Appendix — Gross v. National Ass'n of Securities Dealers, Inc.

Supreme Court brief1974

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UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF COLUMBIA

ARTHUR GROSS, JOSEPH LER-

MAN. and ROSE LERMAN, on be-

half of themselves and all other

individual mutual fund share-

holders similarly situated,

Plaintiffs,

v. Civil Action No. 426-73

THE NATIONAL ASSOCIATION

OF SECURITIES DEALERS,

INC.,

MASSACHUSETTS INVESTORS

GROWTH STOCK FUND, INC.,

FIDELITY FUND, INC.,

WELLINGTON FUND, INC.,

THE CROSBY CORPORATION,

VANCE. SANDERS & COMPANY.

INC.,

THE WELLINGTON MANAGE-

MENT COMPANY, INC..

MERRILL LYNCH PIERCE FEN-

NER & SMITH, INC.,

BACHE & COMPANY, INC.,

REYNOLDS SECURITIES COR-

PORATION,

F. I. duPONT, GLORE FORGAN,

INC.,

E. F. HUTTON, INC.,

WALSTON & COMPANY, INC.,

DEAN WITTER & COMPANY.

INC.,

PAINE. WEBBER, JACKSON &

CURTIS, INC.,

HORNBLOWER & WEEKS-

HEMPHILL, NOYES, INC.,

Defendants.

DISTRICT COURT ORDER (12/14/73)

This matter having come on for ruling on the defen-

dants’ motions pursuant to Rule 12 of the Federal Rules of

Civil Procedure to dismiss the complaint for failure to state

a claim upon which relief can be granted, the parties having

filed briefs in support of their respective positions, and the

Court being fully advised in the premises and having issued

its Memorandum Opinion on December 14th, 1973;

It is this 14th day of December, 1973,

ORDERED that the above-captioned case be, and the

same is, hereby dismissed on the merits and with prejudice

for failure to state a claim upon which relief can be granted.

HOWARD F. CORCORAN

Judge

be Stata Rete —

UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF COLUMBIA

GENEVIEVE M. HADDAD

v. Civil Action No.

2454-72

THE CROSBY CORP.., et al.

UNITED STATES OF AMERICA

v. Civil Action No.

338-73

NATIONAL ASSOCIATION OF

SECURITIES DEALERS, et al.

ARTHUR GROSS, et al.

v. Civil Action No.

426-73

NATIONAL ASSOCIATION OF

SECURITIES DEALERS, et al.

THE NATURE OF THE CASE

Filed December 14, 1973

The above-captioned lawsuits are civil actions alleging

violations of the federal antitrust laws in connection with

the distribution of securities of open-end management in-

vestment companies (“mutual funds”).! The operations of

1. By definition an open-end management investment com-

pany is any issuer which (1) “is or holds itself out as being primarily

in the business of investing, reinvesting, or trading in securi-

ties” (15 U.S.C. §80a-3); (2) is not a face-amount certificate com-

pany or a unit investment trust (15 U.S.C. §80a-4); and (3) is

“offering for sale or has outstanding any redeemable security of

which it is the issuer” (15 U.S.C. §$80a-5).

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such companies are governed generally by the Investment

Company Act of 1940? (the 1940 Act).

In Civil Action No, 2454-72, plaintiff Haddad purports

to sue on behalf ofa class and subclass of mutual fund

investors. Haddad alleges violations of the antitrust laws

{Sherman Act, Sections 1-3, 15 U.S.C. §§1-3)] and the

securities laws [Securities Exchange Act of 1934, Section

10(b), 15 U.S.C. § 78j(b); Exchange Act Rule 10b-5, 17

C.F.R. §240.10b-5 (1972)]. The antitrust claim is that the

various defendants, including underwriters of and dealers

in mutual fund shares and unnamed co-conspirators have

agreed, combined and conspired to inhibit, or to refuse to

participate in, transactions as agents or brokers in mutual

fund shares at prices below the applicable public offering

prices established in the prospectuses of such mutual funds

and have placed unreasonable restraints upon the trans-

ferability of such shares: In essence, the securities claim is

that there is a failure to disclose the alleged antitrust viola-

tions and that such failure constitutes an independent

violation of the securities laws. Haddad alleges damages

to her and her purported class of undetermined millions of

dollars. Haddad’s antitrust claim requests treble damages

and injunctive relief. The securities claim requests actual

damages, punitive damages, and injunctive relief.

Civil Action No. 338-73 is brought by the Antitrust

Division of the U.S. Department of Justice. The complaint

alleges violations of Section 1 of the Sherman Act, 15

U.S.C. §1. The gist of the complaint is that defendants

National, Association of Securities Dealers (NASD),* funds

and dealers have participated in agreements, combinations,

2. 15 U.S.C. $80a-1, et seq. (1970). | 3

3. The NASD, incorporated in Delaware on July 18, 1939,

became registered under the Maloney Act, $15A of the Securities

Exchange Act of 1934, 15 U.S.C. $780-3 on August 7, 1939. Na-

tional Association of Securities Dealers, Inc., 5 S.E.C. 627 (1939).

It is the only association ever to have applied for or been granted

registration under the Maloney Act. Its membership is comprised

of some 4400 brokér-dealers and principal underwriters.

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and conspiracies, the effect of which has been to inhibit a

“market” for “brokerage transactions” and thereby to sup-

press the growth of a “secondary market in mutual fund

securities,” and to cause the public to pay artificial and non-

competitive sales loads for mutual fund shares. The govern-

ment complaint seeks only prospective, injunctive relief,

Civil Action No, 426-73, the Gross case, is another

private antitrust suit and purported class action which

substantially duplicates the government allegations in No.

338-73. This action seeks injunctive relief and treble dam-

ages for injury to the purported plaintiff class over an

indeterminate past period. '

The individual defendants in each case are principal

underwriters® or broker-dealers* in mutual fund shares.’

4. Since the filing of the above-captioned actions, some fifty

private suits, purporting to be class actions under Fed. R. Civ. P. 23,

have been filed in various United States District Courts around the

country. These cases have been transferred to this district by the

Judicial Panel on Multidistrict Litigation, and are collectively cited

as: In Re Mutual Fund Sales Antitrust Litigation, Civil Action No.

Misc. 103-73. Pre-trial discovery and other activity in all cases

(including the instant cases) has been stayed pending disposition

of the motions to dismiss under consideration here.

The Court has also reserved judgment in all alleged class suits

on the question of whether the actions may be maintained as class

actions under Fed. R. Civ. P. 23.

5. A principal underwriter is defined by the 1940 Act as

any underwriter who as principal purchases from (an open-end

investment) company, or pursuant to contract has the right

. . . from time to time to purchase from such company, any

such security for distribution, or who as agent for such com-

pany sells or has the right to sell any such security to a dealer

or to the public or both, but does not include a dealer who pur-

chases from such company through a principal underwriter

acting as agent for such company. 15 U.S.C. $80a-2(a)( 29).

6. A broker is defined by the 1940 Act as “any person engaged

in the business of effecting transactions in securities for the account

of others, but does not include a bank or any person solely by rea-

son of the fact that such person is an underwriter for one or more

investment companies.” 15 U.S.C. $80a-2(aX6). A dealer is defined

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Additionally the NASD is named as a defendant in all three

cases. In each case the defendants have moved to dismiss

the complaints, pursuant to Fed. R. Civ. P. 12(b) on the

grounds:

(a) That as a matter of law, Section 22(d) of the

Investment Company Act of 1940, 15 U.S.C. §80a-

22(d), establishes a system of fixed, retail price main-

tenance in the distribution of investment company

securities which is totally inconsistent with antitrust

concepts and which accordingly creates, as Congress

clearly intended, an exemption and immunity from

antitrust liability for the defendant dealers’ conduct

in maintaining the fixed, public offering price of such

securities;

(b) That as a matter of law, Section 22(f) of the

Investment Company Act of 1940, 15 U.S.C. §80a-22(f),

sanctions contractual restrictions on the transfera-

bility or negotiability of investment company se-

curities, subject to supervision of the Securities and

Exchange Commission (SEC), which restrictions are

totally inconsistent with antitrust concepts and which

restrictions, therefore, as incorporated in the defen-

dant dealers’ publicly-filed investment company sales

agreements, are exempt and immune from antitrust

liability; and

Congress subjected the acts and practices of the defen-

dant dealers in the distribution of investment com-

Note 6—Continued

as “any person regularly engaged in the business of buying and sell-

ing securities for his own account, through a broker or otherwise,

but does not include a bank, insurance company, or investment

company. or any person insofar as he is engaged in investing, rein-

vesting, or trading in securities, cr in owning or holding securities.

for his own account, either individually or in some fiduciary capaci-

ty. but not as a part of a regular business.” 15 U.S.C. §$80a-2(a)(11).

7. The identities of all the parties in each of the above-cap-

tioned cases are reflected in the accompanying Orders.

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pany securities to continuous and pervasive regulation

by the SEC as well as NASD acting under the SEC’s

supervision; and, accordingly, the SEC has exclusive

jurisdiction to regulate those acts and practices, and

such acts and practices are exempt and immune from

the claims herein alleged as violations of the Federal

antitrust laws.

The motions were consolidated for argument.”

THE REGULATION OF MUTUAL FUNDS

The dispute can only be determined ultimately by an

analysis of the several subsections of Section 22 of the 1940

Act and an antitrust exemption purportedly given by Sec-

tion 15A(n) of the Securities and Exchange Act of 1934 (the

Maloney Act) [15 U.S.C. 780-3(n)}. Before reaching that

point, however, it would seem appropriate to view the

overall regulatory scheme imposed by Congress on invest-

ment companies through the 1940 Act.

It became apparent to the Congress in 1935 that the

disclosure and antifraud provisions of the Securities Act

of 1933 (the 1933 Act) and the Securities Exchange Act

of 1934 (the 1934 Act) were not adequate for the regu:ation

of investment companies. Accordingly, it directed the SEC

to make a comprehensive study of the investment com-

pany industry with a view to proposing corrective legis-

8. In opposition to the motions to dismiss all the plaintiffs also

rely on the proposition that a complaint should not be dismissed for

failure to state a claim unless it appears beyond a doubt that plain-

tiffs are unable to prove any set of facts which would entitle them

to relief. Neither the defendants nor this Court have any argument

with that general proposition, but, as the issues are drawn here for

purposes of these motions to dismiss. they are strictly legal ones as

to which the facts as alleged in the complaints or otherwise are not

relevant.

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lation. The SEC did so* producing a draft “Investment

Trust Bill” which was the subject of hearings conducted by

a Senate subcommittee.'” Representatives of the invest-

ment company industry were invited to participate in the

hearings. Ultimately a compromise bill emerged which

finally became law as the Investment Company Act of 1940,

15 U.S.C. §80a-1 et seq."

The 1940 Act brought many investment companies

within the disclosure requirements of the federal securities

laws for the first time. It tightened up those requirements

and tailored them to prohibit certain undesirable practices

in the investment company industry. Presently, pursuant

to the 1940 Act investment companies must register them-

selves (§§7 and 8) and their shares [§24(a)] with the

SEC, update periodically their filings with quarterly and

annual reports [§§30(a)(c)], and submit prospectuses

and sales literature to the SEC [§24(b)]. Companies

must issue to their shareholders, at least semi-annually,

financial reports containing specific types of information

[$30(d)}.

The 1940 Act also imposes detailed restrictions upon

investment company structure, conduct, financial policies,

and dealings with and by affiliates. '*

9. Report of the SEC, Investment Trusts and Investment Com-

panies, Part Three, Abuses and Deficiencies in the Organization

and Operation of Investment Companies, H. R. Doc. No. 279, 76th

Cong., Ist Sess. (1939) (hereinafter cited as Investment Trust

Study of 1940).

10. Hearings on S. 3580 Before a Subcomm. of Senate Comm.

on Banking and Currency, 76th Cong.. 3d Sess. (1940) (hereinafter

cited as 1940 Senate Hearings).

11. That Act, included $22(d), one of the sections in contro-

versy in this case. discussed infra. Section 22(d) prohibited sales of

investment company shares to the public at any price other than the

fixed public offering price.

12. The Act delimits permissible methods for selecting direc-

tors of investment companies (and trustees in the case of invest-

ment trusts) ($16), sets out qualifications for securities custodians

{$17(i)| and methods of safekeeping securities [$17(g)|]. and prohi-

bits indemnification for official conduct [$$17(h) and (i)|. Certain

In 1938 (prior to the enactment of the 1940 Act), the

Congress had amended the 1934 Act through the passage

of the so-called “Maloney Act,” 15 U.S.C. §780-3. The

Maloney Act provided for the registration with the SEC

of a national securities association with rule-making power

upon the finding by the SEC that:

persons guilty of prior malfeasance are barred altogether from

affiliating with investment companies. advisers, custodians. and

principal underwriters ($9). Others who commit misconduct or

abuse their positions of trust can be enjoined ($36). Misappropria-

tion of company funds is made a federal crime ($37).

The Act also sets out minimum capitalization requirements for

the companies ($§14 and 18). tt requires a majority shareholder

yote for changes in a company's open-end or closed-end nature. its

diversification, its capacity to borrow money, issue senior securities,

underwrite others’ securities, purchase and sell real estate and

commodities, or make loans, its investment policies, and its funda-

mental business ($13). Certain dividend distributions are barred

unless timely disclosed to the shareholders ($19). Investment com-

panies are barred from participating in certain types of securities

transactions [§12(a)] and from making certain loans ( §21). Some

proxy solicitations are barred {$20(a)] and some exchanges need

prior SEC approval ($11). Reorganization plans must be submitted

to the SEC. which can render a negative advisory report and seek

an injunction with respect to such reorganizations ($25). Voting

trusts and cross or circular ownership patterns are barred ($35).

Accountants must meet certain criteria, be selected in a particular

fashion, and perform certain functions ($32). The regulated com-

panies must keep and refrain from destroying certain books and

records ($$31 and 34). Unit investment trusts ($26) and face amount

certificate companies ($$28-29) are given special regulatory treat-

ment.

The Act curtails the pyramiding of mutual funds [$812(d)(g)]-

Unless it is itself the principal underwriter, no investment company

may acquire shares of another company whose principal under-

writer is related to the first company [$10(f)]. At least 40° of the

company’s board must consist of independent directors ($10). Ad-

visory contracts must first be approved by a majority of directors

unaffiliated with the adviser or by a majority of shareholders

[$15(c)]. Investment company transactions conducted by or with

affiliated persons are prohibited in some cases and narrowly cir-

cumscribed in others ($17).

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the rules of the association are designed to prevent

fraudulent and manipulative acts and practices, to

promote just and equitable principles of trade, to pro-

vide saf2guards against unreasonable profits or un-

reasonable rates of commissions or other charges, and,

in general, to protect investors and the public interest,

and to remove impediments to and perfect the mech-

anism of a free and open market; and are not designed

to permit unfair discrimination between customers,

or issuers, or brokers or dealers, to fix minimum profits,

to impose any schedule of prices, or to impose any

schedule or fix minimum rates of commissions, allow-

ances, discounts, or other charges. '*

When Congress enacted the Maloney Act in 1938 it

specifically provided:

If any provision of this section is in conflict with any

provision of any law of the United States in force on

June 25, 1938, the provision of this section shall pre-

vail. 15 U.S.C. §780-3(n).

The defendant NASD is the only securities associa-

tion registered with the SEC under the Maloney Act.

By §22(a) of the 1940 Act, Congress gave the NASD,

as a registered national securities association, the power

to promulgate rules setting the minimum price at which

its members may buy redeemable fund shares from a fund,

the maximum price at which its members may resell to or

redeem with a fund, and the minimum period which must

elapse after sale before a member may resell to or redeem

with a fund. The SEC can exercise its overall supervisory

power to promulgate rules superseding NASD’s rules on

sale, redemption and repurchase prices, holding periods,

Section 22(b\(1) of the 1940 Act empowers the NASD

to adopt rules prohibiting members from charging “exces-

sive” sales loads, provided that such rules “allow for rea-

13. $15A(b\8), 15 U.S.C. $780-3(b)(8).

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sonable compensation for sales personnel, broker-dealers,

and underwriters.” '* In so doing the NASD is expressly

freed from a provision’® in the Maloney Act which had

prohibited it from issuing rules designed to impede “a free

and open market,” “fix minimum profits,” “impose any

schedule of prices,” or “impose any schedule or fix mini-

mum rates of commissions, allowances, discounts, or other

charges.” Section 22(b)(3) of the 1940 Act, added in 1970,

authorizes the SEC to alter and supplement the NASD’s

Section 22(b\1) rules.'6 And in 1970, Congress added

Section 22(b)(4) to the 1940 Act to the effect:

If any provision of this subsection is in conflict with

any provision of any law of the United States in effect

on December 14, 1970, the provisions of this subsec-

tion shall prevail. 15 U.S.C. §80a-22( b\ 4).

An investment company, its principal underwriter,

and its dealers are prohibited from selling redeemable

securities for distribution to the public except at a current

public offering price described in the prospectus [§22(d)].

Dealers and principal underwriters may, however, sell

such securities to other dealers, the principal underwriter

or the fund at other than a public offering price. (Id.)

An investment company may restrict the transfer-

ability and negotiability of its shares, but only insofar as

that is done in conformity with the company’s registra-

14. Before 1970, then-Section 22(b) authorized the NASD to

issue rules barring “unconscionable” and “grossly excessive” sales

loads. and then-Section 22(c) empowered the SEC to issue super-

seding rules for both NASD members and non-members.

15. $15A(b\(8). 15 U.S.C. §780-3(b)\(8).

16. The SEC may also grant qualified exemptions from NASD

rules for “smaller companies” [$22(b)(1)}. Section 22(b)(2), another

1970 addition, gives the SEC the same rate-fixing powers over non-

NASD broker-dealers as Section 22(b)(1) gives the NASD over its

members. An underwriter whose shares are distributed by non-

members of NASD, however. may elect to have its shares sold

under the NASD rather than the SEC sales load rule. [$22(b)(2)}.

