Wall Street WARZONE

Mutual Fund Lobby: Warning, Your Fund Owners Have No Fiduciary Duty to You, But Many Conflicts-of-Interest, So “ICI” Spends Millions of Your Profits Helping Fund Owners Get Richer!

by Paul B Farrell, JD, PhD
| | 4/22/2010

The Investment Company Institute is the mutual fund industry’s lobby. Their members are the owners of the fund management companies, not the investors whose $12 trillion they manage. Unfortunately, fund investors are not well represented by ICI. This organization has no specific fiduciary duties to its Main Street investors. This lack of a fiduciary obligation has been a major issue for investor reformers since the Investment Company Act of 1940, especially for men like Jack Bogle, founder of Vanguard Funds. History has proven over and over that the ICI and its fund company owner/members consistently represent their own personal interest first, and only secondarily the interests of Main Street investors … and they aggressively fight any and all reform efforts.

The ICI operates in virtual secrecy, isolated from the very mutual fund shareholders it purports to represent. A few years ago ICI had about $50 million money in its budget for 5 full-time, 30 part-time, and 75 outside lobbyists. A couple years ago, as part of the K-Street power grab, conservative members of the ICI’s controlling executive committee, all fund company owners were able to engineer a coup that pushed out ICI’s top two executives—both known Democrats—and replaced them with a Washington securities attorney who earlier worked in Republican administrations.

Here’s one major incident involving the new ICI president highlighting how the industry actually operates solely to promote the best interests of fund owners and managers first, ahead of investors. In reality, they believe and act in their own self-interest with absolutely no fiduciary duty to investors. No fiduciary duty? That’s right, America’s mutual funds have total control over $12 trillion that belongs to you and the rest of Main Street America’s 95 million average investors, and yet they have absolutely no fiduciary duty their investors, no specific obligation to put our interest first—none! One of the principal duties owed by anyone handling someone else’s money is missing, an oversight in the original Investment Company Act of 1940 that fund owners and managers refuse to acknowledge or correct.

This became obvious back in 2003, at the peak of the mutual fund scandals and reform movement when we were interviewing several industry leaders, including Jack Bogle, various independent investor advocates and former SEC attorneys about how the fund industry was able to hid behind so many layers of secrecy, protected by Congress and the SEC. In the process, we discovered that were at least twenty-five conflict-of-interest situations in which your mutual fund owners, managers and directors were putting their personal economic interests ahead of their investor‘s interests, and taking advantage of these investors. But the big mystery: Why do funds have absolutely no stated fiduciary duty to its own investors? That was puzzling.

Lighten up with “New Rules” on the humor bookshelves

As we dug deeper into the details of these 25 conflicts, a terribly dark picture emerged of America’s greedy, corrupt and secretive fund industry. It was depressing. And as often works when I need a break from stuff like this, I escaped to my favorite bookstore. An old trick I learned from a Zen Master long ago did the trick—walk away from the problem for a while, relax, and the solution will find you! As indeed it did, a sudden insight while standing in the investing books aisle in San Luis Obispo Barnes & Noble.

As I turned, I noticed the humor section across the aisle. Suddenly I see Bill Maher was staring at me from his new book, New Rules. I smiled back, even thinking I heard him saying: “Lighten up, Paul. Yes, funds are a joke. So make up some ‘New Rules!’ Help investors laugh. They got nobody to blame but themselves. Nobody forced them to buy into what one senator called ‘the greatest skimming operation in the world.’ So what if funds are corrupt? Even if that’s true and those investors know it, it’s their own damn fault. Now that is funny! Aren’t the behavioral finance guru telling us we’re our own worst enemy?” I didn’t totally buy the “voice” I heard, but I had a starting point.

ICI boss commits faux pas on fiduciary duties

Then a flashback, a mini deja vu. Two months earlier, Reuters news reported that Paul Schott Stevens, the new president of the Investment Company Institute (the lobbying arm for fund owners and managers) had remarked that ICI “doesn’t represent fund shareholders.” What? ICI doesn’t represent fund investors? That was a blatant contradiction of ICI’s 68-year-old talking-point on the fiduciary duty issue. And here was the new ICI president—a former Washington securities lawyer and Republican lobbyist—making an historic faux pas.

Then the next day Stevens confused matters even more by sending a memo to ICI’s insiders asserting: “I categorically reject the implication of these reports that the ICI no longer concerns itself about the interests of fund shareholders.” Interesting, but still not a clear admission that they have a fiduciary duty to put the investor’s interests first. And to make matters worse, he then contradicted himself again: “The undeniable fact is that the members of the Institute consist of investment companies and their advisers. We are not an organization whose membership includes investors or shareholders as such, and in this sense we do not and cannot claim to represent them.” So which was it—you do, or you don’t?

I called and asked to interview Stevens. But they apparently knew Stevens was trapped in a contradiction. So, ICI declined and sent a statement that began: “We believe the interests of shareholders must come first.” Unfortunately, “comes first” is terminally vague—but clearly, it was obvious that one of Washington’s top securities lawyer was caught in a double bind that was creating a big problem for the ICI lobby.

What is a fiduciary duty? Do investors always come first?

So I followed up with an email asking four questions of Stevens, hoping for some clarity: (1) Does “come first” translate into a fiduciary duty? (2) Does “come first” mean “always come first?” (3) If not “always,” what specific problems trigger conflicts? (4) What are ICI’s procedures for handling conflicts that arise?

