Investment Co. Institute v. Camp

PETITIONER:Investment Co. Institute
RESPONDENT:Camp
LOCATION:Arizona Dept of Public Welfare

DOCKET NO.: 61
DECIDED BY: Burger Court (1970-1971)
LOWER COURT: United States Court of Appeals for the District of Columbia Circuit

CITATION: 401 US 617 (1971)
ARGUED: Dec 14, 1970 / Dec 15, 1970
DECIDED: Apr 05, 1971

Facts of the case

Question

  • Oral Argument – December 14, 1970
  • Audio Transcription for Oral Argument – December 14, 1970 in Investment Co. Institute v. Camp

    Audio Transcription for Oral Argument – December 15, 1970 in Investment Co. Institute v. Camp

    Hugo L. Black:

    Mr. Cox.

    Archibald Cox:

    Mr. Justice Black, may it please the Court.

    Yesterday, I pointed out that since the Federal Reserve Act of 1913, managing other people’s money’s in various fiduciary capacities has been a traditional banking function.

    And that the individual managing agency account has been one way of performing that function along with testamentary trust, inter vivos trust, executorships and the like and other forms of agency.

    In the beginning, the Federal Reserve Board followed the common law and forbade National Banks to commingle the assets of different beneficiaries or different principles.

    About 1920, it began relax that rule.

    And in 1937, there came a major relaxation that permitted the commingling of the 101 of different trust executorships and guardianships and the like.

    And under that new regulation, the now familiar common trust fund grew and flourished.

    Partly, I think because the economies of commingling which reduced the management cost and partly because of the advantages of diversification.

    Potter Stewart:

    And that you say goes back to 1913.

    Archibald Cox:

    The statute goes back to 1913.

    The commingling was not authorized until about 1920 then on a very small scale.

    And then commingling on the scale that we’re all familiar with for the common trust fund came in 1937.

    But in 1937, the rule was not relaxed so far as individual managing agency accounts are concerned.

    It was relaxed for all other fiduciary capacity.

    Potter Stewart:

    That is for Inter-Vivo trustees or Testamentary trustees and what Bank —

    Archibald Cox:

    Executorships, guardianships and the like.

    Potter Stewart:

    It could participate in a commingled fund for various —

    Archibald Cox:

    Managed by the banks of course.

    Potter Stewart:

    In executorships, right.

    Archibald Cox:

    Yes.

    The effect of Regulation 9 which is an issue in the next case is to extend to managing agencies, the same privilege to commingle that it proved to be successful and so free from abuse in the case of trust and that kind of fiduciary capacity.

    Indeed, if you will look — when you come to look at Regulation 9, you would see that it treats commingling strict trust funds and managing agency funds in exactly parallel capacity.

    The reasons for this were very well stated somewhat later by the Federal Reserve Board in a letter to the Congress speaking of the public interest in having banks continue to offer this kind of managing agency commingled investment account and a letter quoted in the back of our brief on page 35 (a).

    We had pointed out that there were three advantages.

    First, this was a means of performing a traditional banking function more efficiently and at less cost.

    Second, that it provided competition for the mutual funds which of course in these cases are seeking to preserve a monopolistic or quasi-monopolistic position free from competition.

    And third, that in special cases, it enabled a combination of investment and other special fiduciary services.

    During the time that Regulation 9 was under consideration, the Securities in Exchange Commission took the position that any commingled fund of managing agency accounts would be subject to the Investment Company Act.

    It said that the interest in the fund would be securities, that the fund or the bank would be an issuer or underwriter and that consequently, there had to be registration under the Investment Company Act.

    Archibald Cox:

    I would point out in this connection however and indeed emphasize that while the SEC and Chairman Cary and Chairman Cohen stood very stoutly on the position that there must be conformity with the Investment Company Act.

    They never took the view that the managing agency commingled investment account.

    It was unlawful or in anyway against the public interest.

    Indeed from the very beginning, Chairman Cary later Chairman Cohen and the staff all indicated that they would look favorably at exempting a managing agency commingled investment account.

    For many of the provisions of the Investment Company Act that might be a bar to performing the function authorized by the comptroller under Regulation 9 and later approved by the Federal Reserve Board.

    Potter Stewart:

    Now if there were about a single investor of the 1940 Act would not be applicable.

    Archibald Cox:

    Not at all, no.

    And the 1940 Act would not be applicable to the type of common trust fund involving an Inter-Vivo or Testamentary Trust because it is expressly exempted.

    Potter Stewart:

    Nor would it be applicable to the management, service by a Bank for a single investor.

    Archibald Cox:

    No, that’s correct.

