United States v. National Association of Securities Dealers, Inc. – Oral Argument – March 17, 1975

Media for United States v. National Association of Securities Dealers, Inc.

Audio Transcription for Opinion Announcement – June 26, 1975 in United States v. National Association of Securities Dealers, Inc.


Warren E. Burger:

We’ll hear arguments first today in Number 73-1701, United States against the National Association of Securities Dealers.

Mr. Norton.

Gerald P. Norton:

Mr. Chief Justice, here’s a chart that I’ll be using in the course of the argument which I would like to have set up before I proceed.

Warren E. Burger:

Well, is that reproduced in —

Gerald P. Norton:

Yes, copies have been handed up to the Court.

Warren E. Burger:

Is this the thing we have?

Gerald P. Norton:

That’s right.

William H. Rehnquist:

Is that thing you’ve just put on Mr. Norton, is that in the record or is this just illustrative?

Gerald P. Norton:

It’s just illustrative.

Mr. Chief Justice and may it please the Court.

This case is on appeal from a judgment of the United States District Court for the District of Columbia granting the defendants motion to dismiss the Government’s complaint in a Sherman Act case.

The case involves interpretation of several provisions of the Investment Company Act of 1940 concerning mutual funds and the relationship of that Act to the antitrust laws.

In reviewing the many briefs, we found some confusion in terminology and some misapprehension of the Government’s position in this case, so we’ve tried to address some of those problems in the reply brief we filed last week and we’ve also prepared this illustrative chart which I think may help clarify some of the relationships that are involved in this case.

Basically, a mutual fund or an investment company is a company that invests shareholder’s money in the stock of other companies.

This case involves the most common type of mutual fund which is the “open end” mutual fund.

Its distinctive characteristics are that share are always redeemable by the shareholder from the fund at a proportional amount of the net asset value of the funds at the time of redemption.

Although they are not required to do so by law, funds most of them are continually offering shares to the public.

Some however have for either short-term or long-term periods stopped offering and are closed up as they say.

There are two basic types of open end mutual funds, the load funds and no load funds.

The load refers to a sales charge that the purchaser pays at the time of purchase.

As a practical matter, the issues here involve only the load funds and it is to those load open end mutual funds that I will be referring throughout.

In the initial distribution of mutual fund shares, we have the vertical alignment shown in the center of the chart.

The mutual fund distributes its share to a single underwriter known as the principal underwriter pursuant to an underwriting contract.

Then the underwriter typically sells those shares to a large number of dealers through dealer contracts.

We’ve only shown one in the chart for illustration but there would be many of these in the ordinary scheme.

Then the contract dealer, as that dealer is known, sells the shares to the public to investors.

Investor can then redeem directly from the fund or it can also redeem by going through the dealer or the underwriter, although we have not shown that path here.

Now, this is called the primary distribution system in the mutual fund industry.

There is also a secondary market and transactions involving mutual funds as with any other securities.

Now in the ordinary securities market, the secondary market is the one of most importance to investors that is where issued shares are traded on stock exchange.

Gerald P. Norton:

A secondary market provides alternatives to the primary distribution system for an investor if wishing to buy or sell shares.

Now if the investor can purchase from either a contract dealer or another dealer or from an investor either going through a broker or directly.

And because of the nature of the securities business, a security’s firm will be acting in various capacities depending on the transaction involved.

The same firm can at different times and different transactions be a broker mean that it’s acting as an agent in the purchase or sale of securities whereas a dealer meaning that it’s acting as a principle for its own account and if it has a contract with respect to the shares involved, there would be a contract dealer and as to those shares for which it has no contract, it would be a non-contract dealer.N

ow, although the chart here shows contract dealer, non contract dealer and broker is three separate categories, the same firm could be in all three of those categories as to different transactions.

The term “broker-dealer” is used generically to refer to any firm in the security’s business as either a broker or a dealer.

Nearly all broker-dealers are members of the Defendant National Association of Securities Dealers.

That is the only association that has been registered under the Maloney Act of 1938 which amended the Securities Exchange Act.

That provides a measure of industry self Government subject to the oversight of the Securities Exchange Commission under rules adopted by and reviewed by the commission covering specified subjects.

None of the rules of the NASD are involved directly in this case.

Now, Section 22 (d) of the Investment Company Act provides in relevant part that if a mutual fund is currently offering its shares to the public then no principal underwriter and no dealer may sell shares of that fund to any person except another dealer, underwriter or the fund, except that the public offering price described in the perspectives, I’ll return to that public offering price in a moment.

Also involved in this case is Section 22 (f) of the Investment Company Act which provides that no mutual fund may restrict the transferability or negotiability of its shares except in conformity with the statements made with respect thereto in its registration statement and not in contravention of any rules prescribed by the commission in the interest of the holders of all outstanding shares.

22 (d) has no direct effect on the price of mutual fund shares, I’m sorry, 22 (f) has no direct effect, 22 (d) does as I’ll illustrate.

If the fund is currently offering its shares to the public, there’s no dispute that the price to an investor charged by a dealer must be the public offering price price described in the perspectives whether that’s a contract dealer or a non-contract dealer.

Now that price is effectively the net asset value of the proportional amount of the net asset value of the fund plus a sales load designated by the fund.

Typically, that is a maximum of 8.5% of the total amount paid.

Now the price from the underwriter to the dealer is governed by the dealer contract and that is typically the public offering price less a dealer discount which for 8.5% sales load would typically be 7%.

The price to the underwriter from the fund would be net asset value meaning that the underwriter gets a net of the 1.5% difference between public offering price and its price to the dealer.

Thurgood Marshall:

Is there no control on this load, no governmental control?

Gerald P. Norton:


There are other provisions of the Act which provide means regulation of the sales load, other provisions of Section 22.

Now, there is also no dispute that the Act places no limitation on the price that one investor can charge another for shares of the fund.

It’s competitive market price there.

As a practical matter, the range is likely to be between net asset value that the selling investor can get from the fund on redemption and the public offering price that the buying investor could get the shares for from a dealer.

There’s also no limitation on the price that an investor can get from a sale to a dealer.

Now by its terms, 22 (d) does not apply to sales by one dealer to another.

This is the so-called interdealer market.

And 22 (d) also does not impose any restrictions by its terms on sales by a broker to anyone.

William H. Rehnquist:

Is it clear that the language, the word dealer in 22 (d) does not apply to a broker as well?

Gerald P. Norton:

Well, those terms are separately defined and as I’ve indicated the same — any broker-dealer is at various times a broker or a dealer, someone who was acting in a brokerage capacity would not be governed by 22 (D).

William H. Rehnquist:

So when you were describing the functions — those functions are descriptions contained in the statute itself?

Gerald P. Norton:

They are in part contained in the statute and in part a description of the industry as it operates and as it has been characterized by the commission to which I’ll come in a moment.

Now unlike the markets for other securities, the market for mutual funds is almost entirely this primary distribution system.

There are no really, no secondary markets for mutual fund shares.

There’s a tiny interdealer market.

There’s no dealer market of sales to investors and is virtually no brokerage market.

Therefore, at present the investor has as a practical matter, no choice but to buy at the public offering price and to sell at net asset value.

With the development of computer technology, the potential impact or importance of a brokerage market has been somewhat enhanced and it’s possible to match buy and sell orders in a brokerage transaction in a way that has not always been so.

But secondary interdealer and brokerage markets have not developed because in large part they have been restrained by agreements, provisions in underwriting agreements and dealer agreements which effectively either fix the price at which such transactions must occur thereby removing any competitive incentive or preclude brokers, dealers and underwriters from engaging in them.

The validity of those agreements is what is at issue in this case.

Now, the case is here in motion to dismiss so that the allegations that the complaint of course must be accepted as true and construed.

The Government’s favor in determining whether there’s any state of facts that the Government might prove that would entitle it to any relief.

Not necessarily the precise relief requested in the complaint but any relief.

Although there are some variations, the essence of counts II, IV, VI and VIII is that underwriters and dealers have included in their dealer contracts various restrictive provisions which either require the dealers to act as dealers in their transactions therefore subjecting themselves to the fixed price of 22 (d), or that if they do act as brokers required that they maintained that fixed price or preclude them from dealing with other broker-dealers.

Counts III, V, and VII allege that mutual funds have engaged and entered into underwriting agreements containing provisions that either require the underwriters to impose these restrictive provisions in their dealer contracts or have imposed other restraints on the underwriter’s ability to engage in competitive transactions.

Count I of the complaint alleges that NASD and its members including underwriters and broker-dealers have combined to restrain the development of competitive secondary inter-dealer markets and brokerage markets through a variety of means.

And let me make it clear that when we talk about a secondary dealer market in the complaint and in this case, we’re talking about the market between dealers, contract dealer to a non contract dealer or an investor sale to a dealer.

We are not talking about a dealer’s sale to an investor.

