Speech by SEC Staff:
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Thank you Commissioner Hunt. Last year we celebrated the 75th anniversary of the introduction of the mutual fund in the United States. This year we celebrate the 60th anniversary of the Investment Company Act. This afternoon we will look back at 60 years of amazing growth in the fund industry and parallel regulatory evolution. To know where we are going (which our distinguished guests will discuss), we need to know where we are now and, maybe more importantly, where we have been.
It is important to note that the turbulent, early history of the investment company industry is a primary source of the principles reflected in the ’40 Act. The story begins in the Roaring ‘20s. World War I was over; business was booming; and Wall Street was thriving. Most investment companies were closed-end funds. This means that shareholders did not have a right to redeem their shares based on the value of the fund’s net assets. Shares of these funds traded in the secondary market at market prices. Many of these companies were sponsored by, and affiliated with, investment houses. These investment houses seemed to have the magic touch with regard to investments, creating a tremendous demand for securities of investment companies affiliated with them. These funds were the vehicle for the average investor to participate in the attractive returns generated by these investment houses. And before the market crash of 1929, shares of these closed-end funds frequently traded at a premium to the funds’ net asset values. After the crash, not surprisingly, the supply of shares of closed-end funds exceeded the demand, and their shares began trading at a discount.
This liquidity crisis aided the emergence of two other kinds of investment companies: the unit investment trust, which held a fixed portfolio of securities, and the open-end managed fund, now known as the mutual fund. Shareholders were attracted to these types of funds because they offered the ability to redeem shares for cash at the funds’ net asset values. With the exception of disclosure requirements and anti-fraud requirements, the fund industry grew without effective regulation.
By the mid-1930’s, it had became apparent that there were problems prevalent in the investment company industry. The close relationships between investment companies and their sponsors proved disastrous as a group of unscrupulous sponsors treated fund assets as their own. Many funds failed, and many shareholders lost their investments. The SEC estimated that between 1929 and 1936, investment company shareholders lost 40 per cent of their investments.
In 1935, Congress asked the Commission to conduct a comprehensive study of the investment company industry, looking specifically at the functions and activities of investment companies, their corporate structures and their investment policies. Congress also wanted to know how investment company sponsors and affiliates exerted influence over the investment companies they controlled. The resulting report, called the Investment Trust Study, laid the foundation for the ’40 Act.
The Investment Trust Study, and the subsequent Congressional hearings, found that, to an alarming extent, investment companies were being organized and operated to benefit the interests of their affiliates rather than the interests of their shareholders. In short, a number of fund sponsors abandoned their fiduciary obligations and acted without regard to any stewardship on behalf of fund investors. Some suggested that the whole investment company industry was a parasite upon the stream of industrial earnings, levying a toll upon the yield of blue chip companies, resulting in unnecessary administrative costs and taxes that were not economically justified.
It is fortunate for our economy and millions of investors that Congress, the Commission, and the investment company industry worked to address these problems, rather than listen to those who advocated shutting down the industry. The resulting legislation – the Investment Company Act of 1940 (enacted on August 22, 1940) – was truly a negotiated statute, with extensive hearings before Congress, punctuated by intensive discussions between the Commission and the industry. Concepts embodied in the Investment Company Act were borrowed in particular from the Public Utility Holding Company Act, the Securities Act of 1933, the Securities Exchange Act of 1934, the Chandler Act (which regulated the reorganization of companies in bankruptcy), the banking laws, including the Glass Steagall Act provisions and, strangely enough, the Civil Aeronautics Act. However, there were issues involving investment companies for which there was no precedent and the Act reflects in various areas novel approaches to these problems.
Since 1940, the ’40 Act has proved to be remarkably resilient. Its drafters understood that markets and circumstances change, and that industries evolve. Consequently, Congress gave the Commission express authority to exempt any person, security, or transaction from any section of the Act – consistent with the protection of investors. This authority makes the Act flexible and allows it to accommodate change and innovation in ways that preserve its underlying principles. This flexibility has permitted the development of money market funds, variable insurance products, expanded international investing, securities lending programs, and unique exchange-traded products that serve particular investor needs.
I am confident that the Act’s flexibility will prove sufficient to meet the challenges that the next 60 years of evolution in the financial products and services that the statute regulates will bring.
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