    It was the pooling that the SEC said brought it under the Investment Company Act.

    Byron R. White:

    Wasn’t it plus the issuing of certificates of participation or whatever you call it, the selling of shares?

    Archibald Cox:

    I think not Justice White.

    I think their position was that even if there were no piece of paper, it would be the interest, the undivided interest would nevertheless be regarded as something that brought them under the Investment Company Act.

    That’s my understanding of the testimony.

    Of course as we do it there are those certificates.

    Byron R. White:

    For a purpose I suppose.

    Archibald Cox:

    For the purpose of carrying — we say for the purpose of carrying out our fiduciary responsibilities and for no other purpose.

    It was a controversy between the comptroller and the commission which led to congressional hearings.

    During that controversy, City Bank developed the plan in which it was believed would comply both with the requirements of the banking laws and be satisfactory to the SEC under the Investment Company Act.

    And what it contemplated was this.

    City Bank would continue to receive assets in their fiduciary capacity under the relation of managing agent and principle with all the fiduciary duties.

    And it was discretion to invest those through a common fund.

    To the extent necessary to comply with the Investment Company Act, the common fund or account as it came to be called, was given a separate structure.

    The principles, the customer investors were given Certificates of Participation which were nonassignable and nontransferable which would terminate upon their death.

    The certificate holders were given the right to choose as they wished a committee made up of five individuals as it developed, two of whom were not required to be connected with the bank.

    And the committee or the participants were given power to terminate the bank’s investment adviser contract and anytime at the end of the year.

    That subject however to the possibility of that is very small.

    The bank has a custody of all the assets, manages, tends to them in every way, chooses what investments to make and to change and so forth.

    So, in the ordinary day-to-day operation, the whole thing is carried out by the bank subject only to this possibility of the certificate holders exercising common control to kick the bank out.

    Archibald Cox:

    There are a few other minor departures.

    They’re outlined in our brief in footnote 12.

    None of them, I think affect the theory or the fiduciary relation.

    Certainly none affect the individual fiduciary relation between the bank and the customer investor’s principles.

    And the bank continues to be required to conform.

    In all respects except I’ve mentioned and the other details to the provisions of regulation that.

    Now, from the standpoint of the banking laws, it seemed important that all these activities be conducted as the Federal Reserve Board later put it as an arm or department of the bank as one of many functions within the trust department of the bank.

    And while the managing — while the investment advisers contract alone might be enough to do that.

    It seemed advisable to the bank and its lawyers that a majority of the Board of Directors should also be officers of the bank.

    And it was that that led to the application for an exemption from Section 10(c) which provides that a bank may not have a majority of the Board of Directors of an investment company.

    When the matter came before the SEC, it made three critical findings.

    The first on page 60, points out that this account which is technically an investment company.

    Hugo L. Black:

    Page 60 of the record?

    Archibald Cox:

    Page 60 of the appendix.

    Hugo L. Black:

    Appendix?

    Archibald Cox:

    Yes.

    It pointed out that this was not the kind of investment company and at with Section 10(c) appeared to be (a).

    Although Section 10(c) is general in terms, it does not appear that it was directed at the type of open-ended investment company represented by the account and then skipping a few sentences.

    It is clear that the account is substantially different both in purpose and nature of operation from the bank dominated investment companies which led to passage of the act.

    The second finding is over on page 62.

    In our opinion in the commission sent, the bank you shown that substantial safeguards are present here against conflicts of interest which could arise as a result of the bank’s commercial banking activities.

    And the third finding which is in flaccid is that the exemption to permit these activities to go forward would be in the public interest.

    We submit first in our legal argument that if these findings are reasonable, these conclusions are reasonable.

    Then, the commissions order is plainly valid.

    Section 6(c) of the statute which is on the back of our brief on page 7(a) plainly gives the commission the power to exempt any person conditionally or unconditionally from any provision or provisions of this title.

    Surely the words in a provision or provision to this title are broad enough to encompass the provisions of Section 10(c).

    And the fact that literally the bank, the account that falls within Section 10(c), does not defeat the power to exempt because of course the very purpose of the power to exempt is to take care of cases which literally fall within the language of the statute.

    Furthermore, that has been the consistent interpretation of Section 10(c) for 28 years.

    It was explained to Congress when Section 10(c) was pending before it in 1940.

    That the aim was to take care of cases which had not been foreseen by the drafts which might fall within the literal language of the statute but in the judgment of the commission not really within its policy or spirit.

    Archibald Cox:

    At the time, Section 10(c) was before Congress, there was no commingling of managing agency accounts.

