You will recall that the so-called Maloney Act amendment to the Exchange Act (which, among other things, added section 15A to that act) was designed to provide for the establishment of a mechanism of regulation among over-thecounter brokers and dealers operating in interstate and foreign commerce or through the mails, comparable to that provided by National Securities Exchanges under the Securities Exchange Act of 1934. It came about as the result of cooperation between Senator Francis T. Maloney, the Securities and Exchange Commission, representatives of the investment banking and securities business and the deliberations and ultimate approval of your committee, and I think it is generally recognized as a highly significant and promising experiment in cooperative regulation by government and business. More specifically, section 15A contemplates the formation of associations of brokers and dealers and their registration with the Securities and Exchange Commission for the purpose of providing such associations with effective means or sanctions to bring about self-regulation of association members, under governmental supervision. Such associations are thus enabled to promulgate and enforce, with Securities and Exchange Commission approval, such rules of fair practice as they deem necessary and appropriate to carry out the purposes of the act. The National Association of Securities Dealers is the only association to date which has registered with the Securities and Exchange Commission pursuant to the provisions of said section 15A. Its registration statement became effective on August 7, 1939, at which time it had 1,469 members. Today it has 2,891 members, which are located in every State and in substantially every impor tant city or town in the country, and it is believed that the present membership does well over 90 percent of the underwriting and general over-the-counter securities business of the country. For purposes of administration, the country is divided into 14 districts, and each district elects a district committee which has general supervision and charge of the affairs of the association in its district. There is also a national board of governors of 21 members who are elected from the various districts, and the board of governors is the national governing body of the association. The association has adopted some 25 rules of fair practice, and these are enforced by district and local business-conduct committees and by the board of governors. In accordance with the provisions of section 15A of the Exchange Act, decisions of district business-conduct committees are appealable to the board of governors, from the board of governors to the Securities and Exchange Commission, and from the Securities and Exchange Commission to the Federal courts. Section 15A gives such associations the right, by rule, generally to restrict the preferential dealings of members to members of such associations, and the National Association of Securities Dealers has adopted such a rule. In view, therefore, of the size and importance of its membership in the business, the fact that no other association has registered with the Commission, and the fact that a member expelled for violation of the rules may no longer deal with association members on a preferential basis, it can readily be seen that the association has effective economic sanctions for requiring compliance with its rules. As I have already indicated, the association at present has 2,891 members, and since there are some 6,700 brokers and dealers registered with the Securities and Exchange Commission, it might be thought that the association covers only a part of the field to be regulated; but in this connection, I should like to call your attention to the fact that of the 6,700 brokers and dealers registered with the Commission, some 1,000 are largely brokers and dealers in oil royalties. and thus have no interest in membership in the association or in the provisions of S. 3580. By the same token, it is estimated that several hundred are dealers in real-estate mortgages and notes and some 700 are brokers or dealers who are solely connected with exchange trading; so that when the list of brokers and dealers registered with the Commission is thus broken down, I think it fair to say that only some 4,000 brokers and dealers can be said to be in the general over-the-counter securities business and thus interested in membership in the association or in the provisions of S. 3580. You will see, therefore, that roughly 75 percent of this 4,000 are already members of the association. Indeed, substantially all of the so-called open-end investment-trust underwriters are at present members of the association, and it is our belief that the vast majority of dealers who distribute shares of open-end investment trusts are already members of the association; so the association does afford an effective medium for handling the regulatory problems which are sought to be reached by the provisions of S. 3580 insofar as they affect the underwriting and distribution of openend investment-trust shares. As a matter of fact, there is a standing committee of the Association of Investment