Guest Post: Who Doesn’t Let Money Managers Off the Hook?

Submitted by Leo Kolivakis, publisher of Pension Pulse.

Before I get into the latest topic, I want you all to read Rolfe Winkler’s latest post on Well’s Dodgy Accounting. After that, read Tim Knight’s Be a Fool or Fight It? (I’d rather be a fool and make money in Q2).

Now to the latest topic. Diane Urquhart sent me this NYT article, He Doesn’t Let Money Managers Off the Hook:

EVERY once in a while, if only for sanity’s sake, it is wise to leave our bankrupt era behind and seek out a bit of wisdom from a moral authority. It’s a challenging exercise, given that so many formerly stellar reputations are now shipwrecked and that all those once-smart guys and gals have been reduced to bull-market geniuses.

And yet there are a few voices of reason and integrity left in this upside-down world. One is John C. Bogle’s. He is the founder of the Vanguard Group, an author and an investor advocate. With almost 58 years in the money management business, Mr. Bogle has kept his reputation intact. That alone sets him apart.

But Mr. Bogle is also worth talking to because he is a thinker, a sort of financial philosopher. And earlier this month he lectured at Columbia University about, not surprisingly, the financial crisis and its causes. What he said was illuminating.

In his talk, he cited the usual suspects: borrowers, lenders, securitizers, regulators and Wall Street traders. But he also identified one group that hasn’t been singled out for shame: the institutional money managers that allowed the nation’s financial companies to amass enormous risks on their balance sheets and pay gigantic compensation based on false profits. The big funds let this happen without uttering a word.

“When I read the causes of the recent unpleasantness, I haven’t seen one single person who has said that the owners of these corporations, including the banking corporations, didn’t seem to give a damn about how they were being run,” Mr. Bogle said in an interview last week. “We own all this stock but we pretty much do nothing.”

That “we” he talks about really refers to those in charge of our retirement accounts, pensions and savings: mutual funds and professional money management firms that, as institutional investors, control 70 percent of the shares of large public companies today.

Such an outsize stake means that the institutions wield great power and influence over corporate America. Yet, as Mr. Bogle points out, few institutions have played an active role in board structure and governance, director elections, executive compensation, stock options proxy proposals or dividend policies at the companies they own.

“Given their forbearance as corporate citizens,” Mr. Bogle said, “these managers arguably played a major role in allowing the managers of our public corporations to exploit the advantages of their own agency.”

INDEED, while many still believe that the American way of investing makes ours an ownership society, Mr. Bogle says we live in an agency society, one in which we rely on agents — mutual fund managers, pension fund managers — to make our investment choices for us.

An ownership society was an accurate depiction of where this country was 50 years ago, Mr. Bogle says. Not today.

And he says that the trust we have placed in these agents is undeserved. In his view, the agents have failed to serve their clients — mutual fund shareholders, pension beneficiaries and long-term investors; instead, the agents have served themselves.

Consider fees. Charges levied on mutual fund investors are much higher than those that the identical firms exact on pension clients, for example. The three largest money managers, Mr. Bogle pointed out, charged an average fee rate of 0.08 percent to pension customers. This compares with 0.61 percent charged to fund shareholders.

Money managers also haven’t done the kind of due diligence that might have protected their investors from titanic losses. “How could so many highly skilled, highly paid securities analysts and researchers have failed to question the toxic-filled, leveraged balance sheets of Citigroup and other leading banks and investment banks?” Mr. Bogle asked.

Keep in mind that these failures have occurred in spite of the Investment Company Act of 1940, which states that “mutual funds should be managed and operated in the best interests of their shareholders, rather than in the interests of advisers.”

In the face of all this, Mr. Bogle suggests that we force our agents to relearn what being a fiduciary means. A fiduciary, these managers seem to have forgotten, acts for the sole benefit and interest of another. We need to replace the agency society with a fiduciary society, he argues.

To achieve this, Mr. Bogle says, the government must apply a federal standard of fiduciary duty to institutional money managers. This would force them to use their stock holdings as a cudgel, to demand that directors and executives of corporations honor their responsibilities to their owners.

“We need Congress to pass a law establishing the basic principle that money managers are there to serve their shareholders,” Mr. Bogle said. “And the second part of the demand is that fiduciaries act with due diligence and high professional standards. That doesn’t seem to be too much to ask.”

Some money management firms are publicly traded themselves, and Mr. Bogle says that those firms offer an added layer of deep and serious conflicts because executives running them try to serve two masters: their shareholders and their fund clients.

Such conflicts can be resolved only by separating the money management units from the larger, publicly traded firms, Mr. Bogle said. Under such a plan, the Deutsche Bank Group, for example, would spin off DWS Investments, its mutual fund unit, or Sun Life of Canada would divest itself of MFS Investment Management.

And with a fiduciary law in place, Mr. Bogle believes, money managers would be far more responsible about corporate citizenship than they are now.

“The funds should demand with all their voting power that the companies they own are putting the interests of their shareholders first,” he said. “This would have implications for executive compensation, nominating directors, and other corporate governance matters.”

Mr. Bogle doesn’t think that the mutual fund industry will rush to embrace his idea. The powerhouses in the business have battled fiercely against attempts to shine sunlight on their practices or rid their operations of conflicts.

But as our current financial crisis has made clear, there are significant problems in the structure of the mutual fund business, and now is the perfect time to solve them.

“This will create a lot of opposition, but it is not a regulatory solution, it is a principles-based solution,” Mr. Bogle said. “We would gradually develop a series of decisions about how these things fit into the overall fabric of investment management. Is it easy to articulate? No, but is the principle easy to understand? Absolutely. Shareholders come first.”

It’s a shame there aren’t more John Bogles out there slamming institutional money managers, including pension fund managers for their lousy due diligence.

But don’t hold your breath for major changes. It looks like it’s business as usual and shareholders and pensioners will pay the price.

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  1. Anonymous

    Great post. John Bogle has been a vocal critic of the bubble economy and Wall Streets function during that bubble economy for some time. If only we had more “important” people like him.

    I wanted to repost one thought from a dead thread (“Are Pensions a Girl’s best friend”) from a while back. The whole thread was a disaster as people didn’t seem to understand my argument at all, instead attempting to find some sort of patriarchal mysogyny in my thought process (when there was none). However: my reposted thought:

    to Leo: rereading my first post the tone was more negative than it should have been, so I apologize for that. it was supposed to be an irritated tone for misusing data, but it comes off more scolding than I intended.Happy easter.Pseudonymousalso, sorry for this OT post.

  2. MarketBlogic

    YES, BUT . . . . I’d argue vehemently there’s not much evidence that Vanguard (that would be Bogle’s mutual fund company for oh, about 40 of those 58 years of experience in the money management business) has been an active agent fighting against high levels of executive compensation.

    Do as I say and not as I did, Mr. Bogle?

    And on fees, with the low fee presence of Vanguard in the industry, mutual fund investors have a choice. If they want low investment management and administration fees, mutual fund investors can all choose Vanguard. And if mutual fund investors want a broader selection of fund managers, or wish to pursue a premium priced fund manager in hopes of higher returns, they can do that.

    Don’t think that I disagree with Bogle on the “agency” issue, though – I most certainly do agree. But there’s a lot of irony in a bitter old man railing against a problem that his organization has done very little to combat over the years . . . . . .

  3. Neuberger

    The inherent conflict between money management customers and the shareholders of a publicly-traded money management firm is insurmountable. Please, Congress, SEC, do something.

  4. Anonymous

    I glad somebody “of note” is talking about this issue. What Bogle said is, however, should be freaking obvious to anyone who has two brain cells to rub together.

    What he didn’t get into is that the CEOs and the money managers and the bankers are all essentially one socio-economic group. Even if there was nice separation between this and that part of the financial-industrial complex, the culture – at least in the executive suites – would still be the same in all the parts.

    Perhaps all broad-participation (retail) mutual funds should be run by organizations that are mutually owned themselves. No public shareholders, no narrow private owners.

  5. Anonymous

    Bogle is a greedy slime ball ass wipe cry baby.

    He personifies the plain old vanilla greed folks having a tantrum against the newer more vicious elite greed folks who have hijacked the financial arena (and government) and are changing the utility vs exploitation ratio of money to full exploitation so as to eliminate the middle class globally and reduce consumption of resources.

    What a hoot. He wants the institutional money manager crooked agents to
    be reined in by the crooked politician agents he has been buying for years.

    The real losers are those that believe and waste their valuable time reading the propagandistic crap in The New York Slimes that portray Bogle as one of; “a few voices of reason and integrity left in this upside-down world.” Yuk! Gag me with a spoon! Billionaire hero worship propaganda bullshit!

    What really needs the public’s attention is the lop sided ‘rule of law’ — that Bogle himself has played a part in turning into a scam that favors the wealthy few. That rule of law needs a reset!

    Deception is the strongest political force on the planet.

    i on the ball patriot

  6. Anonymous

    I was not a fan of “Mr Vanguard.” As he took the mutual fund industry to task over expenses etc. However, I will say that I do agree with some of what he says here.

    Due to the fact that some fund managers got in the CDS business, expect a number of class action lawsuits coming from that (Oppenheimer is facing one at this moment). Another cds related problem: a prominent fund company is holding bonds that will pay more if defaulted due to a cds contract. In the end this helps the fund, but at what cost to the company that is in trouble and other shareholders? This is the part that gets “fuzzy” to me. I guess the fund company is only to act in what is in their financial best interest, however at what cost is this best practice or ethical??

  7. Anonymous

    Sadly, Bogle sounds like an archaic relic from a past age, where technological innovation drove the productivity increases that generated our nation's wealth & prosperity.

    As we all have learned to our chagrin, we were the ultimate dupes & rubes. Never again. An entire generation of intelligent citizens has learned that crime does pay.

    Due to this distortion, we will see efforts by those previously directed towards discovering the next "big thing" to focus instead on gaming the system.

  8. Adam

    I think it’s ironic that especially passive mutual funds were one of the important agents that allowed managment to operate with near total impunity (because their largest shareholders didn’t give a rat’s ass how the company was being run so long as it remained in the index and ISS signed off).

    It seems to me that concentrated stock ownership is a public good, and his firm was structured to free ride on that public good until everyone noticed that free riding was very cheap.

    Tax breaks for corporate raiders anyone?

  9. Anonymous

    I think it is evident that we do not prosecute people in this country for financial crimes with two exceptions: if you ponzi $50 billion or if you are a woman media celeb who gives household tips.
    Other than that you can run wild and brag about it in public.

  10. Carlosjii

    Screw Bogle and Vanguard – they once bounced a 6 figure executor’s check to me on a Friday so they could keep the funds over the weekend.

    My client fees are based SOLELY on gains in the account value.

  11. Anonymous

    la la laaa,la la laa I am not listening Leo, you cannot expect me to spend my time checking up on my pension fund manager. I don’t do small print, and if it takes more than 5 seconds to sign away my life and earnings I don’t want to know. I dont expect my pension fund manager to go against the flow and do the right thing, and if the manager did then he ought to be sacked, in fact I did sack him, more than once. It is so hard to find a good pension fund manager these days, I guess all the good ones have left the industry.
    If you were that worried about it you should have gone into banking, I did and made a nice little packet out of the bonuses selling rubbish to pension fund managers. Ok so I lost my job recently, but to be honest I have so much loot I was looking to retire anyway. You could have been sunning yourselves on the beach all day before your 30th birthday like me, if you had just been born with the right background. That is why i am rather cross with you Leo for trying to interupt our birth given rights, what is my little Timothy going to do if he cannot sell derivatives to pension funds?
    Checking up on things and enforcing the law should be up to government and decision makers you cannot expect the average person to spend even 2 seconds trying to be financially literate. Timothy’s elder brother Jonathan is doing rather well as a regulator and has caught two pensioners who cheated on their tax this week. He agrees with me that regulation on borrowers has been lax and to ensure the financial stability of our banks and incomes we need to stamp out behaviour which rocks the boat. Now Leo you seem like a intelligent nice chap how about we pass some loot across your desk and you fade into the blogging background so to speak.

