Collective Branding and the Origins of Investment Fund Regulation

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 portfolios, for example, shows that mutual funds in the late 1930s were just as passive with respect to the governance of their portfolio companies as mutual funds are today. 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