January 2024
Drafting a New Constitution: The Investment Company Act of 1940
MFS worked closely with Congress to draft the Investment Company Act of 1940 to preserve the future of the mutual fund industry that served so many. The 1940 Act is still the pillar of financial regulation in the US today.
After opening the door in 1924 for everyday people to invest in the stock market, the last thing MFS wanted to see was that access jeopardized by imbalanced legislation.
In early 1940, the US was beginning to recover from the Great Depression — caused in part by an unregulated stock market — which had decimated the country and the economy in the previous decade. Congress was looking to create a stable regulatory framework to prevent a repeat of the Stock Market Crash of 1929. In doing so, Congress introduced a massive bill — more than 100-pages — targeting the entire investment industry. With proposals to limit fund sizes (capping them at just $150 million),1 ban directors from overseeing more than one fund and possibly even bar investment companies from managing their own fund investments and distributing their own shares,2 many early supporters of new regulations feared it went too far.
As written, the legislation would reduce investor choice, punish ethical and unethical funds alike, and, most frightening of all, undermine the value of professional management that made open-end mutual funds so attractive to small investors.3
Major newspapers across the country predicted the bill would never pass.4 How could any fund continue to attract — and retain — shareholders if these restrictions became law? One industry leader spoke for many, declaring, “The cure they suggested was a bill that would burn down the barn to kill the rats.”5
Looking out for everyday investors, the industry and the firm itself, MFS wasn’t taking any chances on that kind of outcome. At the time, Massachusetts Investors Fund (MIT) trustees had broadened the investor base by acquiring a second growth-focused mutual fund and had launched one of the industry’s first in-house research departments while backing a national distribution strategy for MIT’s funds.6,7 This legislation would not bring just MIT’s growth since the crash to a screeching halt but that of the industry itself.
Working with industry professionals and government officials, MFS made sure the bill protected investors, promoted a responsible industry and allowed widespread access to mutual funds.
As the industry lacked an official trade association, MFS’ then Chairman Merrill Griswold decided to be proactive, take the long view, lead with common sense and prioritize collaboration. Timing was everything. The clouds of World War II hovered over Europe, and Griswold saw the ideal moment to prove to Congress, as well as millions of small shareholders, that everyone had more to gain than fear from a properly regulated mutual fund industry. A healthy investment industry made for a healthy nation.
Griswold gathered support for the creation of a “task force” made up of 12 industry executives,8 who worked together to draft an acceptable compromise.9 The task force wasted no time in presenting its own set of concrete suggestions to Congress, highlighting helpful regulations and questioning inequitable ones.10 Legislators were shocked that the industry was trying to help, rather than thwart, its efforts.
The ethical guidelines MFS established for MIT became a template for the entire industry.11 By August 1940, this unexpected collaboration led to the drafting and passage of the compromise legislation now known as the Investment Company Act of 1940.12,13
Working with industry professionals and government officials, MFS made sure the bill protected investors, promoted a responsible industry and allowed widespread access to mutual funds. In fact, MFS noted that the 1940 Act called for “very few changes in the business methods of our Company.” And subsequent reports suggested that MFS’ bylaws were so similar “that we had to change only a few commas.”14
The 1940 Act covered governance, share redemptions, sales and much more and is often referred to as the “constitution” of the mutual fund industry, holding immense significance as it continues to act as a strong but fair regulatory framework today.15,16 As a result of the events of 1940, MFS not only secured a prominent place in financial history but also leveraged its client-first ethos to help shape one of the most important regulatory frameworks ever drafted.
Please note: Not all of the funds included in this material may be available for sale in your country.
Endnotes