The Securities Act of 1933 is primarily concerned with adequate disclosure on offerings of shares to the public. Since virtually all open-end investment companies are continuously offering shares to the public, they are constantly subject to the provisions of the act. A prospectus containing or summarizing the essential information in the registration statement must be prepared, kept current, and delivered to purchasers of open-end company shares. The Securities Act places severe restrictions on advertising and promotion of new issues. The sale of investment company shares is, therefore, continually subject to these restrictions which, generally, do not apply to outstanding securities traded in the securities markets. The Securities Act also contains provisions, applicable with respect to investment company shares, which make unlawful, in the offering or sale of securities generally, any fraud or misrepresentation by means of any untrue statement of a material fact, or any failure to state a material fact necessary to make other statements not misleading.

Thus, investment companies operate under a strict and overlapping framework of laws designed to provide for disclosure and fair dealing. It should be mentioned, however, that nothing contained in Federal regulatory laws purports to interfere with investment judgment or discretion: the thrust of the Securities Act of 1933 is toward adequate disclosure; and the thrust of the Investment Company Act of 1940 is toward a climate in which management discretion can be exercised effectively, free from improper influences and considerations.

TAXATION WITH RESPECT TO INVESTMENT COMPANIES AND THEIR

SHAREHOLDERS

Mr. Edwin S. Cohen, whose firm is tax counsel for the National Association of Investment Companies, in his statement will discuss the Federal taxation of investment companies and their shareholders. I will, therefore, in this statement merely touch upon the general principles underlying that tax structure.

Most investment companies which are members of the National Association of Investment Companies have qualified as "regulated investment companies" under subchapter M of the Internal Revenue Code. These companies normally distribute currently to their shareholders substantially all of the income which they receive in the way of interest and dividends, and normally also distribute net capital gains realized on the sale of their portfolio securities. A regulated investment company must distribute 90 percent or more of its ordinary income, and to the extent that it distributes its income and its realized gains, the shareholders rather than the company are taxed. The company itself is, of course, taxable on any income and gains which it does not distribute.

The theory which underlies this method of taxation is that the investment company is in fact an investment medium for its shareholders. Thus, the tax burden on the investment company shareholder is made substantially the same as if he had invested individually rather than as a part of an investment pool. An extra layer of taxation, which would discriminate against the person of moderate means who invests through the medium of the regulated investment company, is eliminated.

There is presently an area in the tax law regarding regulated investment companies which the NAIC, after some study, has concluded warrants modification. This matter relates to the treatment of interest on municipal bonds. Such interest is today tax exempt to a regulated investment company if it owns municipal bonds, as it is to other holders, but the interest loses its tax-exempt character when it is distributed currently by the company to its shareholders. In their hands the interest becomes taxable as dividend income.

The interest rate on municipal bonds has risen to such an extent in recent years that they merit consideration for inclusion as a part of a balanced investment program for individuals in the lowest income tax brackets. In these circumstances, the association believes that the Internal Revenue Code should be amended to permit such interest received by a regulated investment company to retain its tax-exempt status when distributed currently to its shareholders. This would make it feasible for such bonds to be included in the portfolio of regulated investment companies when sound investment management makes such a program desirable for the company's shareholders in the light of its investment objectives. A memorandum dealing specifically with this matter is attached as an appendix to Mr. Cohen's statement to the committee.

CONCLUSION

The provisions of the Internal Revenue Code relating to regulated investment companies have, in my judgment, enabled the companies to make a substantial contribution to the health of the American economy. They have afforded to the person of moderate means the opportunity, without tax disadvantages, of investing in the means of production, distribution, and services of our economy on a rational and intelligent basis, with diversified investments under continuous professional supervision. To that extent they have served to broaden the economic base underlying our democracy. As a corollary they have, of course, brought to the markets of our Nation capital resources which would not otherwise have been forthcoming. The companies have been able to stimulate this development by offering a variety of methods of investment which enable the individual investor to tailor his individual investment plan to his own financial circumstances.

In my judgment, therefore, these provisions of the code have encouraged the growth of the economy, broadened the capital markets, and greatly facilitated the participation of the small investor in the development of the Nation's industry.

REAL ESTATE INVESTMENT SYNDICATE

Harry Janin

I have been invited by your chairman to discuss the question of whether a corporate or similar tax should be imposed on real estate investment syndicates. The problem posed is the development of sound criteria for the taxation or nontaxation of a particular entity.

Before proceeding further, I should mention that among the clients in my office are a number of real estate investment syndicates. I do not pretend, therefore, to be completely impartial; however, the philosophy which follows reflects my own thinking.

I. DESCRIPTION OF REAL ESTATE INVESTMENT SYNDICATE

A real estate investment syndicate has come to denote an unincorporated organization which has invested in some form of real estate equity. The investment may take the form of the acquisition of a fee or long-term leasehold ownership of a hotel, office building, industrial building, shopping center, or apartment house. Generally, the syndicate owns only one property.

The method of investment constitutes a pooling arrangement whereby small and modest investors can secure benefits normally available only to those with larger resources. These benefits include the spreading of the risk of loss; the opportunity to secure the advantages of expert investment counsel; and the means of collectively financing projects which the investor could not undertake singly.1 A basic and essential element in the type of syndicate here discussed is that its available cash income is required to be distributed periodically during the year to its participants.

Theoretically, almost any type of property may be syndicated. In practice, however, syndicates concentrate mainly upon properties used for business rather than residential purposes. Thus hotels, office, and loft buildings, shopping centers, etc., lend themselves more readily to syndication than apartment houses.2 The reason lies in the fact that tenants' leases in business properties usually run for longer terms than residential leases, and business concerns are usually more financially responsible than apartment house tenants. Properties devoted to business purposes therefore offer a greater opportunity for stability andmore often than not-yield a greater return than do apartment houses. This is not to say, however, that syndications of apartment houses do not occur. There are such and some are quite successful. New construction has also been syndicated; usually, however, only to sophisticated investors willing to take greater risks to share greater rewards. Manifestly, the investor is unable to diversify his risk by investing

1H. Rept. 956 to accompany H.R. 8102, 85th Cong., 1st sess., p. 3.

See Helmsley, "Business Aspects of Real Estate Syndications," 14 The Record of the Association of the Bar of the City of New York 50 (1959).

in one syndicate. However, he achieves diversification by investing relatively small amounts in a number of different syndicates. It must be recognized that the syndicate performs a valuable national service in making the capital of innumerable small investors available to the real estate industry.

Syndicates may start in humble circumstances. A owns a small office building which is reasonably successful, yielding him a good return. B, a friend or business associate, notes A's success with his property. B asks A whether he may participate in his next purchase indicating a willingness to supply his pro rata share of the funds and bear his proportionate share of the risks. A agrees and A and B share the next purchase equally. And so the interests spreads and A becomes aware that his friends and associates have collectively substantial sums available for investment in sound, income-producing real estate. A's resources are not unlimited but in view of the capital made available to him A begins to show interest in larger parcels-investments which he never could have handled with his own funds.

The number of persons participating in A's purchases begins to grow-10, 50, 100. Soon A finds it necessary to formalize his relationship with his participants and becomes aware of the double tax which may be imposed if the entity he creates is deemed an association taxable as a corporation.

The responsibility of a syndicate falls upon the syndicate manager and his staff. He must be an expert in appraising the value of real estate, be familiar with its management and operation and also aware of the methods of financing a purchase. The syndicate manager's initial and most crucial decision is the particular parcel of property to buy, the price to pay, and the terms of payment.

Careful scrutiny prior to purchase requires an investigation of the location, the nature of the improvement erected and its physical condition. A study must be made of the roster of tenants, their financial standing, the length of leases, the rent paid and the prospects of renewals. Inquiry must also be made into building operating expense under current and future conditions.

Prospects of financing the purchase are also given consideration. In our present hard money market, a property may be considered attractive because of the low interest rate required by the mortgage which is a lien thereon. If new financing is necessary, the mortgage market must be canvassed to determine whether the sum required may be borrowed, and, if so, on what terms.

Having selected his property, the syndicate manager next enters into a contract to purchase it. In this connection, of course, he must engage counsel and is usually required to place a deposit on contract generally equal to 10 percent of the total cash consideration to be paid. Ordinarily, the period between signing of contract and closing of title is 30 or 60 days. The syndicate manager, however, usually requests 120 to 180 days in order to arrange his syndication and raise the funds necessary to complete the purchase. Some syndicate managers prepare elaborate brochures, describing the property in detail, giving its past operating history, naming the persons responsible for

See Wien, "How the Syndicate Functions," 14 The Record of the Association of the Bar of the City of New York 54 (1959).