Letter to the Editor: Issue 17

In 1719 the British Parliament passes a piece of legislation known as the Royal Exchange and London Assurance Corporation Act 1719, also known as The Bubble Act 1720 (the year it received Royal Assent). This act forbade the formation of Joint Stock Companies without a Royal Warrant. The reason it had two names was that the company that lobbies hardest for it was The South Sea Company, as they wished to prevent competitors forming that would provide alternative investments to their wildly popular share offering; between January and May of 1720 their share price rose from £128 to £550. The legislation was effective and their share price jumped to £890 when the legislation was signed, hitting £1000 by August of the same year. It then promptly collapsing and the South Sea Bubble was born.

18th century politicians still being politicians began referring to the act as the Bubble Act 1720 with their spin doctors arguing that this bill had been passed to save unwary investors from similar schemes, hence the adoption of 1720 as opposed to 1719, as their argument held significantly less water if the bill could be seen to cause the bubble rather than be enacted as a response to it. This act stayed in force for over 100 years until it was repealed in 1825.

During this time, it was possible for business to be conducted by unincorporated associations, which could have thousands of members. Any arising litigation had to be conducted in the names of all the individual members, which was completely impractical. In 1844, the British Parliament passed the Joint Stock Companies Act allowing anyone to incorporate a company for the princely sum of £10. Limited liability was not introduced until 1855 (Limited Liability Act1855) and the following year they were consolidated into the 1856 Companies Act, which established the principles for corporate law which are still largely followed today.

The public, unsurprisingly, was a little wary. In 1856 Mr. Robert Lowe the then Vice President of the Board of Trade introduced the legislation with an argument you could hear on

Fox News today:

“A company formed on the principle of limited liability carries on the face of it something like prudence and caution. Its shareholders seem to say, "we have entered into a partnership, but it is impossible to tell what may happen, and since the company may fail, we will not risk all we possess in the undertaking….

My object at present is not to urge the adoption of limited liability. I am arguing in favour of human liberty - that people may be permitted to deal how and with whom they choose without the officious interference of the state; and my opinion will not be shaken even though very few limited companies be established. Every man has a right to choose for himself between the two principles, and it is ill-advised legislation, which steps in between him and the exercise of that right. It is right the experiment should be tried; and, in my judgment, the principle we should adopt is this, - not to throw the slightest obstacle in the way of limited companies being formed - because the effect of that would be to arrest ninety-nine good schemes in order that the bad hundredth might be prevented; but to allow them all to come into existence, and when difficulties arise, to arm the courts of justice with sufficient powers to check extravagance or roguery in the management of companies, and to save them from the wreck in which they may be involved”.

Unfortunately, we will never learn Mr. Lowe’s view of hedge funds and other such purely speculative entities. Instead, we will have to decide for ourselves whether we believe that it is appropriate to allow such companies to continue to benefit from the provisions that have undoubtedly benefitted the economic growth and wellbeing of the societies that have adopted them.

That is not to say that hedge funds and their ilk should be banned or forced to cease trading, just that those who wish to participate should not be allowed to hide behind limited liability provisions. They have to be made to take responsibility for their losses as well as their gains. If they want unlimited upside fine, but they need to be aware that the downside can be every penny they own.