    OK so I made it up, but how far from the truth could it be really?

  12. autodidact

    Now wait just a minute here. Wasn’t Bogle the biggest advocate of index funds. An index fund basically does not manage. It buys the index.

    How can such a fund exert any pressure or control over the big basket of companies they own? By the very nature of the fund, all they do is buy all those companies in the proper proportion to mirror the index.

    That means there is no check on what the corporations do, as far as shares owned by index funds are concerned.

    So, while I agree with Bogle’s point here, I see his company and the index funds he promoted as part of the problem. If people had to buy individual stocks, perhaps they would at least read the annual reports of the company before plunking down $5K for a hundred shares. Or perhaps not. But at least they’d have no one else to blame.

    Index funds are convenient, but they are basically passive shares when it comes to corporate governance. Whatever the corporate boards do, no matter how much debt they amass or what risky expansion schemes they concoct, those index funds would continue to own the shares, as long as they’re in the index.

  13. Harlem Dad

    Bogle says that Money Managers have violated our trust, in spite of the Investment Company Act of 1940, which states “mutual funds should be managed and operated in the best interests of their shareholders, rather than in the interests of advisers.”

    And his solution is?

    “We need Congress to pass a law establishing the basic principle that money managers are there to serve their shareholders.”

    What a load of crap! Or should I say CARP? Congressional Asset Relief Program. It’s where Congress Relieves me of my Assets.

    Bogle is running to Congress for even more legitimization of the Financial Industry’s favorite pastime, Grand Theft Taxpayer.IRAs and 401(k)s, virtually force working people to hand over their money to these Agents of Fraud. If I work for a firm that has a 401(k) program, I am NOT allowed to put my money into an IRA. And as long as I continue to work for said employer, my 401(k) options are limited to those that my employers give me.

    And even if I put my money into an IRA, I’m severely restricted as to the nature of that “defined contribution.” What if my uncle has a thriving grocery store that needs a little investment? Maybe my siblings and I would like to buy a working farm, grow some local organic vegetables? Or maybe I’d like to invest in a really solid utility company in East Asia, or Western Europe? The answer is no, but you can invest in John Bogle’s International East Asian Energy/Commodity/Rape Your Daughter and Burn Your House to the Ground Fund!

    The enormous Transfer of Wealth from the have-nots to the haves didn’t begin with Tim Geithner or even with the A.I.G. bailout. It started a long, long time ago.

    Unsophisticated, unconnected, powerless, ordinary folk like me are on our own in this society. We know it. We just haven’t begun to act like it yet.

  14. Markeblogic

    Ditto, autodidact.

    Just one more go-round the hypocrisy trough for the angry old man of Vanguard.

    Btw, I don’t know for sure who paid for it, but there’s an incredibly ugly lifesize bronze statue of Bogle out on the Vanguard grounds.

  15. wunsacon

    >> plain old vanilla greed folks having a tantrum against the newer more vicious elite greed folks

    Bring back plain old vanilla!

    It worked better.

  16. Anonymous

    Wow, you guys are tough. His book, Battle for the Soul of Capitalism was well written, well thought out and rang true to anyone who had worked in a company managed for the benefit for management rather than shareholders.

    My guess is that he is one of the good guys.

  17. Harlem Dad

    Anonymous @ 2:23 said:

    > My guess is that he is one of the good guys.

    I’ll accept that. Which means that I accept that my painting of John Bogle with too broad a brush may be overly harsh and unwarranted. Mea Culpa.