Trust Underwriters which is charged with the duty of studying all aspects of the problem of underwriting and distributing shares of open-end investment companies with a view to formulating recommendations of appropriate rules and regulations, to be adopted as rules of fair practice of the association, governing this particular branch of the investment banking and securities business, and this committee is presently at work on the task assigned it and is hopeful of formulating a comprehensive regulatory program to be carried out through the association in the immediate future. As the underwriting and distribution of shares of open-end investment trusts is after all an important branch of the general securities business; and as the Congress, on the recommendation of your committee, has already seen fit to provide for this mechanism of self-regulation, under governmental supervision, of this business, and as the National Association of Securities Dealers, Inc., has already registered with the Commission and is seeking to carry out the purposes of section 15A of the act, and as the investment trust underwriters and distributors are already proceeding through the association to develop a comprehensive regulatory program for their phase of the business, it is submitted that investment trust underwriters and distributors should be given a fair opportunity to effectively regulate their branch of the securities business through the Association as envisaged by the Maloney Act. Very truly yours, HUGH BULLOCK. Hon. ROBERT F. WAGNER, MAY 2, 1940. Chairman, Subcommittee of the Committee on Banking and Currency, DEAR SENATOR WAGNER: During the hearings before your committee on S. 3580 the members of the staff of the Securities and Exchange Commission have minimized the effects of title II of this bill. In his rebuttal testimony on Friday, April 26th, in discussing this title Mr. Schenker made the following statements: "All we are asking them to do is file a piece of paper and say, Who are you? What's your name? What's your address? Have you ever been convicted of a crime? If you have been convicted of a crime, you have no business to be an investment counsel and you can't use the mails to perpetrate a fraud. That is the extent of this whole regulation on these people.” If this description could be regarded as a complete summary of the provisions of title II, it would indeed be difficult to see why the investment counsel profession is so seriously concerned about the effects of this bill. Title II consists of more than 30 pages, over two-thirds of which are incorporated by reference from title I. Obviously no such long and complex bill is required to accomplish the purposes enumerated by Mr. Schenker. In connection with the filing of the registration statement provided for in this bill and in addition to the information specifically mentioned in the text, the Commission is empowered to demand such further information and copies of such further documents relating to such investment adviser or its affiliated persons and employees as the Commission may by rules and regulations or order prescribe as in its opinion is necessary or appropriate in the public interest or for the protection of investors. This is hardly "Who are you? What's your name? What's your address? Have you ever been convicted of a crime?" All of the enforcement provisions of title II are incorporated by reference from the title I. These provisions which were designed to meet the problems incident to the public's holdings of the securities of investment companies are thus transferred to cover the highly personal and confidential relationship existing between an investment counsel and his clients. They are not appropriate for this purpose, and they are more far-reaching than is necessary to accomplish the stated objectives of the Commission. Section 38 of the bill gives the Commission discretion and broad powers to investigate facts, conditions, and practices within our profession. These powers are not limited to the determination of whether a person has violated the law or is about to violate the law or to investigations in connection with the enforcement of the provisions of title II. Despite the broad scope of this bill, it contains no provisions to safeguard and protect the interests of clients of investment counsel firms in the privacy of their affairs. This letter is not intended to be a summary of our objections to title II of this bill. It is merely a statement of the more important reasons why we feel that Mr. Schenker's description of the effects of this title is not in accordance with its actual provisions as we read them. We would appreciate having this letter printed as part of the record of the hearings before your committee. Respectfully yours, C. M. O'HEARN. DOUGLAS T. JOHNSTON. DWIGHT C. ROSE BOSTON, MASS., May 2, 1940. Re: Investment company bill. Hon. ROBERT F. WAGNER, Chairman, Committee on Banking and Currency, Washington, D. C. MEMORANDUM FOR THE RECORD OF THE SENATE BANKING AND CURRENCY COM- On Wednesday, April 24, 1940, Mr. Schenker, testifying before the Committee regarding the tax treatment of mutual investment