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Alternative Look at the Origins of Mutual Fund Regulation

A new paper by John Morley of the University of Virginia School of law, takes a look at the origins of mutual fund regulation, proposing that the body of regulation for open-end funds that emerged from the Great Depression was not necessarily a product of populist and SEC influences, but lobbying by the mutual fund industry itself.  Morley's provocative look at the inception of regulation of the investment management industry provides an interesting historical lens through which to view reform efforts today. 

According to the paper's abstract:

This paper examines how market and political forces interacted to create the American mutual fund industry and its regulation between 1936 and 1942. Contrary to previous scholarly work, this paper argues that the key elements of regulation that now differentiate modern mutual funds from modern hedge funds had their origins in lobbying by the mutual fund industry itself, rather than in populist or public-spirited forces in the SEC or the Roosevelt administration. The largest funds desired to maintain an industry-wide brand for a passive, low-risk style of investing and they sought regulation to maintain this brand. They did so even though some investors rationally might have preferred risky or active styles of investing that regulation ultimately prohibited. An understanding of the industry’s brand-building motivations can explain several puzzling features of mutual fund regulation, including restrictions on borrowing, redemption rights and control over portfolio companies. The mutual fund industry was able to achieve strong agreement on how to influence regulation because the industry had grown into its modern shape well before Congress adopted the current regulatory regime. Evidence from mutual funds’ portfolios, for example, shows that no funds that had any chance of being swept up in the mutual fund tax and regulatory regime in the late 1930s had any substantial interest in the governance or control of their portfolio companies. This paper also examines the key distinguishing feature of modern mutual fund taxation - actual, rather than nominal, distribution of income to shareholders - and shows that it may have originated in an attempt by open-end mutual funds to drain assets from closed-end mutual funds.

The full text of Morley's paper is available via: