Around 1970, a Switzerland-based asset management firm, Investors Overseas Services, had grown into one of the largest in the world in the span of just a few years, this despite a small initial target market of American soldiers deployed in Europe. Of course, the company had grown far beyond this limited market in the years since it was founded, but it would have been best had it not. The firm’s growth and disregard for regulation brought it into conflict with American regulators. By 1972, Investors Overseas Services had been sold for little and its new ownership, rather than rescue the firm from the errors of its prior management, made off with hundreds of millions of dollars in investors’ money.
Investors Overseas Services
The founder of Investors Overseas Services was Bernard Cornfeld. Born in Istanbul, Cornfeld grew up in New York City, became a social worker and then a mutual fund salesman. He led Investors Overseas Services through its quick early growth. He founded the company in Paris with just a few hundred dollars in 1955 before relocating it to Geneva. Edward M. Cowett, the legal mind behind IOS had positioned the company to be free from government regulation, hence the Swiss home.
Investors Overseas Services was essentially an American mutual fund manager based in Europe. Since, it operated outside the United States, the company did not have to comply with the Investment Company Act of 1940. IOS sold mutual funds to American servicemen in Europe, about 800,000 of them were stationed there around the time IOS was formed, and later extended its services to other Americans abroad.
The product that catapulted IOS into the ranks of the world’s largest asset management firms was a ‘fund of funds’ launched in 1962. The fund of funds would invest in U.S. mutual funds. Largely because of this one product, IOS was very successful in raising money from investors; $15 million in just a year and in excess of $100 million in two years. The fund issued Class A shares to the public and these had no voting rights; the Class B shares that did were kept by Cornfeld and Cowett. The Investment Company Act of 1940 had prohibited this structure in the United States but the fund of funds Cornfeld launched was domiciled in Canada.
IOS was keen on attaching itself to illustrious names. Credit Suisse would be the fund’s cash bank and a subsidiary of Royal Bank of Canada its transfer agent and registrar. The company hired as either executives or directors men like James Roosevelt, the son of a former American President, and Donald Nixon, the nephew of a former Vice-President. By 1966, the company’s fund of funds was managing $360 million, the result of a much faster fundraising than had been achieved by almost any other fund before it.
Eventually, the fund of funds would invest in other IOS-managed funds as their sole investor, meaning the individual funds were proprietary and so the Investment Company Act did not apply even though these funds were U.S.-based, run out of New York. This structure also allowed the company to capture two layers of management fees for itself, on top of the already high initial commissions, to pay the company’s talented salespeople
Within ten years of launching its fund of funds, Investors Overseas Services was running eighteen funds, had offices in over 100 countries, employed 25,000 salesmen, and managed $2.5 billion. Besides management fees and commissions on shares sold, it also earned a performance fee on profits. Cornfeld was enriched by his business, and owned his own jet and homes in New York, London, and Switzerland.
Crimes
Unfortunately, IOS was not managed according to its investors’ best interests and also engaged in unethical and illegal activities. The fund was not diversified as advertised and engaged in short-selling when its prospectus said it would not. IOS also engaged in shady dealings with its officers and directors and in illegal currency transfers at a time when foreign exchange transactions, even those in developed market currencies, were tightly controlled.
Amidst this misconduct, IOS’s growing holdings of U.S. mutual funds brought the firm to the Securities and Exchange Commission’s attention. IOS was investigated by the SEC in 1966; the latter believed the Switzerland-based company was selling shares to Americans within the United States, which would have required it to comply with American regulations. IOS reached a settlement with the regulators, agreeing not to sell its fund products to U.S. citizens anywhere in the world. It was also barred from investing in American funds. The company got around this latter restraint by turning its U.S.-based funds into sub-accounts of a Canadian firm, but the managers remained U.S.-based.
Despite the regulatory pressure, IOS succeeded in raising $52 million in an initial public offering in 1969. While some banks declined to take on the IOS offering, the firm still found many willing underwriters: among them twelve French banks, thirty-four British, and twenty-three American, among those from at least seven other countries. Around the same time, the company was again accused of illegal conduct by the SEC, specifically fraud and illegally selling its fund to U.S. investors.
