advised enough, to stay away from these loan funds because of the charges. It is not only the initial charge which must be amortized over a period of time.

Senator MAGNUSON. How can it be amortized?

Mr. COHEN. By holding it long enough.

Senator MAGNUSON. If the stock goes up, it has to go up 10 percent before you can get even.

Mr. COHEN. That is right. You have your finger right on it.
Senator. MAGNUSON. Supposing it does not go up at all?

MANAGEMENT FEES

Senator ALLOTT. You touched on the point here. Are you saying that there is evidence in this area of what I would call the churning of accounts?

Mr. COHEN. I didn't mean to suggest that at all, though it has been suggested. I am not arguing that. The reason why that has been suggested is as follows: This great competition to get dealers' favor which was brought into this particular aspect of the business

Senator MAGNUSON. What do you mean by "dealers' favor"?

Mr. COHEN. In order to produce the giveups and giveaways for that dealer, you do have to have portfolio transactions. It has been suggested that there is a motivation there that might produce some churning. I am not now arguing that. I am just discussing it on the basis on which we all assume that everybody is behaving properly. But, despite the fact that we discount the possibility of churning, they do have transactions-they are getting management fees, and when you get that you have to earn your money because you are managing securities, and I think they try to do a good job. They buy and sell securities and every time they do there is a commission involved. The bigger the fund, the bigger the transaction, the bigger the discount the executing broker is willing to give, but he does it indirectly.

The stock exchange rules forbid a rebate, so it doesn't go back to the little fellow whose money is being used to develop the transaction. At the direction of the manager, it goes to a dealer or a lot of dealers who are selling the fund, because the manager makes his money by managing a bigger pot. The bigger the pot, the bigger the return, even though the number of securities in the portfolio is not larger. These transactions build up, and this is what has been going on here. We think that in a situation like this, where there is price fixing, by law, and where the Federal Government has the obligation to enforce the price fixing, maybe somebody ought to see to it that the prices are not out of line.

MUTUAL FUND SALESMEN

There is another thing that happened here. Because of the great rewards that exist here, disproportionate to any other aspect of the business, even new issues, it has drawn a lot of people into selling mutual funds, a great many people. As the economists who already issued statements of various kinds say, you keep drawing people in until you get to a point where you have more people than you really need and there are some people on the fringes who may be affected by any cut. But one economist also said that, even if you double the load,

you would be drawing more people in and inevitably there would be some people who say if you cut it one-half of 1 percent you are going to cut my skin. The mathematics are pure and simple and clear.

Our argument is that a fund is a good vehicle, and not that people who invest shouldn't pay a fair charge, and not that those who sell should not make a fair profit, but that some attention ought to be paid to the people who make this possible, the investors, and we don't think they have received enough attention.

REASONABLE CHARGES

Senator ALLOTT. What have you recommended?

Mr. COHEN. Congress fix a 5-percent maximum charge, with power in the Commission to raise it if necessary and appropriate.

This idea of fixing a maximum fee in the statute is not new. Even in 1940, the Congress fixed a maximum of 9 percent for certain types of investment company securities, front-end load plans. I will get to that later if you are interested in them. There is already a history of Congress intervening in this area. And there is also in the statute a provision whereby the NASD in the first instance can write rules dealing with what the statute calls "unconscionable or grossly excessive" charges, with the residual power in the Commission, if it doesn't like the NASD rules, to write its own.

Because of those difficult words, the NASD has never undertaken to exercise that power. Senator Sparkman wrote to the president of that organization and said in effect: "You fellows seem to be interested in self-regulation, so why don't you take on the job of writing rules that will produce reasonable charges, or at least not excessive charges?" I think he used the words "not unreasonable."

He received a reply from the NASD which was generally in the affirmative, that they would be willing to undertake that job. That is the status of that situation now.

The Commission itself has not been asked to respond to that suggestion as yet. We are aware of it, and we are discussing it among ourselves to determine whether or not it does provide as acceptable an alternative solution of this problem as the one that we have recommended. When we are called upon we will express our view.