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tion statement and not in contravention of SEC rules

[§22(f)].'7

By rules and regulations upon its own motion and

by order upon application, the Commission may condi-

tionally or unconditionally exempt persons, securities, or

transactions, or classes thereof, from any provision in the

Act or any rule or regulation thereunder, to the extent such

exemption is in the public interest and not inconsistent with

investor protection and the Act’s purposes [§6(c)].'*

Finally, no person may be held liable for any act done

in conformity with an SEC rule, regulation, or order which

is later invalidated [§38(c)].

Since 1940, the SEC has actively regulated the pric-

ing and distribution of mutual fund shares. The Commis-

sion has promulgated a rule!’ for calculating fund share

prices. It has promulgated another rule?® allowing dis-

17. The 1940 Act contains other provisions with respect to

distribution. Redemption privileges may not be suspended or post-

poned for more than seven days after tender except during certain

exceptional circumstances as defined by the SEC [§22(e)]. A fund

may not issue shares for services or property other than cash or

securities except as a dividend or shareholder distribution or in a

reorganization [§22(g)]. Thus watering of shares is prevented.

Investment companies issuing periodic payment plan certifi-

cates may charge no more than a 9% sales load, nor deduct more

than 50% of that load from the first year's payments, nor deduct

disproportionate amounts, nor allow periodic payments of less than

certain small amounts, nor make proceeds subject to management

or other fees which exceed the amount the Commission prescribes

as reasonable ($27). 1970 amendments added refund requirements

and empowered the SEC to make rules with respect to reserves. (Id.)

Close-end funds are specially regulated with respect to water-

ing and repurchase prices (§23).

18. Baum v. Investors Diversified Services, 286 F. Supp. 914.

921 (N.D. Ill. 1968), aff'd, 409 F.2d 872 (7th Cir. 1969).

19. Rule 22c-1, 17 C.F.R. §270.22c-1, adopted in Investment

Co. Act Release No. 5519 (1969), CCH Fed. Sec. L. Rep. 67-69

Decisions £77,616.

20. Rule 22d-1, 17 C.F.R. §270.22d-1, adopted in Investment

Co. Act Release No. 2798 (1958).

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count sales to certain groups and individuals and has

periodically proposed?! and adopted?? amendments

to this rule. It recently proposed a third rule?* relating to

no-load exchange privileges for fund shareholders who wish

to switch to other load funds. The Commission has enter-

tained a wide variety of applications for exemption from

these rules and the relevant statutory sections and has

granted some of these applications.2* SEC administra-

tive proceedings have barred both underpricing and over-

pricing of fund shares.?*

The SEC has approved NASD Rule 26 which regu-

lates in great detail the distribution, redemption, and

repurchase of mutual fund shares.2* The rule?’ says,

21. Investment Co. Act Release No. 5507 (1968), in CCH

Fed. Sec. L. Rep. 67-69 Decisions 77,609; Investment Co. Act

Release No. 6069 (1970) in CCH Fed. Sec. L. Rep. 69-70 Decisions

€77,826 and Investment Co. Act Release No. 7571 (1972) in CCH

Fed. Sec. L. Rep. °72-73 Decision £79,148.

22. Investment Co. Act Release No. 6347 (1971), in CCH Fed.

Sec. L. Rep. 70-71 Decisions £77,953.

23. Rule 22d-2, proposed in Investment Co. Act Release No.

7555 (1972), CCH Fed. Sec. L. Rep. 72-73 Decisions 79,132.

24. See the list of more than 100 such applications in 4 CCH

Fed. Sec. L. Rep. at p. 68,751 et seq. The Commission staff has is-

sued an abundance of letters in response to “no action” requests

with respect to these rules and the basic statutory provisions. From

1971 through March 21, 1973, there were 49 such letters listed in

4 CCH Fed. Sec. L. Rep. at pp. 63,134; 63,789; and 63,894.

25. See, e.g., Spiro Sideris, Exchange Act Release No. 8816

(1970) (underpricing); Russell L. Irish, Exchange Act Release No.

7687 (1965), CCH Fed. Sec. L. Rep. 64-66 Decisions £77,274 (over-

pricing). The Commission has also sought to regulate excessive

“indirect” compensation to fund dealers. E.g., SEC approval of new

NASD Rules of Fair Practice, Section 26(k), which bars members

from selling certain investment companies’ shares in such a way

that the companies will reciprocate with portfolio brokerage com-

missions, and conversely, Exchange Act Release No. 10147 (May

14, 1973), 5 Fed. Sec. L. Rep. £79,372.

26. Proposed Amendment to the Rules of Fair Practice of

National Ass'n of Securities Dealers, Inc., 9 SEC 38 (1941).

27. NASD Rules of Fair Practice, Article III, Section 26 in

CCH NASD Manual £2176.

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inter alia, that principal underwriters must require their

dealers to sign selling agreements containing certain re-

strictive provisions, that sales loads may not be “unfair,”

that the public offering price must be calculated in a par-

ticular fashion, that dealers and underwriters may not

withhold customers orders or accumulate investories, that

certain conditional orders are barred, that the fund may

_ not redeem at prices above net asset value, that sales loads

must be refunded if the purchasers redeem soon after pur-

chase, that fund shares may not be purchased at prices

* lower than the fund’s next-quoted bid, and that non-contract

dealers may not sell their shares back to the fund unless

they are record owners of the shares. The SEC has super-

vised NASD enforcement of this rule and reviewed NASD

enforcement proceedings.?*

For more than three decades, since the enactment of

the 1940 Act, the agreements between dealers and princi-

pal underwriters, and between principal underwriters and

mutual funds, have been filed with the SEC. The agree-

ments are filed under both the 1933 Act and the 1940

Act.29 The Investment Trust Study of 1940 described

such agreements in detail.*” The 1940 Act specifically calls

for written contracts between funds and their principal

uncersriter [§15(b)]. As noted above, the Commis-

Sica: bras approved a N/SD rule which requires dealer-

unde, wriics agreements; and Commission decisions have

Aeyvemiy turned on particular provisions of the dealer-

un lorwritcr agreements.*!

28. See note 25 supra.

29. Sve Part IV infra.

30. See note 47 infra and accompanying text.

31. See, e.g., Mutual Funds Advisory, Inc., Investment Co. Act

Release No. 6932 (Jan. 12, 1972); First Multifund of America, Inc.,

Investment Co. Act Release No. 6700 (1971), CCH Fed. Sec. L. Rep.

‘70-71 Decisions ‘78,209 at p. 80,602; Russell L. Irish, Exchange

Act Release No. 7687 (1965), CCH Fed. Sec. L. Rep. ‘64-66 Deci-

sions 77,274 at 82, 431 n.13.

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THE OPERATION OF A MUTUAL FUND:

RESALE PRICE MAINTENANCE

We look briefly at the manner in which a typical

mutual fund operates within the foregoing framework.*”

A mutual fund is an investment company which in-

vests in the securities of other corporations and issues and

has outstanding common stock representing an interest

in the assets of the fund. The owner of the stock of the fund

is entitled, on demand, to receive from the fund his propor-

tionate share of the market value of the fund’s net assets.

To insure that the fund has sufficient cash or liquid assets

on hand to meet current redemptions, the fund offers its

common stock continuously. The offering price per share

consists of the “net asset value” per share, computed daily,

plus a sales charge or “load.” The viability of a fund thus

depends upon a distribution system which will effect con-

tinuous sales at prices which will support current redemp-

tion demands.

The primary distribution of the shares of a fund is

controlled for the most part by §22(d) of the 1940 Act and

follows a basic pattern throughout the industry, i.e., (1)

a fund enters into a contract with a principal underwriter

who has the exclusive right to purchase the shares from

the fund; (2) the principal underwriter acts only as a

wholesaler supplying shares to retail dealers; (3) the retail

dealers, who sell the shares to the investing public, are

bound by contracts, commonly known as uniform sales

agreements, with the principal underwriter which require

that those dealers shall not sell at other than the public

offering price, thus insuring that the price of the fund

32. See generally Investment Trust Study of 1940; Report of

the Securities and Exchange Commission of the Public Policy

Implications of Investment Company Growth, H. R. Rep. 2337.

89th Cong., 2d Sess. (1966) (hereinafter cited as Public Policy

Report ).

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Bat KX

kD eS EEO AS te rent

Geist baczlons Rete i SS aa ied

es te

Al6

shares will not be the subject of competition among sellers

of shares in the same fund; (4) the sales charge or “load”

(which usually amounts to 7.5% to 8.5% above net asset

value) is split between the underwriter and the dealer

making the sale while the fund receives the net asset value

component of the public offering price; and (5) when the

shares are redeemed by the fund, as they must be upon

demand, the redemption price is the net asset value pre-

vailing at the time of redemption.