    Common trust funds, the nearest analog were exempted from the Investment Company Act.

    And consequently I suggest that if the commission’s findings are reasonable then this is a classic case for an exemption.

    The commission’s finding that the proposed relationship between City Bank and the account is not the kind addressed by Section 10(c).

    It seems to me to be supported by five considerations.

    First, the type of Investment Company with which Congress was concerned in 1940 when it was debating Section 10(c).

    Was a close-end investment company, a fixed pool of securities which bank insiders were selling very largely in the hope of making their own profit, a company in which they certainly had an interest.

    This account of course, is wholly the property of the customers, the principles.

    It’s run solely for their benefit and the bank gets nothing more from it than the usual fee that it gets for any fiduciary service of the subject to the comptroller of the currency.

    Second, those investment companies for the most part purported to be independent concerns with as — when the customer but it’s not the customer, when the investor bought a share, he thought he was buying a share in the Investment Company.

    And if the bank through its control over the directors dominated it, he wasn’t getting something free from the influence of the bank.

    Here of course when he goes to the bank and opens his managing agency account.

    What he is looking for is the bank services.

    And what he gets subject to this power of ultimate control is the bank services throughout the entire enterprise.

    Third, I would emphasize that there is in this instance but not in the kind of Investment Company at which Section 10(c) is concerned, a direct fiduciary relation between the bank and the individual customer investment.

    Byron R. White:

    In that respect Mr. Cox, what is the governing law?

    What would be the governing law as between the bank and the people who were investing in this fund or giving their money to the bank?

    Archibald Cox:

    Well, it would be the common law, I presume of New York and that would be backed up by the regulations of the comptroller of the currency in Regulation 9 which spell out many of the duties and of course the comptroller annually inspects the fund as he does in other banking activities also and not always quite that often.

    Byron R. White:

    What is the — just for curiosity, what would restrict the bank from using the funds of his customers in this fund for banking purposes.

    Could they invest this money in commercial loans?

    Archibald Cox:

    No, no.

    They’re rigidly forbidden by Regulation 9 and also by the Investment Company Act to have any dealings with the account.

    Byron R. White:

    Right, right.

    Archibald Cox:

    Both Reg. 9.

    Byron R. White:

    Any investment say make it up with outsiders.

    Archibald Cox:

    Any investments must be outside.

    They may make no loans to the account.

    They may have no interest in the securities that the account acquires.

    Indeed, Regulation 9 even would restrict the bank from buying securities of companies to which it has made a shaky loan, of where that would be a breach of trust and the controller’s representatives have instructed to be on the lookout for such things in the instruction we’ve putted on our brief.

    I would emphasize that this direct fiduciary relationship was noted by the District Court in the ICI case.

    Archibald Cox:

    It spelled out in the Hoga affidavit, the Executive Vice President of the bank in the ICI case.

    It was also noted by the Court of Appeals and the SEC.

    A fourth difference between the Investment Company at which Section 10(c) was directed and the account is of course that the securities affiliates and the Associated Investment Companies at which Section 10(c) was directed were set out for the purpose of evading the banking laws and getting out from under scrutiny of the controller.

    I Perhaps shouldn’t say vague but avoid, I don’t meant there was any deceit about it whereas all these activities are carried on as I said a moment ago constantly under the control of the controller.

    The result is from those four differences that none of the evils which were pointed to during the investigation and the bank securities affiliates and bank dominated investment companies are possible the presence setup.

    Indeed, not even the petitioners argue that they are.

    Mr. Lewin(ph) argues that the SEC findings are immaterial because Section 10(c) imposes a rigid barrier to the banks ever having a majority on the Board of Directors where there is any possible conflict of interest.

    Even so it’s found that this is not the kind of thing that 10(c) was directed at, even so the commission finds that there are adequate safeguards and even so the commission finds that the existence of the account is in the public interest.

    I submit that that argument is unsupportable for four reasons.

    First, it’s certainly contrary to the plain words of Section 6(c) which give power to exempt without restriction except for the necessary findings.

    Second, and very important, the characteristics of the account or the relationship between the bank and the account that are said to give rise to the danger of abuse here are characteristics that are attendant upon all fiduciary banking functions and we know that Congress didn’t find them so dangerous as to prohibit this kind of relationship because it authorized such fiduciary banking functions in Section 11(k) of the Federal Reserve Act now Title 12 Section 92(a).

    It would certainly be incongruous if Congress somehow had singled out this one special form of activity which is just like the others, so far as any of these problems are concerned, and forbidden it, especially since in this case, but has not only the usual safeguards of the fiduciary relationship in the controller supervision but one has the additional safeguards of the Investment Company Act.

