and loan industry in the United States during 1966, the year in which tight money resulted in withdrawals being substantially in excess of new savings, and its effect on the housing market and new construction, to envision the possible repercussions on the securities markets of any substantial net redemptions in mutual fund shares. Any such repercussions could have a significant impact on the value of the remaining shareholders' investments. There is no other product or service that we know of where the welfare of the existing users is tied so closely to the maintenance both of the quality of the product or service and the quality of its sales efforts and to the actions of other users of the product or service.

SECTION 22(d) SHOULD BE RETAINED

This Association strongly recommends that Section 22(d) of the Investment Company Act remain unchanged; that it not be repealed. This position is not based simply upon the fact that Section 22(d) has been on the books for more than 25 years, and thus represents the status quo. Instead, our position is based upon our conviction that the unique characteristic of mutual funds calls for a strong barrier to cut-price sales.

THE SIZE OF THE REDEMPTION OBLIGATION

It is sometimes easy to overlook the magnitude of the redemption obligation of mutual funds. The arithmetic is simple. Based on the redemption rate of 5.8% of average net assets for the 12 months ended June 30, 1967, sales during the next 12 months must equal $2.3 billion if the industry is not to shrink.

To put the $2.3 billion figure in another perspective, it represents more than half of total sales of open-end investment companies during the 12 months ended June 30, 1967, and more than 75% of the total regular sales and voluntary accumulation plan sales during the same 12 month period.

Still another way to orient the $2.3 billion sales requirement is to relate it to the total SEC-registered corporate offerings of common stocks for cash in 1966, which amounted to $2.265 billion, of which $1.573 billion was underwritten or sold on a best-efforts basis.

The ability of any savings institutions, whether it be a bank or a savings and loan association, to honor requests for the withdrawal of funds depends in the final analysis upon the ability of the institution to attract at least an equal volume of deposits from other savers or depositors to offset the inevitable outflow. Likewise, mutual funds cannot over a period of years continue to afford shareholders the present redemption privilege unless there is a reasonable assurance that there will be a sufficient flow of new capital into the mutual funds to at least equal the inevitable outflow arising from exercise of the redemption privilege.

"REINVESTMENT" OF CAPITAL GAIN DISTRIBUTIONS DOES NOT OFFSET REDEMPTIONS

On pages 68 and 69 of the Statement of the Securities and Exchange Commission before the Senate Committee on Banking and Currency on S. 1659, on July 31, 1967, the Commission contended that the mutual fund industry's apprehension that a reduction in sales charges might produce a situation where redemptions exceeded sales, so that mutual funds would be a liquidating operation, is invalid because such a large proportion of redemptions is offset by the reinvestment of investment income dividends and capital gain distributions. The SEC made this same claim in its Report entitled "Public Policy Implications of Investments Company Growth."

On page 69 of the Statement, the Commission said, "In 1966 shareholders reinvested almost $1 billion of dividends, which equaled 73 percent of the approximately $2 billion of redemptions during that year. 1965 reinvestments of dividends amounted to 60.5 percent of redemptions." The 73 percent and 60.5 percent figures could only have been derived by combining the reinvestments of investment income dividends and capital gain distributions and labeling the total as "dividends."

While the reinvestment of investment income dividends may properly be regarded as a source of new capital to a mutual fund, and hence as an offset to the outflow of capital resulting from redemptions, the "reinvestment" of capital gain distributions can under no circumstances properly be regarded as new capital to a mutual fund, offsetting redemptions.

An investment income dividend represents the dividends and interest earned on the assets of a mutual fund which, after deducting operating expenses, are distributable to shareholders. In contrast, a capital gain distribution arises from the realization of capital gains in the sale of portfolio securities. If an investor is to maintain his investment in a mutual fund, he must take his capital gain distributions in shares; if he takes such distributions in cash, he reduces his investment. It is no different than the outright sale of shares. The "reinvestment" of capital gain distributions is not an additional to the assets of the individual investor or to the colective assets of the fund and hence does not in any way offset redemptions.

If the SEC had related investment income dividends reinvested to the total redemptions of mutual fund shares in 1965 and 1966, the Commission would have shown that dividend reinvestments offset 22% of redemptions in 1965, rather than the 60.5% shown in the Statement, and 24% of redemptions in 1966, rather than the 73% figure cited in the Statement. Similarly, Chart C on page 70 of the SEC Statement would have been drawn to reflect the reinvestment of investment income dividends only in the cross-hatched portion of the sales column.

NO-LOAD FUNDS EVIDENCE OF COMPETITION

The shares of mutual funds do not sell themselves, and funds which do not have effective distribution tend either to stagnate or to shrink. So-called no-load funds have found that effective sales require effort and expense.

We are not critical of no-load funds, as such. In fact, they evidence in a most dramatic way the competition which exists among funds in the area of sales charges. One has only to read the tombstone advertisements of the so-called noload funds to be aware that the primary, if not sole, appeal used in such advertisements is price.

