market value of approximately $11,500,000. On a cost basis 62 percent is invested in rails; on a value basis 24 percent. It would indeed be hard to imagine a better illustration than that here present of the vital importance to investors of receiving information about the assets of their company on the basis of their market value rather than simply their cost, as required by the Investment Company Act and not by the Interstate Commerce Act. II. CONSTITUTIONALITY OF THE PROPOSED AMENDMENT As shown, the proposed amendment is of general application encompassing a class of persons; namely, those who are subject to regulation under the Interstate Commerce Act but nevertheless are primarily engaged in the business of investing, reinvesting, owning, holding or trading in securities. We do not presently know how many companies would be within the reach of the proposed amendment. Even assuming only Alleghany would be affected by the amendment, it would not be unconstitutional for such reason. 1 The 5th amendment, unlike the 14th amendment, contains no equal protection clause, and provides no guarantee against discriminatory legislation by Congress. However, discrimination, if gross enough, is equivalent to confiscation and subject, under the fifth amendment, to challenge and annulment.* The Supreme Court has stated the test to be: "*** whether in the light of all the facts and circumstances there was any substantial basis for the conclusion. * * #11 3 The reasons which impelled the Congress to provide for the regulation of investment companies are amply and expressly set forth in section 1(b) of the act. This, without more, would seem sufficient basis for the modification of an exception originally allowed as a matter of legislative grace. Indeed, if Congress may not constitutionally restrict the area of exception it would seem that it was powerless in the first place to adopt the exception. Moreover, the exception, designed to protect shareholders of a railroad holding company from the possible burden of dual regulation, may be used, and has been used, by companies which are essentially investment companies to deprive these stockholders of the protections and safeguards of the Investment Company Act. Furthermore, in the case of water carriers and freight forwarders the ICC does not even have jurisdiction over security issuances although such jurisdiction as exists has formed the basis for a claim for a section 3 (c) (9) exception as in the case of American-Hawaiian Steamship Company. There would, thus, seem to be ample basis upon which the Congress may rely in amending section 3 (c) (9). All companies falling within the section would be subject to like treatment. There is here no classification of an arbitrary and capricious nature. Certainly there is no taking of property without due process of law. We turn now to discuss the argument advanced by Mr. Wallace that regulation of Alleghany is unnecessary because it is presently regulated "to the hilt" by the ICC, and that such regulation provides all the basic protections to investors contemplated by the Investment Company Act. We shall discuss (1) the purpose and scheme of regulation under the Investment Company Act; (2) the history of section 3 (c) (9); (3) ICC regulation of holding companies and the purpose of such regulation; (4) the comparative investor protection afforded by ICC regulation under section 20a of the Interstate Commerce Act and under provisions of the Investment Company Act. We shall also set forth in appendix A various transactions of Alleghany which were not regulated by the ICC but which, had Alleghany been a registered investment company, would have required exemption or approval by the SEC in the interests of investors before they could have been consummated. 1 Detroit Bank v. United States, 317 U.S. 329, 337 (1943); La Belle Iron Works V. United States, 256 U.S. 377, 392 (1921); Stewart Machine Co. v. Davis, 301 U.S. 548, 584-585 (1937); Sunshine Coal Co. v. Adkins, 310 U.S. 381, 400, 401 (1940); Helvering V. Lerner Stores Co., 314 U.S. 463, 468 (1941); Brushaber v. Union Pacific R. Co., 240 U.S. 1, 24 (1916). 2 Steward Machine Co. v. Davis, 301 U.S. 548, 585 (1957); Currin v. Wallace, 306 U.S. 1, 13 (1939). 3 Kiyoshi Hirabayashi v. United States, 320 U.S. 81, 95 (1943). 15 U.S.C. 80a-1 (b). III. PURPOSE AND SCHEME OF REGULATION UNDER THE INVESTMENT COMPANY ACT Generally speaking, it is the purpose of the Investment Company Act to subject to its regulation all "large liquid pools of the public's savings" which have been entrusted to others for investment. Section 1 of that act recites the adverse effects on the national public interest which the Congress found to flow from the abuses to which such pools of capital were subjected. The act provides for the registration and regulation of any company which falls within the definition of an investment company. Section 3(a) (1) of the act defines as an investment company any company which is primarily engaged, or holds itself out as being primarily engaged, in the business of 'investing, reinvesting, or trading in securities. To cover situations in which such primary engagement is not readily apparent because the company is either directly, or through controlled companies, engaged in an industrial or other business together with investing in securities, section 3(a) (3) raises the presumption of an investment company if, generally speaking, more than 40 percent of the company's assets consist of securities other than those of majority-owned subsidiaries. Section 3(b) (2) provides a means for rebutting the presumption raised by section 