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Opening Remarks at the 75th Anniversary of the Investment Company Act and Investment Advisers Act
“The Investment Company Act and Investment Advisers Act Standing the Test of Time”

Chair Mary Jo White

Sept. 29, 2015

Introduction

Good morning. Thank you for coming today, and welcome to the SEC, both those here in person and through our webcast. Before I say anything else, I would like to acknowledge staff from the Division of Investment Management for their hard work in putting this anniversary program together. In particular, kudos go to Director Dave Grim, Jennifer McHugh, Bridget Farrell and Jamie Walter. I also would like to thank my fellow Commissioners who are introducing the panels, and all of the stellar panelists who will be sharing with us their insights throughout the day.

Today, we celebrate 75 years of the Investment Company Act and the Investment Advisers Act — two pieces of legislation that came to shape the financial markets as we know them. And this event is more than an anniversary celebration — it is a day to reflect on this extraordinary regulatory system that has facilitated the management and growth of assets for millions of Americans and other investors from around the world. In these opening remarks, my assignment is to first take us on a brief historical tour and then come back full circle to today where we see just how powerful and alive these Acts are in the modern markets.

The History

The Acts, which passed both houses of Congress unanimously, provided a solid regulatory foundation and afforded the Commission the ability to develop rules and other regulatory responses to adapt to changing markets and an evolving asset management industry. These critically important statutes were designed to protect investors from certain abuses that had arisen in the industry and were the product of the constructive cooperation of the Commission and the asset management industry.

When President Franklin D. Roosevelt signed the Acts into law, he hoped they would enable the industry “to fulfill its basic purpose as a vehicle to diversify the small investors’ risk and to provide a valuable source of equity capital for deserving small and new business enterprises.”[1] President Roosevelt began with that bold vision.

And the reach of the Acts has dramatically expanded since then, as funds and investment advisers continue to fulfill their basic purpose, playing a major role in the lives of Americans and our national economy. At the end of 2014, more than 53 million households, which accounted for more than 43 percent of all U.S. households, owned mutual funds.[2] In 1940, the asset management industry held only about $2 billion in assets, which included some $1 billion held by registered funds.[3] Now, 75 years later, the Commission oversees registered investment companies with a combined $18.8 trillion in assets and registered investment advisers with approximately $67 trillion in regulatory assets under their management.

Our distinguished panelists will highlight developments in the asset management industry and Commission regulations over the last 75 years from various perspectives. But first, I would like to have us briefly reflect on the development of the Acts leading up to 1940 and their unique characteristics. This early history provides insight into why our regulation of the asset management industry has endured for 75 years and highlights the strengths of a regime that will continue to operate in the future.

The Early Asset Management Industry

The modern American investment company started in the 1920’s with the end of certain state corporate laws that limited the growth of funds and with a desire of investors, particularly those of modest means, to invest in stocks by pooling their assets with those of others.[4] Initially, the industry was dominated by closed-end funds, and by 1929 a closed-end fund was being created at the rate of almost one a day.[5]

Many fund sponsors used a number of different structural and functional devices to control the funds that effectively excluded the participation of investors in fund management, leaving sponsors free to use fund assets fraudulently for their own benefit, including taking out personal loans, financing their own companies, and outright embezzlement.[6] As a consequence of mismanagement and the market crash of 1929, holders of fund securities lost large amounts of money, including smaller, unsophisticated investors who were particularly attracted to these funds.[7] By 1940, SEC Commissioner Robert Healy lamented that “the record of the industry [was] shocking,”[8] as investors’ capital in all types of investment trusts and companies had fallen by about $3 billion.[9]

The Study

The Commission conducted a congressionally mandated study of investment funds and investment advisory services beginning in 1935, which revealed that the industry’s problems were much bigger and even deeper than expected.[10] Between 1938 and 1940, Commission staff led by Commissioner Healy produced reports to Congress on the industry.[11] Ultimately, the Commission recommended legislation designed to address the specific abuses that had been identified, to restore investor confidence through certain protections and to allow for innovation and diversity in the industry.

