the shares to the public. Other open-end companies distribute their shares through underwriters to securities broker-dealer firms throughout the country who in turn bring the investment company shares to the attention of the public. It has been estimated that at the present time some 3,000 brokers and dealers, and some 50,000 salesmen, are registered and permitted to offer investment company shares to their clients.

There is, then, a substantial national network which is currently engaged in informing the public as to the purpose of and the advantages of investment in investment company shares. That it is a successful network is indicated by the growth in industry assets and in the broadening public ownership of investment company shares. There has been a fourfold growth in investment company accounts from 1940 through the end of 1957-from 762,000 accounts to 3.3 million; in 1957 alone, investor purchases of newly issued shares in open-end investment companies totaled $1.4 billion.

THE INVESTMENT COMPANY SHAREHOLDER, AND WHY HE INVESTS Investment through purchase of investment company shares appeals to the person of moderate means. His investment company holdings are, and should be, part of an overall program which includes savings accounts, savings bonds, and insurance.

Thus the median open-end investment company shareholder has an income of $6,600 per year. He owns life-insurance coverage of $9,200. He has $3,100 in savings accounts and bonds, holds directly corporate securities valued at $6,900, and has $3,700 invested in regulated investment company shares. For this median investment company shareholder, investment company shares are an important segment of his total financial plan.

Investment companies offer a wide variety of methods and types of investment, in an effort to be responsive to the wide variety of investor desires and needs. The prospective investor has several choices. He can choose between various investment companies, with various investment objectives. There are investment companies with objectives of high current income, others with objectives of capital appreciation, others with objectives of capital and income growth. Investment policies differ between companies, too. Some stress balance in their portfolios between equity securities and bonds; others specialize in bonds. Some investment companies concentrate their investments in particular industries; others concentrate geographically. The investor can choose an investment company or companies which best fit his own financial program.

The investor may also select his own method of investment. He can make a lump-sum investment; or he can invest small or large amounts on a regular basis, thus taking advantage of the principle of dollar-cost averaging; or he can invest on an irregular basis. He can receive all income dividends and capital gains distribution on his investment in cash; or he can reinvest income dividends and accept capital gains distribution in additional shares; or he can work out some modification thereof. Many investment companies have developed plans which call for the investment by the investor of stipulated amounts for a period of years, with systematic withdrawal thereafter.

Thus regulated investment companies have appealed to investors as a useful medium of investment not only because they offer diversification and professional investment management, but also because they have developed other services which help the individual investor meet his needs.

TAXATION OF INVESTMENT COMPANIES

Most regulated investment companies have elected to qualify for the tax treatment provided by subchapter M of the Internal Revenue Code.

The basic purpose of subchapter M is to put the person investing through the medium of a regulated investment company in the same position taxwise as if he had invested directly in the securities held in the investment company portfolio. This principle conceives of the investment company as a conduit between the corporations whose securities it holds and the investment company shareholder.

This principle was first enacted into law by the Congress as to open-end investment companies in 1936 and as to closed-end companies in 1942 and has become an integral part of the Federal tax law ever since.

Subchaper M treatment may be elected by any investment company which otherwise qualifies if it is registered under the Investment Company Act of 1940 and conforms to detailed requirements with respect to diversification of investments.

The shareholder is taxed on the income dividends he receives from the investment company at the income-tax rate applicable to his tax bracket, and he is taxed upon capital-gain dividends he receives from the investment company at the long-term capital-gain rate applicable to his tax bracket. The investment company pays no tax on its distributed income if (1) 90 percent of its income is derived from dividends, interest, etc., and no more than 30 percent is derived from short-term capital gains, and (2) it distributes 90 percent of its income to its shareholders. To the extent it distributes its net long-term capital gains to its shareholders it pays no tax thereon.

Thus the investment company shareholder occupies substantially the same position taxwise as if he had received income directly from the companies whose securities are held in the investment company's portfolio, and as if he himself had sold portfolio securities and realized a net long-term capital grain thereon. The effect of subchapter M taxation is in the direction of equity-an extra layer of corporate income taxation, which would discrimiate against the investment company shareholder, is avoided. Without the corrective provisions of subchapter M, there would be three tax levels: (1) An income tax on the underlying portfolio corporation; (2) a tax on the investment company shareholder; and (3) a tax on the investment company itself. Subchapter M eliminates this third tax which, if it were imposed, would discriminate against the person who invests through the medium of the regulated investment company as against the direct owner of corporate securities.

Under the Internal Revenue Code of 1954 the foreign-tax-credit provisions applicable to persons who invest directly in the securities of foreign corporations were applied to the persons who invest indirectly in foreign corporations through the medium of a regulated investment company, provided that 50 percent or more of the assets of the investment company consist of securities issued by foreign corporations.

Up to the present time, however, the tax treatment provided for those receiving tax-exempt interest from direct investments in municipals has not been applied to shareholders who would invest indirectly in municipal bonds through the medium of a regulated investment company.

