Mr. HEALY. I think that is true. At the same time I think it is fair to give that branch of the industry credit for voluntarily doing what they could in the direction of changing that. I think the recital of these things happening in the past and the fact that we had to resort to injunctions, which I think has a distinct bearing on the necessity of regulation, I do not think ought to obscure the fact that in these conferences with the industry they have tried to cooperate and achieve some improvement in their practices.

Senator WAGNER. Yes. I asked the question not to intimate that any of those companies changed their plans, but to find out what the state of the law is. That is what I had in mind.

Thank you, Mr. Boland. I believe Mr. Bane is next.

Mr. SCHENKER. Do you mind taking me now instead of Mr. Bane? Senator WAGNER. You have your choice as to the order of the appearance of witnesses.

FURTHER STATEMENT OF DAVID SCHENKER, CHIEF COUNSEL, SECURITIES AND EXCHANGE COMMISSION INVESTMENT TRUST STUDY, WASHINGTON, D. C.

Mr. SCHENKER. If I may say just one word on the installment plans, and we will discuss those a little more in detail when we come to that portion of the bill which relates to that type of investment company, their problem in some respects is not unlike the problem of other investment companies which have to continuously sell their securities, and one of the fundamental problems that this bill deals with is the whole problem of distribution of investment company securities.

To my mind one of the fundamental problems in the investment company industry as constituted today is just this-the closed-end company is the type of company which raised its money in one offering, say $100,000,000, and then did not sell any more. If you wanted to get out of that company, you had to sell your security in the open market as countra-distinguished from the open-end company, which raised its capital by continual sales-because the certificate holder could come in at any time and tender his certificate and receive not the amount of money he paid in, but the asset value of the certificate, which, in the last analysis, depends on the market value of the portfolio securities.

Now, we will elaborate upon that as we go along with the specific provisions, but the point I want to make is that one of the fundamental problems, in my opinion, which confronts this industry, is-Is the investment company going to be something that is devoted primarily and exclusively to the management of other people's money, or is it going to become a subservient or secondary function of the company and the primary emphasis be placed on the distribution of the securities? You have that conflict as you go along: Is this business going to depend upon the amount of money you can get from the distribution of the securities and is the emphasis going to be placed upon that, or is this industry going to be an industry where the small investor is going to turn his money over to it and say, "You invest it," and the people who sponsor it get the management fees? We are going to indicate the safeguards we think are needed to place the emphasis upon the investment management rather than upon distribution.

Just one other thing before I go to the analysis of the bill. In these installment investment plans, and that is true also with the open-end companies, there are some companies who perpetrated these practices, and they came to us and they talked to us and they said, "Well, we will make these changes," but the unfortunate thing, Senator, is that this is a highly competitive business. Now, he might be prepared to follow certain principles, but there is no provision in the law which says that everybody else has to subject themselves to the same provisions or limitations. Therefore a person engaged in sponsoring an installment plan, who wants to do the right thing, finds himself handicapped, because the next day a different individual can organize a company and he is under no compulsion or duress, and there are no sanctions which compel him to comply with any standard that the good people in the industry set.

All of the abuses in the installment companies have not been eliminated. I think they have manifested good cooperation. I think they are convinced, as we are convinced, that you cannot meet that problem unless you have legislation.

Although I do not assume to talk for them, my definite belief is that the provisions we have formulated meet the problem substantially and they are prepared to accept them-in fact, they would like to see them adopted and I think the representatives of that branch of the industry would say so if they were requested to come here.

Senator, before I commence the fairly detailed discussion of the provisions of the proposed legislation or bill, I would like to make one observation. Nobody is more conscious than I am, Senator, of the difficulty of saying in precise language what you intend to accomplish. Now, our experience has been, for instance, that in connection with the preparation of the questionnaire that we sent to the entire investment-trust industry, we had a rough draft, we conferred with the industry, and they were of incalculable help, because you say something and it accomplishes something diametrically opposed, or does things that you did not intend it to do, or accomplishes something you did not intend it to accomplish.