Some suggested on the other side that that is the market we are trying to develop or redevelop in this case.

That is not true.

As the complaint was later clarified, we are not challenging in the complaint any rules adopted by the NASD.

It is asserted that those rules deal only with the primary distribution system and the complaint here is directed at the secondary markets.

And none of these restrictions that we are challenging is required by any rule of the commission or of any rule of the NASD.

The defendants acknowledged that they have the burden of establishing some implied exception to the antitrust laws because there’s no expressed exception.

And they therefore must overcome the strong presumption against implied repeal of the antitrust laws.

In this effort, they contend that 22 (d) was intended by Congress to eradicate secondary markets that had existed prior to 1940 and to require that all transactions and mutual fund shares be at the fixed prices.

They also claimed that Congress intended Section 22 (f) to permit the funds, underwriters and dealers to make private arrangements which would restrict any other competition in this secondary market area that was not precluded by 22 (d).

Building on these premises, the defendants claim that the entire distribution, sale and redemption process of mutual fund sales including secondary market transactions is covered by an implied immunity because of the exclusive jurisdiction they say of the Securities and Exchange Commission.

The District Court agreed and granted their motion to dismiss.

We should note that the District Court did not deal with any of the factual submissions made by the parties on various aspects of the case and treated the motion as raising strictly legal questions and the various factual issues are of course not before the Court.

Gerald P. Norton:

But we don’t believe that the language of Section 22 (d) with its plain inapplicability to inter-dealer transactions or the broker transactions or the language of 22 (f) will bear the weight of the defendant’s argument as to its sweeping purpose and effect.

Our more limited reading of these sections is confirmed by their legislative history.

And I think it’s important to place the Act in context.

The defendants would have the Court think that the Act was enacted because mutual funds wanted protection from the secondary market competition which they were troubled by.

It’s quite contrary that the Act was thrust upon the industry as a response to revelation of a variety of abuses that had developed by funds in the 1920’s and ‘30s.

1939, the SEC submitted to Congress a study, 3500 page study, the result of four years of intensive investigation which revealed a wide variety of abuses by mutual funds.

And the principal abuses are reflected in the Congress’s findings in Section 1 (b) of the Act involve such matters as inadequate disclosure to investors, discriminatory treatment of different classes of investors, favoritism of insiders as undue speculation.

They’re all abuses of the mutual funds.

There’s not a single one that involves abuses by a secondary market dealers, which the – other side would have the Court believe was the target of the Act.

Defendant’s reference to the legislative history is rather dubious because they can cite no single instance in which any person said that 22 (d) or 22 (f) was aimed at restricting the secondary market.

In the course of the vast investment company study, there is a half of page, a single paragraph which we’ve quoted in its entirety, page 32 of our brief which refers to what the industry, not the commission called a “bootleg market.”

This was a market involving some secondary market dealers who would be buying at somewhat above the net asset value and selling at somewhat below the public offering price.

And as the report stated, they started a small price war.

Byron R. White:

Suppose the Securities and Exchange Commission had promulgated a rule under 22 (f) that brokers or that funds should restrict the transferability of their share so that brokers as well as dealers couldn’t sell to investors at anything less than the offering price.

Would you — I suppose your argument would be that that regulation would be or that rule would be invalid?

Gerald P. Norton:

Well, that hasn’t been presented.

On the face of it I think that would go beyond the power the commission has under 22 (f) and in any event they have not done so.

It is clear that these restrictions are not the result of any rule that the commission has promulgated.

Byron R. White:

Yes, but the argument isn’t it — the argument on the other side I take it among other things is that that commission would have power to do such a thing.

And that the — it’s the commission that has the exclusive power to deal with this matter and that the power the commission preempts the antitrust law.

Gerald P. Norton:

That is the argument.

One problem with that argument is that the commission prior to this case never exercised its authority under 22 (f) in any respect.

Byron R. White:

Well the commission —

Gerald P. Norton:

It never indicated in any way that it had the expansive view of it’s jurisdiction that the defendants and to some extent the commission now claim.

Byron R. White:

Well the commission is now asserting it, isn’t it?

Gerald P. Norton:

It’s not saying that it could require the industry to impose its restrictive agreement.

It’s saying that it has some authority to regulate them because it says these agreements maybe treated as if they were restrictions on the transferability of the shares.

Byron R. White:

Alright, suppose the fund did impose this restriction and the commission expressly approved it, expressly approved those restrictions such as we’ve been talking about.

I would — I suggest the commission says at least that would preempt antitrust to the effect.

Gerald P. Norton:

Well I suspect that would be their position.

Byron R. White:

Well it is here, isn’t it?

Gerald P. Norton:

Well they haven’t expressly approved them.

So they can’t really take that position.

But I think their position leads in that direction but we would not agree.

Because that would present the different case referred to in Silver as to which the Court has not given any definitive answer.

Byron R. White:

Well, they say they could do that and if they could, that means that although the power is un-exercised, the power is there and it should not be interfered with by antitrust prosecution.

Gerald P. Norton:

Well that’s true because this involves several problems.

One is that they’re trying to convert agency in action into some evidence of affirmative approval and that is something that there’s no basis for here.

If the commission had been exercising a broad jurisdiction under 22 (f) and had been actually reviewing these agreements since 1940 and passing some kind of relevant judgment on them, they might have a stronger argument.

But the fact is that they were not.

That this — that the restrictive agreements are contained in underwriting and dealer contracts, not in the registration statements.

They’re filed with those statements but they are not reviewed in anyway that is relevant to whether there should be an antitrust immunity.

In fact if we look at 22 (f), the standard under 22 (f) is extremely narrow, it’s not the question of whether restrictions are in the public interest.

The commission is authorized to prescribe regulations in the interest of all holders of outstanding shares.

Now that may or may not involve any competitive implications.

And this Court has never found an implied immunity based on agency review or agency jurisdiction where the agency hasn’t had to give some consideration to antitrust or competitive considerations.

And there is no — nothing on the face of 22 (f) that requires the commission to do so.

Now whether 22 (f) might be construed to authorize that broad review is another matter but it’s perfectly clear.

That it has not been so construed and applied by the commission since 1940.

William H. Rehnquist:

Well, isn’t one of your arguments that a secondary market would benefit the holders of this security?

Gerald P. Norton:

Well, it would benefit the holders but it would benefit people who are not yet holders.

William H. Rehnquist:

Well then when this 22 (f) says the commission has to act in the interest of all the holders wouldn’t it have to take into consideration the fact if you’re right that a secondary market would benefit some of the holders?

Gerald P. Norton:

We would not argue that the commission ought not to take competitive factors into it, into consideration.

What we’re saying is that this is a view of 22 (f) which is novel.

It has not been the way the act has been — the section has been applied.

So that the fact that the commission has had all of these agreements filed with it if it — that is the fact and has taken no action is of no significance because the commission has not been giving them any kind of scrutiny that is relevant.

They have not been applying that standard in the past but let me — let me just address 22 (f) in terms of its legislative history.

The defendants would have –they argue that 22 (f) gave general validity to any restrictions in registration statements imposed by the fund that were not contrary to some explicit commission rule that there is absolutely no support for that reading of 22 (f) in the legislative history.

22 (f) was intended to restrict the ability of funds to impose such restrictions by requiring that they be disclosed so that investors know that if they buy a mutual fund, there maybe some limitation on its transferability.

The funds involved in this case do not have limitations on their transferability.

Gerald P. Norton:

They’re fully transferable and in the same manner as any other security.

The restrictions here go to the distribution system not to the transferability or negotiability of the fund.

Those are technical terms used in a technical statute and is simply no basis for thinking that Congress would have used them to encompass a variety of contractual limitations of which it had noticed and still used the narrow language but anyway the 22 (f) stemmed from the commission’s intent to restrict the activities of the funds.

It was not imposed or suggested by the funds as a means of enabling them to deal with the secondary market.

Indeed in the legislative history, they opposed 22 (f), they now see it as their salvation but they didn’t want it and it was adopted only as a result of the compromise between the commission and the funds that led to final Act.

Our position and we think it is the only way that 22 (f) can be read consistently with this Court’s approach to questions of implied repeal is that 22 (f) particularly where the commission has taken no action has no effect on the validity of restrictions that are within its terms under other federal of state laws.

If they were unlawful under some federal of state law prior to 1940, they would be unlawful after 1940, if they were not unlawful then no effect, it left them where they stood.

All it did was impose additional requirements.

Requirement of disclosure in the registrations statement and the requirement that they comply with any additional rules that the commission might adopt, of course the commission has never adopted any such rules.

Let me just – while we’re on 22 (f), the idea that the filing of a contract as an exhibit to a registration statement is the same as inclusion of it in the registration statement is also unfounded here.

The registration statement is intended with the prospectus that incorporates most of it to inform investors.