It is obvious from the foregoing outline of marketing

procedures thai the sale and distribution of mutual fund

shares is accomplished through a retail price maintenance

system which is patently repugnant to the free and open

competition requirements of the Sherman Act. This price

maintenance scheme, however, does not operate in a vac-

uum. Rather, it is expressly immunized from the otherwise

applicable antitrust laws by virtue of the provisions of the

1940 Act and the Maloney Act. As the SEC recently re-

ported to Congress, “Section 22(d) is an exception to the

usual congressional policy, expressed in the antitrust laws,

against price fixing.**

It has been authoritatively recognized that the Ma-

loney Act, superimposed upon the regulatory scheme of

tae 1940 Act, provides a limited immunity for participants

in the primary distribution system of mutual fund shares

under SEC-approved NASD rules. That exemption*4

was noted by Mr. Justice Frankfurter in his dissenting

33. Public Policy Report 218-19. See Report of the Staff of the

Securities and Exchange Commission on the Potential Impact of a

Repeal of Section 22(d) of the Investment Company Act of 1940 pt.

1, at 1 (November 10, 1972) [hereinafter cited as SEC Staff Report

on Repeal of §22(d)}, CCH Fed. Sec. L. Rep. No. 450 (Nov. 15,

1972) pt. II, at A-1.

34. See also the exemption from the antitrust laws provided

by §22(b4):

If any provision of this subsection is in conflict with any pro-

vision of any law of the United States in effect on December

14, 1970, the provisions of this subsection shall prevail. 15

U.S.C. §80a-22(b)(4).

40 Da ARNG RT RN Ear ee %

Oe anew

Al7

_ opinion in International Association of Machinists uv.

Street, 367 U.S. 740, 809-10 n. 16 (1961):

The Maloney Act of 1938 added §15A to the

Securities Exchange Act of 1934. 52 Stat. 1070, 15

U.S.C. §780-3. In order to be registered, a number

of statutory standards must be met. The statute spe-

cifically requires that an association’s rules provide

for democratic representation of the membership and

that dues be equitably allocated. See §15A(b)(5) and

(6). Only one association, the National Association

of Securities Dealers, Inc., has ever applied for or been

granted registration. NASD membership comprises

roughly three-quarters of all brokers and dealers reg-

istered with the Securities and Exchange Commis-

sion. Loss, Securities Regulation 766-67 (1951, Supp.

1955). Sections 15A(i) and (n) of the Act authorize

the NASD to formulate rules which stipulate that

members shall refuse to deal with nonmembers with

immunity from the antitrust laws. See S. Rep. No,

1455, 75th Cong., 3d Sess. 8-9 (1938); Loss, op. cit.,

supra, 769-770. The Commission has stated that it is

“virtually impossible for a dealer who is not a member

of the NASD to participate in a distribution of im-

portant size.” National Association of Securities Deal-

ers, Inc., 19 S.E.C. 424, 441.

; Again, in United States v. Socony-Vacuum Oil Co.,

310 U.S. 150, 227 n. 60 (1940), Mr. Justice Douglas stated:

It should be noted in this connection that the

typical method adopted by Congress when it has

lifted the ban of the Sherman Act is the scrutiny and

approval of designated public representatives. Under

the N.I.R.A. this could be done through the code

machinery with the approval of the President as

provided in §§3(a) and 5, supra. note 18. Under

§407(8) of the Transportation Act of 1920, [41

Stat. 482; 49 U.S.C. §5(8)}, carriers, including cer-

pikes wie he es ie «

Al8 .

tain express companies, which were consolidated

pursuant to any order of the Interstate Commerce

Commission were relieved from the operation of the

antitrust laws. And see the Maloney Act (§15A of

the Securities Exchange Act of 1934; 52 Stat. 1070)

providing for the formation of associations of brokers

and dealers with the approval of the Securities and

Exchange Commission and establishing continuous

supervision by the Commission over specified activi-

ties of such associations. . . . (Emphasis added.)

The plaintiffs recognize a limited antitrust immunity

accorded to the primary distribution system. The grava-

men of their complaints, however, is that the defendants

have conspired to use the primary distribution system to

. foreclose the development of a secondary market in mu-

tual fund shares. This is allegedly accomplished through

the use of the uniform sales agreements mentioned above,

which even after the primary distribution of the shares,

set the price at which the shares shall thereafter be sold,

thus precluding the dealers from selling shares as brokers

in a brokerage market or as dealers in a secondary dealer

market in which market-place conditions and arms-length

bargaining would be the price-setting factors. The plain-

tiffs insist that Congress, while allowing the primary mar-

ket to flourish with benefit of antitrust immunity, did not

intend to foreclose secondary market growth, but that

such secondary markets are in fact being discouraged and

suppressed by certain NASD rules and the restrictive pro-

visions contained in the industry-wide uniform sales

agreements between principal underwriters and dealers.

IV |

SECTION 22, 1940 ACT

‘

The fact that a secondary market is to all intents and

purposes nonexistent might seem to substantiate the plain-

_ tiffs’ claims. However, the position of the plaintiffs fails to

A19

take into account that the creation and maintenance of a

free and open secondary market would be totally incon-

sistent with and might destroy the primary marketing

system that is created by the 1940 Act, and particularly

by §22(d), the repeal of which has several times been

urged upon Congress with no success. It is an economic

fact, recognized by Congress, that the two markets—the

primary market described in Part II] supra, and a secon-

dary market as urged by the plaintiffs—cannot coexist

and both remain viable. Having established a resale price

maintenance system in the primary distribution system

in which ordinary competitive influences cannot operate,

Congress has rejected all attempts to foster a secondary

market which might operate to the detriment of the pri-

mary market.

In support of those conclusions we look to the legis-

lative history of the key sections of the 1940 Act and to

the congressional intent in enacting that legislation.

A. Section 22(d)

Section 22(d) provides in pertinent part,

. . no principal underwriter of such security and no

dealer shall sell any such security to any person ex-

cept a dealer, a principal underwriter, or the issuer,

except at a current public offering price described in

the prospectus.

As written, and as applied, that language clearly

contemplates a congressionally sanctioned retail price

maintenance system which is inconsistent and in conflict

with the antitrust laws so far as underwriters and dealers

are concerned.

Plaintiffs assert, however, that since the term “broker”

or “broker-dealer” is not used in the subsection, that 22\d)

permits a person to sell to another through a broker at a

price less than the specified public offering price for the

same shares, and that the absence of a significant broker-

es eee =

ae bee ed

Brewece sartrsetosrenasns sat steed oa

A20

age market in those shares implies the existence of conspir-

atorial anti-competitive activity on the part of defendants

to prevent the growth of that market.

This argument, however, ignores the price mainte-

nance purpose of §22(d) and its corollary that there must

not be price discrimination between similarly situated

investors.

On this latter point, so far as this Court is aware,

there is no SEC or SEC staff pronouncement which can

be construed to sanction price discrimination between

similarly situated investors. To the contrary the SEC

has said:

The purposes of the Section [22(d)] are to prevent

discrimination among purchasers and to provide for

orderly distribution of such shares by preventing their

sale at a price less than that fixed in the prospectus.

Investment Company Release No. 2798 (December 2,

1958). See also Investment Company Release Nos.

8816 (February 13, 1970); 2718 (May 29, 1958); 89

(March 13, 1940). See In the Matter of Investors Di-

versified Service, 39 SEC 680 (1960).

Again, in its most recent annual report the SEC has

stated:

Section 22(d) precludes the sale to public investors

of redeemable investment company securities which

are being currently offered to the public on or through

an underwriter except at a current public offering

price described in the prospectus. SEC, Thirty-

eighth Annual Report 97.

Thus, the language of the statute, its legislative

history and subsequent interpretation by the SEC all

indicate that its object was to allow the pre-1940 method

of mutual fund share distribution to continue subject to

the changes necessary to suppress what was sometimes

dubbed the “bootleg” market. Greene, The Uniform Offer-

ing Price of Mutual Fund Shares Under the Investment

Company Act of 1940, 37 U. Det. L.J. 369, 371 (1960);

A21

In the Matter of Spiro Sideris, Securities Exchange Act

Release No. 8816 (Feb. 13, 1970).

The legislative history of §22 indicates that in the

pre-1940 period there was in fact a secondary market in

mutual fund shares, a market very similar in size and

scope as that for which plaintiffs here attempt to make a

case.“ This market—the “bootleg market”"—was being

maintained by brokers and dealers who were not under

contract with the issuers or underwriters and who were

not, accordingly, a part of the established distribution

system of any given fund.

Those non-contract broker-dealers, without the au-

thority of fund underwriters and in competition with

authorized retail distributors of mutual fund shares, were

buying shares in the market directly from shareholders at

a price slightly above the published redemption price and

reselling them to investors at prices lower than those fixed

by the funds’ principal underwriters.** Contract dealers

35. Hearings on S. 3580 Before a Subcomm. of the Senate

Comm. on Banking and Currency, 76th Cong.. 3d Sess. (1940):

Hearings on H.R. 10065 Before a Subcomm. of the House Comm.

on Interstate and Foreign Commerce, 76th Cong.. 3d Sess. (1940);

S. Rep. No. 1775, 76th Cong.. 3d Sess. (1940); H. R. Rep. No. 2639.

76th Cong., 3d Sess. (1940): Hearings on S. 1659 Before the Senate

Comm. on Banking and Currency, 90th Cong., Ist Sess. (1967):

Hearings on H.R. 9510 and H.R. 9511 Before the Subcomm. on

Commerce and Finance of the House Comm. on Interstate and

Foreign Commerce, 90th Cong.. Ist Sess. (1967); S. Rep. No. 1351.