Now, the probabilities are that in a bill of this size there are such situations. I personally and the Commission have had the finest relationship with the industry. I will say this unequivocally, Senator: We have had the utmost cooperation of these people throughout the entire course of our study. I think it is unfortunate, and I am not being critical, Senator, that the industry did not do all they could have done. Whether they were too busy or whether they were trying to ascertain the full scope of this legislation or trying to see if we had any sleepers in the proposed legislation, the fact of the matter is that by and large after the bill was introduced few people from the industry conferred with us. There were some who came to us and indicated that a mere change of a word here would not change the substance, yet would either tighten the bill or eliminate the "bugs" in the legislation. I am candid and frank and happy to admit that those people have been of great help to us. However, although we made the announcement that we were prepared to discuss it with them, it has not happened.

Senator WAGNER. Have you had any conferences at all?

Mr. SCHENKER. Not the same type of conference, Senator, that we had before the bill was introduced. I want to make this clear.

I am not being critical. They probably had a man-sized job on their hands studying the bill and getting all its implications, but the only thing that I and the staff and the Commission feel is that there probably are some little phrases or a misplaced comma that might accomplish something we did not intend to do. What we want to do is to give you the broad purposes of the bill and try to illustrate what is aimed at, the different approaches that you can take to the problem, and why we selected the particular approach that we did.

Now, section 1 is the usual preamble to a bill and just sets forth the findings upon which the bill was predicated and incorporates by reference the reports and the studies of the Commission.

Section 2 contains a broad statement or declaration of policywhat the bill, when it becomes an act, hopes to accomplish.

Now, in that respect, Senator, and I am not going to elaborate on that, I think the declaration is clear on its face and so are the findings. In that respect I would like to read a statement made by Mr. Justice Stone before the Conference on the Future of the Common Law, held August 19, 1936, which is reprinted in 50 Harvard Law Review 4, at page 15:

I observe in recent statutes a revival of the ancient practice of stating in them the reasons for their enactment. The reasons were addressed, it is true, to the removal of constitutional doubts, but the practice can similarly be made an aid to construction. As the force of judicial decision is enhanced by the reasons given in support of it, so the union of statute with judge-made law may be aided by the statement of legislative reasons for its enactment, or by a more adequate preservation of the record of them in its legislative history.

That is one of the things that impelled the Commission to recommend that the bill incorporate in the form of sections, which are really a preamble, what our findings were and what the purpose or policy of the bill is.

Now, coming to the substantive provisions of the bill, section 3 defines an investment company, and that problem required a great deal of thought and care. In the popular mind an investment company is a company which is engaged in the business of investing, reinvesting, holding, and trading in the securities of other corporations. Section 3 (a) (1) says that an investment company includes a company which says it is an investment company and engaged in the business of investing, reinvesting, or trading in securities.

There are situations, however, where that purpose is not so definitely stated.

Paragraph 2 of section 3 (a) sets forth what we call a statistical formula which will be of assistance in determining whether a company is an investment company or is not an investment company. Substantially, what does section 3 (a) (2) say? It says that a company, a very substantial part of whose assets consists of marketable securities, is an investment company, and that a company which is an industrial corporation, although it may have up to 40 percent of its assets in marketable securities, is not an investment company. That will eliminate all industrial companies which may have invested a substantial part of their funds in fairly small blocks of the securities of other corporations.

We took this formula and checked it against 1,800 companies which registered with the Commission under the Securities Act of 1933 or the Securities Exchange Act of 1934. We excluded all companies which considered themselves investment companies. When we

analyzed the balance sheets of these companies we found that although in the aggregate they had $5,000,000,000 of marketable securitiesand by "marketable securities" we mean securities other than the securities of their subsidiaries-very, very few companies were caught by this formula. In order to take care of even those few companies, we have made specific exemptions.

Our approach is that an investment company, for the purposes of this proposed legislation, is a company which is engaged in the business of investing and reinvesting in securities, or is a company which invests and reinvests or holds securities of other corporations, provided that at least 40 percent of its assets consists of marketable diversified securities.

We have set forth this definition in our first report that we transmitted to the Congress back in 1938.

The number of instances that have created difficulty are really negligible. There was only one instance, as I remember it now, where there was some doubt as to whether this formula caught that company as an investment company, and we have made provision for that situation.