    We’ve outlined in our brief, a number of indications as the commission did in its opinion that the board was — that the Congress was not seeking such a rigid separation between banks and investment companies as Mr. Levin argues.

    There’s a grandfather clause in Section 10(c).

    Banks are allowed to act as investment advisers which from a day-to-day point of view is the really controlling manager of the investing company and of course, we lay great stress on this.

    The one form of commingling that was none at the time the Investment Company Act was adopted, the common trust fund was exempted from the Investment Company Act.

    An important analog even though the commission said we couldn’t bring ourselves within it.

    The remaining question is whether there was adequate support for the SEC findings that there were adequate safeguards against abuse of the banks control over the fund to the detriment of investors.

    The commission took up point by point all the abuses which it was said might result and found that they were not sufficiently serious and that they were adequate safeguards against them.

    Judge Bazelon took them up point by point as the same arguments were made to the controller and he rejected them.

    The Federal Reserve Board scrutinized most of them in the letter that is set forth at the end of our brief.

    And it concluded too that there were adequate safeguards and that the existence of such funds would be in the public interest.

    Consequently, we submit that the commission’s findings are reasonably based in the record and that its judgment ended its order, should therefore be affirmed and the order — and the judgment of the court below affirm.

    Hugo L. Black:

    Mr. Friedman.

    Daniel M. Friedman:

    Mr. Justice Black and may it please the Court.

    At the outset, I would just like to explain in view of the somewhat unusual posture of this case that the commission is not appearing here in defense of its order one, why the United States is appearing in this case and secondly, why we think that the commission’s position in this case does not undermine the validity of it’s decision.

    As it’s been indicated when the commission granted this exemption in 1966, the vote was four to one with a strong dissent against the grant of the exemption by Commissioner Badge.

    The commission vigorously defended its order early in 1967 before the Court of Appeals and that Court unanimously upheld the order.

    Now, by the time the case reach this Court however and this Court had granted the petition there had been a significant change in the membership of the commission.

    Three of the five commissioners who had originally participated in the case were no longer on the commission and of the remaining two, one is Mr. Bage(ph) who by that point had become chairman, had voted against the exemption that the other commissioner had voted in favor of it.

    Daniel M. Friedman:

    And it was in that posture that the commission advised the solicitor general in June of 1970, that it was taking a position in this case.

    This is the statement that Mr. Levin read to the Court yesterday from page three of the Government’s brief.

    And I just like to reiterate two of the sentences that the commission included in its statement.

    The commission said, the three subsequently appointed members of the commission are not prepared to take any position.

    This was after the commission had pointed out that there are only two remaining members.

    And one was — had voted for and one had voted against the exemption.

    Accordingly, the commission expresses no position on the merits and urges neither affirmance nor reversal of the judgment of the Court of Appeals.

    Now, we think what in effect the commission has said to us in this case is that it is not able at this time to master a quorum to decide what position to take in this case.

    Only two members of the commission at that point were prepared to vote on what to say.

    We strongly disagree with Mr. Levin’s characterization of the commission’s action yesterday as that the commission had disavowed its decision.

    The commission has not disavowed its decision.

    If I may just mix an athletic metaphor for a moment.

    The commission in this case contrary to petitioner’s suggestion has not thrown in the tile on this case.

    It is merely sitting this one out on the sidelines.

    Potter Stewart:

    There is an indication in the footnote, I don’t have it in front of me but something to the effect that it’s possible or may be even likely that if the commission were dealing with this problem now, it would not reach the same conclusion.

    Daniel M. Friedman:

    Well all of the commissions to this —

    Potter Stewart:

    I’ve read it, I don’t have in front of me.

    Daniel M. Friedman:

    Yes, it’s the one that says there’s no assurance that the commission would reach the same judgment if a similar matter is again presented.

    I think that merely is a rather briefer statement of what was said in the original brief that is as of that time the commission didn’t know what its position would be because there are only two of the original commissioners then available.

    I would like to just say that the commission has not disavowed its decision and it seems to us that basically, the validity of the commission’s action must be determined on what happened when it acted.

    Not on the basis of the fact that sometime thereafter there had been changes in the membership of the agency and that the present membership is not prepared now to state, what position it would take if the issue came before.

    Indeed, there’s another change in the offering in the commission.

    We talked about shifts in membership.

    Chairman Badge who was the lone dissenter has announced his retirement.

    So that presumably by the time this case gets back to the commission, there’ll only be one of the original commissioners and we think that the commission by definition is a continuing body.