3(a) (3) upon a showing that the company is primarily engaged in a business or businesses other than that of an investment company. Counsel for the Commission stated to the Congress with respect to section 3(b) (2): "That [section 3(b)(2)] will fortify the exemption of companies which are essentially industrial corporations or railway companies which may have a substantial part of their assets in marketable securities." " IV. LEGISLATIVE HISTORY OF SECTION 3(C) (9) The original bill, S. 3580, contained no counterpart of section 3(c) (9). The exemptive provisions of section 3(b), previously referred to, were considered sufficiently broad to have made any specific exemption unnecessary. This was recognized by R. V. Fletcher, counsel for the Association of American Railroads, who submitted the precursor of present section 3(c) (9). Thus, Mr. Fletcher stated: "A careful examination of S. 3580 rather indicates that perhaps the bill was not intended to cover railroads and their subsidiaries." Nevertheless, he submitted section 3(c) (9) as a "clarifying" amendment "in order that all doubt might be removed." 8 117 In other words, the amendment was intended to make clear that a company which was primarily not an investment company but a railroad or a railroad holding company, i.e., controlling and operating railroad companies, was to be excluded from the operation of the Investment Company Act. It is to be noted that the presently proposed amendment to section 3(c) (9) is fully consistent with this original intention and would preserve the exclusion originally contemplated. The amendment is intended only, as more fully pointed out below, to preclude the use of the section 3(c) (9) exception by a company which is not primarily a railroad or railroad holding company, but primarily an investment company. Mr. Fletcher, in the context referred to earlier, pointed out the desirability of avoiding "any overlapping of authority or any conflict between two Government agencies regulating the same matter," particularly in light of the provisions of S. 2903 which had passed the Senate and was then pending before the House. The provisions of that bill, proposing amendments to the Interstate Commerce Act, would have granted the Interstate Commerce Commission extensive powers over the investment transactions of railroads and their noncarrier investment company subsidiaries. It was pointed out that the then existing provisions of the Interstate Commerce Act were not adequate to protect the interests of investors in railroad securities. S. 2903 did not become law, and the Wheeler-Lea 5 Hearings before Senate Committee on Banking and Currency on S. 3580, pt. 1. p. 38 (76th Cong., 3d sess.), hereinafter referred to as Senate hearings. Senate hearings on S. 3580. pt. 1. p. 177. Senate hearings on S. 3580, pt. 2, p. 777. • Ibid. Commissioner Eastland, speaking on behalf of the Interstate Commerce Commission, the sponsor of S. 2903, stated, inter alia, that because of the lack of powers over the investments of railroads in subsidiaries, which in turn invested in noncontrolling interests in railroad and other securities, that the law as then in force was not "adequate to protect the investor in railroad securities." Hearings before a subcommittee of Committee of Interstate Commerce on S. 2610 (successor to S. 1310 and subsequently amended and reintroduced as S. 2903), 76th Cong., 1st sess., p. 30. bill, which was subsequently enacted, contained no comparable provisions, thus leaving unchanged, in the substantive respects here relevant, the provisions of the Interstate Commerce Act described below. V. ICC REGULATION OF HOLDING COMPANIES AND ITS PURPOSES Railroad holding companies were first subjected to regulation by the ICC pursuant to the provisions of the Emergency Railroad Transportation Act of 1933 (48 Stat. 217-220). The legislative history of that act makes it abundantly clear that its purpose was twofold, namely, (i) to prevent, through the holding company device, the unification of operating railroads without the ICC supervision which was contemplated by the Transportation Act of 1920; and (ii) to prevent the holding companies from creating top-heavy capital structures which would create pressures on the operating railroad subsidiaries to indulge in unsound financial practices in order to service excessive amounts of holding company fixed-return securities.10 The applicable provisions of the Interstate Commerce Act are as follows: Section 5(2) provides, in pertinent part: "(a) It shall be lawful, with the approval and authorization of the Commission * "(i) *** For a person which is not a carrier to acquire control of two or more carriers through ownership of their stock or otherwise; or for a person which is not a carrier and which has control of one or more carriers to acquire control of another carrier through ownership of its stock or otherwise; "(c) In passing upon any proposed transaction under the provisions of this paragraph (2), the Commission shall give weight to the following considerations, among others: (1) The effect of the proposed transaction upon adequate transportation service to the public; (2) the effect upon the public interest of the inclusion, or failure to include, other railroads in the territory involved in the proposed transaction; (3) the total fixed charges resulting from the proposed transaction; and (4) the interest of the carrier employees affected. "(e) No transaction which contemplates a guaranty or assumption of payment of dividends or of fixed charges, shall be approved by the Commission under this paragraph (2) except upon a specific finding by the Commission that such guaranty or assumption is not inconsistent with the public interest. No transaction shall be approved under this paragraph (2) which will result in an increase of total fixed charges, except upon a specific finding by the Commission that such increase would not be contrary to public interest." 