The Creation Of The Investment Company Act

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When Wall Street and Washington cooperate it is news indeed. It could be 100 years before we see anything similar to the events of 1940 when the Investment Company Act was passed: It was approved Aug. 22 and became effective on Nov. 1 of that year.

Its terms and provisions were worked out in conference between representatives of the industry and the Securities and Exchange Commission after the commission had completed an exhaustive study and investigation of investment companies.

The key to the provisions of the Investment Company Act was the experience of the industry. As the Commission put it, the problems of investment companies flow from the very nature of their assets, which consist of cash and securities, i.e. assets, which are usually liquid and readily negotiable. Because of these characteristics, control of the funds offers manifold opportunities for exploitation by an unscrupulous management.

The Commission might have added that the conception of management-stockholder relations also had changed in the interim and that practices which fell short of being scrupulous were now frowned upon, if not universally, at least by many in the industry, who felt the need of legislation to impose the new concepts on the industry at large. The provisions of the Investment Company Act may be divided into two broad categories:

1. Informational requirements, in which the act carries forward the doctrine of full disclosure contained in the Securities Act of 1933.

2. Positive requirements and prohibitions, in which the act regulates the practices and activities of companies in the manner of the Public Utility Holding Company Act.

One might offer this bird's-eye view of the act: investment companies are required to register with the Securities and Exchange Commission, and they are regulated by the act. Investment companies are defined as companies engaged primarily in the business of investing, reinvesting, and trading in securities. This excludes companies, which may own securities but are mainly engaged in operating businesses other than investment companies. Also excluded are brokers, underwriters, banks, insurance companies, small loan companies, factors, and the like.

To afford investors full and complete information with respect to investment company activities, the act requires disclosure of their finances and investment policies. Such companies are forbidden to change the nature of their business or their investment policies without the approval of stockholders. Management contracts must be submitted to security holders in advance for their approval. Persons guilty of security frauds are barred from serving as officers and directors of investment companies. No more than a minority of the directors of such companies may be underwriters, investment bankers, and brokers. Transactions between investment companies and their officers, directors, and other insiders are prohibited except on the approval of the Commission. Except in specific instances and under safeguards, the issuance of senior securities is prohibited. Pyramiding of such companies and cross-ownership of their securities also are prohibited.

The Commission is authorized to prepare advisory reports on plans of reorganization of registered investment companies upon their request or the request of 25 percent of their stockholders and to institute proceedings to enjoin such plans if they are grossly unfair. The act also requires that face-amount-certificate companies maintain reserves adequate to meet maturity payments upon their certificates.

This act has given shareholders a right to demand fair treatment by the companies in which they have invested their hard-earned money, and rightfully so. As the catastrophe of the Crash of 1929 showed us, unscrupulous investment firms benefit no man.

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