Mr. CARY. Well, let's say it is a 10-year contract, so you give $100. Now if in the first year the sales load might be as much as 50 percent of that, $50 of that $100. Now let's say then at the end of that year you find you cannot continue making payments. If you want to get your money back, how much would you get back?

Just $50. In other words, you just have a $50 investment. Senator MAGNUSON. I am getting this confused with the service charge. What is the service charge normally?

Mr. CONWILL. Mr. Chairman, may I perhaps clarify the record on this. If you buy mutual funds in the conventional way with an 8-percent load, for every $100 you put in, $8 goes to the salesman and $92 is invested for you, so at that point you have a $92 interest. Senator MAGNUSON. Yes.

Mr. CONWILL. If you got out at that point you would get $92. You never see the $8 again. Now the front end load the chairman is speaking of means that if you take out a 10-year plan for $100 a year, over the entire period of the 10 years they can still only charge you 8 percent or it can go as high as 9 percent, so that over the 10-year period you would be paying out of your $1,000, $80, and you would wind up with a $920 interest.

However, in the first year, they are permitted to deduct 50 percent, so that out of your first-year payment of $100, $50 would go to the salesman, so that if because of illness, family emergency, or any other reason at the end of the first year you had to get out, you would only get 50 percent of your investment back.

Now, in subsequent years, in order to average out so that they never charge more than 9 percent, they may only charge say three and a half percent in the second year, the third year, the fourth year, and for the balance of the contract, so that the longer you stay in, the less load you pay. But if you get out in the early years, it is very costly to you.

Senator MAGNUSON. If you sign a contract.

Mr. CONWILL. Yes, sir.

Senator MAGNUSON. But your equity may absorb that if their portfolio goes up.

Mr. CONWILL. If it does, yes.

Mr. CARY. It could be, yes, that is possible.

Senator MAGNUSON. But if it goes down, what? Then the same

thing applies.

Mr. CONWILL. You are in bad shape.

Mr. CARY. It has a doubling effect.

SERVICE CHARGE

Senator MAGNUSON. Is 8 percent unusual for a service charge?
Mr. CARY. No, sir; that is the normal.

Mr. CONWILL. That is the normal in the mutual fund industry. In fact 81⁄2 percent I would say is typical in the mutual fund industry. Senator MAGNUSON. That is assuming the portfolio stays just the same?

Mr. CONWILL. Yes, sir.

Senator MAGNUSON. But at the end of 10 years your equity goes up in proportion to the value as the assets of the fund go up.

Mr. CONWILL. Yes, sir.

Senator MAGNUSON. Is that correct; so you are taking a chance on growth to absorb that 8 percent if you stick with the contract? Mr. CONWILL. That is right, sir.

Senator MAGNUSON. But if their portfolio didn't go up 8 percent, you wouldn't get as much back as you put in?

Mr. CARY. That is correct.

Mr. CONWILL. That is right.

Senator MAGNUSON. If it went up over 8 percent you would get a little more.

Mr. CONWILL. Yes.

Senator MAGNUSON. But it would have to go up 13 percent for you to get 5 percent on your money over 10 years, wouldn't it? Mr. CONWILL. I think the mathematics is correct, Senator.

Senator MAGNUSON. I am just thinking about the poor guy who buys the contract.

Mr. CONWILL. Yes.

Mr. CARY. Of course there would be some income being paid out during that period as well that would have to be taken into consideration which would be the dividend income of the shares. So you would have to figure that factor in as well.

Senator MAGNUSON. Oh, yes. I mean there must be some merit to these funds because a lot of people invest in them.

Mr. CARY. That is right.

Senator MAGNUSON. And there are people who figure out whether they should put in dividends of investments, and they choose this for

some reason.

Mr. CARY. They have been generally very successful in the past 10 years.

SUCCESS OF MANAGEMENT

Senator MAGNUSON. I would think the management is very successful too. Their risk is not too great, is it? The guy with a 10-year contract is guaranteeing him a certain amount, and if the stocks go down or the portfolio goes down, why they are still going to get the same amount from the guy that bought, aren't they?"

Mr. CARY. He will be continuing to buy shares, Senator Magnuson, over an extended period of time.

Senator MAGNUSON. Yes.

Senator ALLOTT. But this happened in 1961.

Mr. CARY. This happened in 1961.

Senator MAGNUSON. This is the situation you are getting at.

PROBLEMS OF SALES LOAD

Mr. CARY. The problem that we were particularly worried about was this extra sales load in the so-called contractual plan, where it was a 50-percent bite in the first year. That was the principal problem Now we exposed this problem to the public. I mean we presented it in the special study. We probably believed that any actual final solution of that problem would require legislation rather than just action on our part. After the problem had been posed, the question is: What can you do about it?

We recognize that we really can't do anything about it basically without legislation. However, by bringing the problem to public attention, certain factors seem to be taking place.

It is

One, some of the companies are stretching out their load. not going to be in many cases as much as 50 percent in the first year. Secondly, there are other firms that are thinking of going into the mutual fund industry that really will have no front end load at all. So as a consequence, we think that the exposure has been of considerable help in meeting the problem, although it doesn't meet it all the way.

MUTUAL FUNDS AS TRUST FUNDS INVESTMENT

Senator MAGNUSON. Let me ask this and then I will quit asking about this because I am getting too deep in it. Are mutual funds ever listed as a proper investment for, say, trusts?

Mr. CONWILL. Yes, sir.

Mr. CARY. Yes, sir.

Senator MAGNUSON. They are, some of them are.
Mr. CARY. Yes.

Senator MAGNUSON. In other words, some of them are solid enough to be listed as proper securities say for a trust?

Mr. CONWILL. Yes, sir; and you will find that trust instruments often specifically empower the trustee to invest in mutual funds.