The exhibits and all of the technical matters that are filed with the commission don’t all get sent out to the investors so that an investor might well buy a mutual fund on the basis of a prospective saying his shares are fully transferable and then find that there are contractual restrictions on who he can buy and sell to.

So not only does 22 (f) not validate any limitations, the type of restrictions here contained in the contracts are simply not within its terms.

Now let me return to 22 (d).

The defendants say the 22 (d) intended to impose resale price maintenance on all transactions.

Again, there is not and to restrict the competition of the secondary market, there is nothing in the legislative history that supports that purpose, 22 (d) was first proposed by the industry as a means of dealing with insider trading.

No reference to secondary market transactions.

It was then incorporated in a compromised measure that resulted in the revised bill that was then enacted without change.

Again, no reference to secondary market.

There is not a reference to secondary markets and now the committee reports are in the debates.

There is simply not a word in the pertinent legislative history that supports the defendant’s attribution of purpose.

Now we say that the language of this 22 (d) is perfectly clear.

It does not applied to inter-dealer transactions, that does not to apply to brokerage transactions.

On this, the commission agrees with us and has explicitly taken the position in its amicus brief here that the District Court was wrong to the extent that it read 22 (d) as requiring resale price maintenance in all such transactions.

That has been the commission’s consistent view and first announced contemporaneous with the enactment of the statute.

It’s entitled of course to the weight — the great weight that such interpretations normally receive.

Now, in mentioning the commission’s interpretation and its reiteration of that interpretation in this brief, I think it fairly shows that the defendant’s argument based on certain legislative history concerning the 1970 Amendments to the Investment Company Act in which 22 (d) was reenacted without any material changed and certain prior legislative proposals that were not enacted simply is of no relevance to the question of what 22 (d) means.

The commission’s interpretation has been consistent and has been unaffected and the statements that the other side has relied upon in that legislative history, we have addressed in our reply brief simply did not deal with the precise questions before the Court in this case.

One of the arguments that the defendants make in trying to say that 22 (d) ought not be construed to permit a brokerage market to flourish is that such a market would be impractical but the major premise is obviously unacceptable because legality is not governed by practicability.

But even the question of practicability, we cannot accept the defendant’s premise.

Gerald P. Norton:

If such a market were so impractical then why do they go to such elaborate lengths to preclude it through contractual agreements?

If it’s so impractical, why has the commission undertaken in a 1974 report which the parties have made great reference to permit such a market to develop.

There was simply no basis for saying that this market cannot exist under 22 (d) because it would be impractical.

Lewis F. Powell, Jr.:

Mr. Norton has there been any congressional reaction to that 74 study?

Gerald P. Norton:

I am not in the position to say.

Let me return to the commission’s role under 22 (f) because that has a bearing on the question of immunity.

As I’ve indicated the commission for 35 years has not been playing an active role in reviewing this agreements that are filed with it under 22 (f) and certainly has not been reviewing them with antitrust or competitive principles in mind, that in itself and the fact that there is no obligation on the commission to consider competitive consequences, removes one of the essential conditions for a finding of a broad implied immunity.

As I said this Court to my knowledge has never found such an immunity to exist where the agency did not have an obligation to review matters with some kind of competitive considerations as part of the mix of its regulatory factors.

William H. Rehnquist:

If this has been going on for 35 years, why did the Government wait so long to bring this suit?

Gerald P. Norton:

Well, there was I think until the early 60’s, it was less clear to everyone that these securities transactions were fully subject to the antitrust laws and the practices were —

William H. Rehnquist:

But what happened that in the early 60’s that made it more clear?

Gerald P. Norton:

Well, there was the Silver case for one and it was also and with the particular reference to the securities industry of 1963 or so, a study which revealed a lot of the competitive problems of the industry.

It is basically said in motion a lot of thinking in consideration of these problems.

In addition as to the brokerage market for example, I mentioned it as a practical matter, it may have required computer development before it became as feasible as it might be now.

Of course, we are seeking here injunctive relief only.

A further problem with the immunity argument of the other side is that there is really no commission proceeding in which the allegations of the complaint and the conduct that is challenged in this case could be considered and it gets highly significant that the commission itself while it supports the defendants as to Counts II through VIII and says that under its present reading of 22 (f), all of those agreements come within its jurisdiction, it does not support them as to Count I.

It makes no claim that the allegations of Count I or within its jurisdiction and makes no claim that those allegations are covered by some kind of anti trust immunity but in any event —

Lewis F. Powell, Jr.:

Mr. Norton, would you summarize very briefly the essential difference between Count I what the Government is driving out there as contrasted with the practical consequences of what it is seeking in the other counts.

Suppose you won on Count I and lost on the others and vice versa, what are the results of this?

Gerald P. Norton:

Well I think it’s hard to give a precise answer to that because Count I is a broad horizontal type of combination which has as its focus the — among other things, the development of these vertical arrangements which are challenged in Counts II through VIII, so they are somewhat interrelated.

Lewis F. Powell, Jr.:

Specifically what types of agreements would Count I address that are different from the agreements addressed by the other counts.

Gerald P. Norton:

Well, Count I referred to other matters such as discouraging people who — a number of things to suppress the development of the secondary market in addition to contract such as discouraging people who might be interested in engaging in such a market by saying and suggesting that it was not lawful or a distributing information that mischaracterized the legality of such transactions and sort of supplemental to the —

Lewis F. Powell, Jr.:

The information like that violates the antitrust laws if it were erroneous.

In other words both the brokers and dealers would have lawyers to advice them whether or not the NSAD information was correct or not.

Gerald P. Norton:

But one problem on — in answering on Count I is that we’re here on a motion to dismiss, we don’t have the facts but there are some indications in the record that are suggestive.

Government exhibit 13 which is an interoffice memorandum from the Crosby Corporation in 1970, refers to the problem of dealers buying from the investors and selling again not redeeming and addresses the question whether such — the dealer agreements should be amended to preclude those transactions and indicates awareness that to do so would raise serious questions under the antitrust laws.

There is knowledge that going beyond the bounds of 22 (d) presents serious antitrust questions so that it’s not as if they were babes in the woods.

Another exhibit, Government exhibit 12, 13 is at page 267 of the Appendix, 12 the last page at 266 which is another interoffice memorandum in 1950, it talks about the importance of eliminating the competitive business and knitting together in a coordinated campaign to cut down on competitive street markets.

We don’t know what else there maybe behind the face of the complaint.

We haven’t had discovery yet.

Gerald P. Norton:

So I just can’t give you a definitive answer but the activities challenged in Count I supplement and reinforce and give broader effect to the agreements challenged in Counts II through VIII.

Now the test of course, under silver on the question of immunity is whether immunity as to a particular challenged transactions is necessary to make the regulatory act work and even then immunity is implied only to the minimum extent necessary to do so and there has been no showing here that the kind of sweeping immunity for all kinds of restraints on secondary markets that are comprehended by the complaint satisfy either of the Silver tests.

I was beginning to say earlier, the commission simply has no appropriate authority to review the kinds of activities that are challenged in the complaint.

22 (d) provides it with no jurisdiction, it has no function under 22 (d) except —

Byron R. White:

Do you agree Mr. Norton that 22 (d) does oust the antitrust laws with respect to the primary market, of course you don’t attack, you don’t say that the price — the resale price maintenance scheme that the funds that the underwriters use is illegal?

Gerald P. Norton:

No, no obviously if the statute requires someone to sell at a price fixed by his supplier we would —

Byron R. White:

Now when does that — when does that principal market end?

When a particular share has been bought by an investor, once he has purchased at the first time.

Gerald P. Norton:

That’s right.

Byron R. White:

And has never been held by an investor before.

Gerald P. Norton:

That’s right.

Byron R. White:

Then you say the primary market has ended and he should be able to sell to that to another investor either through a broker or directly.

Gerald P. Norton:

Well there’s no question you can sell that —

Byron R. White:

I know but without any — without any interference from.

Gerald P. Norton:

That’s right, imposed —

Byron R. White:

— by the fund or the underwriter or other dealer.

Gerald P. Norton:

That’s precisely right.

Byron R. White:

So that just isn’t the question of — or do you say that the primary market just can’t reach out and keep investors from selling to another one at as lower price even though the fund is continuously offering its new share.

Gerald P. Norton:

That’s right and of course if the fund suspends offering and some do from time to time then the whole resale price maintenance is out and let me point out the agreements here don’t limit their provisions to times when the fund is continuously offering.

That maybe the norm but that is not the condition set forth in the agreements.

Lewis F. Powell, Jr.:

Mr. Norton, I thought that clients did offer continuously or because they are obligated to buy back continuously.

Gerald P. Norton:

Well they generally do.

There’s no question about that but they are not obliged to.

They are obliged by law to redeem at anytime.

They’re not obliged by law to continuously offer and some have been closed up for decades.

Lewis F. Powell, Jr.:

There must be a liquidation.