    But I’m standing by the first 3 paragraphs of my post at 1:42. I’m not impressed with his solution to the problem. And from his point of view the problem to be addressed is holding money managers to a fiduciary standard.

    My point is that those of us who must provide for our own (defined contribution) retirement by law must turn our money over to these guys. How much money would Mutual Funds have to manage if they didn’t have an income stream guaranteed by the Tax Code?

  18. Mara

    Commenting on the fees for funds (nearly 8x greater for MF’s rather than pension funds), don’t forget the very real “front-running” effect those funds can collude with brokers. Please don’t tell me it doesn’t happen. It does, the smart ones just break it up so it doesn’t look so obvious.
    The entire madness being played out with the govt pledging to make bad bank loans whole, guaranteeing pensions, etc. What a crock, they can’t guarantee all that. The pension and retirement money has been stolen and/or never existed, frittered away on overpriced stocks and poisonous derivatives. Admitting that would cause a revolution, with lots of angry boomers with pitchforks (at least the ones who could even confront that much).

  19. Economic Darwinism

    I can tell you that from the inside of one of the world’s largest and most respected global asset management firms that they truly thought they were being diligent. They just didn’t understand the issues. They didn’t understand the mechanics of a CDO. They looked at capital ratios, but didn’t understand the weaknesses of risk management that went along with them.

    Even asset managers who were responsible enough to not invest in toxic assets did not understand the risks posed to the banks by their very existence.

    Most traditional asset managers have been in the business for decades. They are not quants. They couldn’t model a stochastic process to save their lives. Why should they? They like it that way.

    In fact, even if they had a quant at the firm who tried to warn them, they did not understand the mathematics well enough to pay attention. Besides, why should I listen to a quant anyway? I remember being extremely frustrated trying to warn internal banking analysts about CDOs and weaknesses in risk management systems. I would hear (back in late 2006, early 2007), “The banks are healthy. They are more capitalized than in any time in history.” That was true. Then I would ask, “Well, what if they turn out to be less well capitalized than they should be given the risk they have taken on?” I tried to explain how every bank on Wall Street was using almost identical risk models. I tried to explain how CDOs represent a blind spot to risk models due to the fact that almost all the risk is “in the tails”, where risk models don’t even attempt to look (VaR represents a boundary of what is considered a tail event and does not look at what lays beyond). Part of it was a failure to communicate. The two worlds (quants and their toxic assets and traditional asset managers) were just too different.

    The events that have transpired are so far beyond the experience of even the most aged asset managers that they had trouble considering the remotest possibility that such losses could mount. Does that let them off the hook. I agree with Bogle. No, it does not. Asset managers failed their clients in a massive way. The warnings were there. People tried to tell them, but the returns were just too attractive even for the best and most responsible (relatively speaking) asset managers.

    Look at the large asset managers. Look at the largest shareholders in the biggest companies. Those deserve a larger portion of the blame then they currently are accepting. Does it matter? No. They will continue to reap the benefits of management fees from shell shocked retirees and life will go on as it always has.

  20. Leo Kolivakis

    Economic Darwinism wrote:

    "Look at the large asset managers. Look at the largest shareholders in the biggest companies. Those deserve a larger portion of the blame then they currently are accepting. Does it matter? No. They will continue to reap the benefits of management fees from shell shocked retirees and life will go on as it always has."

    >>Unfortunately, you are right. Asset managers find safety in numbers. Very few like to stray from the herd.

    But you did not need to be a "quant" to figure out that the securitization bubble was bound to explode, exposing the bad assets that banks held on their books.

    I looked at one chart from the Fed showing the explosive growth in securitized assets back in 2006 and I cringed. I also saw billions of pension dollars flowing into hedge funds, private equity and real estate funds and I cringed again.

    Now banks are reporting profits again. No magic here…it's all about the SPREAD!!! If they are borrowing at .25% and lending at prime at 3.25% or even at Libor at 1.9%, they are making a killing, printing money. Moreover, they are charging higher rates on existing customers citing the credit crunch and stopped lending to new customers (give me a break!).