I must reemphasize that behind all of this is the price-fixing scheme in the statute which makes all of it possible. They could fix a 20percent sales charge if they could get dealers to sell it at that price and if anybody wanted to sell at 19.5 percent and did it deliberately over a period of time, we might have to refer the matter to the Attorney General for prosecution. I have never heard of anything like that in any fair trade State.

DIVULGING INFORMATION TO PROSPECTIVE INVESTORS

Senator MAGNUSON. If I go down and buy mutual fund stock-am I not told how much they are going to take out?

Mr. COHEN. Mutual funds are normally sold at home-they are sold person to person, and the Congress decided 'way back in 1940-these funds were being sold long before there was a commission, before 1933 that disclosure was not enough. That the nature of the merchandise that is sold to the people who buy them, and the manner in

which it is sold, required something more than disclosure. There is disclosure. Investors get a prospectus before the salesman leaves. They see that there is a loading charge in the prospectus. It is all there. Yet some of the studies that have been made would seem to indicate that while all that information is there, a great many of these people don't really realize what the charge is, nor do they realize that there are alternatives available to them.

NEW YORK STOCK EXCHANGE COMMISSION RATE STRUCTURE

x

Senator MAGNUSON. Say the manager of a mutual fund makes the decision he wants to buy a number of shares of corporation A for the fund. Can he not just go to the market and buy it through a broker? Why does he have to favor one or the other?

Mr. COHEN. He does. He goes to any particular broker, the one he likes, and he pays him a commission. It has to be the full commission. But because it is a big transaction and because that particular broker wants to do this large ticket business-and there is a great deal of profit in it-I did not explain that the New York Stock Exchange commission structure requires that for one unit, or 100,000 unitsand I use units as referring to a regular lot of a hundred sharesproportionately you pay the same commission; that is, you pay for 100,000 shares 1,000 times what you would pay for 100 shares. There is no discount involved. If you were to buy a fleet of cars or if out to buy 2 dozen refrigerators

you went Senator MAGNUSON. If I buy a thousand shares, it is the same as if I buy 10,000?

Mr. COHEN. Exactly, only you pay 10 times as much. You don't get any discount. There is a certain amount of fat in these large orders, and the dealer is willing to give it up, sometimes as much as 80 percent of that commission.

Senator MAGNUSON. When he wants to buy the 10,000 shares he shops around to get a dealer that will give him a little discount.

Mr. COHEN. He can't get a discount. He has to pay the full price. But the broker is willing to give away a portion of his commission to whomever the manager suggests, and he does.

Senator MAGNUSON. Is that a third party?

Mr. COHEN. Yes, usually the persons who sold the mutual fund shares to begin with. He may not be a member of the exchange. He may have nothing-usually he has nothing to do with the transaction, but he gets a check one way or another.

Senator MAGNUSON. In other words, he went to the manager of the mutual fund and convinced him that he should buy 10,000 shares of corporation A. That it is a good investment, he says. So he has to getsomething for that.

Mr. COHEN. Maybe I confused you, Mr. Chairman.

The manager doesn't wait for anybody to come to him to make a recommendation. He is getting a fee for management. So he decides he wants to buy 10,000 shares of United States Steel. Now, the fee, the commission for selling 100 shares of United States Steel is approximately 1 percent. For 100,000, it would still be 1 percent of the price of 100,000 shares. The amount of extra effort involved in executing a transaction for 100,000 as compared with 100 is not in the same propor

tion to the fees earned. Therefore, this broker says, OK, I am willing to keep a percentage of the regular commission. I will give the rest away upon your instructions.

The manager who is interested in building a bigger fund so that his management fees increase and wants to get more dealers to sell the fund shares, will give so much to Mr. Budge, so much to Mr. Cohen, so much to Mr. Owens.

Senator ALLOTT. Who would be the agents of this particular fund? Mr. COHEN. Right, exactly. That is the way they try to get the broker to sell the fund, and they are competing to do that.

Senator MAGNUSON. And then he will say the mutual fund is much better because they bought this, because he got a little kickback on that; is that right?