What do we go on to say? We say that even if you find that more than 40 percent of the assets of a company are in marketable securities, securities of companies which are not its own subsidiaries, we still say that it cannot be an investment company, within the purview of this legislation if-what? If this company is engaged primarily directly or through wholly owned subsidiaries in a business other than that of investing and reinvesting or trading in securities.

That means what, Senator? It simply means this. Take the Standard Oil Co. The top holding company holds securities of all its subsidiary operating companies. We are not even remotely interested in holding companies. They are not within the scope of this legislation. The Commission does not want any part of that type of situation. So if you take that type of company, even though it may fall within this 40-percent provision, we say it is not an investment company. We say, "You are not within the purview of this legislation if you are primarily engaged in any other business even though you may have a substantial part of your assets in marketable securities."

So that such holding companies are specifically exempt. That 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.

Then we say, further, that even if you may fall prima facie within the statistical formula, if you can prove that even though you do not do your business through wholly owned subsidiaries but through majority-owned subsidiaries, if you make out a case that you are engaged in a business other than investing and reinvesting in securities, you will be exempt.

Then we go on further to a situation where we have an industrial corporation that has a substantial part of its assets invested in marketable securities. If for some reason they see fit to take that portion of their activities and put it into a wholly owned subsidiary, instead of having their transactions in marketable securities, a sort of division of the company, we say that that wholly owned subsidiary is not an investment company.

Senator WAGNER. That is so, even though the subsidiary might engage in the business of buying and selling securities?

Mr. SCHENKER. On that aspect, Senator, we do not want to let ourselves in for a lot of circumvention, and the test there is: What is your primary business? Suppose there is a company with assets of $100,000,000 that has a small chemical factory worth $2,000,000, and takes $99,000,000 of its assets and puts them into a subsidiary to speculate on the New York Stock Exchange. That is an investment

trust.

We say if, looking at the whole picture, his primary business is the chemical business, then the fact that he has a number of his assets in a wholly owned subsidiary which invests and speculates in securities of other companies, does not make him an investment company.

Senator WAGNER. That is where there is discretion. That is not a fixed proposition?

Mr. SCHENKER. No; that is not a fixed proposition. As we go along, Senator, I will try to elucidate those things that prompted us to recommend to your committee that the Commission be given the power to make rules and regulations in connection with that matter. You cannot set down hard and fast rules. I can give you instances showing that it is really doubtful what the primary business of a company is. Are they engaged in speculating in common stocks on the New York Stock Exchange, or are they engaged primarily in the business of manufacturing or in the chemical industry or the banking industry?

Senator WAGNER. I did not intend to be critical.

Mr. SCHENKER. I am glad you raised the point. I do not know whether I have made this clear or not; but with respect to a company which is engaged in a business other than investing in securities through wholly owned subsidiaries, we have no discretion in that at all. That company has an exemption, because, if you will look at the set-up of that type of company, what do you find? If you just pierce the corporate veil and get rid of the legal fiction that every corporation is a separate entity, and just go down from the top holding company to the operating company, the top holding company is really engaged in the operating business. For instance, the Standard Oil Co., the top holding company, is in the oil business. It is not in the business of investing and reinvesting in securities.

In the closer cases, not where you have the top company operating through wholly owned subsidiaries, the closer type of case is this, Senator and that is what this provision was intended to meet; I mean, section 3 (a) and section 3 (b) (2). Take, for instance, Senator, some investment companies: Their primary business is something like this: Instead of buying securities listed on the New York Stock Exchange and trading in them, they buy big blocks of stocks in particular companies and stay with the investment for a substantial period of time.

Take the Phoenix Securities Corporation. It virtually has no marketable securities in the sense that it has a portfolio of New York Stock Exchange listed securities. A substantial portion of its money is in its control of a block of stock of the Unite Cigar Co. Another substantial portion of its assets is in Celotex, of which it owns 30 percent. A substantial portion of its assets is in the Autocar Co. A substantial portion of its assets is in the controlling block of stock in the New England Bus Co., and a substantial portion of its assets is