SCOPE OF THE MUNICIPAL-BOND PROBLEMS

The pending legislation has been proposed by the President in the context of the acute financing problem faced by State and local governments and school districts today. A brief review of that problem will be useful in bringing the proposed bills into focus.

Municipal bonds are offered, generally, in large denominations, by some 170,000 issuers throughout the country. They are undertaken by a relatively small group of underwriters in the municipal-bond field and are marketed by a correspondingly small group of dealers to individuals and institutions of wealth. A great variety of municipal bonds are offered. There are significant differences in regard to such matters as period until maturity, issuer, types of bonds, qualities of bond, face amounts of the bond, interest rates, yields, bond provisions, etc.

For many years there was a fine balance in the municipal-bond market between bonds maturing and new issues being offered. Funds realized by municipal-bond investors at the maturity of one issue were usually available for investment in new issues being offered the same year. Thus in the period from 1936 to 1946 maturities and new issues were substantially in balance and there was relatively little change in the total issues outstanding:

Commencing in 1947, however, there has been a substantial expansion in the annual total of new municipal issues, illustrated in the following schedule:

This increase in new issues has been reflected in a startling increase in the past decade, in the total municipal debt outstanding, from $16.5 billion in 1947 to $47.4 billion in 1956:

The result has been, of course, more supply in the municipal bond market than there is demand and a rising municipals interest rate which has perhaps been accentuated by a general rise in interest rates.

The growth in the number and dollar amounts of new issues is closely related to the need for expansion and updating of the services State and local governments must render. Roads and schools must be built; police and fire protection must be financed; sewers must be adequate. Projections of our population for the next 20 years indicate that it will continue to grow; government on the State and local levels must be prepared to match in services this growth in population, and means must be found to finance the development of State and local government facilities.

The nub of the financing problem of local governments is that the market for municipal bonds has not expanded sufficiently to absorb without dislocation the ever-increasing volume of municipal issues. A new market or new markets are needed, not to supplant the traditional market, but to supplement it.

LIMITATIONS UPON THE GROWTH OF THE MARKET FOR MUNICIPALS

Expansion of the municipals market is essential to the orderly distribution of the debt securities of our State and local governmental instrumentalities. The market can only be expanded by developing, in a wide cross-section of the American public, an interest in investing in such securities. Various characteristics of municipal bonds and of the municipals market presently deter investment therein by the person of moderate means:

1. Municipal bonds are generally offered only in large denominations.—Municipal bonds are generally offered in round lots, and in individual bond denominations of $1,000 or more. The investor of moderate means, particularly one who invests out of income rather than capital, either cannot commit such a substantial amount at one time, or would prefer not to make such an investment. 2. Information concerning municipal bonds is not generally available.—An estimated 170,000 instrumentalities have issued municipal bonds. Municipal bonds are a specialized investment field, and particularized information with respect to the relative merits of various issues, essential to intelligent investment, can be obtained from only a comparatively few sources. The municipal bond dealer has, through the years, sought and done business with the person or institution of substantial wealth. He has not been equipped to do business with or to service the person of moderate means. The broker or dealer who has handled the problems of the investor of moderate means has had little or no familiarity with the municipal-bond field, and no incentive to interest his investor-clients therein.

3. Municipal bonds are generally not liquid.—Municipal bonds have fixed, and in most cases long-deferred, maturity dates. The present market for municipal bonds is a relatively small one, and municipals are generally not quoted upon

national exchanges. Hence, unlike regulated investment company shares or shares which are listed upon national securities exchanges, the possibilities of disposing of such bonds at a fair price prior to maturity, particularly bonds of little known issuers, are at best uncertain. Thus persons with limited capital have been reluctant to commit their funds to an investment in which their prospects of liquidation prior to maturity are unreliable.

Corollary to the problem of the investor is that of the broker or dealer who services the investor. Most brokers and dealers do not carry municipal bonds in their inventory of securities nor do they trade in municipal bonds to any appreciable extent. Municipal bonds represent a specialized field and brokers and dealers have found it too expensive to undertake occasional transactions therein. 4. Diversification is not available to the average investor in municipal bond investment.-Largely because municipal bonds are available only in large denominations, the person of moderate means cannot invest therein and at the same time distribute his risk by intelligent diversification. Such diversification in the municipal-bond field would only be available to the individual or institution of substantial means.

ENACTMENT OF THE LEGISLATION PROPOSED IN H. R. 8810, H. R. 8811, AND H. R. 8812 WILL BE IN THE PUBLIC INTEREST

In his economic message to Congress in 1957, President Eisenhower reiterated his recommendation that subchapter M of the Internal Revenue Code be amended in order to encourage the use of the regulated investment company medium to broaden the market for State and local bonds:

"The expenditures of State and local governments are now about half those of the Federal Government, and their recent rate of increase has been considerably higher. The principal objects of this increased spending are schools, highways, and the variety of community facilities required by population increase and the rapid growth of suburban areas. In view of the exceptionally high demands for the labor, materials, and equipment needed to carry out these projects, it is inevitable that not all of them can go forward as rapidy, or on as large a scale, as may be desired. Financial considerations also may require some rescheduling of proposed projects, since State and local governments with large borrowing requirements have already encountered heavy competing demands in the capital markets. Some improvement in the ability of these governmental units to finance their projects would result from an amendment of the Internal Revenue Code to extend the 'conduit principle' to regulated investment companies that hold their assets in State and local securities. The amendment, which would involve no loss of revenue, would permit regulated investment companies of this type to pass through to their stockholders the tax-exempt status of the income received on State and local securities. The Congress is requested to enact legislation to accomplish this result." [Italic supplied.]

