When John Bogle Speaks, People Should Listen!

By Robert L. McMahon

Yesterday The Corporate Library sent out a great Tweet regarding John Bogle, the founder of The Vanguard family of mutual funds, titled JACK BOGLE ON THE SILENCE OF THE FUNDS. The man who created index fund investing was speaking at the CFA Institute in Boston and ardently implored institutional fund managers, at all levels, to get off their collective duffs and pay closer attention to corporate governance.

One would imagine that if you're investing trillions of dollars for the future benefit of millions of Americans a duty of care would be exercised whereby you would know as much as possible, not only about a company's balance-sheet and income-statement, but that the company has an educated, experienced and effective board; that this board is not a rubber-stamp for management, that their are competent compensation, governance, and accounting committees; that the firm doesn't have pending legal issues that would compromise earnings, and is generally compliant with state and federal regulations. How about that the company offers shareholders "voting-rights"? But Mr. Bogle addressed the issue that mutual and pension fund managers have no interest, incentive or motivation to follow any of these governance issues.

In Mr. Bogle's address to the CFA he admonished mutual and pension fund managers for moving away from their "own-a-stock" outlook to a more "rent-a-stock" perspective. The Corporate Library reminded readers of the fact that average portfolio turnover now is 100%. Mr. Bogle urged professional investment managers to return to a long-term point of view and even supports the reinstatement of Glass-Steagall - the seperation of investment & commercial banking.

Mr. Bogle's final swings at these large money management firms was in calling for them to take corporate governance into consideration in the securities analysis process and would support legislation that would establish a "fiduciary responsibility" for the industry. Now there's some change I can believe in!

Improving Corporate Governance: A Memo to Investment Managers

By Robert L. McMahon

On May 10th John Brennan, Chairman Emeritus of the Vanguard Mutual Fund Company, penned an Op-Ed for The Wall Street Journal titled, “Improving Corporate Governance: A Memo to the Board”. In his piece Mr. Brennan makes eight (8) suggestions that Board Members can undertake to enhance company performance and improve overall governance; all of his advice should be well taken and understood to be well meaning for board members and shareholders alike.

However, when I saw that it was Mr. Brennan writing this piece about corporate governance I held out hope that he would also take the time to address issues of corporate governance from the perspective of an investment manager. I was looking for Mr. Brennan to weigh-in much like John Bogle has by saying that investment managers, like board members, need to be engaged in looking at the “governance characteristics” of the firms within which they are investing other peoples’ money.

Ironically, as Mr. Brennan was writing his piece, congress has found itself considering financial reform legislation that deliberately omits the two firms – now in conservatorship – at the heart of the financial crisis: Fannie Mae (FNM) & Freddie Mac (FRE), the two huge mortgage giants that nearly destroyed our economy. Even more ironic these two GSE’s (Government Sponsored Enterprise) were publicly traded firms, in the S&P 500 index, and were widely held by nearly every index, pension, and mutual fund in America. But as far back as 2002 any equity analyst or portfolio manager could have learned that these two firms were abject corporate governance disasters rivaling Enron. In fairness to FNM & FRE, they did work to improve their governance profiles since 2002, but there wasn’t a great deal of consistency to the effort. By 2007/2008 they had slid all the way back to rock-bottom per GovernanceMetrics (http://www.gmiratings.com/) governance reports. In 2008 we saw FNM and FRE fall to price levels that would not have bought you a copy of The Wall Street Journal as we saw the prices dip below $2.00 a share.

Incredibly though, between 2002 and 2008, we saw no major fund or portfolio manager call out the risks these two firms presented to the financial community and their investors in general. We didn’t see S&P look to remove them from their most widely tracked index (S&P 500), and we repeatedly saw congress look to minimize and mitigate the risks to the mortgage and credit markets these two presented even as everyone knew they were exempt from regular SEC filing standards and their executives were compensating themselves via accounting games designed to make their earnings look better than they actually were.

It simply isn’t the sole responsibility of the Board to keep an eye on corporations. I would additionally say that investment professionals should be a force in readiness to assess the risks when investing the hard earned money of working Americans. There needs to be a fiduciary standard of care for investment managers that requires them to assess the corporate governance risks of companies they buy and sell for our long-term benefit.