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Funds managed by IOS
The following table presents information concerning the open-end mutual funds distributed and managed by IOS:
Aug. 31, 1969 Total net assets of mutual funds under management.---- $1, 821, 754, 000 Fund (year organized or acquired) The Fund of Funds, Ltd. (1962) Total
676, 161, 000 IIT, an International Investment Trust (1962) Total
623, 195, 000 IOS Venture Fund (International) N.V. (1969) Total
137, 198, 000 Fonditalia (1967) Total
126, 593, 000 The Equity Unit Account of The Dover Plan (1963) Total
114, 842, 000 I.O.S. Regent Fund Ltd. (1963) Total
70, 700, 000 Investors Funds (1968) Total
49, 458, 000 The Fund of Funds Sterling Limited (1965) Total
36, 044, 000 1.0.S. Venture Fund Ltd. (1968) Total
29, 225, 000 I.V.J. Invest N.V. (“IVM”) (1969) Total
1, 271, 000 Svenska Internationella Invertmentfonden ("Interfond") (1969) Total
874, 000 Rothchild-Expansion (1969)
(1) 1 Not available.
In early 1965, the Securities and Exchange Commission began an investigation of IOS to (1) determine the impact of its activities on registered mutual funds and on the securities markets and (2) to determine whether it or any of its subsidiaries had violated the Federal Securities laws. Litigation by SEC against IOS resulted from this investigation, and culminated in a settlement under which IOS agreed to cease all operations in the United States which come under the regulation of SEC. This included sales to United States citizens anywhere. The details of the investigation, the litigation, and the settlement are discussed in the SEC testimony before this Committee. Ios investments in United States companies
Securities and Exchange Commission personnel furnished the Banking and Currency Committee with a listing of IOS and IOS-affiliated company investments at September 25, 1969. The list shows the combined stock, bond, and note holdings of Fund of Funds Proprietary Funds, Ltd., International Investment Trust Fund, Fonditalia, IOS Venture Fund of Canada, IOS International Ventures Fund, and Regents Funds.
Our analysis of the information in the list indicated that IOS and its affiliates held stock, bond, or note interests in a total of about 522 companies (domestic and foreign) at September 25, 1969, and their combined holdings represented 4 percent or more of the oustanding issues of such holdings in about 62 of the 522 companies. About 464 of the 522 companies were United States companies and the IOS and affiliated company combined holdings represented 4 percent or more of the oustanding issues of such holdings in about 50 of the 464 United States companies.
In preparing this paper concerning Investors Overseas Services we have tried to be responsive to Chairman Patman's letter of November 7, 1969 to Chairman Budge, which stated :
"We would like background information on how this organization was formed and the circumstances of the agreement whereby Overseas Investors Services removed itself from SEC jurisdiction. We are interested in the inability of the Commission to examine the books and records of iOS because of the latter's argument that such disclosure would be a violation of foreign law. We are particularly interested in this organization's activities in this country, including the number and amount of its acquisitions and any general patterns which may have developed therefrom. This would include its influence in the management of American companies in which it has acquired an interest. The Investigation
In early 1965, the Commission's staff first became aware of the very substantial positions which had been acquired by The Fund of Funds, Ltd. (“FOF") in the shares of several registered investment companies.? FOF was incorporated in Canada but its securities are not sold there. It was operated from Geneva by I.O.S., Ltd. (S.A.) ("IOS”), a Panama company also controlled from Geneva by a group of expatriate Americans headed by Bernard Cornfeld and Edward M. Cowett. Because of the size of FOF's holdings and the apparent scope of the activities of both FOF and IOS, in early 1965 the Commission directed the staff to conduct an investigation of IOS to determine (1) the impact of the activities of FOF and IOS on registered mutual funds and on the securities markets and (2) to determine whether FOF, IOS, or any of its other subsidiaries violated the Federal Securities Laws.
At the time the investigation was ordered, IOS was a registered broker-dealer. It had registered in 1960 because its principal business then involved the purchase of securities through the use of the jurisdictional means and the sale of such securities to Americans overseas. As a registered broker-dealer, IOS was required to keep copies of its books and records in the United States, or file an undertaking to produce any or all of its books and records in Washington, D.C. on demand by the Commission. It had filed such an undertaking and consequently was permitted to keep its records and books in Geneva.
The staff's investigation uncovered a number of violations of the Securities Act of 1933 ("Securities Act"), the Securities Exchange Act of 1934 (“Securities Exchange Act”) and the Investment Company Act of 1940 (“Investment Com. pany Act”).