companies, said: "I can state why, and I think I can state my difficulties with the tax discrimination. Unfortunately, Senator, there is no legislative history upon that provision in the tax law. As I remember it, it was introduced on the floor, and the first thing we knew was that the open-ended companies, as counterdistinguished from the closed-end company, had this tax preference." The above statement is incomplete and we wish to correct it. In this connection, we have been told that Mr. Schenker will offer a correction of his testimony. But inasmuch as reference to this matter has recurred from time to time, both at this hearing and prior thereto, and in order that the facts may e fully known, we wish to give herewith a brief history of that phase of to tax legislation. In his Message to Congress on June 19, 1935, the President of the Uted States recognized that bona fide investment trusts that submit to public lation and perform the function of permitting small investors to obtain ? benefit of diversification of risk should receive special tax treatment. As a result of this statement, late in 1935 and early in 1936 a group rep senting a large number of open-end companies had conferences with mai individuals in the Treasury Department, with various Senators and Represent tives and the President of the United States, relative to tax relief for inves ment companies. The more important of these interviews will be detailed below. Prior to any of these conversations, Paul C. Cabot had an interview with Mr. James Landis, then Chairman of the Securities and Exchange Commission, in which Mr. Cabot outlined to the Chairman what specific tax relief this group sought and solicited the Commission's aid in respect thereto. In substance, Chairman Landis at this time stated that in view of the fact that the Securities and Exchange Commission was about to undertake an exhaustive study of the investment trust industry, he felt that it was inadvisable for the Commission to initiate any attempt to change tax legislation in favor of or in opposition to investment companies. He did state, however, that he would be interested in knowing what, if anything, was accomplished along these lines. Because of this, the group kept Mr. Landis' assistant, Mr. Thomas H. Gammach, informed as to their procedure from time to time. On June 12, 1936, the group met with Mr. Milton Katz, executive assistant to the Chairman, and related to him in detail what had transpired. At that time, Mr. Katz wrote a memorandum under date of June 12, 1936, a copy of which is hereto appended, marked "Exhibit A," which was marked to go to Chairman Landis, Mr. Schenker, and Dr. Gourrich. On March 16, 1936, Merrill Griswold wrote President Roosevelt, urging that the taxation problems of investment trusts be most carefully considered in connection with the proposed new revenue bill. In the course of his letter, he said: "The Securities and Exchange Commission is at present making a thorough study of investment trusts and is consequently already reasonably thoroughly familiar with their taxation problems. I venture to suggest, therefore, that the views of the Commission be ascertained by the administration and by Congress as to how the interests of the shareholders of investment trusts can best be reconciled under the new law with the interests of the Government." In reply, the President's secretary, Mr. Gaston, wrote Mr. Griswold that Mr. Morgenthau had asked those of his associates who were particularly studying the type of problem described to read the material submitted very carefully and to consider it in connection with other suggestions that were under discussion. On March 11, 1936, an interview was requested with Mr. Guy T. Helvering, Commissioner of Internal Revenue, and under date of March 18 this interview was arranged for March 25. From Mr. Cabot's letter of March 11, we quote the following: "I am most anxious to have an opportunity for a personal interview not only to go over the subject of my previous correspondence relative to section 102 of the Revenue Act of 1934, but also to present to you certain ideas relative to future taxation which have been brought about by the President's recent message. On March 24, 1936, an interview took place with Messrs. L. K. Sunderlin, Hill, and McGinnis of the Department of Internal Revenue. Under date of May 18, 1936, a letter was written by Mr. Cabot to Mr. C. E. Turney of the Treasury Department, from which we quote the following: "Since that time I have had a very satisfactory talk with Messrs. Sunderlin, Hill, and McGinnis of the Internal Revenue Department. In talking with these gentlemen I had occasion to enter into a discussion with them as to the then pending House revenue bill (H. R. 12395) and left with them a memorandum, copy of which I am enclosing marked 'Exhibit A.' At their suggestion I also had at that time a talk with Mr. L. H. Parker, Chief of Staff of the Joint Committee on Internal Revenue Taxation, and left with him also a copy of exhibit A. "As a result of these conversations we drew up certain Suggestions Regarding Treatment of Mutual Investment Trusts and Corporations under Revenue Bill