Gerald P. Norton:

Not necessarily.

No, they have good results, they may just have their shares traded in a secondary market.

If they’re doing well people will trade there rather than redeem.

Lewis F. Powell, Jr.:

Pertaining to a question that Mr. Justice Marshall asked earlier, isn’t that fundamental problem to the extent of the load and the SCC does have authority to regulate that.

Gerald P. Norton:

They have authority to regulate that in the primary distribution system.

It is tied with the resale, same scope as the resale price maintenance.

Lewis F. Powell, Jr.:

But if the law were fair, what would be the advantage of having the secondary — the pre-secondary market that you speak of?

Gerald P. Norton:

Well at present, an investor has to pay the load whether or not the dealer performs any services that sales load and mutual funds reflects a large selling expense.

But if you’d already bought fund, you know about mutual funds and you don’t need to be sold on them.

All you need is the mechanics to be taken care of why should you have to pay a full sales load when if you could go to a broker, you could buy this shares that someone else down the street is trying to sell.

Potter Stewart:

8 1/2%.

Gerald P. Norton:

8 1/2 %, it’s sizable.

Byron R. White:

Your problem though but the situation would still exist, but perhaps not to the same extent that even if there was no sales load because investors may want to sell, another people may buy it less than the asset value.

Gerald P. Norton:

That’s right.

It’s not just the load, it’s the freedom of options which is very basic in the competitive system.

And the final consideration on the question of immunity is that it’s essential there be some conflict.

Now there is no conflict here, there is certainly no conflict with anything the commission has done in the past.

As to the future, the purpose of this suit is consistent with the commission’s proposals in its 1974 report.

They want to end these contractual limitations too.

So there’s no conflict there, there’s no conflict either with the commission’s proposals to permit funds to impose transfer fees and other measures.

They’re just not in conflict.

Now going beyond that, the defendants suggest well, there maybe some possibility of conflict between something that the Court here might require and something that the commission might require someday.

Byron R. White:

An investor can always redeem at that asset value.

Gerald P. Norton:

That’s right, but it’s net asset value with the date of receipt by the fund if he wants to get cash quickly and at more certain price, he may want to redeem on the secondary market.

Byron R. White:

But then he may have to pay a brokerage commission.

Gerald P. Norton:

Well, it depends.

Byron R. White:

I mean he does know any other investors.

Gerald P. Norton:

He sells to a dealer, he would pay whatever the market price was.

If he sold through a broker there would be a small commission but as to this remote possibility of some future conflict of course the Court held in Silver and in Gulf States, (Inaudible) rather that that is not sufficient.

You need an actual conflict.

In addition, we don’t have a judgment here.

The judgment if and when it is entered could take into account the possibility that the commission might act differently in the future and it could accommodate the possibility of some overlap of jurisdiction.

So we believe that none of the conditions of implied immunity is satisfied here and that the defendant’s restraints are not justified and certainly not required by 22 (d) or 22 (f) that the judgment of the District Court should be reversed.

I’d like to reserve the balance of my time.

Byron R. White:

I take it Mr. Norton that the antitrust(Inaudible)

Gerald P. Norton:

That would appear to be the situation.

Byron R. White:


Gerald P. Norton:

That’s right.

Warren E. Burger:

Mr. Norton you’ve consumed all of your time.

Mr. Loevinger.

Lee Loevinger:

Mr. Chief Justice and may it please it the Court.

In the first of the great antitrust cases in the Securities Industry, Judge McDine (ph) back in 1953 observed the initial inquiry and the antitrust case must be in to the character and background of the industry involved.

Now, Mr. Norton has sketched very nicely the character and the operation of mutual funds, of the few points I may take exception too, however he has not undertaken to examine the character of the Securities Industry.

Well, all there’s a limited record here.

Fortunately all of the facts of significance on matters of public record.

In 1963 there was a special study of the Securities Market which has been referred to by this Court cited in Silver and Cartwright and another cases and therefore I have had reference to that as a source of available information.

And my information concerning the markets comes from that.

There are two basic types or markets.

First, the initial issue of market for distribution of Securities in the public hands which is usually in handled through underwriters and second, trading markets for continuous trading and outstanding securities.

The special study says the uses and mechanisms of trading markets are substantially different from those of distribution markets.

The term primary is sometimes used to refer to the original issue market and the term secondary to the secondary trading markets and the terms are so used in this case.

There are however two types of trading markets exchanges and over the counter markets.

The special study says that these are fundamentally similar in purpose and function but substantially dissimilar in mechanics and practices.

In the exchange markets, there is a physical congregation of buyers and sellers represented by brokers on the floor of the exchangers and actually at physical locations within the exchanges.

There is continuous auction trading with buying and selling and the price fluctuating according to supply and demand.

Trades are executed quickly often and within minutes of the time the order is given.

The market could function solely as a nexus for matching public orders to buy and sell although there are dealers on the market they handle odd lots and perform various other functions.

The over the counter markets in contrast have no physical place of congregation.

The special study says that such markets exists only as and to the extent that dealers elect to make them by standing ready to buy and sell for their own accounts.

These dealers are market makers and in the over the counter markets, there is no mechanism for matching public orders so that the market makers are the over the counter equivalent of the nexus between buyers and sellers provided by the exchange floor.

There is also something called the third market which consists of stocks listed on any exchange brought or sold over the counter.

This exists almost exclusively to serve the needs of very large institutional investors often trading tens of thousands of shares worth millions of dollars and occasionally these are brokered transactions because there’s enough involved so if they can go off and look for buyers or sellers to match the orders.

There is also been some discussion recently of a so-called electronic market resulting as Mr. Norton have said from recent developments of computer technology and electronic communication and it has made theoretically possible, the combination of the New York stock exchange, the regional subsidiary exchanges and possibly even of over the counter markets.

Whatever the merits or demerits of the so-called electronic mark, if they lie wholly in the future and are entirely theoretical, have nothing to do with this case because they never have existed, are not yet in existence.

Lee Loevinger:

Now, as Mr. Norton had said, there are various types of mutual funds or open-ended management investment companies.

However, this case is concerned with only one type, open-end management investment companies engaged in continuous sale of their shares.

We are not concerned with the so-called closed-end or with the closed-up funds.

Mr. Norton said that there maybe occasions when an open-end company is closed up, that may very well be but on those occasions the sales agreements to which he objects are no longer in effect.

So those are completely out of the case.

In any event, all of the defendants here are open-end funds that have never been closed up and so we are not concerned with any closed up funds.

Mutual funds have been well analyzed and described in both of the majority and dissenting opinions in the United States versus Cartwright so that this Court is presumably familiar with them as a means of providing a diversified investment portfolio and management service, mainly for small individuals and institutional investors.

They have as was said the unique characteristics of being continuously offered through underwritings and primary distribution and of being required to buy back any outstanding shares at any time of the net asset value.

Thus, the price of funds is not set as are the price of almost all other securities by supply and demand.

In the first place, the supply is practically unlimited so there would be no limitation on that side of the equation.

In the second place, the price depends upon the net asset value which is based on the market value of the underlying portfolio securities.

This is simply determined mathematically by a clerk in the office.

There is no management discretion involved.

That’s a pure mathematical computation.

Furthermore, although the Government talks about a restriction or restraint of competition here, there is vigorous competition between funds based on performance, portfolio, selection of type and nature of operation and various other characteristics.

There is vigorous inter fund competition and there is no contention to the contrary here.

Potter Stewart:

But they don’t compete in terms of the load percentage?

Lee Loevinger:

Yes sir they do, because some funds have higher loads, other funds have no load, some funds have no loads.

There is competition between funds as to load.

The Government is addressing its case solely to the fact that as to within the organization of a single problem, the dealers engaged in the distribution of a single fund do not compete as the load.

That’s the whole government case here.

Now —

William H. Rehnquist:

Well, do to the load factors in your open fund vary — they’re not all 7.5%.

Lee Loevinger:

Indeed they are not, sir.

No, sir.

They vary from a very low percentage to eight and a half percent.

As a matter of fact there is a pending NASD rule that sets a maximum of eight-and-a-half percent with things scaled down according to various contingencies.

This has been given tentative approval by the SEC an will into effect fairly shortly but they —

Potter Stewart:

You say, there are some with the open-end investment companies with the zero load?

Lee Loevinger:

Yes, sir but no load funds on the market and available.

Potter Stewart:

I knew that they were closed down, no load funds.

Lee Loevinger:

Now there are open-end, no load funds on the markets.

Potter Stewart:

So where is the —

Lee Loevinger:

Right, why do people buy load funds that’s —

Potter Stewart:

How can that economically be?

Lee Loevinger:

That’s a very good question, Mr. Justice and that brings me to the next point which is that mutual funds are and have been as found by the SEC dependent upon their primary distribution system.

By and large, the demand for fund shares is the result of advertising a sales promotion efforts by the under writers and the dealers.