1. IOS had sold interests in FOF within the jurisdiction of the United States in violation of the registration requirements of both the Securities Act and the Investment Company Act. The prospectuses and selling literature used by IOS to describe FOF contained statements which fell far short of the disclosure standards of the Securities Act and the Securities Exchange Act.
2. The investigation revealed that IOS was causing registered investment companies to directly execute transactions for their portfolios with certain broker-leaders, or directing such companies to require that their own executing broker-dealers give up a portion of their brokerage commissions to the brokerdealers designed by IOS. IOS or its affiliated persons apparently were able to benefit from such brokerage commissions, although as discussed later, we were stymied in tracing the flow of the monies, which over a relatively short period of time aggregated several millions of dollars, by the secrecy laws of the Bahamas. IOS also caused the registered investment companies involved to inadequately describe such arrangements in their prospectuses.
3. The investigations also disclosed that IOS had violated Section 17 (1) of the Investment Company Act in that an investment company under its control engaged in a transaction with certain registered investment companies in which FOF had substantial stock holdings, in violation of the Act.
During the investigation, we also conducted an inspection of a wholly-owned subsidiary of IOS, Investors Continental Services, Ltd. ("ICS”), also a registered broker-dealer, at the principal office of ICS in New York City. During that inspection, the staff found, reviewed and then requested ICS to furnish a copy of a certain letter written by Mr. Cowett to another employee of the IOS organization in Geneva with a copy sent to Mr. Cornfeld. Although the letter was not turned over and apparently destroyed, a hand-written copy of the letter had been made by the Commission's staff when they were in ICS' offices during the inspection. In that letter, Mr. Cowett stated in part:
"As you are probably aware, the ICS files are always open to complete examina. tion by the NASD or SEC. One improper paper in the file, if discovered, could lead to a complete investigation of the entire workings of ICS. Such an examina. tion would include, in all probability, a review of all correspondence coming into the office over a protracted period. Since the correspondence in any period of three
1 A schedule showing the size of FOF's reported holdings at June 30, 1966 is attached as Exhibit A.
2 The full text is set forth in the Commission's order for public proceedings of February 3, 1966, a copy of which is attached as Exhibit B.
or fonr or five days is bound to include at least one daming (sic) letter, you can see that the results could be disastrous,
"I do not mean to panic everybody involved by this letter and my letter of even date. I can ask no more than that each person involved do his part in cutting down the extent of our obvious violations."
After the investigation continued for some period of time, we concluded that it was necessary to determine the extent of the apparent violations of the registration provisions of the Securities Art and the Investment Company Act. Accordingly, the Commission then demanded that IOS produce, pursuant to its 1990 undertaking, its customers' records or its records of all transactions or acrouts effected by IOS with or for l’nited States citizens or nationals, whicherer IOS preferred. Although that undertaking was still in effect. Ios refused to produce the records relying on Swiss secrecy laws. Also, during the course of the investigation, a subpoena was served on the manager of the IOS branch in Puerto Rico for production of the books and records maintained in that office relating to sales of interests in FOF to United States citizens. In response, in December 1965, IOS brought an action in the United States Federal District Court in Puerto Rico to enjoin the investigation and to quash the subpoena. The Litigation
IOS' lawsuit to enjoin the Commission's investigation was, in effect, a final effort to prevent the Commission from further delving into IOS' activities, such as the reciprocal brokerage and give-up arrangements, IOS' sales of interests in FOF to Americans, the effect of its purchases and sales on the l'nited States markets and the conflicts of interests of its affiliates.
In the litigation, IOS sought a declaratory judgment that it could withdraw its broker-dealer registration and that it had not violated the Securities Exchange Act and the rules thereunder when it failed to comply with the Commission's demand. IOS questioned the Commission's jurisdiction and relied, in part, on alleged interdictions of the Swiss secrecy laws as justifying non-compliance with the Commission's demand. On February 3, 1966, shortly after IOS started the lawsuit, the Commission issued an order for public proceedings pursuant to Sections 15(h) and 15A of the Securities Exchange Act and IOS then sought to enjoin the conduct of the proceedings.