    It continues as an entity without regard to changes in its membership.

    And that if the commission’s action was valid when it was taken, it should be upheld even though changes in the body since that time might suggest that if the commission would have considered anew, the commission might come up the other way.

    The commission in this case has not asked this Court to remand the case — for it to take another look at the case.

    And I think the reason it hasn’t done that is again the same reason that there is no majority of the commission that it’s prepared to take any position at this time.

    So that in these circumstances —

    John M. Harlan:

    Was the solicitor general asked this — that sort of circumstances as to (Inaudible)

    Daniel M. Friedman:

    In this case you mean?

    John M. Harlan:

    Yes.

    Daniel M. Friedman:

    No, Mr. Justice.

    We were not but we came in to the case because it was our belief that in view of the importance of this issue and in view of the fact that the Court of Appeals had unanimously upheld the commission’s order, we thought it was not appropriate that the validity of the audit should just be defended by the bank which had received the exemption.

    We thought there is an interest to this.

    And in addition to that although we haven’t set it forth in our brief, the Government, the solicitor general representing all Government agencies has an interest in the basic legal issue here which is the scope of judicial review of an agency or granting an exemption, a question that this Court has not directly dealt with as far as I know.

    Well, this is the way of background as to why we think it was appropriate to give weight to the discretion of the commission in this case even though the commission is not here appearing.

    In defense of its order, I’d like to turn briefly to the merits which Mr. Cocks has fully covered.

    And why we think that in this case, the commission clearly has not abused its discretion.

    The statute under which the commission granted this exemption Section 6(c) gives the commission authority in the broadest possible terms that allows it to exempt any person, any transaction from any class of persons, from any provision of the statute.

    It couldn’t be broader.

    And there is certainly nothing in that sweeping language that in anyway suggests that Section 10 of the Act is not within the commission’s power to exempt.

    What we think the Congress is obviously contemplated by this Section is that the commission shall have authority to exempt any transaction, any person, any security within its terms, if the particular thing for which exemption is sought comes within these public interest factors that are listed as the conditions for the exemption.

    That is if the exemption is necessary or appropriate in the public interest, consistent with the protection of investors and the purpose is fairly intended by the policy and provisions of the Act.

    Now, the determination, the weighing of these many factors that make up to this broad public interest standard is of necessity, something that calls for a very difficult, close, and subtle factors of balancing of judgment.

    This is not the kind of thing that is capable of precise measurement, exactly.

    You can’t take a yardstick and say whether it reaches a certain point and therefore is or is not consistent with the public interest.

    The granting of an exemption, the decision whether or not the public interest standards are met in this kind of a case is really the essence of administrative discretion.

    It’s the kind of thing that necessarily has to be within the discretion of the agency.

    And we have developed in our brief and as Mr. Cox has indicated at some length, the commission certainly in this case did not abuse its discretion.

    The basic evils at which 10 Section (c) was directed are not the evils present here.

    Section 10(c) was put into the Act because of a lot of abuses that had been shown to have taken place in the 1920’s in the way in which the banks operated these investment affiliates.

    What the banks were doing, they were using the investment affiliates as methods for speculating in the Securities market and they were unloading on the investment companies, a lot of the speculative securities.

    Potter Stewart:

    I think I understood Mr. Cox to say and answer a question to Mr. Justice White’s that the bank or perhaps I didn’t hear it correctly, could not make a loan to one of these accounts?

    Daniel M. Friedman:

    The bank cannot make a loan to the account or the fund, that is correct.

    There are several reasons for this first —

    Potter Stewart:

    I know.

    What is the significance in 18 a of Mr. Cox’s brief of Section of 3(F)?

    A national bank may make a loan to an account and may take a security therefore assets of the account, provided such transactions fair to such account and it’s not prohibited by local law.

    Potter Stewart:

    It started with F at 18(a) Mr. Cox’s brief of July 18th.

    There are two briefs in this, one in December and the other in July.

    Daniel M. Friedman:

    Well, I assume that that is basically – if for some short term basis is something like that but —

    Potter Stewart:

    This does say that under the conditions there set out, the bank may make a loan to —

    Daniel M. Friedman:

    Mr. Justice if I may retract my statement.

    I’ve been informed that relates to an individual account.

    Potter Stewart:

    But does it deal with this account?

    Daniel M. Friedman:

    That does not deal with this type of account.

    That’s the controller’s mind that’s informed me.

    If I may explain several things first of all —

    Potter Stewart:

    I thought Mr. Cox were telling us that Regulation 9 governed to the operation of the relationship between the bank and the account we have before us.