SO0th Cong., 2d Sess. (1968); Hearings on S. 34 and S. 296 Before

the Senate Comm. on Banking and Currency, 91st Cong.. Ist Sess.

(1969); Hearings on H.R. 11995, S. 2224. H.R. 13754 and H.R.

14737 Before the Subcomm. on Commerce and Finance of the

House Comm. on Interstate and Foreign Commerce, 91st Cong.. Ist

Sess. (1969); S. Rep. No. 184. 91st Cong.. 2d Sess. (1969), H.R.

Rep. No. 1382, 91st Cong.. 2d Sess. (1970): H.R. Rep. No. 1631. 91st

36. Investment Trust Study of 1940 865: see also Hearings on

H.R. 9510 and 9511 Before the Subcomm. on Commerce and

Finance of the House Comm. on Interstate and Foreign Commerce.

90th Cong... ist Sess. 59 (1967) Chereinafter cited as 1967 House

Hearings).

PDL ADA ANGE DORSAL AEE ABR, MAE AL TH Na IIA a egies

A22

operating in the primary distribution system, on the other

hand, were obligated by their distribution contrg¢ts to sell

fund shares at the price (including the sales charge) set by

the principal underwriters.

Thus, non-contract dealers were effectively by-pass-

ing the primary distribution system and retaining for

themselves the selling commissions in full.*? If investors

bought in the secondary market but redeemed through the

fund, it was feared that redemptions would exceed sales

of new shares and the fund would no longer have the cash

available to satisfy its redemption obligations. Thus if the

proceeds of new sales did not accrue to the fund, forced

liquidation might result.

The congressional response to the problems of the pre-

1940 market conditions was §22. By §22(f), infra, a fund

was given the right to limit transferability. By §22(d), all

dealers were required to maintain the public offering price

in sales to the public. The effect of the Act was for the first

time to bind non-contract dealers to the public offering

price. A stated purpose of §22(d) was to insure that “no

securities issued by an investment company shall be sold

to insiders or to anyone other than an underwriter or dealer

except on the same terms as are offered to other in-

vestors.”38

This was a clear recognition that cut-price competition

resulted in discrimination between similarly situated in-

vestors.

“Another factor in the decision to give statutory sanc-

tion to price fixing in 1940 was the fact that mutual fund

distribution was then and for many years thereafter con-

ceived of as a specialized type of underwriting, and under-

writing was regarded as a field in which the law sanctioned

price fixing.” 1967 Senate Hearings 153-54 (Chairman

Cohen). Cf. United States v. Morgan, 118 F. Supp. 621,

697 (S.D.N.Y. 1953).

37. Investment Trust Study of 1940 864; Public Policy Report

219.

38. 1940 Senate Hearings 1057.

A23

As alluded to supra, a very real danger of the “bootleg”

market was that its short term price advantage would drain

profits from the primary distribution system and leave the

issuers unable to engage in continuous sales of new se-

curities necessary for long-term growth and the financial

health of a fund. According to one commentator, a purpose

of the price maintenance provisions was “to prevent the cut-

price competition which had then been making serious in-

roads upon the contractual distribution system of the

mutual fund underwriting firms.” Greene, Uniform Of-

fering Price, supra, 37 U. Det. L.J. at 371.

Section 22(d) has been reconsidered by Congress

several times. Its modification or repeal has been urged.

Congress has consistently refused to modify or repeal it,

and in the course of hearings on various proposals, the

position of the SEC and the congressional intent are clearly

reflected. For example, in 1967 Congress was re-examining

the problems of public offering prices and sales loads. It

was being urged that competition for sales loads could

only be realized by a repeal of 22(d). While testifying before

the Senate Committee, then-Chairman of the SEC Cohen

remarked:

However, this argument [that 22(d) be repealed to

allow competition] overlooks a fundamental theme of

state and federal securities regulation. Securities regu-

lation has done a good deal for the knowledgable in-

vestors, principally by increasing the quantity and im-

proving the quality of the information available to

them. But one of its primary concerns has always been

the welfare of the unsophisticated investor, who is

often the one most likely but least able to bear the

burden of high charges in a competitive market. If it

is desirable for millions of unsophisticated investors

of modest means to invest in securities through the

medium of mutual funds, it is also desirable that

they should not subsequently have cause to believe

that they were unfairly dealt with. On balance, we

ati AW AAe tt MY ah me ae Hie

Prine: Bale ON erie ae IL

A24

concluded therefore that a modification of the manner

in which sales charges on mutual fund shares are now

regulated was more consonant with the spirit and

purpose of the securities laws than the elimination of

Section 22(d). We therefore recommended that sales

charges be limited to 5° of the amount invested, with

authority in the Commission to raise this limit in

appropriate situations.**

It is significant to note, that in the same hearings,

some participants recognized that brokerage transactions,

necessarily executed in the secondary market, were within

the prohibition of §22(d).

Senator Proxmire, for example, asked whether or not

the SEC would recommend the repeal of 22(d) “in order to

permit price competition in the sale of the same mutual

fund by various broker-dealers.”*” Senator Mondale stated

that section “22(d) permits—indeed makes it illegal for

agents to sell at a sales charge less than that prescribed by

the company,*! while Professor Paul Samuelson, Mas-

sachusetts Institute of Technology, testified that “Congress

should repeal the provision in section 22(d) of the Invest-

ment Company Act of 1940 which prohibits a broker from

selling mutual fund shares to the public at less than the

public offering price.”*? Later in the hearings, Senator

Mondale again remarked that “Section 22(d) makes it il-

legal for an agent to charge less than his company says he

must charge as an agent's fee, but it does not prohibit or

have anything to do with competition as. between com-

panies.”

39. Hearings on S. 1659 Before the Senate Comm. on Banking

and Currency, 90th Cong., Ist Sess. 154-55 (1967) (hereinafter cited

as 1967 Senate Hearings).

40. Id. 51-52.

41. Id. 275 (emphasis added).

42. Id. 348 (emphasis added).

43. Id. 769 (emphasis added).

A25

Similar statements appear in the House Hearings, in-

cluding the following exchange between Congressman

Watkins and then-SEC Chairman Cohen:*

Mr. Cohen, The statute now, and since 1940, inter-

feres with competitive business in this area.

Mr. Watkins. Not to the extent you are proposing.

Mr. Cohen. I am sorry, sir. The statute is unequivocal.

No person, no matter where he got it, from the issuer,

from another dealer, or even from a private person, no

broker-dealer may sell a share of a particular fund at

a price less than that fixed by the issuer.

Mr. Watkins. True.

In the same House Hearings, the Department of Jus-

tice, while urging the repeal of 22(d), characterized its

provisions as follows:

It is true that Congress, in originally enacting the

“fixed price” provisions of Section 22(d) in 1940, pro-

vided for the mutual fund industry an exception to the

basic competitive requirements of the antitrust laws.

In view of changed conditions, however, and the fact

that the mutual funds are so important an outlet for

the small investor, it would seem that he should not

perhaps be deprived of the opportunity of purchasing

his investment at a price arrived at through the free

operation of competitive forces.

The SEC took the same view. The then-Chairman

Cohen stated that “sellers of mutual fund securities have

been insulated by Federal Law from price competition at

the retail level ever since 1940” (1967 Senate Hearings 26),

and that §22(d) “provides an exemption from the antitrust

laws” (1967 House Hearings 140). Furthermore, the SEC's

view that §22(d) requires retail price maintenance by

44. 1967 House Hearings 711.

45. Id. 21 (letter from Warren Christopher, Deputy Attorney

General, to Chairman Harley O. Staggers. October 18. 1967).

BF othe ee ess

A26

broker-dealers who are members of the primary distribu-

tion system is also evident in its acceptance of NASD Rule

26(e), which provides that “no member shall offer or sell

any such security except at the effective public offering

price described in the current prospectus of the issuing

company. . . .. CCH NASD Manual 92176.

The same thread runs through hearings conducted in

1969.46 again with a view to the modification or repeal of

§22(d). In the 1969 Senate report, we find these comments

on §22(d):

The provision for “reasonable loads to investors” is

intended to assure that the sales loads fixed by the

principal underwriters (which continue to be protected

against price competition by Section 22(d) of the act)

will be established at levels which recognize the in-

terests of investors.

The provisions of this proposed section shall prevail

over any conflicting provision of Federal law. ‘This

provision, which is identical to Section 15A(n) off the

Securities Exchange Act, is designed to make it clear

that no cther provision of Federal law, including the

antitrust laws, prevents a registered securities asso-

ciation from adopting rules consistent with, and

necessary to effectuate, the purposes and provisions

of this section. S. Rep. No. 184, 91st Cong., Ist Sesis. 18

(1969) (emphasis added).

The basic sales commission charged for mutual ‘fund

shares is in most instances about 812 percent off the

total payment or 9.3 percent of the amount invested.

This charge is protected by Section 22(d) of the Inivest-

ment Company Act which provides for a umique

scheme of retail price maintenance. Under this sec-

46. Hearings on S. 34 and S. 296 Before the Senate Comm. on

Banking and Currency, 91st Cong., Ist Sess. (1969); Hearings on

H.R. 11995, S. 2224, H.R. 13754 and H.R. 14737 Before the Sub-

comm. on Commerce and Finance of the House Comm. on IInter-

state and Foreign Commerce, 91st Cong., Ist Sess. (1969).

