The Beginning And Tacit Control Of U.S. Investment Companies

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A few investment companies were organized in the United States before World War I. Although investment companies in the United Kingdom were well-established, we must remember that before World War I the United States was a debtor nation. Not until the bull market of the 1920s was well under way did investment companies begin to pop up on U.S. soil.

When investment companies began to raise funds, the rush to buy soon developed into a stampede. Without going into details, we may note that by the end of 1926 there were about 160 investment companies of various kinds with assets of about $1 billion. Growth was rapid: 140 new companies were formed in 1927; 186 in 1928. By 1929, the rate of formation was one every business day; assets at the end of the year were valued at more than $7 billion. The amount of new capital raised by investment companies in 1929 was about $1.5 billion. Undoubtedly, purchases by investment companies contributed substantially to the rise in stock prices during the last three years of the bull market, which ended in 1929.

Some of the bizarre episodes and unsound practices, which characterized the period, occurred because of the very soundness of the investment company principle. Investors and bankers alike became careless in their over enthusiasm. Standards of disclosure and ethics were not what they are today. Most serious defects and abuses, by and large, have been corrected by statute and by self-regulation, so that we need present only a brief outline of dubious or reprehensible practices.

The evils enumerated in the findings and declarations of policy of the Investment Company Act describe the practices, which affected investors adversely. One may add that there is evidence to support the language used in the Act:

1. Investors were without adequate, accurate and explicit information, fairly presented, concerning the character of the securities and the circumstances, policies and financial responsibility of investment companies and their management.

2. Investment companies were organized and managed in the interest of officials and affiliated persons or under writers, brokers, or dealers; or in the interest of special classes of security holders or others rather than in the interest of all classes of security holders.

3. Investment companies issued securities containing inequitable or discriminatory provisions or failed to protect the rights of security holders.

4. Control of investment companies was unduly concentrated through pyramiding or inequitable methods of control or control was inequitably distributed, or investment companies were managed by irresponsible persons.

5. Investment companies employed unsound or misleading accounting methods and were not subjected to adequate independent scrutiny.

6. Investment companies were reorganized or changed the character of their business, or the control or management was transferred without the consent of the security holders.

7. Excessive borrowing and the issuance of excessive amounts of senior securities (leverage) increased unduly the speculative character of the junior securities of investment companies.

8. Investment companies operated without adequate assets or reserves.

It is difficult to recapture the mood of the period -- but simple, with the aid of hindsight, to adopt a condescending air now that the entire environment has changed. As always, it is best to learn from the past and try not to recreate the same problems in the present.

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