The Acts were the product of extraordinary discussion, cooperation and agreement among industry participants and the Commission.[12] Industry leaders were willing to sit down with government representatives and think constructively about solutions.[13] In the end, the asset management industry largely supported the legislation. In general, they had a common interest in ridding the industry of wrongdoers who had tarnished the reputation of the entire industry.[14] Fortunately, the industry was relatively young, so that the abuses had not become fully embedded in the business practices.[15]

At the time, politicians heralded this agreement on the Acts as “an amazing thing”[16] and a “miracle.”[17] Senator Henry Cabot Lodge said that “after very painstaking and careful study, in which really almost a miracle occurred…an agreement which is embodied in this bill was reached between those engaged in the industry and the members of the SEC.”[18] He went on to say that this was “a very unusual and beneficial occurrence.”[19] President Roosevelt similarly commented that “it [was] a source of satisfaction that business men” recognized his goals of helping “the honest businessman and bringing higher standards to his particular corner of the business community.”[20] As you can tell from their comments, the passage of the Investment Company Act and Investment Advisers Act was cause for great celebration in both the public and private sectors.

The Acts

The Acts served to protect the public in many ways and addressed the identified abuses through the regulation of both funds and advisers.

The Investment Company Act, as you know, is the primary statute that regulates funds. The law incorporates some of the same principles of full and fair disclosure that are the foundation of our securities laws generally, but also extensively and comprehensively regulates funds through specific prohibitions and governance requirements, which reflect the characteristics of these funds.[21] For example, the Act limits funds’ issuance of debt and other senior securities, and includes requirements related to valuation, redemptions of fund shares, and dealings with service providers and other affiliates. The Act also gives the Commission broad discretion to grant exemptions from requirements, which paved the way for the diversity of funds to develop and be made available in the market.[22]

While the Investment Company Act contains specific directives, the Investment Advisers Act is more principles-based. The Advisers Act imposes a few specific restrictions, but investors are protected principally by the Act’s anti-fraud provisions and through application of a fiduciary duty, requiring disclosures that give investors the information they need to make informed decisions. Over the years, enforcement has made good use of the fiduciary duty owed by advisers to their clients to bring cases to address a wide range of problematic practices of investment advisers, including not adequately disclosing conflicts of interest related to compensation, expenses and loans to affiliates,[23] distributing misleading advertisements,[24] and misleading advisory clients about investments in affiliated entities.[25]

Having briefly explored the foundations and applications of both of the Acts we celebrate today, I will end my historical tour and make a few observations about how the SEC continues to use these powerful tools as we look to the present and future of asset management.

The Future

With these pivotal Acts in our arsenal, the Commission continues to enhance, strengthen and adapt its regulatory programs in response to an evolving asset management landscape. Over the last 75 years, Commissioners and staff have worked tirelessly to regulate funds and advisers while also allowing for innovation, and the industry has provided important input to help shape our regulations. In that constructive way, the contributions of the groups that led to the adoption of the Investment Company Act and Investment Advisers Act have continued for almost eight decades.

Today, as many of you know, the Commission has an ambitious agenda to address evolving risks for funds and advisers, recently proposing enhanced data reporting by investment companies and advisers, and, just last week, proposing to require open-end funds to enhance funds’ liquidity risk management. As we speak, Commission staff is also developing recommendations that I hope to advance for the Commission’s consideration by the end of this year related to the use of derivatives by funds, including measures to appropriately limit the leverage these instruments may create, as well as enhancing risk management programs for such activities.

Beyond that, the staff is developing recommendations regarding transition planning for advisers, annual stress testing by large investment advisers and funds, a program of third party examinations for investment advisers and a uniform fiduciary duty for investment advisers and broker-dealers. Talk about a full plate of critical initiatives. These measures will stay focused on keeping alive the promise of the Investment Company Act and Investment Advisers Act to protect investors and the vibrancy of funds. On these initiatives and others, we look forward to the continued dialogue with the asset management industry and its constructive input.