    Bogle might not be one to talk because for years he stayed mum. But at least he is slamming fiduciaries now and I think he raises several excellent points.

    The big problem is that the whole financial system is fraught with conflicts of interests.

    I prefer the hedge fund model where managers have skin in the game and do not get paid performance fees until they pass their high water mark and a hurdle rate.

    The problem is that most hedge funds are charging alpha fees for disguised beta and juicing their returns through leverage.

    One thing is for sure, Joe & Jane Investor who have to contribute to DC plans are getting screwed on fees since most mutual funds can't outperform a low cost index fund.

    Who says the military industrial complex is where all the power is concentrated? Try the tyranny of the financial complex.

    I thank all of you who posted your comments.



  21. Anonymous

    Didn’t Vanguard lose more than 50% of value last year? I figure, this Bogle guy’s do one better Roubini is a desperado attempt to stave off masses of peasants heading his way with extra sharp, flesh-cutting pitchforks in hand.

    Anyway, his proposal is nonsense. How about we turn them all into 5-digit salary employees, with no bonuses and no commissions. Any money beyond their salary that they cannot document should be classified as embezzlement and earn them free lifetime room and board in the nearest Federal joint. Considering the damage and pain they’ve caused, these SOBs should be happy they’d have a job.

    Vinny GOLDberg

  22. Anonymous

    I guess someone has to say it. John Bogle is a grade A A-hole. That’s right…I wrote it.

    Why, you may ask? Well, because the guy built a fortune on the premise that investors need not do any analysis whatsoever of what they own, simply because the “market” — that ether of our times — magically prices things more or less at the appropriate level. Therefore, it is far better for investors to “piggyback” on the backs of other investors who are doing the price setting (and the research that’s required to set prices appropriately) and pursue “passive” investment strategies.

    Now, after being the biggest booster for passive investing, he pipes up and wonders why owners have not stood up and taken an “active” interest in their holdings.

    F-you, Bogle. F-you.

  23. Economic Darwinism

    You are right Leo. It didn’t take a quant to see what was going on. In fact, I remember sitting down with John Sylvia (Chief Economist of Wachovia) shortly before I resigned. He spelled out clearly how bad the credit markets were going to get and insisted I send a report around to anyone who would listen. Soon after, the head of structured credit at Goldman walked us through step by step what would transpire and it did transpire almost exactly as he laid out for us. Did anyone pay heed? No. I was shocked. My total disillusionment was a big reason I resigned. That was just prior to trillions of dollars of wealth being destroyed. Hundreds of billions from this firm alone.

    The asset managers were warned and, I agree, deserve a big part of the blame.

  24. Anonymous

    Now that I take a closer look at the mob of peasants rushing down my street, I see that not all of them carry pitchforks. Um… is that an AK-47 I see that octogenarian carry?

    Wall Street crooks beware. This is still America. The peasants here have a constitutional right to bear more than pitchforks. Minor detail that should never be forgotten.

  25. Anonymous

    Sy Krass said…

    HAHAHAHAHAHAHA!!!!!!!!!!! I give him some credit but “Mr. Index fund,” “the market goes up over time,” was wrong in 2008. The market goes up and down. As a side, per Tyler Durden’s post about private money leaving the market, I am sure there will soon be 3 – 5 large players just trading back and forth with each other. Watch for some truly bizarre market behavior soon. Up 3,000 points, down 4,000… in very short periods of time.

  26. Francois

    Harlem dad wrote:
    “My point is that those of us who must provide for our own (defined contribution) retirement by law must turn our money over to these guys. How much money would Mutual Funds have to manage if they didn’t have an income stream guaranteed by the Tax Code?

    As they say in the soccer’s press box: GOOOOOOOOOL!

    Abolish 401k in its present form and convert it into a self-managed account. Right there, you’ve neutered this legalized robbery.

    Of course, only backassward countries like Canada or Chile can come up with stupid schemes like that. We are so much more civilized and smart to do something like that aren’t we?

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