Today CNBC's NetNet ran a great piece by their Senior Editor John Carney (http://www.cnbc.com/id/44599404/comid/1/cache/238#comments_top) about a fund manager's idea that the government should "license" board directors. John classifies this as "The Worst Idea of the Week" and I agree. I wrote a comment to his piece as follows:

There is no need for the government to "license" board members whatsoever. There already exists several Director Education groups within the country.

What really needs to happen is for more asset and mutual fund managers to take a greater interest in corporate governance, not only as an investment risk, but also as a force multiplier for alpha. If the largest holders of shareholder value behaved more like Bill Ackman, the Pershing Square Hedge Fund Manager, everyones equity investment boat would rise. And we also wouldn't have the need for Sarbanes-Oxley or Dodd-Frank.

This country is awash in MBA's and CFA's who wouldn't buy a car before looking at the car-fax, but would invest other peoples' money in the next Enron. They wouldn't hire a Jr. book-keeper without a background check, but couldn't care less about the corporate character of a firm added to the S&P 500 index. This idiocy and willful ignorance has to stop.

And this is why their should be some form of fiduciary standard enforced upon these firms - the largest holders of shareholder equity in America.

Great WSJ Interview with John Bogle

Jason Zweig, The Intelligent Investor writer for The Wall Street Journal, had a marvelous interview with a man I consider a genuine American Hero - John Bogle, founder of the Vanguard Mutual Fund Family of Funds (see it here; http://online.wsj.com/video/jack-bogle-why-mark-cuban-is-wrong-on-investing/A12A870B-7B21-42F5-BCA6-69329DDF5CA0.html?mod=WSJ_hpp_mpvidcar_2). Likewise Mr. Zweig follows up his interview with an equally as good column(http://online.wsj.com/article/SB10001424053111904103404576560913892680574.html) offering the reader additional insight and anecdotes.

Everyone out there who considers themselves a long-term investor should take advantage of this interview and column and steady themselves against what you see and hear about our financial markets. More and more our markets appear to be taken over by investment ghouls whose sole purpose is to diminish the value of investing and replace that disciplined approach with the instant gratification of "flash-trading". To me it's as if the rules of our roads were taken away and the Indy, Formula 1 and NASCAR drivers were driving with us on our own streets and highways, imagine that if you will? You and I simply wish to get from Point A to Point B, but these other drivers are allowed to drive among us at speeds that can approach 275mph! Their goal is to simply get there faster than you and in the process, maybe damage that car (mutual fund) of yours or even total it (an individual stock holder).

The SEC and CII should really be investigating all of these "dark-pools", HFT's, and ETF caused market swings. To my mind, these are what the front-runners were of the 1920's. Our long-term interests are being gamed and men like John Bogle are calling out the industry to do something about it.

Timely John Bogle on CNBC - 8 August 2011

It was really great to see John Bogle on CNBC today and weigh-in on his views regarding the S&P downgrade - http://video.cnbc.com/gallery/?video=3000037855 . It was also good to see and hear Jim Cramer asking Mr. Bogle a few prescient questions regarding ETF's and how ETF's are used by HFT (high-frequency-traders) to speculate. Both men agree that the SEC is not doing its job once again.

ETF's, HFT's, Dark-pools, have all made it much for difficult for "small" investors to have full-faith in the equities markets. The small investor knows they are being used as pawns and that "price discovery" and "liquidity" have very little to do with with why ETF's, HFT's and Dark-pools exist. They exist because they all make lots of money at the expense of others. They exist to "hide" activity, not to make the market more open, more transparent, or more accessible to the small investor. If the the SEC really cared why would they ever permit something called a "dark-pool" to exist in the first place; it's very name reveals it's purpose - "we're doing something we don't want the market to know about" in a very big way!

Acting Like An Investor - Bill Ackman

This weekend BARRON'S ran a wonderful profile by Jon Laing of hedge-fund manager Bill Ackman's PERSHING SQUARE CAPITAL MANAGEMENT titled, "The Happy Warrior". However, it was the cover title that caught my eye, "America's Amiable Activist".

The term "Activist" in investment circles usually conjures up the stereotype of the liberal gadfly railing against the corporate machine to change their ways, not kill snail-darters and butterflies, ceasing making bullets, booze, cigarettes, or only employee union workers. Here, however, the term "activist" really means "rational investor". For what Bill Ackman has done is engage companies he and his investors have "invested in" and coached, prodded, and charmed the coporate boards and managements of these firms to make better use of their corporate capital.

As some mutual fund managers might say, "In his doing this, he has essentially given other investors in these very same companies a free ride; his actions have not only lifted Pershing Capital's boat, but every fund manager who has invested in these same companies." Imagine if more professional investors acted more like Bill Ackman and, in turn, their actions in engaging corporate managers and boards created the kind of success and returns Bill Ackman's clients enjoy.

Acting more like an interested and concerned investor just might lead to better returns for everyone and even a more robust economy. I thought this is what Capitalism was all about.

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.

Fiduciary Standards and Financial Reform

In recent weeks the words "fiduciary standards" has been elevated in the discussions surrounding financial reform and this is good. Largely these discussions have centered around Financial Advisers and Brokers though and not around where the largest pools of capital are invested - mutual funds and asset managers.

With respect to the discussions involving FA's and Brokers, largely the discussions come around to the "appropriateness" of certain investment asset classes for their clients, disclosures of fees and compensation, and whether or not the FA/Broker is putting the interests of their clients first and foremost. One would think that 70 years after the Investment Adviseries Act of 1940, 76 years after the Securities Exchange Act of 1934, and 9 years after Enron, Tyco, Worldcom, Global Crossing etc... looking out for the investors' interests would have been settled. And naturally what adds to the complexity for these two differing investment managers is that one is regulated directly by the SEC and state regulators - FA's, and the other falls into the category of SRO - a self-regulated organization under the Financial Industry Regulatory Authority, or FINRA - Brokers. And FINRA and the SEC both played large parts, for 20 plus years, in doing very little regarding the Madoff affair. So good luck with those fiduciary standards.

My concern with fiduciary standards has more to do with ideas expressed by Vanguard founder and "Grand-Old-Man" of low-cost mutual fund investing, John Bogle. Institutional fund managers and fund firms - the single largest owner-shareholders of stock in America, and worldwide, need to get more involved in corporate governance than they have been previously. When John Bogle looked back at the investment crisis earlier in this decade that gave rise to the costly and dubious legislation known as Sarbanes-Oxley, he saw a crisis not only in the idiocy that transpired in corporate America, but in the army of professional investment managers in this country who should have known better when assessing a potential company for investment selection.

In Mr. Bogle's view, these investment professionals should have been a first line of defense in uncovering some of this corporate foolishness and accounting lies, but because of inherent internal conflicts of interest, a lack of fiduciary duty, and near industry-wide view that corporate governance is for bow-tied, loafer-wearing academics in law schools a blind-eye was turned to red-flag issues that could have raised questions about Enron's accounting, Tyco's rubber-stamp board, out-sized options dilution, etc...

The subject of Corporate Governance is not just a topic for social activists and public-policy wonks to discuss at cocktail parties. Investment professionals have to take Corporate Governance into consideration as an investment risk. The same people who wouldn't buy a $500K or $1,000,000 home without it being inspected professionally are the very same people who are perfectly willing to take $500 million of other peoples money and invest it in the next Enron. This has to stop and bringing a fiduciary standard to the mutual fund and asset management industry would be an excellent way of starting.