Conclusion

In conclusion, the next 75 years of asset management will undoubtedly hold many challenges. But the drafters of the Investment Company Act and Investment Advisers Act devised a regulatory structure with a broad and sturdy foundation. The past 75 years have been witness to that. Since the beginning, each successive generation here at the Commission has been steadfast in protecting the core ideals of protecting the investor while also maintaining the intended flexibility of the Acts. We have inherited a regulatory framework and a legacy of collaboration that is the bedrock of an industry envied around the world, and I am confident it will continue to thrive and play its intended major role in the lives of Americans and our national economy.

* * *

In a moment, we will turn to SEC Chief of Staff Buddy Donohue who will moderate our first panel. But first, we have a brief video presentation showcasing some of the most important people who shape our regulations and work with the Acts every day, staff from the Division of Investment Management.



[1] Franklin D. Roosevelt, Statement on Signing Two Statutes to Protect Investors (Aug. 23, 1940), available at http://www.presidency.ucsb.edu/ws/?pid=15993 (“Pres. Roosevelt Statement”).

[2] Investment Company Institute, 2015 Investment Company Fact Book, at 114 (2015), available at https://www.ici.org/pdf/2015_factbook.pdf.

[3] Division of Investment Management, United States Securities and Exchange Commission, Protecting Investors: A Half Century of Investment Company Regulation, May 1992, (“Redbook”), at xviii (“In 1940, the industry held only about two billion dollars in assets, including 105 registered management investment companies holding slightly more than one billion dollars in assets.”).

[4] Redbook, at xvii.

[5] Investment Trusts and Investment Companies: Hearings on S. 3580 before the Subcomm. on Securities and Exch. of the Senate Comm. on Banking and Currency, 76th Cong., 3d Sess. (1940) ( “Senate Hearings”), at 43.

[6] Report Accompanying S. 4108 from the Senate Comm. on Banking and Currency, 76th Cong., 3d Sess. (Jun. 6, 1940) ( “Senate Report”), at 7 (“By various devices of control, such as special voting stocks issued to distributors and managements, voting trusts, long term management contracts, control of the proxy machinery, and pyramiding of companies, public, investors are effectively denied, in many instances, any real participation in the management of their companies.”); Senate Hearings, statement of Robert E. Healy, Commissioner, SEC, (Apr. 2, 1940) ( “Healy Testimony”), at 4 (“I am not speaking merely of the instances of outright embezzlement, I am referring to the unloading of worthless securities and other investments of doubtful value upon the companies; to loans which investment companies have been caused to make to insiders; to the bail-outs of insiders from dubious and illiquid investments, from onerous commitments and from trading accounts. Investment companies have been compelled to finance banking clients of the insiders, and companies in which they were personally interested.”).

[7] Redbook, at xvii (“Failures to observe principles of fiduciary duty were widespread, and, as a consequence, holders of investment company securities, including the small, unsophisticated investors for whom the investment company product was so attractive, lost large sums of money.”).

[8] Healy Testimony, at 4 (“But I must say, because it is the truth, that, considered as a whole, the record of the industry is shocking.”).

[9] Healy Testimony, at 2 (“Altogether investors have sustained a capital shrinkage of approximately $3,000,000,000 in all types of investment trusts and investment companies.”).

[10] Healy Testimony, at 3, 7 (“The fact is, however, by way of explanation and not of excuse, that the size and the problems of industry proved to be much larger or more complicated than either we or congress evidently anticipated.”).

[11] Redbook, at xvii (“In 1935, Congress directed the Commission to study the fledgling investment company industry and report its findings. Between 1938 and 1940, the Commission transmitted to Congress an exhaustive report on the investment company industry. The report, commonly known as the ‘Investment Trust Study,’ laid the foundation for the Investment Company Act.”).