Furthermore, for funds that do have loads and are thus dependent continuous cash flow from their sales is necessary to provide the cash for redemption.

Without such continuing sales, the funds would be forced to sell our portfolio securities in order to meet the demands for redemptions.

This would tend to depress the markets and ultimately make the funds self liquidating.

This method of distribution incidentally is rather logical for mutual funds because as I’ve mentioned, trading markets exist to redistribute outstanding shares previously distributed by the issuer.

For most securities, this is as Mr. Norton correctly said the most important market.

However, since mutual funds are continuously being issued and repurchased by the issuer, there is no function for the secondary market to perform at all analogous to the secondary market trading function for other securities and as noted in Cartwright, this method of distribution is now mandated by statute and under the statutory scheme, the redemption of shares by funds is the market and the only market for investors.

Now, before 1940 when the Investment Company Act was passed, there was a secondary dealer’s market in mutual funds by non-contract dealers which was referred to as the bootleg market.

Non-contract dealers would buy from stock holders at slightly below the net asset value and resell to investors at slightly below the public offering price.

They could do this because they eliminated the underwriting fee which at that time was substantially higher than it is today.

There never has been prior to 1940 or since then a secondary brokerage market in mutual funds.

This simply has been nonexistent for two compelling reasons.

First, it has been functionally impractical because there was simply no way for brokers to function in and over the counter market except on very large transactions where the brokerage commission would enable them to go out and search for buyers or sellers.

Incidentally, it’s unethical for brokers to seek to get fund investors to sell their fund shares because they were guarded as long-term investments.

The second is that it’s been economically unprofitable because the brokerage commissions have always been less than the dealer’s markups on mutual funds.

Now in 1935, Congress directed an extensive study of investment companies and after four years, the SEC submitted its investment study to Congress as a result of which Congress in 1940 enacted the Investment Company Act.

The congressional intent contrary to the representations of the government clearly was to restrain and inhibit the growth of a secondary trading market in mutual fund shares in order to maintain the primary distribution system and protect it against disruption.

Mr. Norton has suggested that there is no testimony to this effect.

I suggest the testimony of Mr. Skinker(ph) the director of the investment trust study which can be found in the dealer’s brief which is the big red one at page 31, specifically mentions the bootleg market.

This was mentioned in the investment trust study and there is as we demonstrate at considerable length in our brief.

A legislative background showing that in fact the suppression of the bootleg market was one of the purposes of the Investment Company Act.

Potter Stewart:

That became the proposal that this problem will be dealt with my forward pricing.

Lee Loevinger:

That has been implemented by the SEC.

It was implemented in 1969, Mr. Justice by an SEC rule requiring forward pricing which is now the present practice.

Lee Loevinger:

Therefore, the problem of dilution resulting from forward pricing has been totally eliminated and when Congress reenacted Section 22 (d) in 1970, it had no such problem before it which again reinforces the same conclusion.

In any event in an Investment Company Act, there was — there were ample provisions for the regulation of mutual fund sales and distribution.

22 (a) referred to the method of pricing, gave the NASD and the SEC a power to pass such rules, 22 (b) gave the NASD and the SEC power to regulate mutual fund loads, 22 (d) provided the mutual fund share should be sold to investors only at a current public offering price which in effect protected the sales, load or sales margin against the price cutting of a secondary market and 22 (f) authorized restrictions on transferability and negotiability of fund shares which were fully disclosed to the SEC and not disapproved.

The SEC says in its brief that it was the intention of Congress to regulate through Section 22 (f), restrictions on secondary market activities in mutual fund shares and we fully agree with that position.

Byron R. White:

I guess you’ll get to it but you — wholly aside from 22 (f) — I suppose you’re saying that 22 (d) — or 22 (d) and 22 (f) together mean that the primary — it means that the — there is only supposed to be a primary market.

Lee Loevinger:

They eliminated the secondary market, Mr. Justice.

Byron R. White:

And wholly aside from the power of the SEC.

Lee Loevinger:

As a practical matter, yes.

They did eliminate the secondary market.

Incidentally, the SEC has —

Byron R. White:

Well, let’s assume we disagreed with you on the 22 (d) that just by on its face or in the light of its legislative history, 22 (d) standing alone didn’t eliminate secondary market and then we are left with the argument that the powers of the SEC under 22 (f) are sufficient to preempt the antitrust laws —

Lee Loevinger:

Or that the —

Byron R. White:

Are you saying the 22 (f) alone has that —

Lee Loevinger:

We needn’t rest on that sir that the —

Byron R. White:

I know you don’t and you needn’t but what if you have to?

And what if we —

Lee Loevinger:

As a practical matter, the powers of the SEC under 22 (f) are perfectly adequate to this case to answer the question asked by Mr. Justice Powell as a practical matter all of the restrictions the Government has complaining about are in fact contained in the agreements and if the SEC made regulations under 22 (f), that would as a practical matter end the case.

However, there is ample authority under other sections.

Under 22 (b), there is an expressed antitrust exemption for control of sales loads by the SEC and by the NASD, 22 (d) sets the price however Section 6 (c) of the Investment Company Act gives the SEC full exemptive power as the Department of Justice has often urged before the SEC so that the SEC in Section 38 gives the SEC power to promulgate any rules and regulations of likes to implement of the other sections of the Act.

So the SEC has plenary power to control all of the matters that are in discussion here.

Furthermore, the history actually — (Voice Overlap) Yes, it has sir to a large extent.

In the 1974 report as the SEC points out, all of these matters are discussed.

There are proposals relating to every single thing that Government has under discussion and there are — some of them have been Some of them are in the forms of tentative rules, others in the form of recommendations for no action but they have all been thoroughly discussed, considered and are the subject of either past or pending actions by the SEC.

I submit Mr., Justice that history has in fact answered your question as to the effect of 22-D and 22-F.

There was a very active secondary dealer market up to the time of passage of the Investment Company Act in 1940.

It has been estimated, it was approximately as large perhaps, it tried for larger than the primary distribution market.

Since 1940, the secondary market has disappeared except for what the SEC refers to as miniscule market and which all the parties agree amount to less than 1/10 to one percent of the total market and that has been entirely the result of the passage of The Investment Company Act.

William H. Rehnquist:

Of course the Government says part of the reason it has disappeared is because of the agreements among your clients.

Lee Loevinger:

Those existed prior to 1940, Mr. Justice.

If it hadn’t, the only thing that changed in 1940 was the passage of the Investment Company Act.

Lee Loevinger:

Consequently it’s the only thing to which we can attribute the disappearance of the secondary market.

Furthermore, the protest from the secondary market dealers which are in the record largely as Government exhibits show that in fact these were — that this was what the secondary market dealers saw as driving them out of business.

The reason for this is fairly simple you see, because as I explained you have to understand the mechanism of the market.

In the secondary market, secondary trading markets, there are enough brokers for transactions of this kind.

There are only dealers.

The Government admits, both in its main and its reply brief as I recall, page two of the reply brief that Section 22 (d) applies to all sales by all dealers regardless of the capacity in which they are acting are the market, in which they are acting.

Since secondary market dealers can not offer an investor any advantage in selling price, there is simply no function for the secondary market anymore.

Therefore, the Investment Company Act wiped out the secondary market in 1940 and it exists as a minuscule thing or a curiosity, I assume largely is a matter of convenience among dealers and for other peripheral things but obviously not of any real importance.

Byron R. White:

Let me get it clear.

Let’s assume that an investor has bought some shares in a mutual fund and he wants to get rid of it.

Let’s assume he just sells to a dealer and the dealer buys it for his own account.

Now if he does that, if he wants to sell to an investor he must sell at the offering price.

Lee Loevinger:

No, the — I’m sorry if the dealer wants to sell, yes sir.

The dealer must sell at the public offering price.

Byron R. White:

Even though an investor has previously held though here.

Lee Loevinger:

Yes, sir.

That’s conceded by the Government, no question about that.

Potter Stewart:

A special investor just wants to sell his shares to a friend and they say why would you split the difference between the redemption cost and the offering?

Lee Loevinger:

Obviously proper, there’s no law against it, no rule against it, no restriction against it, it’s not involved in the case.

Potter Stewart:

And if he goes through a broker it isn’t at all?

Lee Loevinger:

There is some question as to whether or not 22d reaches the case of a broker who is not in fact a dealer and acts only as a broker between two investors but again that’s a pure abstraction.

It’s the most exceptional case, it’s something the only case that has ever come to light at that time is the Oxford case which involves most extraordinary circumstances perfectly obviously redolent of fraud and overreaching on the part of a small firm that had two customers and substantially only two customers and it sold fund shares for one at the same time.

It bought the same fund shares for the other and attempted to charge the full spread and the SEC said “you couldn’t get away with it,” but there is nothing in there to indicate that it ever acted as a dealer.