Senator MAGNUSON. In mutual funds. And are the assets of mutual funds always common stock or do they vary?

Mr. CONWILL. They vary.

Senator MAGNUSON. They might be bonds, municipals, end stocks, or any combination?

Mr. CONWILL. That is right.

Senator MAGNUSON. Can they make an investment in a business that is not listed?

Mr. CONWILL. Yes, sir.

Senator MAGNUSON. That is not traded? They do that often too? Mr. CONWILL. Yes, sir. They are required under our statutes and regulations to set forth for the investor what their investment policy is. Senator MAGNUSON. So the buyer gets the portfolio and he knows what they are in?

Mr. CARY. That is right.

REACTION OF MUTUAL FUND INDUSTRY-CONTRACTUAL PLANS

Mr. CONWILL. He knows what they are in and knows what they are empowered to invest in. May I add just one thing on the contractual plan matter. The exposure the chairman referred to in the special study occurred last summer in chapter 11 and it was critical of the contractual plans. Before the staff recommended action in this area to the Commission, we thought it would perhaps be unfair to do so until we heard a response from the contractual plan industry. They prepared a very elaborate response, running over 500 pages, which we received in late February, and we are in the process of analyzing their response, which naturally was critical of our exposure. Mr. CARY. Right.

MANAGEMENT OF MUTUAL FUNDS

Senator ALLOTT. Just one or two other thoughts. On the loading, on the 8 percent, what this means of course is that if a man is planning and investing his money for a year or two he is generally on the bal

ance ill advised to put it in a mutual fund because he can't bear an 8-percent loading on a 2-year investment.

Mr. CONWILL. The mutual funds bring that point home. They emphasize that it should be for the long term.

Senator ALLOTT. Secondly, this 8 percent as a rule as I understand it also covers costs of sales as well, does it not? In most instances it is supposed to cover cost of redemption, if you want to put it that way, of the share?

Mr. CONWILL. That is correct; yes.

Senator MAGNUSON. The total service charge.

Mr. CON WILL. Yes; except for an annual management fee.

Senator ALLOTT. I read the reports as much as I could. Forbes had several articles about it. Fortune had one article about it I believe, and the Wall Street Journal carried many of the things. What I am concerned about, are you satisfied now that the management of these funds is up to the standards of competency that people have a right to expect when they invest in them, because I won't name specific funds but we all know that during the crash of 1961-is that the year?

Mr. CARY. 1962.

Senator ALLOTT. 1962 in May. Many of these funds, unfortunately some of them are big names, didn't do as well as you could have done if you just had any number of common stocks.

Mr. CONWILL. Senator Allott, I think our answer to that overall as far as the staff is concerned would be that in general the managements are very well qualified. Some unfortunately are not, and that is one of the things that has been developed in our inspection program and one of the reasons why we are asking for additional investment company inspectors in our regional offices of you this morning.

Senator ALLOTT. I didn't mean to lead us off, but I think this is informative, and it constitutes a big portion of their responsibilities. It is worth going into.

Mr. CARY. This is an area by the way which has been growing enormously as you well know. It is now let's say 2 years ago, it was I would say somewhere around $30 billion or less than that-$27 billion at one point when we reported to you. It is now estimated to be $38 billion. The area that is growing so rapidly is the so-called mutual fund or open end fund arrangement.

UNION WELFARE AND PENSION FUNDS

Senator ALLOTT. While we are on this, one time, and this was before your office, we were talking about union welfare and pension funds, primarily union. And the SEC was reluctant to assume any jurisdiction over this field, extremely reluctant. Do you have any figures at the present time as to the total amounts in welfare and pension funds, not only those which are contributory but noncontributory of industry and unions?

Mr. CARY. I think we will have to supply that for the record. It is vastly in excess of the investment company figure that I gave you of $38 billion.

Senator ALLOTT. Could we get that for the record?

Mr. CARY. We will be glad to supply that for the record.
Mr. WHITNEY. We can get it.

1 Other types of welfare plans do not involve the substantial accumulation of funds and have a relatively smaller impact on savings. Assets of welfare plans amounted to $2.2 billion at the end of 1960. Source: SEC Statistical Series Release 1902, Corporate Pension Funds, 1962, and supplementary tables.

REQUIREMENTS TO REGISTER AS AN INVESTMENT COMPANY

Senator MAGNUSON. One more question. What if a group of people, not a group but 5 or 10 people-I remember once years ago about 5 of us put in $500 and we gave the authority to one fellow to go out and invest it. Now are we a mutual fund? Do we have to

register?

Mr. CARY. You are not under the law.

Senator MAGNUSON. Not under the law?

Mr. CARY. We are not going to go after you.

Senator MAGNUSON. Because that would be voluntarily and would not be open to the public. That is the difference, isn't it?

Mr. CONWILL. There is a statutory test, Senator Magnuson and you would be not under the statutory test.

Senator MAGNUSON. I must say it turned out very well because it was a long time ago.

Mr. CONWILL. Generally if there are less than 100 of you
Senator MAGNUSON. We declare a dividend once a year.
(Discussion off the record.)

Senator MAGNUSON. The difference is the public matter.
Mr. CONWILL. That is right, sir.

REASONS FOR INVESTMENT COMPANY INSPECTION PROGRAM

Senator YOUNG. When do you investigate a mutual, on complaint? Mr. CARY. No, sir.

Senator YOUNG. Spot check?

Mr. CARY. The very thing we are hitting at this time and why we need more people is because we think that unless we get around to those on a fairly regular cycle, Senator, that things will happen that we think can be prevented by this kind of inspection. We believe very strongly about our inspection program, which we accelerated about 3 years ago. Before that, I think there have been only a very few investigations or inspections made of investment companies. We found since that acceleration of this inspection program has corrected many deficiencies.