There was also a bear market in 1969. With all this bad news, IOS shares fell from $14 apiece in mid-October 1969 to $4 by the end of May 1970. This happened despite, or perhaps because of, spending by the company to prop it up. One of the largest beneficiaries of the company’s efforts to support the price was Bernard Cornfeld, and not merely because he was a large holder of the shares. In fact, he was also a large seller. Cornfeld was selling his shares, working against IOS’s own buying. By now, IOS’s distress was becoming well known and fund managers elsewhere began to sell securities they knew were overrepresented in IOS’s funds.
Robert Vesco
With the ire of regulators well-earned and the firm faltering, Cornfeld abandoned Investors Overseas Services and fled to Mexico. Cornfeld had sold the company to Robert Vesco for just $5.5 million in January 1971. Vesco’s purchase was financed by a brokerage firm that depended on IOS’s survival for its income. A high school dropout, Robert Vesco had already become wealthy amalgamating several industrial companies via leveraged hostile takeovers into his International Controls Corporation. One of IOS’s funds had been the largest holder of his company’s bonds and Vesco had earlier made an emergency loan to IOS.
Vesco was not arriving to rescue investors. Once in control of IOS, he began embezzling their funds. Vesco had the portfolio liquidated and made off with over $200 million that had been custodied with American banks on behalf of four IOS funds. The money was transferred to two other banks, one in the Bahamas and one in Luxembourg, both controlled by Vesco. He was charged by the SEC on November 27, 1972 alongside 41 other firms and individuals, including James Roosevelt, but not the SEC’s old troublemaker at IOS, Bernard Cornfeld. Vesco fled to Cuba to evade prosecution and extradition to the United States. His embezzlement ensnared even a number of banks with exposure to IOS.
While in hiding, Robert Vesco was included in a Forbes list of the wealthiest people in the world. Meanwhile, he was hopping between countries to escape extradition to the U.S., protected from prosecution at various times by the governments of Costa Rica, Nicaragua, Colombia, Libya, and Cuba. The charges against him would continue to mount. Vesco was accused of making an illegal campaign contribution to Richard Nixon in 1972 and bribing American officials years later to permit Libya to buy American airplanes.
Vesco was eventually imprisoned in Cuba in 1996. The charge against him was fraudulently marketing a drug supposedly curing cancer and AIDS, a project he engaged in with Donald Nixon, also of IOS infamy. The pair were accused of defrauding a Cuban state-run biotechnology laboratory run by a nephew of Fidel Castro. After his release, Vesco died in Havana in 2007. Bernard Cornfeld had died in 1995.
Lesson
If the story had ended in 1970, Investors Overseas Services would hardly be remembered except perhaps in the footnotes of a textbook for aspiring securities regulators, largely forgotten in favor of even more dramatic tales of misconduct. But the story after 1970 somehow managed to become even more notorious. Indeed, in comparison to Robert Vesco, Bernard Cornfeld’s propriety seemed unquestionable. Cornfeld may have been uncaring and self-serving, but Vesco was a bold criminal. It was probably no coincidence that Vesco would be attracted to IOS. The story of Investors Overseas Services shows how, left unstopped, fraud begets more fraud.
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Further Reading
1. Baldwin, A. Heroes & Villains of Finance: The 50 Most Colourful Characters in the History of Finance. John Wiley & Sons, 2015.
2. Lacey, Marc, and Jonathan Kandell. A Last Vanishing Act for Robert Vesco, Fugitive. The New York Times, 3 May 2008.
3. Markham, Jerry W. A Financial History of the United States. M.E. Sharpe, 2002.
4. Raw, Charles, et al. Do You Sincerely Want to Be Rich?: Bernard Cornfeld and IOS: An International Swindle. Penguin Books, 1972.
5. Robards, Terry. Suit Sees Misuse of $224 ‐ Million in Mutual Funds. The New York Times, 28 Nov. 1972.