Potter Stewart:

Assume that you may be right that it hardly ever happens but are you saying that the Act 22 (d) and 22 (f) would exempt the NASD from any antitrust liability and the brokers if they all agreed that we will just ever help an investor sell to another investor?

Lee Loevinger:

There’s no charge that they have done this.

The only charge is that the contract dealers —

Byron R. White:

Well, how about my question though, let’s assume there was such an agreement, is that exempted by the —

Lee Loevinger:

I think it would be sir because these are so — there is such a pervasive system of regulation by the SEC.

It is impossible to conceive of any practice that any of the dealers or brokers or underwriters can engage in here that is not subject to SEC control.

Byron R. White:

Well, I thought part of the Government’s case was that the NASD and the formal system was suppressing any kind of a development of secondary market through brokers?

Lee Loevinger:

There is a formal allegation to this effect but in fact it has been largely abandoned.

This formal allegation rests upon the assertion that NASD rules have this effect but they have now retreated from that allegation and thereby substantially withdrawn their Count I charges.

As a matter of fact, Government’s exhibits 12 and 13 that Mr. Norton referred to are concerned exclusively with vertical restrictions and not the horizontal restrictions.

Byron R. White:

You’re suggesting this is just a non-case.

Lee Loevinger:

I believe that is precisely the incidence, Mr. Justice.

William H. Rehnquist:

Assuming Mr. Norton in his response to Justice Powell’s question didn’t indicate that the Government had withdrawn Count I.

Lee Loevinger:

I know he didn’t but in fact they have because all of the substantial allegations have been abandoned.

William H. Rehnquist:

Well, how — you know when you talk about someone withdrawing a portion of their case, I would assume you take their word rather than opposing counsel’s ordinarily.

Lee Loevinger:

The Government is very anxious to have the case reversed and to prevail sir, but there is nothing left of Count I after they have abandoned the charge, the NASD rules violate the antitrust laws.

The Count I doesn’t stand in the record, simply on its fair — in the first place, the things that they are talking about here and in their brief which referred to the refusal of broker dealers to sell to a secondary market dealers don’t appear in Count I as it — of the complaint as it was drafted file and appears in the record.

Count I refers primarily to NASD rules when those have been abandoned, we are left to look to this —

Byron R. White:

What do you point to?

Do you suggest that the Government has abandoned its claims on the Count I?

Lee Loevinger:

Its concession that the NASD rules are not under attack.

Byron R. White:

Where is that?

Is that just a letter —

Lee Loevinger:

Yes that’s — there is a letter from counsel and the Joint Appendix at page 327.

It set forth in the jurisdictional statement on page 26.

It’s repeated in the Government brief at page 51 and Mr. Norton made the admission in oral argument here.

There is no attack upon NASD rules, that’s perfectly clear at this point.

Byron R. White:

But they do say that there is a — there are agreements which have this effect of ousting the development of any secondary market?

Lee Loevinger:

Yes sir.

These are the agreements that are attacking constitutional way.

Now, actually the existence of agreements is required by rule 26 of the NASD which is of course not under attack and the restrictions on the sales fund, on the fund sales are we maintain plainly authorized by Section 22 (f) so that indeed it does come down to the question of what is this case all about and let me quote from the Government brief to suggest what the case maybe about.

The Government brief says at page 9, that the secondary dealer market does not ordinarily produce any monetary advantage to a buying investor.

Furthermore, if this leads to the conclusion on Government brief at page 34, that the prices in a competitive secondary market are not likely to differ substantially from the price established in a primary distribution chain.

Consequently, one is really entitled to ask why has the Government brought and why does it pursue this case and we believe that it is because it is dissatisfied with its efforts to get the SEC to act immediately to exempt or abolish Section 22 (d) and to get Congress to repeal 22 (d).

There were three exhaustive studies presented to Congress in 1962, 1963, and 1966 on the securities markets.

There was four years of hearing from 1967 through 1970.

The Department of Justice contended that 22 (d) should be repealed.

Lee Loevinger:

The SEC said, no, don’t repeal 22 (d) but impose a flat statutory maximum of 5% on sales loads.

Congress rejected both proposals and in a legislative — with a legislative history that is perfectly clear that they were talking about the protections of primary distribution system against any secondary trading markets.

They reenacted Section 22 (d) in full in 1970 with the full knowledge that since 1940 to 1970, the action of 22 (d) and the Investment Company Act had in fact eliminated the secondary markets.

This was fully explained, it was fully explored, there are numerous statements by senators representatives and witnesses in the — before the Congress during the period, 1967 to 1970 so that we must look to the 1970 enactment of Section 22 (d) to see that Congress was fully aware that in enacting Section 22 (d) and the other provisions of the Investment Company Act which were fully reexamined, it knew it was eliminating the secondary trading markets.

Furthermore, I think that if the Court will look at all of the provisions of this extremely complicated and complex statute coupled with the provisions of the Maloney Act, it will see that regardless of the technical construction that maybe put on the specific terms of particular sections that there can be no real quarrel with what the SEC states as the basis of its interest in this case and in its brief at 19 where it says, the Investment Company Act of 1940 vests in the commission pervasive authority to regulate the process of distributing mutual fund shares and then roll a retail price maintenance therein.

Furthermore, I call the Court’s attention to the fact that the Government has sought to file its brief in Gordon in this case as further elucidation or part of its position and in the Government’s brief, as amicus in Gordon it says at page 35, it attempts to distinguish this case from the case of the exchange and it says in the Maloney Act, Congress expressly incorporated antitrust principles and made that the duty of the SEC to enforce them as applied to associations of over the counter dealers, thus trying the strengthen this positioning against in Gordon by pointing to fact that here, in fact there was an antitrust duty resting on the SEC.

Now, we submit that under the prevailing precedence of this Court, this complaint must be dismissed and I think this is perfectly clear from the Pan American case and the Hughes Tool case.

In Pan American, the Court said the acts charged as antitrust violation are precise ingredients of the Court’s authority.

If the Courts were to intrude independently with their construction of the antitrust laws, two regimes might collide.

Dismissal of antitrust suits where an administrator remedy supersede at the judicial one is the usual course.

In those cases however, the CAD which was the administrative agency that was involved, filed briefs on the side of the defendants and said it had neither the competence nor the authority to control the acts alleged as antitrust violations.

Here in contrast, the SEC is coming in, saying it has both the competence and the authority to control for these matters.

Now let me speak for just a minute about the diagram which is said to elucidate the Government’s position.

In the first place, it omits and distorts the time dimension, the vertical transactions are all virtually simultaneous transactions whereas the horizontal and diagonal transactions take place at different times and so are not comparable.

One firm cannot, contrary to Mr. Norton’s assertion be a contract dealer and a not contract dealer at the same time with respect to the same fund of one for maybe a contract dealer as to one fund in a non contract dealer as to another fund but that’s irrelevant.

You can’t be both a contract dealer and a not contract dealer.

Second, since there is not and never has been a brokerage market.

The drawing of this thing called broke over here is simply lies on the paper that doesn’t correspond to any reality for the same reason the transaction label Y is simply imaginary because there isn’t any such thing.

Third place, the transaction marked by the same symbol X is not a secondary trading market transaction.

It is clearly part of the primary distribution system.

As part of the primary distribution system, the X transaction is subject to regulation by both the NASD and the SEC, both under Section 22 (f) and rule 26 of the NASD.

The Government brief indeed admits at page 53 that Section 22 (d) permits the NASD and the commission to regulate price and sales loads in connection with the primary distribution market and the SEC is addressing itself to the inter-dealer market.

Furthermore, transaction X is forbidden by rule 26 of the NASD which in effect provides that only contract dealers are entitled to discounts and that they shall purchase only in order to fill investor’s orders.

Consequently, there’s simply no economic incentive and no functional purpose served by transaction X.

Now, since transaction Y is imaginary and non-existent and since transaction X is prohibited by rules which are not now attacked by the Government, there is simply no transaction shown on this diagram which is restrained by any conduct of the defendants which is under attack in this lawsuit.

Byron R. White:

But you don’t suggest that 22 (d) or any other law makes it illegal for a broker to match and to help an investor sell his shares to another one?

He doesn’t violate the law, does it?

Lee Loevinger:

This is disputable, Mr. Justice.

As a matter of fact, there is an argument made in the NASD brief to the effect that the term dealer is used in a generic sense.

However —

Byron R. White:

I’ll put it to you this way.

The Securities and Exchange Commission doesn’t think that it’s illegal for a broker to do this business?

Lee Loevinger:

No, sir.

It has the — no.

Byron R. White:

That in fact they have the contrary opinion.

Lee Loevinger:

Alright, they have never made a ruling that a contract dealer can act as a broker.

They have simply said that a securities firm acting only in the capacity of a broker may match investors by a sale order.

Byron R. White:

That’s right.

So, it’s not illegal for — in their opinion for a broker to do that.