COMPETITION IN THE MUTUAL FUND INDUSTRY

Mr. COHEN. Sir, that happens. What the Congress thought might develop into competition in this industry which would bring down charges has resulted in some competition, but it is an unusual kind of competition. It is a competition for the favor of the dealer, not for the investor's dollar. That dealer will then go out and plug the fund which provides him with the biggest return. And he has to maintain the price. Even if he has a customer that wants to buy quite a few shares, the law says, and we have to enforce it, that he must charge the price fixed by the manager-underwriter. He can't charge a penny less or he has violated the law.

Senator MAGNUSON. Charged to whom?

Mr. COHEN. The ultimate investor, who buys a share of his fund. So you have price fixing two ways here. You have a sort of price fixing in the stock exchange commission which gives rise to this

excess

ADVANTAGES OF PARTICIPATING IN MUTUAL FUNDS

Senator MAGNUSON. Why would people want to buy mutual funds? The only reason they would want to buy them is because they thought they would have a good manager.

Mr. COHEN. Most people say mutual funds aren't bought, they are sold. But they buy them for some good reasons. They provide a good investment vehicle for many, many investors.

Senator MAGNUSON. Because somebody is managing it.

Mr. COHEN. The theory is, somebody is managing it and that he can do better than the individual can himself. And you get some diversification.

Senator MAGNUSON. So they are paying through the nose to some extent for that service.

Mr. COHEN. They pay pretty well; yes, sir.

CLOSED-END INVESTMENT COMPANIES

Senator MAGNUSON. All of us in this room could put up a thousand dollars and tell somebody to go out and buy a few shares of stock, hire a manager, and give him a fee.

Mr. COHEN. We could, and that has been done. Investment clubs are small examples of that, but many funds have been created the same way.

There are other types of investment companies, the closed-end variety, which do not continually sell and redeem shares, and those are listed on the stock exchange, and they have managers, too, who manage them.

Senator MAGNUSON. What do you mean, "closed end", they can't sell stock?

Mr. COHEN. The investor doesn't have the right to go to the company and say, "I want my money back today." It is like an ordinary security; sells it to somebody else. Those securities normally sell at a discount, but some of them have some very good experience.

Senator MAGNUSON. If I own a thousand shares of United States Steel, I cannot call up United States Steel and get my money. Mr. COHEN. Exactly.

Senator MAGNUSON. The only way I can get my money is to convince you or someone to buy it.

Mr. COHEN. Or have your broker do it.

Senator MAGNUSON. Right.

Mr. COHEN. I have spoken about the sales charge, Senator Allott. I don't know if I answered your question.

PROPOSAL TO ELIMINATE GIVEUP AND GIVEAWAYS ON NEW YORK STOCK EXCHANGE

Senator ALLOTT. Now, I have a question to ask you.

If this situation prevails, it must be common knowledge-why has no action been taken since the New York Stock Exchange has said there can be no rebates?

Mr. COHEN. It is a good question.

Senator ALLOTT. Why has not the New York Stock Exchange or you taken steps to stop this practice, because no matter what you call this, it is a rebate of some form?

Mr. COHEN. We have taken action, Senator Allott. Maybe we have been a little slow about it, and to that extent we assume responsibility. But we have been talking to the stock exchange about this for, I think, about a year, and they have been working on it. They came up with a plan last year which we couldn't find acceptable. They have a new committee now and they are working up another plan. In addition to that, in the report to the Congress of last December, we spelled all of this out and we have also sent them a letter, in effect, asking them to do away with this giveup and giveaway practice and to give serious consideration to a volume discount for these very large transactions, or category discounts, and they are working on it.

EXAMPLE OF A GIVEUP OR GIVEAWAY

Senator ALLOTT. In that respect, I would like to ask a question about the mechanics of this situation.

If fund A goes to stockbroker B and he effects a transaction for the purchase of a large amount of shares of a given company, then this situation of giveaway or giveup, as you call it, arises? You say in some instances it has gone as high as 80 percent?

Mr. COHEN. Yes.