Investors Overseas Services Limited (IOS) was a major offshore financial group, which in the 1960s traded in stock funds, real estate and insurance, targeting first the military, then US citizens living abroad, and later wealthy nationals who wished to transfer their money abroad in violation of the tax and currency regulations of their home countries. Its failure around 1970 was resounding.

IOS was founded by an American businessman, Bernard Cornfeld. A concentrate of the sixties: Rolls, cigars and top models. This prophet of ‘people’s capitalism’ marketed investment funds throughout the world, including in Luxembourg. The largest of his funds, the International Investment Trust, launched on 5 January 1961 and was domiciled with the Banque Internationale à Luxembourg. IOS even opened a bank, the Investors Bank, in 1963.

A Ponzi scheme

Cornfeld’s empire collapsed like a house of cards in 1970 when the financial markets turned around. All the ingredients of a good financial scandal were present in this affair: an offshore company that slipped away in the middle of the night, passing without batting an eyelid from Geneva to Panama after being banned from operating in the United States and France. An opaque accounting system and an impenetrable structure of dozens of subsidiaries, banks, insurance companies and investment funds, located in the most diverse tax havens, completed the picture.

In the final analysis, IOS was a gigantic Ponzi scheme. Speaking about the operation of the company, the economist John Kenneth Galbraith explained that “the IOS was primarily a huge sales machine in which securities salesmen recruited other salesmen and thus received a commission on their sales. Those recruited recruited other salespeople, from whom they then received commissions. In Germany, the pyramid finally had six floors and only a fraction of the actual investments was still dedicated to the securities they were supposed to buy. All the rest went to commissions. It would be difficult to imagine a company that was more financially unsuitable for investors.”

First regulation of investment funds

What are the consequences of the collapse of IOS in Luxembourg? There were two kinds of consequences.

Firstly, the creation of Cedel--the future Clearstream--a clearing and settlement company which took all securities into central custody and replaced physical deliveries of securities, the norm at the time, with electronic transfers. It should be noted that at that time, in the event of a purchase or sale, the securities had to be physically delivered from the seller to the buyer, including abroad, with payment usually being made through separate channels after delivery of the securities. This was a slow, tedious, expensive and not risk-free procedure. The move upmarket in the market’s service offering was, in a way, the good part of the story.

The second consequence was increased surveillance of the mutual fund industry. While the marketing of IOS funds had been prohibited since 1956 in France, 1967 in the United States and 1969 in Germany, the Luxembourg regulator saw nothing but fire. In response, the Grand-Ducal decree of 22 December 1972 made funds distributed from Luxembourg subject to the supervision of the Commissioner for Banking Supervision and required the publication of an official list. This decree, drawn up in collaboration with the financial institutions, provided “flexible but precise guidelines which allow for development without sterilising the most worthwhile initiatives”, according to the explanatory memorandum. The Council of State stressed the importance of “protecting the good reputation of Luxembourg’s financial centres” without worrying about protecting investors.

Social consensus

From a political point of view, the affair met with almost no response in the media, with the exception of the German press where it made the headlines and was--modestly--buried.

Just as the Banco Ambrosiano affair in 1982 and the BCCI affair in 1991 would be a few years later. It was as if the social body was at one with its place and adopted the stance that Pierre Dupong and then Pierre Werner had taken in their time to protect the offshore model chosen by Luxembourg. It was a model where niches of sovereignty guarantee prosperity. The matter was never raised in the Chamber of Deputies.

It was not until the LuxLeaks episode that this consensus was called into question.

Originally published in French by and translated for Delano