11 Section 5(3) of the Interstate Commerce Act provides as follows: "(3) Whenever a person which is not a carrier is authorized, by an order entered under paragraph (2), to acquire control of any carrier or of two or more carriers, such person thereafter shall, to the extent provided by the Commission in such order, be considered as a carrier subject to such of the following provisions as are applicable to any carrier involved in such acquisition of control: Section 20 (1) to (10), inclusive, of this chapter, sections 304 (a) (1) and (2) to (11), inclusive, of this chapter, and section 314 of chapter 8 of this title (which relate to reports, accounts, and so forth, of carriers), and section 20a (2) to (11), inclusive, of this chapter, and section 314 of chapter 8 of this title, (which relate to issues of securities and assumptions of liability of carriers), including in each case the penalties applicable in the case of violations of such provisions. In the application of such provisions of section 20a of this chapter and of section 314 of chapter 8 of this title, in the case of any such person, the Commission shall authorize the issue or assumption applied for only if it finds that such issue or assumption is consistent with the proper performance of its 10 Hearings before the House Committee on Interstate and Foreign Commerce on H.R. 9059, 72d Cong., 1st sess., pp. 67-74; see also pp. 247-250. 11 The phrase "public interest" as used in sec. 5(2) of the Interstate Commerce Act, as amended, means "public interest in the maintenance of an adequate rail transportation system." (United States v. Lowden, 308 U.S. 225.) service to the public by each carrier which is under the control of such person, that it will not impair the ability of any such carrier to perform such service, and that it is otherwise consistent with the public interest." Sections 20(1) to 20 (10) relate primarily to the authority of the ICC in connection with railroads and certain other carriers to require the filing of annual, periodic and special reports; they authorize the ICC to prescribe the times and forms for filing reports; and to establish uniform systems of accounts, rates of depreciation charges, and the forms of any accounts, records and memoranda to be kept (to which the ICC shall have access); they prescribe penalties for failure to comply with such requirements and authorize the institution of mandamus proceedings to compel compliance. Motor carriers and water carriers are subjected to similar regulatory provisions by chapters 8 and 12, respectively, of the Interstate Commerce Act. Sections 20a (2) to 20a (11), in general, require the prior approval of the ICC for the issuance of securities and the assumption of liabilities. Section 314 subjects motor carriers and controlling persons thereof to the provisions of section 20a, but no provision is made for the regulation of water carriers or freight forwarders in this respect. VI. COMPARISON OF INVESTOR PROTECTION AFFORDED UNDER THE INTERSTATE (a) Financial structure The standards of sections 5 (2) and (3) and 20a (2) of the Interstate Com merce Act for approval of the issuance of securities or assumption of liabilities by a holding company are designed essentially for the protection of the under. lying carriers subject to its control, although questions of fairness to security holders have been given consideration by the ICC. The primary objective of these sections is the prevention of excessive fixed charges at the holding company level determined on a case-by-case basis in light of the purposes for which the securities are issued, and the capital structures of the controlled companies. To the extent that railroads and railroad holding companies attain sound financial structures, investors will undoubtedly be benefited. The capital structure requirements of the Investment Company Act are more definitive and particularly pertinent to an investment company, whether diver sified or nondiversified. Section 18 of the Investment Company Act, in recog nition of the adverse effect on the public interest found by the Congress to result from excessive senior securities contains specific limitations and requirements as to the senior securities which may be issued by a registered closed-end investment company." Its purposes are twofold, namely, to afford adequate protection to the holder of the senior security itself, and to prevent the common stock of the investment company from becoming unduly speculative as a result of the leverage which attends senior securities. Section 18 (a) of the Investment Company Act prohibits the issuance of senior securities representing indebtedness unless there is a minimum asset coverage of 300 percent for all such indebtedness, and provision is made to prohibit dividends or distributions on the capital stock unless these asset coverages exist. Similarly, the issuance of senior securities representing preferred stocks is prohibited unless there is a minimum asset coverage of 200 percent for the combined indebtedness and preferred stock, and certain other restrictive investor safeguards are included, such as the power to control the board of directors in the event of specified defaults in preferred stock dividends and dividend restric tions. Long-term warrants are prohibited by