BACKGROUND AND PURPOSE

The primary purpose of regulations is to protect investors, and the roots of governmental regulation of mutual funds in the longer-established markets are often associated with major scandals and market crashes.

In the USA, the stock market crash of 1929 prompted an extensive investigation by Congress into the securities industry. It revealed that overselling, or ‘ramming’ of shares, particularly radio company shares, had created unrealistic expectations and false, overvalued markets. The investigation resulted finally in the Investment Company Act 1940, which established the Securities and Exchange Commission (SEC) – this Act remains the cornerstone of US mutual fund regulation – and the Investment Advisers Act 1940. Along with two Acts passed into Federal law in the 1930s – the Securities Act 1933 and the Securities Exchange Act 2934 – these four Acts provide the bulk of federal powers over the activities of US investment companies. In fact, the only addition to US legislation affecting all companies since 1940 is the Sarbanes-Oxley Act of 2002 and that has only an indirect bearing on mutual funds themselves, being more concerned with accounting, auditing and disclosure practices of trading companies, following the Enron and Worldcom scandals.

FundsThe Investment Company Act requires all funds to registcr with the SEC and to meet certain operating standards; the Securities Act mandates specific disclosures; the Securities Exchange Act sets out anti-fraud rules covering the purchase and sale of fund shares; and the Investment Advisers Act regulates fund advisers. The SEC is charged with overseeing the mutual fund industry’s compliance with all these regulations, although the funds themselves are organised under State laws – as corporations or business trusts.

The depression of 1929 also affected Europe and the UK, where the London Stock Exchange recommended the regulation of fixed trusts in 1935. A Board of Trade report the following year concluded that, whilst unit trusts met an investment need, some form of legislation was necessary to protect the public. Formal regulation took a little time to implement and the Prevention of Fraud (Investments) Bill 1939 did not become law until August 1944. This Act was replaced in 1958 and whilst various committees and advisers published recommendations for further reform, little was changed until the Financial Services Act 1986, which repealed all earlier legislation.

As in all European countries that are members of the European Union, UK legislation in 1986 had to take account of the European ‘UCITS Directive’ of 1985 I UCITS: Undertakings for Collective Investment inTransferable Securities). This itself had been the long_ anticipated effort to unify investment regulation across the Member States of the European Union, following the widespread fraud perpetrated by Beanie Cornfield’s Investors Overseas Service organisation, involving ‘pyramid selling’ of funds from a base in Switzerland. The UNITS Directive has been the subject of recent amendments and Member States are at varying stages of implementing national legislation to harmonise regulation of funds across the OE.

Having experienced 10 years of so-called ’self-regulation‘ under the Financial Services Act, major changes to the regulatory structure in the UK were announced in 1997. The Securities and Investments Board (SIB) subsequently was renamed the Financial Services Authority (FAA) and eventually absorbed the separate regulatory powers and responsibilities of the self-regulatory organisations (SRNs) established under the 1986 Act, as well as the supervisory responsibilities of the Bank of England, the authorisation and prudential supervision responsibilities of the Department of Trade and Industry in relation to insurance companies and of the registrars of Building and Friendly Societies, and those of the UK Listing Authority in place of the London Stock Exchange.

By the time the Financial Services and Markets Act 2000 became effective at midnight on 30 November 2001, the FAA was responsible for the regulation and supervision of all companies operating in the UK, whose main business is banking, insurance or investment, and of their senior management and other key employees.

A significant number of firms, such as lawyers and accountants, who conduct investment business but only as an ancillary to their main activities continue to he regulated by their respective professional bodies. By contrast, the FSA has recently taken on responsibility for direct regulation of insurance and mortgage advisers.

This creation of a single regulator (except for pensions, for which there is a separate Pensions Regulator) brings the UK, in relation to investment business, much closer to the USA model, where the Securities and Exchange Commission has been the sole regulator since 1940. In making the FSA responsible for virtually all financial businesses, the UK has taken the model a stage further than the USA, where banks are still regulated by the Federal Reserve Board and State Banking Commissions.

Elsewhere, regulation has typically followed or been taken from US or UK models, depending upon which country has had the most influence in post-war developments, but influenced by local experience, good and bad, of initial legislation. A summary level description of the current law and regulatory structure of a number of these countries follows:

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