Life Before Strict Investment Regulation

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Investment accounting practices were not uniform in the early part of the 1900s and often were dictated by the management or had been adopted, without explicit prompting, to promote management objectives.

Reports to security holders seemed to be part of a design to confuse or misinform investors about the facts. The Securities and Exchange Commission's report contains a brief but comprehensive summary of the evidence upon which it based: The statement that accountancy sometimes was transformed into an instrument by which abuses were perpetrated and concealed rather than exposed.

Reports to stockholders were found to be deficient in numerous respects. Some were deficient in their failure to reveal the method of computation of profits or losses upon sales of securities (i.e. whether based upon average cost; first-in, first-out; or on the identified security basis). In others, there was a deception arising from the failure to qualify the amounts of profits and losses when portfolio securities had been disposed of after a write-down. In these cases, although proceeds from sales of securities were less than original cost, results were characterized as profits without the qualification that they represented merely the proceeds in excess of written-down values.

Likewise, trading losses were considerably understated when they were reported without the explanation that they were not based upon original cost. By a failure in some instances to publish adequate analyses, reserve accounts became instrumentalities for covering up realized losses and for the distortion of trading results. Similarly, inadequate analyses of surplus accounts in published reports led to the concealment of substantial realized losses.

The fixed investment trust flourished for a short time. In the two years that followed the 1929 collapse in the stock market, sales approximated $600 million. Since 1931, sales and creation of new fixed trusts have been negligible. The fixed investment trust is defined as a vehicle in which the investor acquires an undivided interest in a relatively fixed list of securities, together with certain accumulations which are deposited from time to time by a depositor corporation with a trustee, usually a bank or trust company, for the benefit of the holders of the certificates for trust shares. These certificates are in effect receipts issued in small denominations by the trustee to the depositor, who sells them to the public through dealers. Most fixed trusts were of the unit type, i.e., the deposited securities were deposited in units each identical with every other.

It is necessary only to consider briefly the fundamental defect in the very concept of the fixed trust. As a rule, the underlying securities could be eliminated or altered only in the event of combination, consolidation, reorganization, or sale of substantially all the property of an underlying company. Others provided for a change if a dividend were reduced or eliminated.

A study published in 1937, preceding the report of the Securities and Exchange Commission summarized the reasons for the decline of the so-called fixed trust or "unit-type trust." The author observed that the word fixed was a misnomer from the start, since almost all the companies provided for portfolio elimination under certain conditions; the name, however, had a sales value because of the unpopularity of management companies.

The unit-type company declined for several reasons, the most important of which were the continued decline in stock prices to 1932, irresponsible sponsorship, a gradual increase in confidence in the management type, ill-advised efforts to stimulate sales of shares by questionable merchandising methods, the inauguration of new series and the "switching" evil, portfolio eliminations and returns of capital to the investor, the decrease in distributable income and the disappearance of reserve funds, the publication of the requirements of the New York Stock Exchange, restrictive state regulation, and certain internal dissensions in the fixed-company field.

Fortunately today there are many checks in place that prevent such practices and protect investors' investments. They also allow for suit to be brought against offending companies, which can sometimes result in the return of a portion of a lost investment.

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