The experience and practices of no-load funds, moreover, illustrate that effective distribution costs money, money that must come out of the advisory fee or brokerage. In spite of the strong price appeal which is permitted in the advertising of no-load funds, the growth of such funds has for the most part been slow. In short, the experience of no-load funds illustrates that for any mutual fund to continue to provide the redemption feature for its shareholders, it must arrange for the continuing and effective distribution of its shares, and price appeal, as attractive as it may seem, is not sufficient in itself to provide this distribution.

THE CONSEQUENCES CUT-PRICE SELLING

Prior to 1940, the "street market" in shares of mutual funds became of increasing relative importance. The basic appeal of the stock trading houses was, in its simplest terms, the ability to sell shares to the public, either directly or through dealers which were not members of the underwriter's selling group, at less than the underwriter's stated offering price. Such dealers could make trading profits

in the shares of mutual funds, in addition to the commissions which they charged in handling transactions. In their effort to achieve trading profits, they were always in a position to liquidate their inventories at a moment's notice by selling shares back to the mutual fund at the fund's official redemption price.

It is not surprising that members of the dealer selling groups, who were obliged by selling group agreements to maintain the public offering price, became disenchanted with the desirability of devoting the time and effort necessary to the successful merchandising of mutual fund shares, when they were subjected to increasing cut-price competition. The cut-price dealer, whose approach was simply "we can sell it to you cheaper", disrupted the efforts of contract dealers to do a continuing and informative job of distribution. There is no question that cut-price selling discourages sound selling and substitutes cut-price appeal for investment appeal.

PRICE COMPETITION IN MUTUAL FUND SALES

We feel that the suggestion that the so-called price maintenance provisions of Section 22(d) are no longer needed, now that the business has reached its present size, is based, at least in part, upon the assumption that in the mutual fund business there is no competition as to price. It is important to bear in mind just what Section 22(d) does require and what it does not.

Section 22 (d) does require any dealer selling shares of a given fund to charge a price determined in the manner set forth in that fund's prospectus. Thus, for any given fund, all dealers must charge the same price at any given moment on comparable sales of that fund. This prevents cut-price selling of shares of that fund. Section 22(d) does not, however, prevent one fund from competing with another fund on a price basis, as well as on other bases such as performance and services. Indeed, mutual funds do compete vigorously on all three bases.

The mutual fund industry has sales charges ranging all the way from zero to nearly 9%, with innumerable combinations of discounts applicable to various quantities of purchases. While Section 22(d) of the Investment Company Act requires that the shares of any given fund may be sold only at the prices set forth in its prospectus, the door is wide open for any underwriter to reduce sales charges on all or certain portions of its sales if in its judgment such a reduction is likely to lead to a more effective sales effort.

On page 31 of the SEC's Testimony before the Committee, the Commission refers to the most common sales charge as being 8.5%, compared with 7.5% in 1950. (The Commission, incidentally, refers to this as an increase of approximately 15%, whereas a movement from 7.5% to 8.5% actually is an increase of 13.4%.) Thus, in addition to the implication throughout the SEC Report and Testimony that 8.5% is "the" sales charge, the Commission draws the conclusion, without a complete or accurate look at the facts, that there has been a substantial increase in the sales charges in recent years.

We have analyzed the 1967 sales charge structures of the 20 largest groups of mutual funds and compared them with the 1957 sales charge structures of the 19 of the groups that were then in operation.1 We found that—

Seven of the 19 groups increased their maximum sales charges during the 10-year period. Twelve groups, or 63%, made no change.

Seven of the 19 groups reduced the first breakpoint in their sales charge structures to a level below $25,000. In 5 of these cases, this reduction was made in conjunction with an increase in the maximum sales charge. In only one instance was the sales charge increased from the new breakpoint to $25,000. In 3 cases, the sales charge was reduced from the new breakpoint to $25,000, and in 3 cases it was unchanged.

In 1957, only one of the 19 groups offered a cumulative reduction in sales charge, giving the investor credit for prior purchases in determining the level of sales charge to apply to his current purchase. At the beginning of 1967, 13 of the 20 groups offered such a cumulative reduction, in 8 cases to taxexempt organizations and in 5 cases to any purchaser.

For this analysis, we have used the sales charge information appearing in Table 22, at pages 250-251 of the 1957 Edition of Investment Companies, published by Arthur Wiesenberger & Co., and Table 24, appearing at pages 133-134 of the 1967 Edition of Wiesenberger's Investment Companies.

The 20 groups of funds embraced 62 individual funds in 1967, counting for 81.5% of the assets of members of the Investment Company Institute at the end of 1966. Because 1 group in the top 20 was organized after 1957, there were 19 groups in the 1957

analysis, comprising 55 funds and accounting for 82.0% of the assets of members of the Investment Company Institute at the end of 1957.

Without taking into account the level of breakpoints, the level of sales charges above those breakpoints, or the availability of cumulative reductions, we calculated an average maximum sales charge for the 19 groups based upon the 1957 tabulation and an average maximum sales charge for the 20 groups based upon the 1967 tabulation. In making these calculations, the maximum sales charge of each fund was weighted on the basis of its total net assets. Thus, a large fund was given greater weight than a small fund."

