They operate by casino rules that they invented and they manipulate while managing over $10 trillion of your assets. If you play by their rules, you will lose. Guaranteed. Examples: During the 2000-2002 bear market, one manager paid himself $47 million while his shareholders lost 43%. At the same time, the equity fund shareholders of Fidelity Investments lost 37% while Fidelity’s two major owners saw their net worth increase from $11.1 billion to $13.2 billion between 1999 and 2002. In 2006 they were worth $20.5 billion while their shareholders have barely broken even the past seven years. As Vanguard founder, Jack Bogle, put it in The Battle for the Soul of Capitalism: “The business and ethical standards of Corporate America, of investment America, of mutual fund America have been gravely compromised.”
Back in 2004, just before the Senate Banking Committee killed chances of any reform legislation (in spite of a 418-2 approval in the House) I warned fund investors that special interest groups would begin an aggressive campaign to defeat fund industry reforms under consideration by Congress and the SEC. It happened. The reasons were obvious. As critics point out, special interests take tens of billions of dollars right off the top of shareholder returns every year, with virtually no disclosure requirements. So fund company owners had an enormous incentive to oppose all reforms back in 2004—in fact, they always have and do oppose all reforms, all the time, it’s a matter of self-preservation.
Their opposition occasionally surfaces in the press, but more often than not, the press doesn’t get it, meanwhile, special interest money works behind the scenes through lobbyists and political contributions. Fund company owners are one of the major special interest groups identified. So it came as no surprise when Ned Johnson, chairman, CEO and controlling owner of Fidelity Investments, in the middle of the last major attempt at legislative reform, attacked reform legislation out in the open on the op-ed page of the Wall Street Journal—a rare event for a very private man.
Superhuman … or super-selfish?
Johnson’s attack, titled “Interested, and Proud of It!” was confined narrowly to defending his right to remain as the chairman of the board of trustees of Fidelity’s 290 mutual funds, as well as chairman and CEO of the management company, Fidelity Investments. Aside from the impossible, superhuman task of overseeing 290 individual funds, most critics, including independent voices like Jack Bogle, and former SEC Chair Arthur Levitt, as well as the New York Attorney General Elliot Spitzer and other state securities regulators, see this dual role as a clear conflict of interest. Johnson, however, dismissed all these critics and even argued: “Far from a conflict, these dual roles mean that my personal, professional and financial interests are directly aligned with those of the Fidelity shareholders.”
True to form for all fund company owners, Johnson was strenuously opposing the SEC’s proposed new regulations requiring that a fund chairman be independent. If the regs were approved, Johnson’s dominant ownership position in the fund management would force him to surrender his position of absolute control over the empire he created, which dominated more than $800 billion in shareholder assets.
In alignment … or in conflict?
While I admire Mr. Johnson strong convictions, he clearly had not just a conflict-of-interest but a major credibility issue here. The evidence contradicted Johnson’s claims of independence. Johnson’s dual roles actually put him in direct conflict with the interests of Fidelity’s shareholders, resulting in substantial personal gains for him during the 2000-2002 bear market while Fidelity investors lost substantial sums .
Moreover, when I called Fidelity and requested information that might support Johnson’s claim, they refused to release any data, hiding behind the industry’s all-purpose code of secrecy. In effect, Johnson was saying that investors should believe him simply because he said it, without question and without him providing any supporting evidence. So we checked other sources.
Fund industry’s shadowy “code of silence” in action
For the record, I should also add that this was not the first time I had offered Fidelity’s leadership an opportunity to set the record straight. A few months earlier Mr. Johnson and his executive vice president both declined when I asked to interview them on the proposed fund reform bill that had already passed the House and was being considered by the Senate. The bill would also legislatively force Mr. Johnson out of his conflicting roles.