Lee Loevinger:

But there is nothing charged in this suit that would prevent that because these are people who by definition are not subject to the restrictions of the sales agreements and they are not subject to any inhibition in the NASD rules.

They are simply nothing in this suit that is charged.

Byron R. White:

So, you might have some problem if the complaint was alleged to charge that there was some interference.

Lee Loevinger:

If there were different complaint, we might have a different case, Mr. Justice but there is nothing in this complaint nor may I point out also that the Government has filed an affidavit and 30 exhibits taking 75 pages of the printed record from pages 230 to 305 elucidating that the charges in this complaint.

There is no suggestion any where that any thing that has been done in fact does suppress the independent brokerage market.

Byron R. White:

Well, didn’t the District Court rule that Section 22 (d) or 22 (d) and 22 (f) together just preempts, ousts the antitrust laws in this entire case?

Lee Loevinger:

Yes, sir.

Byron R. White:

And that even if there was something to aim that brokers matching investors, the antitrust laws would still be irrelevant?

Lee Loevinger:

As a matter of fact, we would take that position because we think that under the decisions of this Court, there is such pervasive regulation of all these transactions by the SEC that under TWA and Pan American, the Court would hold that the SEC has the authority and therefore these are not subject to the antitrust laws.

We think that in that respect the Court’s decision is right but whether or not they may or not be some remote corner in which independent non-contract dealers, — yes, sir.

As a matter of fact, the SEC is in fact acting and studying those very matters.

There isn’t any question about it.

As a matter of fact I think that insofar as this chart has any relevance to the present case, what it shows is first, that the theoretical model of how the market operates which is in the minds of the Department of Justice, Government attorneys simply doesn’t correspond to reality and second, that there simply is no place where the authority of the SEC and the jurisdiction and the application of the Investment Company Act and the Maloney Act don’t apply.

In other words, that there is precisely that kind of pervasive authority which the Court has said in both TWA and Pan Am makes these things subject to administrative and not to antitrust regulation and this is not a case whereas in Pan Am, there was potential conflict between the administrative and the judicial regimes.

This is a case in —

Warren E. Burger:

Time is up now.

Lee Loevinger:

Yes, sir.

I’m taking just a few minutes of Mr. North’s time with his permission.

This is a case in which there is actual collision because the regulations that have been proposed by the SEC staff are completely incompatible with the remedy that is sought here by the Department of Justice.

As a matter of fact, the SEC staff seeks to establish a possibility for the existence presumably under modern technology of this alleged brokerage market in which case they say the transaction y which is a brokerage transaction could be subjected to a special charge to be payable to the underwriter in order to help support the distribution system.

Now, as I say this is not a case of potential conflict.

Lee Loevinger:

This is a case of actual conflict between the regulatory and the antitrust regime.

This Court has no choice under is precedence but to dismiss the complaint.

Warren E. Burger:

Alright, Mr. Lee Loevinger.

Mr. North.

Walter P. North:

Mr. Chief Justice and may it please the Court.

The SEC is very thankful for this opportunity to participate in this argument.

It is not often that we and the Department of Justice disagree and having done so in this instance and we not being parties to the case and they are, our only opportunity to be heard here was on an amicus basis and we appreciate you are allowing us to do so.

Having listened to nearly an hour-and-a-half of argument by the appellant and the appellees, I see no need at this stage to try to recap the whole case.

I’m going to confine myself instead to making two or three specific points which I think are significant and emphasize and enlarge upon a little the way it was put by the other counsel.

I think the beginning of this case is to take a good hard look at the nature of the open end mutual fund business.

Now, between the Government counsel and counsel for the litigants, private litigants, you had a rather full exposition of the way the market operates and quite a lot said about the legislative history but I think the starting point is perhaps even back of that.

The mutual fund shares are not marketed in the way that General Motors stock is.

You don’t buy it in the market place at an auction.

The mutual fund makes a continuous offering of its shares which it has to do in order to meet the redemptions which the law requires it to make.

In order to make continuous sales of mutual fund shares, there has to be a primary distribution system that will hopefully keep up their new sales parallel with if not in excess of their redemptions.

If you don’t have that result, the fund is going to be forced into a gradual liquidation and eventually will have to go out of business.

I think that when you bear that in mind, it puts the importance of the primary distribution system that Congress has seen fit to try to protect in a much stronger light than you might otherwise consider it.

I think it’s very important that we do take that into account.

Now, I’d like next to touch upon one aspect of the Government’s argument which I think is highly technical and exults form over substance.

They say that the contracts that exist between the fund and the underwriter and in turn between the underwriter and the contract dealers are not sustainable under Section 22 (f) as being restrictions on transferability.

They say apparently that you have to have something that’s written on the face of the stock certificate or expressed in some other way but as long as these contracts are filed with the SEC as they are and always have been since the 1940 Act was adopted and as long as they are incorporated into the registration statement I can see no basis for saying that they don’t fully comply with Section 22 (f).

Thurgood Marshall:

But even if the SEC doesn’t look at them?

Walter P. North:

Doesn’t look at them, you say?

Mr. Justice, I don’t think that makes any difference one way or another.

Thurgood Marshall:

When did you start regulating on 22 f, when did the SEC start regulating

Walter P. North:

Well, it started I would say with 1941 when we first reviewed the NASD’s initial rules that were adopted pursuant to this section of the statute.

Thurgood Marshall:

Did you issue regulations?

Walter P. North:

We have not adopted any specific rule under 22 (f).

Thurgood Marshall:

I’m sure that they have you?

Walter P. North:

Well, I’m not even doing it today.As a matter of fact, we have exercised —

Thurgood Marshall:

I should ask another question, did you ever expressed?

Walter P. North:

We have proposals right now that we’re working on to go to Congress with to change some of these things by statute rather than just by a regulation of our own and we in the meantime have specifically requested the NASD just last November to adopt a rule which would loosen up to some extent the right of others to participate in the market of mutual fund shares as distinguished from limiting it to the primary distribution that we now have.

But, the Commission has exercised cast surveillance in this whole area all throughout the history of the Investment Company Act.

The only thing it hasn’t done is to adapt a specific rule under 22 (f) because it has never found occasion to take exception to the NASD’s rules in this area which it has carefully reviewed and kept track of and commented upon from time to time.

Indeed, the Joint Appendix here contains some conferences between the representatives of the Commission in the NASD which show that there was mutual consultation on the limits of these things and what should be done in these areas.

So, it seems to me that the important thing here is that the NASD and its members have consistently since both before and after the 1940 Act conducted a primary distribution system that was based upon contracts which contain these provisions.

These contracts are on file with the Commission as a part of the registration statement which is what just what 22 (f) says as it should be.

Potter Stewart:

Let me ask you this part here, you are suggesting that the SEC by not disapproving any of these agreements has in effect proved a contract between for example, between a contract dealer and a underwriter that the dealer will never act as a broker between two investors.

Walter P. North:

The commission has approved the portion of that contract which you are mentioning.

Potter Stewart:

Your answer is yes, and that there are such agreements in existence where the people participating in the primary submission system agree that they want brokerage.

Walter P. North:

That’s right.

Potter Stewart:

And the underwriter agrees with the mutual fund that his contract dealers want brokerage.

Walter P. North:

That’s right.

Those are all restrictions —

Potter Stewart:

You say that you have approved those agreements therefore they are exempted from the antitrust laws?

Walter P. North:

I am saying Your Honor that we haven’t disapproved them, 22 f permits —

Potter Stewart:

Well, then the a fortiori, if you would approve them you say that’s the example.

Walter P. North:

Yes, certainly.

Potter Stewart:

But what’s essential to the operation to the Act?

Where do you find in the Act any authorization for approving or for exempting that kind of a contract management form?

Put your finger right on it in this Act, in the — in Section 22 (d) or (f).

Walter P. North:

22 (d) 22 (f) reads, no registered open end companies shall restrict the transferability of any security of which it is the issue except in conformity with the statements with respect to contained in this registration statement which statements are not in contradiction of any rule of the commission.

Potter Stewart:

Well, yes.

You’re saying that under (f), under (f) — any kind of agreement known to man, as long as you don’t approve it is perfectly alright.

Walter P. North:

We’re saying that restrictions on transferability of the shares of an issuer are unobjectionable from the standpoint of the antitrust laws if — as long as they are contained in the —

Potter Stewart:

Are you suggesting that it could — you could say that the stock could’ve honored and they have enforceable and then one investor couldn’t sell to another.

Walter P. North:


Potter Stewart:

Well, why wouldn’t you as you didn’t disapprove it.

Walter P. North:

Because —

Potter Stewart:

The evidence in the registration statement and if its not disapproved by the SEC, I think your answer would be yes under 22 (f).

Walter P. North:

Maybe I didn’t understand the question, I’m sorry.

