October 24, 2008

RECOVERED HISTORY: DEJA VU ALL OVER AGAIN

Your editor's father helped, as assistant counsel, to conduct the SEC investigation into the investment trusts on the 1930s and co-authored the Investment Company Act of 1940, which established regulations for mutual funds - albeit without, unfortunately but understandably, regulating hedge funds, since they hadn't been invented yet. A few echoes from the past. . .

Wikipedia - Following the founding of the mutual fund in 1924, investors welcomed the innovation with open arms and invested in this new investment vehicle heavily. Five and a half years later, on October 24, 1929, Black Thursday took the thrill out of the stock market and led to the Great Depression. In response to this crisis, the United States Congress wrote into law the Securities Act of 1933 and the Securities Exchange Act of 1934 in order to regulate the securities industry in the interest of the public.

Investment companies were still in their infancy in 1940. In order to instill investors' confidence in these companies and to protect the public interest from this new type of security, Congress passed the Investment Company Act. The new law set separate standards by which investment companies should be regulated. The act defined and regulated investment companies, including mutual funds (which were virtually undefined prior to 1940).

The act's purpose, as stated in the bill, is "to mitigate and. . . eliminate the conditions. . . which adversely affect the national public interest and the interest of investors." Specifically, the act regulated conflicts of interest in investment companies and securities exchanges. It protected the public primarily by legally requiring disclosure of material details about the investment company. The act also placed some restrictions on mutual fund activities such as short selling shares. . . The act required investment companies to publicly disclose information about their own financial health.

Time, August 10, 1936 - Tucked away in the Public Utility Act of 1935, lacking even the dignity of a separate paragraph, was a Congressional command to the Securities & Exchange Commission to investigate investment trusts. In the twilight of the 1920's, some $7,000,000,000 worth of investment trusts were floated, according to SEC figures. Their total assets were worth about $2,000,000,000 by the end of last year. It became SEC's job to find out where, how and why the rest disappeared. Last week after over a year of preliminary field work by a staff of 70 experts, the headline stage of the investment trust investigation arrived with the start of open hearings in Washington.

Nearly 1,000 trusts, extant and defunct, will be examined before SEC sends its report to Congress next January with recommendations for regulatory legislation. . . For the men who manage U. S. investment trusts in 1936 the investigation will be a painful ordeal. Even if their own records are spotless, the records of their trusts are probably not. Most trusts have bought other trusts, and the reason they were able to buy them was generally that the trust for sale had been either mismanaged or plundered. SEC intends to study not only present managements but those of predecessor trusts.

Under the SEC microscope last week was Equity Corp., which was built up from other trusts, some with sorry records indeed, but now run by David Milton, son-in-law of John D. Rockefeller Jr. Not concerned last week with Mr. Milton's management was SEC but with earlier history, notably the methods by which a young lawyer from Baltimore had acquired, with virtually no investment on his part, a handful of broken-down trusts early in Depression. Putting them together as Equity Corp., he sold out to Mr. Milton in 1932 at a profit of $750,000. This promoter was Wallace Groves, now in possession of Phoenix Securities Corp., which rose appropriately from the ashes of still another trust. Truster Groves's method was to use one trust to buy another. . .

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