A27

tion, all dealers, regardless of the source of the shares

they sell, are pruhibited by law from cutting the sales

charge fixed by the mutual fund underwriter. Price cut-

ting in this field is a Federal crime.

In its deliberations your committee considered the

possibility of deleting Section 22(d) from the act.

However, impressive testimony was given that there

had not been sufficient study of the consequences of

such an amendment. Therefore, your committee re-

quests the Securities and Exchange Commission to

review the consequences of such a proposal on both

the investing public and mutual fund sales organiza-

tions and report to it as soon as is reasonably prac-

ticable. Id. 7-8 (emphasis added).

It is thus conclusively established that competition in

the sale of a single fund's shares is effectively precluded by

the 1940 Act which was intended, via §22(d), to prevent the

sale of fund shares at a price less than that fixed in the

current prospectus. It is obvious that Section 22(d) of the

1940 Act was premised upon a congressional understand-

ing that principal underwriters and broker-dealers were

exempt from the antitrust laws when entering into uniform

sales agreements for mutual fund shares. It is also obvious

that even at the expense of a secondary market Congress

intended to maintain the resale price maintenance system.

Congressional intent is entitled to substantial weight lest

this Court “change the design that Congress fashioned.”

State Board of Insurance v. Todd Shipyards Corp., 370

U.S. 451, 458 (1962).

B. Section 22(f)

Section 22(f ) is a necessary companion to §22(d). If

the problems of the competitive market created by non-

contract brokers were to be met, restrictions on aliena-

bility were necessary. And Section 22(f ) provides:

No registered open-end company shall restrict the

rs sr eat ok ei ee ier «+

A28

transferability or negotiability of any security of which

it is the issuer except in conformity with the state-

ments with respect thereto contained in its registra-

tion statement nor in contravention of such rules and

regulations as the Commission may prescribe in the

interests of the holders of all of the outstanding securi-

ties of such investment company.

Paraphrased, that language states clearly that if (1)

restrictions on transferability or negotiability are included

in the registration statement, and if (2) these restrictions

are not in contravention of such rules and regulations as

the commission may prescribe in the interest of the share-

holders, then such restrictions are permissible even if they

create departures from antitrust standards.

As noted above in the di8eussion of §22(d), Congress

considered the 1940 Act in the light of then-existing condi-

tions, particularly the disruptive influence upon the market

in mutual fund shares by the practices of non-contract

dealers and brokers.

To overcome this disruptive competition prior to the

enactment of the 1940 Act, some funds restricted the

alienability of their shares, “providing substantially that

the shares could only be sold or tendered for redemption

to the open-end investment company.” 47 Such restric-

tions were usually included in the share certificates.

From and after 1940, §22(f ) required that any restric-

tion on alienability be included in the registration state-

mer s and, additionally, that they be subject to the rule-

making authority of the SEC. Clearly, by §22(f ) Congress

specifically empowered mutual funds to restrict the trans-

ferability and negotiability of their shares, subject, of

course, to disclosure in registration statements and to the

rule-making authority of the SEC. Just as clearly Congress

sanctioned such restrictions with full knowledge of their

47. Investment Trust Study of 1940 865.

48. 1940 Senate Hearings 292 (remarks ‘of SEC General Coun-

sel David Schenker). \

2S UIE RL PORTE ERR hae at RTE SIRI ii che REBUN POR i. chi LSE Saag iC os arse ee

A29

effect upon a secondary market which existed at the time

and in full recognition of the antitrust implications.

testrictions on alienability have consistently appeared

in registration statements and in uniform sales agree-

ments since the passage of the 1940 Act. Not only are such

contracts required by SEC-approved Rule 26 of the NASD

Rules of Fair Practice, CCH NASD Manual $2176, but they

are also disclosed in the registration statements. It is

undisputed that these agreements have remained vir-

tually unchanged since they were first filed with the SEC

along with and as part of the registration statements. It is

also undisputed that the SEC has never challenged the

validity of uniform sales agreements. Indeed, the SEC has

noted that these agreements require a dealer “to place all

orders with the principal underwriter and to refrain from

any attempt to obtain shares from other sources.” 4°

It is thus apparent that Congress designed §§22(d)

and 22(f } to create and protect a primary distribution SYS-

tem which is repugnant to the antitrust laws and did so in

complete recognition of the fact that the legislation would

frustrate the growth of a free secondary market. That statu-

tory scheme is “incompatible with the maintenance of (an)

antitrust action.” Silver v. New York Stock Exchange, 373

U.S. 341, 358 (1963).

Whether the mutual fund marketing structure man-

dated by Congress in 1940 should be eliminated or modi-

fied is an issue for Congress and the SEC, not the Judicial

Branch, to hear and to decide. In fact, in urging its com-

plaint upon the Court, one of the plaintiffs, viz., the Depart-

ment of Justice, seeks to accomplish indirectly what it has

failed, so far, to achieve directly—the repeal or modifica-

49. SEC Staff Report on Repeal of §22(d) A-109. See Report

of the Special Study of Securities Markets of the Securities and

Exchange Commission, H.R. Doc. No. 95, 88th Cong.. Ist Sess. 98

(1963), wherein reference is made to the “fair trade arrangements

established by the Act, the NASD rules and private sales agree-

ments . . .°; Greene. Uniform Offering Price, supra, 37 U. Det.

LJ. at 371-72.

Meta eric

Bittscccannceiareccumivn is

A30

tion of §22(d)—in hearings before both Congress*® and the

SEC.*!

IMPLIED IMMUNITY

Even if a specific exemption granted by the Maloney

Act were deemed to be inadequate to grant immunity from

the impact of the antitrust laws, the defendants urge that

the 1940 Act, particularly §22 thereof, created a pervasive

regulatory scheme which highlighted the Congressional

intent to immunize the investment company industry from

the impact of the antitrust laws.

The plaintiffs, on the other hand, urge that repeals of

the antitrust laws by implication are “strongly disfavored,

and have only been found in cases of plain repugnancy

between the antitrust and regulatory provisions.” They

argue that, in the instant case, plain repugnancy is not

apparent.

The most recent pronouncement of the Supreme

Court on this particular point is to be found in Hughes Tool

Company v. Trans World Airlines, 409 U.S. 363 (1973).

In Hughes Tool the respondent TWA challenged as

violative of the antitrust laws certain transactions and

activities of petitioner Hughes Tool (Hughes). The Su-

preme Court, dismissing the action, held that the chal-

lenged transactions “were under the control and surveil-

lance of the Civil Aeronautics Board” (CAB); that pursuant

to the Federal Aviation Act of 1968 the CAB applying anti-

trust standards has reviewed the same kind of conduct

which TWA alleged to be violative of the antitrust laws. The

Court stated:

50. 1967 House Hearings.

51. In the Matter of Mutual Fund Distribution and the Poten-

tial Impact of a Repeal of Section 22(d) of the Investment Company

Act of 1940, SEC File No. 4-164 (1973).

Sih hae

LO ALE SARE EEL MNRAS a a a,

Lean oan Med

A31

In this context, the authority of the Board to grant the

power to “control” and to investigate and alter the

manner in which that “control” is exercised leads us

to conclude that this phase of CAB jurisdiction . . .

pre-empts the antitrust field. 409 U.S. at 385 (footnote

omitted).

And the Court further stated that where

the CAB authorizes control of an air carrier to be

acquired by another person or corporation and where

_ the CAB specifically authorizes as in the public inter-

est specific transactions between the parent and the

subsidiary, the way in which, that contro] is exercised

in those precise situations is under the surveillance

of CAB, not in the hands of those who can invoke the

sanctions of the antitrust laws. 409 U.S. at 387.

Further the Court said that its holding was “consistent

with the view expressed in Silver v. New York Stock Ex-

change . . . that a statutory scheme that does not ‘create

a total exception from antitrust laws may, nonetheless, in

particular and discrete instances by implication grant im-

munity from an antitrust claim.” 409 U.S. at 385 n.14 (em-

phasis added).

The Court in Hughes Tool relied heavily on its prior

decision in Pan American World Airways v. United States,

371 U.S. 296 (1963), which also involved the pervasive

regulatory scheme of the cab and an implied repeal of the

antitrust laws. In Pan American the Court found that the

Sherman Act could not be applied to matters which the

‘CAB had approved in exercising its statutory function. .

It would be strange, indeed, if a division of territories

or an allocation of routes which met the requirements

of “public interests” as defined in §2 were held to be

antitrust violations. . . . If the courts were to intrude

independently with their construction of the antitrust

laws, two regimes might collide. 371 U.S. at 309-10.