    Daniel M. Friedman:

    Regulation 9 broadly governs all fiduciary activities of banks.

    It’s Regulation 9.18 which specifically deals with commingled accounts.

    This Regulation 9 is the general regulation which affects the bank’s control and operation of fiduciary activities.

    Potter Stewart:

    Well, except for 9.18 then, are you telling us that none of the rest of Regulation 9 printed here has any relationship?

    Daniel M. Friedman:

    No, no, no.

    I’m not.

    I’m saying that Regulation 9 generally governs the banks fiduciary applications.

    And to whatever extent it’s covered by Regulation 9 generally, of course it’s applicable then in addition to that the controller has promulgated special regulations dealing with commingled accounts which is 9.18 which imposes certain obligations —

    Potter Stewart:

    And these 9.18 you’re suggesting is more restrictive on what the market-banks relationship would be —

    Daniel M. Friedman:

    Yes, market-market more —

    Potter Stewart:

    Than is 9.11.

    Daniel M. Friedman:

    I would think so, 9.18 if I may point out.

    A couple of things, first of all 9.18 specifically prohibits the bank from having any interest in the account.

    And in addition to that, the account’s own prospectus states that it will not borrow any money at all.

    And finally there are provisions of the Investment Company Act which specifically prohibit transactions between affiliates at Section 17 of the Investment Company Act would prohibit the bank from selling securities or loaning money to the account.

    Potter Stewart:

    Well, just one more question.

    And I understand then that provision of 9.12 (a) at page 17 (a), that’s still another one.

    Unless lawfully authorized by the instrument creating the relationship or by Court order or by local law, funds held by the National Bank as fiduciary shall not be invested and so forth which means that if they were lawfully authorized by means of creating a relationship, they could be invested in property acquired from the bank (Inaudible) and so forth.

    You’re telling me that does not apply to this kind of account, is that it?

    Daniel M. Friedman:

    Well, it does not apply Mr. Justice for one reason which is that the arrangement between the participants and the bank does not permit this.

    And in addition to that, that the hope —

    Potter Stewart:

    Yes, but that provision says unless authorized by the instrument creating —

    Daniel M. Friedman:

    Well, but it’s not — 9.18 in turn has prohibitions against the bank.

    Potter Stewart:

    Where in 9.18 is a prohibition against the inclusion of a provision under 9.12 in the instrument creating the account, what’s that in 9.18?

    Daniel M. Friedman:

    I’m afraid I don’t have 9.18 in my brief in the —

    Potter Stewart:

    Page 21 (a) of Mr. Cox’s brief.

    Daniel M. Friedman:

    That’s section —

    Potter Stewart:

    9.18, it’s a collective investment.

    I gather this, Mr. Cox is giving us the full text of Regulation 9, hadn’t he?

    Daniel M. Friedman:

    believe, I’m trying — it’s Section 9.18 B8I.

    Potter Stewart:

    B8I?

    Daniel M. Friedman:

    Let me see if I can find that in Mr. Cox’s brief.

    Yes.

    It’s on page 25 (a) of Mr. Cox’s brief at paragraph A.

    And it says, a bank administering a collective investment fund shall not have (a) Any interest in such fund other than in a fiduciary capacity or (b) Make any loans on the security of a participation in search fund, so it prohibits the bank from having any interest in the fund except in a fiduciary capacity.

    That is if the bank itself had some money for one of its — in mind of its own personal trust accounts it could invest that in the account.

    Potter Stewart:

    Do you think that those provisions — do you think on their face proscribe a National Bank making a loan to one of these collective funds?

    Daniel M. Friedman:

    Yes, I think it does because it does have any interest in the fund.

    And in addition to that the prospectus of the fund says that the commingled account will not borrow any money so that as far as —

    Potter Stewart:

    From anybody?

    Daniel M. Friedman:

    Fund?

    Potter Stewart:

    From anybody.

    Daniel M. Friedman:

    From anybody, that’s right.

    The account is to be operated with the monies that the participants have put into the account.

    Potter Stewart:

    Now, where is there any expressed provision saying that the bank won’t sell any — can’t sell any property to the funds?

    Daniel M. Friedman:

    Well, that’s specifically in Section — first of all in Section 17 of the Investment Company Act.

    Section 17 of the Investment Company Act prohibits transactions between affiliates and under the terms of the Investment Company Act, the bank and the fund are affiliates.

    So there’s an absolute bar in that Section.

    In addition to that, I think the provision saying the banks — saying that the bank shall not have any interest in the fund —

    Potter Stewart:

    Prohibits the sale?