The District Court in Puerto Rico flatly rejected IOS' jurisdictional arguments, quickly dismissed the complaint to quash the subpoena and subsequently granted the Commission's motion for summary judgment. The District Court rejected IOS' argument that the Commission's jurisdiction was limited and also did not accept the argument bottomed on the provisions of the Swiss secrecy laws. The Court accepted the view that Swiss law did not preclude IOS from producing its records for staff review in accordance with the provisions of the Securities Exchange Act. Moreover, the Court held that even if there were such a conflict, IOS, as a registered broker-dealer, was nevertheless under an obligation to comply with the United States law to which it submitted, and, if the public interest requires disclosure of its books and records to the staff, then IOS had to decide whether or not it wished to continue to do business in the United States. If IOS wished to do so through the use of the mails and facilities of interstate commerce, the Court said that it must be willing to comply fully with the United States law. If not, it was up to IOS to determine whether it wants to do business.
IOS appealed and also sought a temporary injunction blocking the conduct of the proceeding pending disposition of the appeal. The Court of Appeals for the First Circuit unanimously turned down the request for a temporary injunction, stating that:
“... it is unthinkable that an administrative agency cannot even institute a proceeding until it has had, in effect, the permission of the district court and of the court of appeals whenever the parties to be investigated choose to deny its jurisdiction." The Commission's Proceeding
The Commission's order for proceedings set forth staff allegations of various securities laws violations. First, there was Section 5 of the Securities Act and Section 7 of the Investment Company Act—the registration provisions—in connection with the offer and sale of the IOS Investment Program for the Accumulation of Interests in FOF. This charge was based upon the allegation that the instrumentalities of interstate and foreign commerce were used in connection
3 See Exhibit B attached. * A copy of the District Court's opinion is attached as Exhibit C. 6 A copy of the Court of Appeals order is attached as Exhibit D.
lishing the existence of deposits when in fact none existed. To this date the ultimate destination of the balance remains a question.
We would next like to make a few remarks about the avoidance of the Federal Reserve Board's rules for the regulation of purchases of securities on credit, through the use of foreign financings. As we mentioned a few minutes ago, the recent contest for control of MGM illustrates how large sums are being obtained abroad for the purchase of American securities on terms which are not permitted by the margin rules. In the MGM case, we understand, American lenders would have required over three times the collateral that the foreign banks did. The problem as we see it is two fold.
First, it may be contended that, under the existing margin rules, as interpreted by the Federal court in the MGM litigation, foreign lenders can make loans to Americans for the purchase of securities in American markets on any terms they care to. Obviously, to the extent that the margin rules attempt to prevent unwise market credit extension and "pyramiding", the extension of credit by foreign lenders without regard to the margin restrictions defeats these objectives.
Second, we have the problem of policing the margin rules as to the activity of domestic lenders, who may disguise their participation in transactions with American companies by placing them through foreign intermediaries. We found that some foreign entities, in certain instances, opened and maintanied special omnibus accounts with American brokerage firms for American customers, who used them to evade the clearly applicable margin rules. We suggested that such accounts be restricted to American firms, and last year the Federal Reserve Board limited the availablity of such accounts, which should stem this type of illegal activity. However, the evasion of the margin rules through other types of transactions is still possible unless we have the means necessary to get behind the facade provided by foreign intermediaries.
Because obtaining information on securities transactions coming through foreign entities has been so very important to us in carrying out the responsibilities that the Congress has placed on us under the federal securities laws, this Commission has been in the forefront of those attempting to obtain all relevant information concerning foreign entities involved in any of our cases. While we have had some success in obtaining information in certain cases, as indicated above, by and large we have been thwarted more often than not. The problem is that we have been unable to obtain the information we need on any regular basis. In a few cases foreign authorities have been able to be helpful to some extent, but in most cases where information has been obtained it has only been made available after a considerable lapse of time.
Measures applicable to American citizens and residents, and, in certain instances, persons doing business in America, which help us obtain more information concerning these kinds of transactions, together with treaties or international agreements which would secure the cooperation of foreign governments in our investigatory efforts, are most desirable.
We appreciate that some foreign instituions may oppose any actions which would make it more difficult for them to wrap the cloak of secrecy about questionable financial dealings. However, we believe that responsible foreign financial agencies and investors should support such actions because it is in their best interest to preserve the fairness and honesty of America's securities markets,
We know from experience that it is the confidence in the integrity of our markets, as much as it is the strength of our economy, that has been responsible for the extensive foreign trading and investment in the stocks and bonds of America companies.