of 1936, H. R. 12395, a copy of which is enclosed marked 'Exhibit B.'1 "About a week ago Mr. Griswold and my partner, Mr. Morton, were in Washington relative to these suggestions and at that time discussed the matter with Mr. Parker and various Senators on the Finance Committee; also with Messrs. Harlan, Brown, and Oliphant." On Friday, May 8, 1936, Senator Walsh of Massachusetts introduced before the Committee on Finance of the United States Senate the memorandum hereto appended, marked "Exhibit B." (See Hearings Before Committee on Finance of United States Senate, H. R. 12395. U. S. Government Printing Office Publication No. 68545, p. 799.) Under date of May 23, the memorandum above referred to marked "Exhibit 3" was supplemented by a statement (herewith attached and marked "Exibit C"), from which it will appear that we did not claim or urge that our r. roposal be limited to companies only that had redeemable shares. On Tuesday, May 26, 1936, we had an interview in Senator Walsh's office 1 Suggestions Regarding Treatment of Mutual Investment Trusts and Corporations under evenue Bill of 1936, H. R. 12395, is hereto appended as exhibit B. with Messrs. Lusk and Kent, of the Bureau of Internal Revenue, relative thereto. During this entire period there were many conversations held with Senators and Representatives, and on June 3, 1936, the undersigned had an interview with the President relative thereto. On June 5, 1936, Senator Walsh offered in the Senate certain amendments which he stated that the subcommittee had unanimously agreed upon (Cong. Rec., p. 9070). Such of these amendments as related to the taxation of mutual investment companies were adopted by the Senate and subsequently, with minor changes, made by the Conference Committee (which reported June 19, 1936), were enacted into law. On June 12, 1936, as above-mentioned, the entire matter was taken up again with the Securities and Exchange Commission who at that time wrote the memorandum (exhibit A) appended hereto. On October 19, 1937, the entire history as above-mentioned was again gone into in considerable detail in an interview by the undersigned with Commis sioner Healy in his office, into which he called Messrs. Schenker and Gourrich. On September 23, 1936, Mr. Paul C. Cabot, in his public testimony before the Securities and Exchange Commission, went into the subject of the Revenue Act of 1936, as it affected mutual investment companies, in great detail. To complete the history of this tax matter, brief reference should be made to the 1938 Revenue Act. The Vinson subcommittee of the Committee on Ways and Means transmitted their report on January 14, 1938. Recommendation No. 5 covered "mutual investment companies." (See pp. 10 and 66 of that report.) Representatives of open-end and closed-end investment companies appeared at hearings before the Committee on Ways and Means on the bill that became the Revenue Act of 1938 (see pp. 809 and 827 of the record of hearings). Representatives of the Securities and Exchange Commission also appeared prior to passage of the bill, but at some executive session. The 1938 act provisions appear in section 361. In view of all the above, we believe the remarks made by Mr. Schenker as quoted above are incomplete; that there was considerable legislative history upon this tax provision, and that the Securities and Exchange Commission were fully informed by us about it from start to finish. PAUL C. CABOT, President, State Street Investment Corporation, Boston, Mass. Chairman, Incorporated Investors. Boston, Mass. Chairman, Massachusetts Investors Trust, Boston, Mass. EXHIBIT A JUNE 12, 1936. Chairman Landis, Mr. Schenker, and Dr. Gourrich. Mr. Katz. Conversation with Messrs. Paul Cabot, Merrill Griswold, and W. T. Gardiner concerning "mutual investment companies" Mr. Paul C. Cabot, president of the State Street Investment Corporation: Mr. Merrill Griswold, chairman of the Massachusetts Investors Trust; and Governor W. T. Gardiner, chairman of Incorporated Investors, are in Washington in connection with pending deliberations upon the tax bill. Their specific concern is with the impact of the bill upon investment trusts of a type hereinafter described, which they call "mutual investment companies." The character of these companies is best indicated in the definition of "mutual investment company" set forth in proposed section 1001 (15), a copy of which is attached hereto. Under the terms of the original House bill, earnings paid out would not have been taxable except in the hands of the recipients. In consequence, this bill involved no serious problem for the mutual investment companies. It would merely have required them to pay out capital gains as well as income upon the securities in the portfolio, to earmark the capital gain as such, and to solicit reinvestment of the capital gain by the shareholders. The Senate bill, however, as originally conceived, would have placed a very serious burden upon these companies by reason of its imposition of an income tax ranging up to 18 percent upon the income of the company, as well as the normal tax upon dividends paid by the company to its shareholders. (The Senate |