[12] See Healy Testimony, at 10-14. See also, Redbook, at xvii (“Following several preliminary bills, the legislation that was finally enacted in 1940 was the product of cooperative negotiations between representatives of the Commission and of the investment company industry”).

[13] Investment Trusts and Investment Companies: Hearings on H.R. 10065 before the Subcomm. of the Comm. on Interstate and Foreign Commerce House of Representative, 76th Cong., 3d Sess. (Jun. 13, 1940) (“House Hearings”), at 144 (“I think it is rather fortunate perhaps that the investment trust industry encountered its difficulties and a government study comparatively early in its history…where the leaders of the industry would not be willing to do what they have done here, and that is, sit down with the government representatives and recognize those evils and try to get rid of them.”).

[14] Alfred Jaretzki, Jr., The Investment Company Act of 1940, 26 Wash. U. L.Q. 303, 304 (Apr. 1941) (“[T]he Act was not an arbitrary or irrational compromise of irreconcilable differences, but was the result of an agreement reached by give and take on both sides…Both parties, the Securities and Exchange Commission and the industry, were apparently well satisfied with the result; and Congress seemed pleased to have presented to it without controversy so comprehensive a piece of legislation.”); id. at 330 (“Under these circumstances, and with keen competition between companies in the sale of their shares, it was natural that some questionable practices should have developed. It furthermore became extremely difficult, and in some instances impossible, for any one company or small group of companies to raise standards and at the time same time compete with others.”); Report accompanying H.R. 10065 from the Subcomm. of the Comm. on Interstate and Foreign Commerce House of Representatives, 76th Cong. 3d Sess. (Jun. 18, 1940) (“The essential purpose of [the Advisers Act] is to protect the public from the frauds and misrepresentations of unscrupulous tipsters and touts and to safeguard the honest investment adviser against the stigma of the activities of these individuals by making fraudulent practices by investment advisers unlawful.”).

[15] House Hearings, at 144 (“I think it is rather fortunate perhaps that the investment trust industry encountered its difficulties and a government study comparatively early in its history, before bad practices and abuses and evils had gotten so completely frozen in that they could not be rooted out…It leads me to hope, and it leads me to express the belief that I have that under this regulation and under the kind of sensible and honest management.”).

[16] Senate Hearings, at 1130 (“Senator DOWNEY. Do I understand that the representatives of the investment trusts and of the Securities and Exchange Commission are virtually in agreement now? Senator WAGNER. Not virtually but actually in agreement. Senator DOWNEY. That is a most amazing thing in this chaotic world right now. Senator WAGNER. I think it is. Senator DOWNEY. It is really the first encouraging thing I have heard in several weeks. How was this miracle brought about?”).

[17] Id.

[18] See Walter P. North, Brief History of Federal Investment Company Legislation, 44 Notre Dame L. Rev. 677, 684 (Jun. 1969), at note 17.

[19] Id.

[20] Pres. Roosevelt Statement.

[21] Redbook, at xvii (“The Investment Company Act reflects a congressional recognition that substantive protections beyond the disclosure requirements of the Securities Act of 1933 and the Securities Exchange Act of 1934 were needed because of the unique character of investment companies and their role in channeling savings into the national economy.”).

[22] Id.

[23] See e.g., In the Matter of Guggenheim Partners Investment Management, LLC, Investment Advisers Act Rel. No. 4163 (Aug. 10, 2015); In the Matter of Dion Money Management, LLC, Investment Advisers Act Rel. No. 4146 (Jul. 24, 2015); In the Matter of Kohlberg Kravis Roberts & Co. L.P., Investment Advisers Act Rel. No. 4131 (Jun. 29, 2015).

[24] See e.g., In re F-Squared Investments, Inc., Investment Advisers Act Rel. No. 3988 (Dec. 22, 2014).

[25] See e.g., SEC v. Interinvest Corporation, Litigation Rel. No. 23288 (Jun. 17, 2015).