ICN ERA BORN

faa ONES BORE APA Le Mes ES,

A32

' The Court then found that the implementation of anti-

trust policy in the public interest was for the CAB, under

the Federal Aviation Act’s comprehensive regulatory

scheme, and’ not for the courts. In the case at bar, as in

Hughes Tool and Pan American, there exists a pervasive

regulatory scheme coupled with a legislative history mani-

festing congressional intent to immunize the investment

company industry from the operation of the antitrust laws

to the limited extent necessary to carry out the purpose of

the independently defined federal policy legislated in the

regulatory act, i.e., the Investment Company and Maloney

Acts.52

The decisions in Hughes Tool and Pan American are

consistent with the views expressed in Silver v. New York

Stock Exchange, supra, where the Supreme Court held

‘that the Stock Exchange was not exempt from the antitrust

Jaws when, pursuant to its rules, it ordered its members to

remove certain telephone connections they had with the

offices of a non-member. Although the Exchange was

generally regulated by the Securities Exchange Act of

52. In Hecht v. Pro-Football, Inc., 144 U.S. App. D.C: 56, 444

F.2d 931 (1971), cert. denied, 404 U.S. 1047 (1972), the Court held

the following to be relevant criteria for aera which conduct

is immune from the antitrust laws:

Putting the problem in ‘this light, relevant criteria would in-

clude the specific language of the congressional statute in-

volved, any legislative history which would throw light on the

congressional intent, the relative importance of the govern-

mental action which is asserted to override antitrust policy,

whether the governmental agency is required to take into con-

sideration the possible anticompetitive: effect, of its actions,

whether the agency is required to adhere to a clearly defined

and restricted statutory directive, and to what extent the

agency's actions are subject to judicial review. 144 U.S. App.

D.C. at 60, 444 F.2d at 935.:

See also Thill Securities Corp. v. New York Stock Exchange, 433

F.2d 264, 270 (7th Cir. 1970), cert. denied, 401 U.S. 994 (1971),

where the Court also discussed immunity criteria; United States v.

Morgan, 118 F. Supp. 621 (S.D.N.Y. 1953).

12 Dal MAS NSS WANA do 2 oe Cr ahh Sem mane RARER eoon aie

ABS

1934, the Court noted that the SEC lacked jurisdiction to

review cases such as petitioner's where the Exchange has

enforced its rules. Silver v. New York Stock Exchange,

supra, 373 U.S. at 358.

The Court's opinion in Silver turned on the fact that

there was no justification for the Exchange rule under the

Securities Exchange Act because that rule did not provide

any procedural safeguards for the petitioner. The Court

did find, however, that “particular instances of exchange

self-regulation which fall within the scope and purposes

of the Securities Exchange Act may be regarded as justi-

fied in answer to the assertion of an antitrust claim.” 373

U.S. at 361. The Court noted further that “(s)hould review

of exchange self-regulation be provided through a vehicle

other than the antitrust laws, a different case as ‘to antitrust

exemption would be presented. See note 12, supra.” 373

U.S. at 360. The Court’s reference, “note 12,” refers

expressly to the SEC’s jurisdiction under the Maloney Act

and states that were there such SEC jurisdiction in a

Silver-type situation, “a different case would arise con-

cerning exemption from the operation of laws designed to

prevent anti-competitive activity . . .” 373 U.S. at 358 n.

12.53

This Court is persuaded that the instant case is that

“different case.”>4 The Investment Company Act and the

Maloney Act read together demonstrate that Congress in-

tended to eliminate free competition im the distribution of

53. But see Harwell v. Growth Programs, Inc.. 451 F.2d 240

(Sth Cir. 1971), reh. denied, 459 F.2d 461. cert. denied, 409 U.S.

876 (1972), where the Court applied the Silver rationale to self:

regulatory activities of the NASD. Harwell, however. did not in-

volve a claim of limited antitrust immunity under $22 of the 1940

Act. F

54. Cf. Gordon v. New York Stock Exchange, Inc.. et al., Civil

No. 71-1496 (S.D.N.Y., filed Dec. 4, 1973). where the Court. in dis-

missing an antitrust attack on the commission structure of both the

New York and American Stock Exchanges, found that the fixing of

commissions falls within the congressional policy of exchange self-

regulation embodied in the Securities Exchange Act of 1934.

ee ee

A34

mutual fund shares. The language of both acts clearly de-

fines the pervasive statutory and administrative control

* over the area and manifests a congressional intent to leave

this complex field to the supervision and control of an

expert administrative agency.» The SEC and the NASD

have the statutory authority to control the area and both

have in fact taken an active role. The NASD, under the

control and supervision of the SEC, has adopted specific

rules to govern the activities of principal underwriters and

broker-dealers. The Maloney Act, Section 15A(bX8), spe-

cifically requires the SEC to employ antitrust standards,

i.e., “to protect the public interest,” when reviewing the

rules promulgated by the NASD.* Still further, the SEC

has adopted rules specifically designed to govern non-

NASD members in the distribution and redemption of

mutual fund shares. See 15 U.S.C. §§780(b)(8\10). In

connection with its regulatory function, the SEC has ex-

tensively reviewed the distribution and redemption prac-

tices in the investment company securities industry and

55. In Baum v. Investors Diversified Services, Inc., 286 F.

Supp. 914 (N.D. Ill. 1968), aff'd on other grounds, 409 F.2d 872

(7th Cir. 1969), the plaintiff alleged a violation of the Robinson-

Patman Act. After reviewing the SEC involvement, the court held:

The foregoing demonstrates that the SEC has exercised its

broad regulatory authority in this industry to establish a frame-

work of pricing practices within which investment companies

must operate. It has specifically approved the alleged dis-

criminatory pricing system under attack in the case at hand.

and has justified the system as being “in the public interest

and consistent with the protection of investors and purposes

fairly intended by the policy and provisions of this Title.” 286

F. Supp. at 924.

56. See also Section 6(c) of the 1940 Act which empowers the

SEC to “exempt any person, security, or transaction . . . from any

provision” of the Act “if and to the extent that such exemption is

necessary or appropriate in the public interest and consistent with

the protection of investors and the purposes fairly intended by the

policy and provisions” of the Act. 15 U.S.C. §80a-6(c) (emphasis

added).

Ae 6 eR t ;

oad

A35

even has reviewed the secondary market for such secu-

rities.**

This Court's opinion is further strengthened by the

Supreme Court's decision last Term in United States v.

Cartwright, 411 U.S. 546 (1973). That case challenged a

regulation issued by the Secretary of the Treasury covering

valuation of mutual fund shares for Federal Estate Tax

purposes. The Court at least impliedly recognized the

pervasive regulatory scheme in the investment company

industry.

Private trading in mutual fund shares is virtually non-

existent. Thus at any given time, under the statutory

scheme created by the Investment Company Act,

shares of any open-end mutual fund with a sales load

are being sold at two distinct prices. Initial purchases

by the public are made from the fund at the “asked”

price, which includes the load. But shareholders “sell”

their shares back to the fund at the statutorily defined

redemption or bid price. 411 U.S. at 549 (emphasis

added).

The Court went on to state that the regulation in

question was “manifestly inconsistent with the most ele-

mentary provisions of the Investment Company Act of

1940 and operates without regard for the market in mutual

fund shares that the Act created and regulates.” 411 U.S.

at 557 (emphasis added).

The plaintiffs place great reliance on other recent

Supreme Court decisions. Principally they rely upon Otter

Tail Power Co. v. United States, 410 U.S. 366 (1973), in

which the Court refused to imply immunity from the anti-

trust laws. Plaintiffs cite Otter Tail to show that even

extensive regulation of an industry does not thereby im-

munize that industry from the antitrust laws. The Court's

57. See, e.g., Public Policy Report; SEC Staff Report on Repeat

of §22(d): In the Matter of Mutual Fund Distribution and the Poten-

tial Impact of a Repeal of Section 22(d) of the Investment Com-

pany Act of 1940, SEC File No. 4-164 (1973).

A36

language is clear and unequivocal, however, for it found

congressional intent not to displace the antitrust laws, but

rather to retain the applicability in order to promote com-

petition. That is not the case here.

It is clear, then, that Congress rejected a pervasive

regulatory scheme for controlling the interstate dis-

tribution of power in favor of voluntary commercial

relationships. When these relationships are governed

in the first instance by business judgment and regula-

tory coercion, courts must be hesitant to conclude that

Congress intended to override the fundamental na-

tional policies embodied in the antitrust laws. See

United States v. Radio Corporation of America, supra,

at 351. This is particularly true in this instance be-

cause Congress, in passing the Public Utility Holding

Company Act, . . . was concerned with “restraint of

free and independent competition” among public

utility holding companies. See 15 U.S.C. §79a(b\2).

410 U.S. at 374 (emphasis added).

Otter Tail accordingly is not controlling.

Nor does Federal Maritime Commission v. Seatrain

Lines, Inc., 411 U.S. 726 (1973) support plaintiffs’ position.

That case dealt with the scope of an express repealer of the

antitrust laws in the 1916 Shipping Act®* which by its

terms, limited antitrust immunity to conference agree-

ments approved by the Federal Maritime Commission

(FMC). At issue was whether an agreement which confers

no ongoing obligations is an “agreement” within the mean-

ing of the Act. The Court held that Congress did not intend

to invest the FMC with the power to shield from antitrust

liability mergers which create no continuing responsi-

bilities. Furthermore, the Court found in examining the

legislative history there was an overriding federal policy to

58. 46 U.S.C. §814. See Note, The Shipping Industry Seeks a

Safe Haven: Merger Jurisdiction for the FMC?, 5 Law & Pol. Int'l

Bus. 274 (1973).