Again ICI declined, with this terse comment: “The statement speaks for itself and is all we wish to share at this point.” Unfortunately, it clearly does not speak for itself. ICI is obviously stonewalling. True to form, they desperately did not want clarity on the issue of their fiduciary obligations to investors, other than the terminally vague, “comes first.” So, I sent ICI’s response and my questions to several respected fund leaders for comments. Their replies became a set of “New Rules.” And yes, I know mine aren’t as funny as Bill Maher’s. But writing them did help me lighten up about the duplicity and greed that’s consuming Wall Street and the fund industry, blinding them to all their conflicts of interest with investors.

New Rule #1: You’re not selling Big Macs’n’fries An “embarrassing PR snafu” says Mercer Bullard, former SEC attorney, founder of the Fund Democracy shareholder advocacy group and law professor at the University of Mississippi: “The ICI is not using ‘come first’ in a fiduciary duty sense. It is saying that it’s ‘good business’ putting shareholders first, just as it is good business for McDonald’s to put customers first. It might be a smart move for the ICI to stop pretending that it is not the industry group for fund management companies.”

New Rule #2: An “inherent” conflict that ICI must now admit! Northwestern Law School Professor David Ruder, a former SEC Chairman, says: “Investors want the smallest fees and managers want the largest” and that, my friends, is an “inherent conflict of interest!” By the way, that also sounds like yet another simple restatement of the “Iron Law of Wall Street.”

New Rule #3: You can’t serve two masters, flip a coin! Allan Mostoff, President of the Mutual Fund Directors Forum (MFDF) and former SEC’s mutual funds division boss says: “You can’t have it both ways, where interests diverge, ICI represents the interests of management.” ICI has a $47 million annual budget, most of which comes directly or indirectly out of the shareholders pocket, yet with Mafia-like secrecy ICI refuses to disclose details about how they use investor money against investors. MFDF is a rival organization that works solely for independent directors and shareholders, on a budget of less than a million bucks. ICI’s biggest fear is that MFDF might legally have the right to the money ICI takes from shareholders.

New Rule #4: Weasel words will always trap weasels! Roy Weitz’s FundAlarm.com is one of America’s leading mutual fund advocates and industry critics: “Since the ICI can’t claim that ‘comes first’ means ‘always comes first’, then it has to be qualified, as in ‘sometimes comes first,’ or ‘occasionally comes first,’ or ‘mostly comes first.’ But all are essentially empty phrases and offer no comfort to fund shareholders.” Like the other experts, Weitz, listed several ICI conflicts of interest and concluded: “In every case, the ICI has explicitly or implicitly come down on the side of the fund companies.”

New Rule #5: Enter the “no-spin zone” and tell the truth! Ted Aronson’s AJO Partners manages about $29 billion for pension funds: “When I read that shareholders must come first, I immediately thought, why limit it just to first? Why not first, second, and third? Their language resembles something out of the White House’s spin control center. I’d certainly respect the ICI organization more if they told the real truth and admit: ‘We represent the interests of investment companies (duh) first, not the shareholders.’ Now that would be refreshing!”

New Rule #6: The SEC will always be a pro-manager puppet! After the “PR snafu,” the SEC made a lame PR attempt to disguise the fact they would side with fund management and do nothing: “Use of fund assets to pay ICI dues is a matter within the business judgment of fund directors,” said Meyer Eisenberg, the SEC’s mutual funds division boss. However, Ted Siedle of Benchmark Financial Services, another former SEC attorney and now an investigator of money manager abuses strenuously disagreed: “The SEC should never have allowed the ICI to claim it represents the interests of mutual fund investors, because it’s a blatant falsehood.”

New Rule #7: Warning, the SEC is a toothless Chihuahua! “The fund industry’s moral compass is broken,” says University of South Carolina Law School Professor John Freeman, a former SEC attorney: “The SEC is dedicated to protecting the industry’s managers, and the industry’s managers have an agenda that does not place the fund shareholders first.”

New Rule #8: “Extreme makeover” time—from ICI to ICMI Vanguard’s founder Jack Bogle added: “Certainly the shareholder does not come first when fees are being negotiated. The management company chairman presents the fee to the fund chairman, who can’t help but agree—they are both the same person … If they were really honest, they would call it ‘The Investment Company Managers Institute,’ and ICI would morph into ICMI.”

In Battle for the Soul of Capitalism, Bogle tells us that in recent years aggressive lobbying by the ICI has overwhelmed and killed successive attempts to add a fiduciary duty to the law, correcting the loophole in the 1940 Act. He also makes it clear that the industry needs to be “operated strictly in the interests of ” fund shareholders, not the management companies, and therefore, we need a fiduciary duty. Still, the ICI is still so fiercely opposed that this seems highly unlikely, ever … they want no ethical obligation to the investors whose trillions they manage, for fear of exposure!

Bottom line: These guys control $10 trillion of your money. For every one percent operating fee they charge you, they can siphon $100 billion off the top of your returns annually and stick it in their pockets. Moreover, they can do this behind a wall of secrecy that’s protecting their twenty-five conflicts of interest. Investors, meanwhile, are kept clueless because they have no fiduciary duty to tell them the truth, so the fund company owners and managers continue their corrupt ways.

FirstPubDate: Oct’05

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