H. R. 8810, H. R. 8811, and H. R. 8812 propose legislation which is responsive to the President's recommendation.

Enactment of the legislation proposed in H. R. 8810, H. R. 8811, and H. R. 8812 will be in the public interest for two basic reasons:

(a) it will encourage broad public participation in municipal financing by providing a channel for investment in municipal securities by persons of moderate means;

(b) and as a consequence it will help to broaden the market for municipal securities and thus ease the problems of State and local instrumentalities in financing the construction of urgently needed facilities. The bills would help to broaden the market for municipal securities by making it possible for the person of moderate means to invest in such securities indirectly through the medium of the regulated investment company on the same basis as the person of wealth who invests directly. At the present time he cannot do so; whereas the interest from State and local debt securities is tax exempt to the person who invests directly, it would be taxable to the person investing in the same securities indirectly through the medium of a regulated investment company.

The person of moderate means is, at the present time, unable to invest in State and municipal securities. He cannot invest directly because the unit costs of municipal bonds are too high; information essential to prudent investment is not available; municipal bonds are not liquid enough for his purposes; and he cannot afford the diversification necessary for a sound invstment program. He does not invest indirectly since regulated investment companies generally do not include municipal bonds in their portfolios because they cannot pass

the tax-exempt status of the income from such securities through to their shareholders.

The proposed legislation will not affect existing regulated investment companies with portfolios which consist of equity securities or corporate bonds: it would apply only to regulated investment companies which have 90 percent or more of their assets in cash or a diversified portfolio of State and local debt securities, which derive more than 95 percent of their income from such securities, and which distribute at least 90 percent of this income to their shareholders. Regulated investment companies have long provided an effective channel for investment in corporate stocks and bonds by persons of moderate means. The policy underlying subchapter M taxation has been to provide tax treatment for persons investing indirectly through the medium of a regulated investment company which is similar to that provided for persons who invest directly in corporate securities. The proposed legislation would permit qualified investment companies to serve a similar function with respect to investment in municipal bonds.

Municipal bond regulated investment companies would obviate the existing deterrents to municipal bond investment by persons of moderate means for the following reasons:

1. The shares of a municipal bond fund would be modestly priced at perhaps $10 to $25 per share, as are other investment company shares. They could be purchased in any quantity at any time, depending upon the desires and purposes of the investor.

2. The shares would be redeemable at any time at actual net asset value per investment company share, a characteristic feature of open-end investment companies. Hence they would be an extremely liquid investment.

3. The current market value of a share in a municipal bond fund would be ascertainable by the shareholder of a municipal bond fund at all times, since the net asset value of investment company shares is determined daily, and quotations are reported in newspapers throughout the country.

4. The portfolio securities underlying the shares of a municipal bond fund would be widely diversified as to type of security, grade, maturity, date, yield, etc.

5. The portfolio would be selected and constantly supervised by the trained professional management of the investment company.

6. The tax-exempt status of the income from the underlying securities would be passed through in its tax-exempt form to the shareholders of the municipal bond fund.

Municipal bond regulated investment companies would provide a new market for municipal bonds. Shares in the investment companies would be sold to the public through brokers, dealers, and registered representatives throughout the country. Since they would combine the advantageous aspects of investment company shares today with those of municipal bonds they should find a ready and expanding market.

They would also introduce a new type of investor to municipal bonds, one who invests a part of his income rather than his capital. The past history of investment company development indicates that such companies grow not only because they attract new investors but also because their shareholders develop habits of systematic periodic investment out of income. The growth of these companies would in time bring a continuous and substantial source of new money to the municipal bond field.

The diversification requirements of the proposed law would insure that the relief brought to the municipal bond market by regulated investment companies formed under the new law could inure to the benefit of various issuers, and not of just one or a few issuers. Such companies, required by law to diversify and with professional staffs competent to assess economic conditions and investment possibilities, would invest in the bonds of municipalities and school districts throughout the country, including those located at a distance from the centers of economic and financial concentration. Frequently in the past such local instrumentalities have been unsuccessful in making offerings because their very remoteness has made it difficult for even informed investors and dealers to ascertain the soundness of a proposed issue.

Legislation providing that the exempt status of municipal bond interest will not change as it passes through a regulated investment company to its shareholders will therefore achieve two ends which are in the public interest: it will encourage investment in municipal bonds through the medium of the regulated investment company and thus place the person of moderate means on the same