A Talk With Jack Bogle: Will The Scandal Make The History Books?
August 22, 2005
Jack Bogle, founder of Vanguard, one of the most formidable mutual fund companies and investing approaches in the United States, is always a good man to check in with on weighty industry issues. Money Management Executive Editor Lee Barney spoke with Bogle last week, on the eve of the Sept. 3 two-year anniversary of the mutual fund trading scandal.
Money Management Executive: Do you believe that the reforms resulting from the trading scandal will make any significant difference to the way mutual funds are run - and, the burning question, will the trading scandal even go down in the history books?
Jack Bogle: I'm sure that we are at a defining moment in the history of mutual fund management.
While we clearly need to put meat on the bones of the Investment Company Act of 1940, precluding the need for even more regulation, perhaps a combination of better enforcement of the existing rules and some new ones will underscore the implicit fiduciary standard of the 1940 Act.
There are a lot of positive things in development now, although I fear that progress on these reforms will be painfully slow.
MME: Do you get a sense from investors that they are aware of or even care about the fund scandals?
Bogle: I spend much time speaking to executives and investors - meeting with corporate America, mutual fund America, and investor America - and my sense is that awareness of the scandals is small, and concern is largely lacking.
And awareness of the profound conflicts of interest between fund managers and fund shareholders - from which the scandals arose - is essentially zero.
MME: What needs to be done to prevent their recurrence?
Bogle: Let me remind you of the four requirements that I expressed in my testimony before Congress when the market-timing and late-trading scandals first broke three years ago.
First, there should be no more than one management company official serving on the fund board. Indeed, having any director associated with the investment management company sit on the board, let alone chair it, is odd to begin with. But the Securities and Exchange Commission rule requiring a super-majority of mutual fund directors - 75%-to be independent, although not quite what I wanted - comes pretty close.
Second, we need the chairman of the fund board to be an independent director, unaffiliated with the manager. The new SEC rule also requires this separation, and despite the recent United States Chamber of Commerce win at the U.S. Appeals Court, I believe the SEC rule will stand, as it should.
Third, the fund board must have independent advice on fund costs, performance and other matters. Again, the basic language of the SEC rule strongly encourages mutual fund directors to have their own staff or use outside consultants to provide such independent evaluation.
And fourth, we need a federal standard of fiduciary duty for fund directors and officers, which the SEC itself cannot provide, for it would involve preemption of state law. It will take federal legislation, and the sooner the better.
More broadly, we need fiduciary standards, not only in the mutual fund industry but also in society, to have a clear understanding of whom a financial adviser, director or other executive represents, along with clear standards for delivering on that duty. The law should help to clarify that difficult issue.
There is already a reality out there: The Investment Company Act of 1940 mandates that mutual funds should be "organized, operated and managed" in the interests of fund shareholders rather than in the interests of fund managers and distributors.
Arguably, the industry has been in violation of the letter of that law - and certainly its spirit. We must put a structure in place to get it right, and to give the shareholders a fair shake.
From the industry's and the Chamber of Commerce's point of view, there is a huge economic stake here, for the industry's huge profits come importantly at the direct cost of the returns earned by fund shareholders.
MME: What other lingering problems do you believe must be rectified?
Bogle: The driving force in this industry, once led by small, private investment counsel firms, now comes from giant, publicly or conglomerately owned enterprises. Marketing has replaced management as our highest value.
When the head of Bank of America demands that financial service revenues, now 7% of its total, grow to 15% in five years, it's hardly surprising that its financial service managers pull out all the stops to get there.
Among the investment managers in our industry, similar mandates were already a pervasive refrain. The trading scandals clearly reflect this pressure for asset growth and increased fee revenues, even at the expense of existing shareholders.
The scandals, then, are precisely what we should have expected when managers make unreasonable business and financial demands.