A37

promote competition. Since the FMC’s power to immunize

agreements from the antitrust laws was limited only to

those agreements approved by it, this Court fails to see in

what manner the claim for limited itpmunity in the present

case offends the Seatrain principle since there is no similar

requirement conditioning exemptions jn the 1940 Act.>9

This Court is not, of course, untjndful of the fact that

“(r)epeals of the antitrust laws by implication from a regula-

tory statute are strongly disfavored. and have only been

found in cases of plain repugnancy between the antitrust

and regulatory provisions.” United States v. Philadelphia

National Bank, 374 U.S. 321, 356-51 (1963) (footnotes

omitted). See also United States v. McKesson & Robbins,

Inc., 351 U.S. 305, 316 (1956); California v. FPC, 369 U.S.

482 (1962); United States v. Borden Co., 308 U.S. 188

(1939). That principle, of course, rests upon the sound basis

that “antitrust laws represent a fundamental national

economic policy.” Carnation Co. ». Pacific Westbound Con-

ference, 383 U.S. 213, 218 (1966). With that fundamental

policy in mind, the Court does not hojd that the Investment

Company Act and the Maloney “completely displace the

antitrust laws.” Hughes Tool, supra, 409 U.S. at 389. What

the Court does find is a “limited antitrust exemption.” Car-

nation Co., supra, 383 U.S. at 219. Here, given the fact that

59. Cf. Ricci v. Chicago Mercantile Exchange. 409 U.S. 289

302-03 n.13 (1973), where the Court recognized that where a regu-

latory act contains an express exemption from the operation of the

antitrust laws, or where a regulatory agency is specifically directed

to consider competitive factors in the exercise of its duties, it is

necessary to conclude that Congress intended to exempt from the

antitrust laws activity subject to the administrative agency's adju-

dicative or rule-making authority.

Moreover, the cases at bar do not involve the doctrine of pri-

mary jurisdiction. See, e.g., Chicago Mercantile Exchange v. Deak-

tor, 42 U.S.L.W. 3330 (U.S. Dec. 3, 1973) (No. 241): Ricci v.

Chicago Mercantile Exchange. supra.

60. See. e.g.. United States v. Borden Co.. 308 U.S. 188. 200

(1939). Cf. Maryland & Virginia Milk Producers Ass'n Inc. v. United

States, 362 U.S. 458 (1960).

Oe er a

iit ed

A38

Congress clearly intended to substitute a pervasive regula-

tory scheme, i.e., §22 of the 1940 Act, for the usual anti-

trust prohibitions in the narrow area of distribution and

sale of mutual fund shares, it is clear that the price mainte-

nance practices complained of are immune from ordinary

antitrust strictures.*!

61. Notwithstanding this conclusion, two SEC rulings, cited

by plaintiffs in support of their contention that the price main-

tenance requirements of §$22(d) would not apply if the broker-dealer

acted in the capacity of a broker rather than a dealer, deserve men-

tion. One is an Opinion of SEC General Counsel, Investment Com-

pany Act Release No. 87 (March 14, 1941). In response to an ab-

stract inquiry, the General Counsel thought that the term “dealer”

in §22(d) “refers to the capacity in which a broker-dealer is acting

in a particular transaction.” He concluded ‘hat when a broker-dealer

‘acts as a broker in a specific transaction, he is not bound to sell at

the public offering price. In the Matter of Oxford Co., Inc., 21 SEC

681 (1946), involved a disciplinary proceeding for a broker-dealer

alleged to have violated his fiduciary duty to his clients. There the

broker-dealer sold mutual fund shares from one of his accounts to

another related account, charging the public offering price and

retaining the sales load for himself. The SEC, citing the General

Counsel's opinion, rejected the technical defense that the subject's

actions were mandated by §22(d).

The Court concludes that reliance on these two decisions is

misplaced. They are ad hoc decisions in no way related to the regu-

lated distribution system. Furthermore, they do not address the

problem of likely discrimination between similarly situated inves-

tors. Such shortcomings preclude a basis for allowing industry-wide

cut-price competition in brokerage transactions contrary to the

purposes of §22(d).

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A39

CONCLUSION

In light of the foregoing, the Court concludes that the

plaintiffs in each of the above-captioned cases have failed

to state a claim upon which relief can be granted, and that

accordingly the motions to dismiss in each such case must

be granted. Orders are filed herewith.

HOWARD F. CORCORAN

Judge

Dated: December 14, 1973

aac whl xi

arias Rial tase

A40

UNITED STATES DISTRICT COURT

For tHE District oF COLUMBIA

ARTHUR GROSS, et al.,

Plaintiffs,

THE NATIONAL ASSOCIATION OF

SECURITIES DEALERS, INC..,

et al. Civil Action No. 4266-73

Defendants.

PRETRIAL ORDER NO. 1

Filed April 23, 1973

A Pretrial Conference having been held March, 2.

1973, in Haddad v. Crosby Corp., C. A. No. 2454-72, in tthis

Court, a pretrial order having been entered therein aind

in United States v. National Association of Securitties

Dealers, Inc., C.A. No. 338-73, providing for a stay of poro-

ceedings except as there provided, the Court having beeen

advised of the pendency of certain actions in the Unitted

States District Court for the Southern District of New Yoork.

certain of the defendants having moved for a pretrial cor-

der herein, and an informal meeting with counsel in tthe

Haddad, United States, and Gross cases having been heeld

April 13, 1973, it is this 23rd day of April, 1973, hereby

ORDERED that further proceedings relating to claass

certification and discovery in the present action aare

stayed pending further order of this Court, except as_ is

provided in this Pretrial Order No. 1; provided, howeveer,

that entry of this Pretrial Order No. 1 shall prejudice ino

party hereto with respect to any motion, claim, conteen-

tion, defense or objection otherwise available as of Aporil

Ad]

13, 1973, and thereafter (including any proceedings

which may be commenced pursuant to 28 U.S.C. §1407);

FURTHER ORDERED, that all defendants herein shall

have until May 29, 1973, to answer or otherwise move with

respect to the complaint;

FURTHER ORDERED, that on or before May 29, 1973,

the defendants herein shall file all motions, with full sup-

porting papers, relating to the question of primary and

subject matter jurisdiction and to the defense that the acts,

transactions, practices, and conduct complained of in

the complaint are in any way exempt from the antitrust

laws by operation of the securities laws, including the

Securities Exchange Act of 1934, the Investment Com-

pany Act of 1940, and orders, rules, regulations, acts and

practices thereunder, including those of the Securities

and Exchange Commission, and of the National Associ-

ation of Securities Dealers;

FURTHER ORDERED, that Pretrial Conference No.

1 shall be held June 6, 1973, at 2:00 p.m., at which time

the following matters will be on the agenda:

(a) Scheduling of discovery, if any. relating to and

necessary for determination of the aforesaid

motions;

(b) The scheduling of further briefing and oral argu-

ment of the aforesaia motions;

(d) Continuation or modification of the stay of class

certification and discovery;

(e) Such other matters as the Court or the parties

may wish to consider;

FURTHER ORDERED, that Daniel P. Levitt and

Leonard H. Becker of Paul, Weiss, Rifkind. Wharton &

Ss ADAM AINED + 008

UN ERA aed Na Cait Ha 8 He

Sj in Sem Dd a RIN ily! a UAE

A42

Garrison, 1775 K Street, N.W., Suite 700, Washington,

D.C., are hereby appointed liaison counsel on behalf of

the defendants; provided, however, that counsel for any

party shall continue to serve copies of all pleadings anu

motion papers upon all counsel for the defendants, ac-

cording to their appearances on file with the Court;

FURTHER ORDERED, that pending further order of

this Court, counsel for each of the defendants are au-

thorized to cooperate with one another to promote the

expeditious handling of pretrial proceedings in this case

and to avoid all unnecessary duplication of proposals and

responses to the Court and the plaintiff. Such cooper-

ation, participation therein and efforts preparatory there-

to, including the exchange of written material and the

sharing of costs and expenses shall not be used against

any defendant and shall not be construed as a waiver of

any attorney client, work product or other privilege;

FURTHER ORDERED, that the motion of certain de-

fendants for a pretrial order herein, dated April 5, 1973,

to the extent not granted herein, is denied.

SO ORDERED:

HOWARD F. CORCORAN

United States District Judge

aerial

A43

UNITED STATES COURT OF APPEALS

For THE District OF COLUMBIA CIRCUIT

No. 74-1361 September Term, 1973

Arthur Gross, et al., Civil Action 426-73

Appellants

United States Court

v. . of Appeals for the

District of Columbia Circuit

The National Association of

Securities Dealers, Inc., et al. Filed April 18, 1974

Before: McGowan and Wilkey, Circuit Judges

ORDER

On consideration of appellant's unopposed motion

to stay proceedings, it is

ORDERED by the Court that the aforesaid motion is

granted and proceedings in this appeal are stayed until

10 days after the decision of the Supreme Court in United

States v. The National Association of Securities Dealers,

Inc.

Per Curiam

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