    Daniel M. Friedman:

    Sale, well there are other — prohibits the sale.

    Are you speaking I take it of the security side, that the bank were to sell a security.

    Potter Stewart:

    No, let’s assume the bank has a portfolio or loans of real estate mortgages that it would like to market to free up some of its fund and they are very good real estate mortgages.

    And certainly they might sell them to a mortgage company or something.

    May they sell them to the fund as a perfectly good investment of the fund in real estate?

    Daniel M. Friedman:

    Well, that again would depend on the circumstances.

    There is a provision of the controller’s Regulation Section 9.12 filling with what is called self dealing and it says funds helps —

    Potter Stewart:

    And you said that it doesn’t apply.

    Daniel M. Friedman:

    No, I did not say that it does not —

    Potter Stewart:

    All the instrument would have to do is to authorize it and the bank may transfer properly to the fund.

    Daniel M. Friedman:

    If there was such, it might affect the exercise of the best judge, it provides — if the instrument authorizes that these instruments do not authorize this —

    Potter Stewart:

    Or there’s any provision against the instruments authorized?

    Daniel M. Friedman:

    Well, that would have to again be submitted to the controller.

    The controller would have —

    Potter Stewart:

    Well, here’s the regulation so is there — or isn’t there any provision against the bank selling property to a firm?

    Daniel M. Friedman:

    I don’t know of any specific provision in those circumstances other than the fact that the bank cannot make any investment, have any interest in the fund.

    Potter Stewart:

    Mr. Friedman, do you know whether New York has statutes as many states do which specifically prohibits self dealing.

    Daniel M. Friedman:

    I don’t know Mr. Justice but I would assume that New York being a very enlightened state does.

    Potter Stewart:

    Well, I think there are some states more enlightened in investment fields than even New York but other states do have such either by Court decision common law or by specific statute.

    And I would be surprised if it were not present somewhere in the New York structure.

    Daniel M. Friedman:

    I think the whole question of self dealing is another problem in this which is the bank is a fiduciary and its relationships with the participants in the account.

    And if what the bank does, if it should sell something to the account in a way they violate its fiduciary obligations, I would think that the bank would run afoul of that and of course the controllers constantly inspecting these banks, and inspects them three times every two years.

    It’s trust department inspects the account of the bank.

    And as a result of this, if they soar any existence of this self dealing, it seems to me it would be quickly corrected.

    So that on balance as I say, we think that this is an area within the commission’s discretion, and that the commission has not abused its discretion in granting the exemption here.

    Hugo L. Black:

    (Inaudible)

    Joseph B. Levin:

    Mr. Justice Black may it please the Court.

    I wanted to clarify a response that I gave yesterday in connection with the question that Mr. Justice Harlan directed with respect to the commission’s use of Section 6(c).

    I said that exempt of authority was used frequently and it is.

    Joseph B. Levin:

    But I did not mean that it was used frequently in connection with Section 10(c).

    The commission has used Section 6(c) in two cases both on the same day back in 1959 in an opposed order and there was no opinion but the — in those cases in one of them — all of the stock of the investment company and it was not an open-ended investment company regarding variety of investment company of the kind that we have in this situation.

    But rather a small business investment company.

    It’s a special arrangement designed to facilitate loans to small business concerns.

    In one of the cases all of the stock of the small business investment company was owned by the bank itself.

    In the other case, the stock was owned by the bank and by a trustee for the benefit of stockholders and in the recitals in those particular orders.

    In both orders, there’s the same recital.

    And the recital is that the applicant investment company believes that it’s entitled to the exemption and I quote, in view of the fact that the public investor interest in applicant investment company is confined to the shareholders of the bank.

    So that there we have the very much different situation than we have here because you don’t have the potential conflicts of interest between the bank and the investment company.

    Now, in terms of the scope of the statute, I simply want to make it clear that the type of relationship, the commingled agency account is a relationship that is very specifically reached by the statute.

    The legislative history refers to the situation of the commingled agency account.

    It’s not a bank sponsored account.

    But there was a situation specifically referred to in the legislative history of where certain people had deposited money on an agency basis with an individual and that individual managed the money.

    He pooled it.

    And the legislative history treats that particular commingled managed agency account as an investment company.

    Indeed, the commission in its report to the Congress in the first volume of the investment trust study in part one at page 24 in talking of the types of relationships that give rise to the investment company refers to the corporate form, to the Massachusetts Trust, to the Joint Stock Company and lastly to the agency relationship.

    And I want to quote from that report “it’s a brief passage which indicates what the commission was thinking about.”