Potter Stewart:

Or you would say that such a restriction on the sale from one investor to another would be — not only, it would certainly wouldn’t — it wouldn’t be anything wrong with that as long as you didn’t disapprove it.

Byron R. White:

nd so long as its in the registration statement.

Potter Stewart:


Walter P. North:

That’s undoubtly so but I’m not at all sure about what we wouldn’t disapprove it if they went that far.

In other words, I think —

Byron R. White:

(Voice Overlap) well, do you —

Walter P. North:

— that Congress has vested the authority in the commission to do that.

Byron R. White:

You’re — alright.

You’re suggesting then that the SEC would interpret the Act to exclude that kind of a restriction.

Walter P. North:

I think we would say that —

Byron R. White:

So there are restrictions of which the Act wouldn’t permit you to approve.

Walter P. North:

The Act from its — us to approve only once if we feel are in the best interest of the shareholders and the investing public in —

Byron R. White:

That’s all I want to know.

Walter P. North:

And that’s exactly where we think the authority in this area lies as against lying in the hands of an antitrust court which wants to do the ruling for the commission in this area.

Byron R. White:

Very well.

Walter P. North:

Now —

Lewis F. Powell, Jr.:

Mr. North.

Walter P. North:

Yes, Your Honor.

Lewis F. Powell, Jr.:

In the commission’s letter of November 22 to the NASD, you framed a request that certain be accomplished.

Let’s assume for the moment that the NASD said, “No, we don’t agree with the commission.

We’re not going to make those changes.”

In your opinion, does the commission have authority on the 22 (f) or any other Section of the Act to require compliance?

Walter P. North:

I think the commission has adequate authority to require compliance.

We’re sending that letter to the NASD to give them the first opportunity to move in this area if they see fit to do so.

And I’m not at all sure but what the commission — if the NASD did not see fit to do so, wouldn’t either compel them to do it or enact a rule of its own to that same effect.

Lewis F. Powell, Jr.:

And you’d enact such a rule under 22 (f)?

Walter P. North:

Under that or under 6 (c) or under 30 (a), there are several Sections of the Act that gives the commission a rulemaking authority that I think would cover this kind of a situation.

There are some kinds of situations that we don’t think our rulemaking authority covers.

We’re working right now on a draft to some legislation.

Walter P. North:

We’re going to submit to Congress to — too broad in our powers in some of these respects.

And someone asked the question earlier in the argument as to whether or not we had any reaction from Congress as a result of the report we submitted last November, some 130 or 140 pages long.

The answer is that there — the committees of the Congress are still waiting for us to send over a draft to actual bills that do incorporate or implement some of these suggestions that are made in this report.

So the commission is actively studying this whole situation.

Has some ideas of its own that indicate that maybe this system as it is now isn’t perfect and maybe it needs some changes, maybe it needs some changes, maybe it needs some relaxing.

But they want to go about it in a cautious, judicious manner and not just chop it off by an antitrust court decree that says the whole primary distribution system no longer needs any protection which is I think virtually where you might end up if you had an antitrust court decision in favor of the government in this case.

Incidentally, I would like — and I see my time is nearly up, I would like to close by referring him to an excerpt from this commission report that I’m — that we sent over to Congress just last November.

On the very last page of the government’s — the Department of Justice’s reply brief, they quote what they say is a sentence out of this report.

Incidentally, this report is a report by the staff to the commission.

It isn’t the commission’s own report though they say the commission has made this observation and they say we made this observation in a related context.

Here is what they say we said to the Congress in that report.

And as far as it goes, I don’t see it’s an Act, it’s word for word, the way our report reads.

It says that an exaggerated fear of disorderly distribution should not be permitted before my pretext for avoiding the introduction of price competition which — while perhaps difficult and even unprofitable for particular funds and their underwriters and certain dealers would be to the benefit of an investors and the mutual fund industry generally.

Now, the thing that the Government’s brief does not do is — include the first word of that sentence which was however, it’s a however sentence.

And a however sentence by its very nature assumes that you are distinguishing something that just went before.

Here is the sentence before the “however sentence” which they quote without the however, “There is of course a necessity to avoid disruption of the fund distribution system.”

And then it goes on “however” and then they say this, —

Thurgood Marshall:

Mr. North, in the staff report, what action did the commission’s taking upon that report as of now?

Walter P. North:

They have transmitted it to the Congress.

They’re working now on a draft, to some legislation to implement parts of it.

We have —

Thurgood Marshall:

Was the (Voice Overlap) — did the commission sent any report of its own to Congress?

Walter P. North:

There was an extensive letter of transmittal signed by the chairman of the commission and authorized by the whole commission, some eight pages in length, single spaced stating the commission’s own reaction and sustaining some of the recommendations of the staff.

Thurgood Marshall:

But it took the commission 35 years to get to the point of getting to this bill, right?

Walter P. North:

Well, no.

There have been proposals up in — and a number of other Congress — there were proposed —

Thurgood Marshall:

Not yet — not initiated by the commission, this is initiated by the Department of Justice.

Walter P. North:

Oh, no.

The commission in 1967 and again in 1969 had proposals before the Congress was — including some modifications of this Section 22, the very Section we’re talking about.

Thurgood Marshall:

Granting all of that, what am I — I still want an answer, as the commission done anything in the realm of regulation on 22?

Walter P. North:

22 (f), no.

They’ve never adopted — formed a rule.

I would suggest one other thing and I’ll be through that this quotation that I just read is in a portion of the commission’s report which is recommending legislative proposals.

And yet, they say was made — their statement in a related context, I would say this is just the opposite context.

The context of what you think the law is and the lawsuit of one thing.

The context of what you want when you go to Congress to get the change in the law is quite a different thing.

Thank you very much.

Warren E. Burger:

Thank you Mr. North.

We’ll enlarged your friend’s time by about 4 minutes.

You may have four minutes for rebuttal.

Gerald P. Norton:

I’d like to address one comment by Mr. Loevinger.

He said that these contracts have been in existence before and after the Investment Company Act that the only thing that happened was the enactment of that Act.

Well, it is true that investment companies study show that there were some such contractual restrictions in existence prior to 1940 did not indicate that they had become widespread and virtually the norm the way they are now.

This is indeed part of count 1.

Count 1 says that they have combined to restrain the development of secondary markets and one of the ways in which they have done it is to induce funds and underwriters to include these restrictive provisions in their vertical agreements.

So that — we don’t have a record first of all on what existed prior to 1940 but it is inaccurate to suggest that there is nothing since then that is important.

We certainly do not withdraw.

We have not withdrawn or abandoned count 1 in any way.

What we have done is qualified one single allegation of count 1 which could’ve been read as challenging rules adopted by the NASD.

It made it clear that that is not part of count 1.

The balance of count 1 which is on page 9 of the appendix stands fully in effect.

Now, with respect to 22 (f), commission had conceded that they have done nothing under 22 (f) as we have indicated.

But they also indicated that they thought that they could act with reference to not only protection of outstanding shareholders but protection of —

Byron R. White:

Well, does the rule, does NASD purport to recommend or authorize or forbid a dealer to act as a broker?

Gerald P. Norton:

NASD rules, no.

Byron R. White:

Well, but the —

Gerald P. Norton:

The contracts, yes.

Byron R. White:

I take it that part of your cause of action is that dealers do agree not to act as brokers.

Gerald P. Norton:

That’s right.

Byron R. White:

And you attack that.

Gerald P. Norton:

That’s right.

And the complaint is not limited to brokerage markets involving contract dealers.

Count 1 is unqualified.

Now, 22 (f) does not, as Mr. North indicated refer in terms, the protection of the investment — investing public who are not already shareholders.

Now, another provision that should be borne in mind in considering 22 (f) is Section 50 of the Act which provides that nothing in the Act affects the jurisdiction of any agency or officer of the United States or any state with respect to any person, security or transaction except in the possible extent of any conflict with something in the Act.

Now, there is no conflict with anything in an antitrust suit and 22 (f) standing alone.

So, we have the statute supporting us in that regard.

I should suppose also that the mere fact that a restrictive — that a registration statement discloses a merger for example that would plainly violate the antitrust laws would not mean that that merger is immune.

I mean that is contrary to do — the facts of life in the way this Court has applied the antitrust laws for years.

So if a restriction on transferability precluded the sale to a black person, that would be a violation of the Federal Civil Rights Laws and maybe unlikely but with current activities in the investment world, various things may seem more likely than we would like.

That would not be exempted from the Civil Rights Act just because it was disclosed in the registration statement.

The commission’s require that this is sent to shareholders indicate that the fact that the document has been reviewed by the commission does not constitute approval of it and is not any guarantee of the adequacy or the accuracy of any representations therein.

As an example of that, in government exhibit 8 on page 254, the standard legend which belies any notion of the commission’s function in reviewing these statements is an approval function.

Thank you.

Warren E. Burger:

Thank you gentlemen.

The case is submitted.