section 18(d); common stock must have equal voting rights pursuant to section 18(i). Section 23 contains restric tive provisions covering the sale of an investment company's stock at less than its net asset value. (b) Other protective measures not covered by the Interstate Commerce Act Because of its different primary objectives, the Investment Company Act contains provisions in addition to those noted above which are not touched upon the Interstate Commerce Act. Section 21, for example, prohibits "upstream 13 Sec. 1(b) (7) of the act provides that "the national public interest and the interest of Investors are adversely affected "(7) when investment companies by excessive borrowing and the issuance of excessive amounts of senior securities increase unduly the speculative character of their junior securities; *** loans" by an investment company to a controlling person. Section 23 is designed to protect investors from dilution or discriminatory treatment upon the repurchase by the investment company of any of its outstanding stock. A most important provision designed to protect the investment company against improvident self-dealing transactions with "insiders," and other affiliated persons, is found in second 17 (a) and (b), which prohibit most insider transactions unless excepted by specific order of the Commission pursuant to a finding, among other things, that "the terms of the transactions, including the considerations to be paid or received, are reasonable and fair and do not involve overreaching." The statute provides for a hearing at which interested persons, including public investors, may be heard and present evidence bearing on the question of whether the foregoing statutory standard has been satisfied. In addition, protective measures are contained in subsections (d), (e), (f), (g), (h), and (i) of section 17. Subsection (d) prohibits "insiders" from participating jointly with the investment company in certain transactions in contravention of SEC rules to prevent unfairness to the investment company. Subsection (e) prevents rebates, indirect commissions, or "kickbacks" on the purchase and sale of the investment company's properties or securities and the charging of excessive brokerage commissions; subsections (f) and (g) contain provisions designed to safeguard the assets of the company by custodial arrangements and the bonding of persons with access to cash or securities; subsections (h) and (i) prohibit certain exculpatory charter or bylaw provisions which would purport to protect certain insiders from liability to the company for willful misconduct, bad faith, gross negligence, or reckless disregard of their duties. Other investor protective measures provided by the Investment Company Act pertinent to the type of investment company here involved include: requirements for a minimum number of independent directors (sec. 10); requirements for specific statements of the investment policies of the company and a requirement that stockholders must consent to any change therein (secs. 8(b) and 13(a)); restrictions against pyramiding of investment companies (sec. 12(d)) and crossownership (sec. 20 (c)); provisions covering the election of directors (sec. 16(a)) and the appointment of independent accountants (sec. 32). The Commission is authorized to bring suit to enjoin plans of reorganization believed to be grossly unfair (sec. 25(c)) and to cause the removal of management found to be guilty of gross misconduct or gross abuse of trust (sec. 36). Section 19 requires that the source of dividends, whether from capital or earnings, be disclosed to shareholders. Reporting requirements under both acts are discussed below. The foregoing presentation should make it abundantly clear that just as the basic purposes of the Interstate Commerce Act and the Investment Company Act differ, so do the kinds of regulation imposed under both acts differ and the powers granted to the agencies administering this regulation. While both overlap in a limited area, they do not necessarily coincide nor are they coextensive. Some of the transactions in which Alleghany has engaged, which were not subject to the approval of the ICC but would have been subject to the approval of the SEC in the interests of investors, are set forth in appendix A. In the light of the foregoing there would seem to be no basis for Mr. Wallace's statement that the ICC jurisdiction and scrutiny in the interests of investors is "more sweeping and pervasive" than the jurisdiction specifically designed for those interests in the Investment Company Act. We need note only that Chairman Tuggle, of the ICC, in his letter to the Senate, dated June 16, 1959, stated that he sees "no good reason why either a carrier or a noncarrier which is primarily engaged in the business of an investment company should be exempt from the broader regulation applicable to other investment companies which is provided for in the Investment Company Act," save for limited purposes. VII. CONCURRENT REGULATION BY THE SEC AND THE ICC As the committee is aware we have submitted a revised section 7, which would add a new paragraph (C) to section 3(c) (9) and add a new section 6(f) to the act. These revisions have been worked out with the Interstate Commerce Commission. Their purpose and effect is set forth in a separate memorandum submitted herewith. The bill as revised would (a) subject the investment activities of these essentially investment companies to regulation under the Investment Company Act and (b) subject the carrier and related activities of these companies and their operating subsidiaries to the exclusive regulatory |