We welcome any reasonable measures which will be of assistance to us in dealing with the problems described above and thus be of help to us in continuing to protect the investing public by enforcing full disclosure in connection with public offerings of securities, as well as detecting and preventing evasion of the anti-manipulative, anti-fraud and other applicable regulatory provisions designed for public investor protection. To the extent that the provisions of S. 3678 will discourage Americans from making use of foreign banks and financial institutions for unlawful purposes, or enable Americans who may do so to be more readily identified, it should be of assistance to agencies such as the Commission in carrying out their enforcement and regulatory duties. At the same time, as I have said, we are desirous of encouraging legitimate foreign invest. ment in our securities markets, it is only the illicit practices that we wish to inhibit and eliminate.
We wish to thank you very much for the opportunity to appear here today. and if you have any questions concerning this matter we will endeavor to answer them now to the best of our ability, or undertake to provide you with the answers at a later date.
Senator PROXMIRE. The committee will stand in recess until 10:30 tomorrow morning and reconvene to hear Mr. Rossides of the Treasury Department and other witnesses on these bills.
(Whereupon, at 12:00 p.m., the hearing was adjourned, to reconvene Tuesday, June 9, 1970, at 10:30 a.m.)
(Testimony of the Securities and Exchange Commission before the House Banking and Currency Committee referred to earlier on p. 75 follows:)
FEBRU’ARY 16, 1970. STAFF MEMORANDUM To: Wright Patman, Chairman. Subject: Investors Overseas Services (IOS) and its 11e of secret foreign fi
nancial facilities. Transmitted herewith is a report on Ios, including (1) its background, (2) its sources of revenue, (3) SEC-IOS litigation, and (+) its investment in companies in the United States.
The total net assets of the mutual funds managed by IOS were $1.8 billion at August 31, 1969, of which approximately $1.2 billion or about two-thirds were invested in equity securities of l'nited States corporations. The consolidated net income of ios has increased from about $1.7 million in 1964 to about $14.7 million in 1968.
Each IOS-managed mutual fund is subject to applicable governmental regulation in the country of its organization. The funds are apparently purposely organized in countries with a minimum of regulations. This is particularly true as regards tax regulations, and IOS and its subsidiaries have paid taxes at very low rates (almost no taxes are paid in the United States despite equity investments in this country in excess of $1 billion).
It is the conclusion of the committee staff that the bank secrecy laws of the countries in which IOS operates enable investors in the C.S. securities market to conceal their identity and the purpose of their investments. This in turn makes possible (1) the purchase of stock without meeting the margin limitation on credit promulgated for this purpose by the Federal Reserve, (2) the funneling of funds from illegal enterprises into legal businesses, (3) "insider” trading by those with privileged information, to the possible detriment of other stockholders, (4) possible weaknesses in security when companies controlled by unknown individuals have defense contracts, and (5) evasion of income taxes.
INVESTORS OVERSEAS SERVICES Investors Overseas Services (IOS) was the forerunner of a growing number of off'shore mutual funds which, theoretically, sell their shares to non-Americans, using most of the proceeds to invest in American securities and real estate.
One reason for the tremendous growth of these funds is attributed partially to the fact that most of them operate from countries having corporate and bank secrecy laws. Thus, investors seeking to remain anonymous for any number of reasons, either proper or improper, can do so. Another reason is the Foreign Investors Tax Act enacted by Congress in 1966. This act, in effect, said that if a corporation's sole activity in the United States was the buying and selling of securities, it was not considered doing business in the U.S. and therefore, not subject to U.S. income tax laws. The total amount invested in the American market by these funds is now estimated to be several billion dollars.
IOS is by far the largest of these funds. It was founded as a mutual fund sales business in Paris in 1956 by Bernard Cornfeld. Incorporated as a Panamanian corporation in 1960, it was expanded to include mutual fund management and a vast complex of other financial activities. The Panamanian corporation was reconstituted as a Canadian corporation during the week commencing June 20, 1969, without change in management. The company's principal executive offices are in Geneva, Switzerland, and the registered office is in Montreal, Canada. In addition, the company maintains more than 200 regional sales, administrative, and information offices throughout the world, including Australia, Austria, Bahamas, Canada, England, France, Germany, Hong Kong, Italy, Lebanon, Luxemburg, Malta, Netherlands, Netherland Antilles, Panama, Spain, and Switzerland. IOS divested itself of its United States companies rather than provide full listing of investors, together with their detailed accounts requested by the Securities and Exchange Commission. The litigation leading to the divestitute of these U.S. companies and the revealing agreement are discussed later in the report and in the testimony to be given by the Securities and Exchange Commission before the Committee.