    Another distinctive form of organization of investment companies involves an agency relationship between the individual contributors to the fund and the management upon whom they confer substantially a power of Attorney to act as agent in the investment of the monies contributed.

    The group of individuals is not a legal entity but rather constitutes in essence the combination of distinct individual interest.

    Now, the problem of the commingled account and as I say not in terms of the bank but the general concept of the commingled account is considered in considerable detail in the commission’s opinion in the Prudential case which was affirmed by the Third Circuit, the citation is in our brief.

    And there’s a full exploration of that particular aspect of the Investment Company Act.

    Now, with respect to the exemption for the common trust fund that’s been referred to here.

    The commission itself in this very Prudential case that I just referred to indeed in the Third Circuit adopted the very language of the commission.

    The commission said the following, it referring to the Congress rested this exemption on the special considerations that the funds were used for bonafide the fiduciary purposes rather than as a medium for general public investment and had only a limited impact in the investment fund picture.

    And that the commission did prepare as part of this Investment Trust study, did prepare a special small volume, pamphlet dealing with the matter of the Common Trust Fund.

    Now, point number one, the commission did not make an extensive study of the Common Trust Fund.

    One of the — investigating to the matter of the abuses that were involved in the operation of the Common Trust Fund —

    Potter Stewart:

    You mean at the time of the consideration of the bill that became the 1940 Act?

    Joseph B. Levin:

    That’s right.

    And the commission pointed out and one of the reasons for it was is that at time, they were all tools and 16 common trust funds in the country.

    Joseph B. Levin:

    And in the aggregate they represented that I believe about $36 million.

    There was nothing of consequence in terms of the common trust fund.

    And the commission pointed out in that report that the participation in the fund and I’m quoting now “in the common trust fund is not available to the general public.”

    And indeed, the commission at that time in providing the exemption for the common trust fund had before it, the regulations of the Federal Reserve Board with reference to common trust funds and one of the specific provisions in the regulations of the common trust fund at that time and these appear in the appendix to the commission’s study on the commingled trust account.

    The regulations refer to the fact that the common trust fund means a fund maintained by a National Bank exclusively for the collective investment and reinvestment of monies contributed thereto by the bank in its capacity, its trustee, executor, administrator, or guardian.

    And then it goes on to say and this is of particular significance.

    The purpose of this section is to permit the use of common trust funds as defined in Section 169 of the Revenue Act of 1936, for the investment of funds held by true fiduciary purposes.

    And then it goes on and the operation of such common trust funds as investment trusts for other than strictly fiduciary purposes is forbidden.

    Potter Stewart:

    I don’t understand the point is not available to the general public.

    It’s just as available as a mutual fund is.

    If you have $10,000.00 you’ve been — you have right of trust instrument or Inter-Vivo Trust and turn over to the bank’s trustee and it’s just as available to the man with $10,000.00 as it is an open-ended investment.

    Joseph B. Levin:

    Well, the Federal Reserve Board prior to 1963 when it administered the regulations with respect to the common trust fund said that you could not use for common trust fund by the device of an Inter-Vivos Trust for the — or to get a participation in this common trust when you couldn’t use it as a means in effect for public participation in a pool of securities.

    You couldn’t use it for the very purpose that it is being — that the commingled account is being used.

    In other words —

    Potter Stewart:

    The bank couldn’t use it as a trustee under Inter-Vivos Trust?

    Joseph B. Levin:

    It could not be used.

    I’d rather put it this way that the common trust fund could not be used as means for soliciting public participation in the pool of securities for public investment through the guys of an Inter-Vivos Trust.

    Potter Stewart:

    The Bank couldn’t – as a matter of solicitation of it but it’s certainly was just available, if John Smith has $10,000.00, he could just as well make an Inter-Vivos Trust and turned over to a bank, it could be invested by the bank as trustee in the common trust fund as he could go out and buy shares in an open-end investment trust.

    Joseph B. Levin:

    He could use the trust relationship, create the trust but as I say in terms of the scope of the regulation as it was administered by the Federal Reserve Board was that the trust relationship was not to be used as it is being used here.

    Actually, it isn’t a trust relationship.

    It’s called a commingled account where in effect you go out and create a common package of securities for all commerce to come in and make an investment in what is a mutual fund.

    And the Federal Reserve Board as it administered the common trust fund provision that said if you do have an individualized relationship, the kind of thing that you have in a trust relationship where you can pool it but you cannot go up and create an investment company and use the common trust fund as a device to solicit or public participations which is precisely what is being created here and it is for that very reason that the commission had said that it’s subject to Investment Company.

    Hugo L. Black:

    Is that all the argument?