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A 75-Year Retrospective on the Investment Company and Investment Adviser Acts

Jay Baris and Andrew Donohue review the 75-year history of investment company and investment adviser regulation in Still Spry at 75: Reflections on the Investment Company Act and the Investment Advisers Act. The piece details the prominent abuses that dominated mutual funds in the pre-1929 stock market crash era, the creation of the SEC, and subsequent study of investment funds, and finally in 1940, the passage of the Investment Company Act and the Investment Advisers Act. The article also provides a substantive overview of the two acts, as well as the SEC’s ability to maintain flexibility through the use of exemptive orders.

The authors conclude that the “flexibility and adaptability of the Investment Company Act and the Investment Advisers Act ensure that they will continue to serve investors and the national economy for the next 75 years.” However, they note that the landscape has significantly changed over the past 75 years. The mutual fund industry has grown immensely (from approximately $700 million in 1926 to currently over $15 trillion), and technology and financial products that were unheard of in 1940 are now ubiquitous, according to the authors. For example, legislators “could not contemplate flash trading, electronic settlement, or global investing, or that investors could trade mutual fund shares on an iPhone.”

The authors specifically cite the use of derivatives as an area in which the Investment Company Act struggles to keep pace. They suggest the SEC should act to “address seismic changes in technology and the marketplace” and identify three concerns with funds’ use of derivatives:

1)     Funds should have a means to deal effectively with derivatives outside of disclosure;

2)     A fund’s approach to leverage should address both implicit and explicit leverage; and

3)     A fund should address diversification from investment exposures taken on versus the amount of money invested.