On this basis, we found that the average maximum sales charge in 1957 was 7.80% and the average maximum sales charge in 1967 was 8.18%, representing an increase of 38/100 of a percentage point in maximum sales charge, or an increase of less than 5% from the 1957 level. Interestingly, only 3 groups increased their maximum sales charges from 7.5% to 8.5% between 1957 and 1967.

While is it quite true that none of the 19 largest groups in existence throughtout the 10-year period reduced their maximum sales charges (with the exception of one fund wtihin one of the 19 groups), the increases were for the most part accompanied by reductions in the initial breakpoint.

There was one notable example of a reduction in sales charge during the period. The management of a $250,000,000 fund which had been offered at a maximum sales charge of 8.5%, sought to improve the competitive position of the fund by making it a no-load fund. The management also introduced a new concept. Although there is no sales charge, the adviser-underwriter makes a 3% cash payment from its own treasury to selected dealers selling shares of the fund. Although the specific source of the payment is not identfied, the investment adviser-underwriter receives, in addition to a typical investment advisory fee, the bulk of the brokerage generated by the fund in its portfolio transactions. This illustrates the freedom which exists for any underwriter to change its sales-charge structure in the presence of Section 22(d), if the underwriter feels that such a change will improve its competitive position.

CONCLUSION AND RECOMMENDATION

Presumably the primary objectives of repealing Section 22(d) would be to bring about a reduction in sales charges through the introduction of intra-fund price competition at the retail level. We believe that any immediate advantage to investors arising from such reduction would be more than offset by the destruction of the existing distribution system upon which the mutual fund redemption privilege is based. The loss of orderly distribution, and the return to the conditions which were developing prior to the adoption of Section 22(d), could lead to the ultimate self-liquidation of mutual funds and the consequent liquidation of their portfolio securities over a period of time.

We emphasize that Section 22(d) does not impair price competition between funds. Intra-fund price maintenance is essential to the avoidance of cut-price selling, which could be detrimental to the quality of selling. This would be contrary to the objectives of the SEC and the NASD, both of which have been trying to improve the quality of selling in the securities business by such measures as raising the qualification requirements for persons entering the business and placing greater emphasis upon the supervision of salesmen.

We strongly recommend that Section 22(d) of the Investment Company Act be retained.

2 While a better weighting might have resulted from the use of sales figures, such figures were not readily available and are complicated by the presence of non-sales-charge transactions (such as reinvestments and interfund conversions, in some cases), and one of the important factors reflected in the size of a fund and its relative level of historic sales.

SUMMARY CHANGES IN MAXIMUM SALES CHARGES OF 20 LARGEST MUTUAL FUND GROUPS, DEC. 31, 1966

Number of underwriters...

Number of funds....

Percent of ICI assets..

Average maximum sales charge, weighted by total assets of fund group (percent)...

NUMBER OF GROUPS

1 One of the 20 largest mutual fund groups at the end of 1966 (Tsai Management Co.) was not in existence at the end of 1956. 2 In some instances new funds organized after 1956 have sales charges higher than the rates for their groups at the end of 1956, or minor fund was brought into line with major fund in group.

The CHAIRMAN. Our next witness is Mr. Lawrence Bogert, president of the Investment Bankers Association of America. He is accompanied by Gordon L. Calvert, executive director, and Rucker Agee. Mr. Bogert, are you the spokesman?

STATEMENT OF H. LAWRENCE BOGERT, PRESIDENT, INVESTMENT BANKERS ASSOCIATION; ACCOMPANIED BY DONALD T. REGAN, VICE PRESIDENT FOR GOVERNMENTAL RELATIONS; GORDON L. CALVERT, EXECUTIVE DIRECTOR AND GENERAL COUNSEL; RUCKER AGEE, MEMBER, BOARD OF GOVERNORS; W. BRUCE MCCONNEL, JR., CHAIRMAN, FEDERAL SECURITIES ACTS COMMITTEE; AND FRANKLIN JOHNSON, CHAIRMAN, INVESTMENT COMPANIES COMMITTEE

Mr. BOGERT. I am the spokesman, Mr. Chairman.

The CHAIRMAN. You may proceed in your own way. And you all understand that the complete statement will be printed in the record with the exhibits.

Mr. BOGERT. Thank you, Mr. Chairman, members of the committee. I am H. Lawrence Bogert, president of the Investment Bankers Association of America and a partner in Eastman Dillon, Union Securities & Co., an investment banking firm in New York.

With me today to assist in providing expert or technical information in response to your questions are:

On my extreme left, your right, Mr. Donald T. Regan, IBA vice president for governmental relations and executive vice president of Merrill Lynch, Pierce, Fenner & Smith, Inc., New York.

On my immediate left, Mr. Gordon L. Calvert, executive director and general counsel of IBA.

On my immediate right, Mr. Rucker Agee, member of the IBA board of governors from Alabama and President of Sterne, Agee & Leach, Inc., Birmingham, Ala.