I requested that earlier interview after reading Johnson’s remarks on the late trading and market timing posted on Fidelity’s website. Since Johnson rarely makes public comments, I offered him a forum to widen the discussion. I said that such an interview that would be a perfect opportunity for Fidelity’s leader to publicly air Fidelity’s opposition on all 21 provisions of Senate bill, not just selectively and narrowly discuss the market timing and late trading issues in public.
Fidelity held to the party line. Johnson and his officers refused, stone-walling me. The truth is, fund companies have become so used to their “conspiracy of silence,” as Jack Bogle calls it, that they oppose any disclosures to investors as a matter of principle. Witness how effective the industry was in getting an exception to the Sarbanes-Oxley requirements which covers all public corporate executives—but not the fund industry!
Fidelity investors lost 37% in bear … but insiders profited
Mr. Johnson’s central assertion in The Journal was very simple. He claimed that his “personal, professional and financial interests are directly aligned with those of the Fidelity shareholders.” Unfortunately, the evidence contradicted his claim. We know, for example, that during the bear market of 2000-2002 America’s stock market in general lost over 40 percent of its value. And yet, while the average American fund investor lost over 40 percent, fund owners, directors and managers took in more than $200 billion annually in fees, operating expenses, transaction costs, soft-money and other hidden compensation from deals with brokers and silent third-parties.
In fact, Morningstar said that during the bear years, 1999-2002, stock funds even increased their average expense ratio by a whopping 36 percent, forcing investors to fork out even more money for operating expenses during a crashing market, making sure the insiders wouldn’t suffer much while the financial markets crashed and lost over $8 trillion in market-cap.
One: Owners net worth increased 10% in bear
The assets of Fidelity’s shareholders actual declined 37 percent from $662 billion in 1999 to $416 billion in 2002 according to information provided to me directly from Fidelity. Moreover, during the bear market, Fidelity’s flagship Magellan Fund had a 35 percent decline in its net asset value, from $105 billion to $68 billion, according to Morningstar, while Fidelity charged its 18,000 investors well over $1 billion in management fees. By comparison, between the bear years 1999 and 2002, the net worth of Fidelity’s two principle owners, Edward Johnson and Abigail Johnson, actually increased from $11.1 billion to $12.3 billion, as reported in the Forbes 400 lists of America’s richest billionaires.
In short, while Fidelity’s fund shareholders lost 37 percent of their assets during the bear market, the owners of the fund management company saw their net worth increase more than 10 percent. Flash forward: In the 2007 list of billionaires, the two Johnsons now have a combined net worth of $20.5 billion, roughly equal to the wealth of Prince Alwaleed of Saudi Arabia, the 13th richest person in the world.
Two: Fund directors increased their pay by 26% during bear
In addition, according to InvestmentNews, fund company directors voted themselves an average 26 percent pay raise during the bear market years from 2000 to 2002, increasing their average compensation to $249,500, for part-time work averaging five week a year. In Fidelity’s case, each of their fourteen directors were paid over $250,000 annually. Ned Johnson is chairman, and Fidelity claims that ten of the directors are independent.
Three: Fund managers pay increased 35% during bear
Nationally, the salaries of fund managers increased 35 percent between 1999 and 2001, to an average salary of $436,500 according to a survey of the Association for Investment Management & Research. The survey covered 10,000 portfolio managers and was conducted by Russell Reynolds, a national executive search firm. At the time, MSN columnist Timothy Middelton also looked at publicly owned fund companies. All of them had losses well in excess of the negative 30 percent in the S&P 500 index, and still they paid their executives huge compensations:
Fund company ….. executive ….. compensation … investors’ losses
Gabelli Asset Mgt … Mario Gabelli … $47.1 million … minus 43.3%
Alliance Cap Mgt … Bruce Calvert … $12.1 million … minus 45.6%
Blackrock Inc … Laurence Fink … $ 9.5 million … minus 52.9%
Janus/Stilwell … Thomas Bailey … $ 8.9 million … minus 62.7%
LeggMason … Raymond Mason $ 7.7 million … minus 38.8%
Eaton Vance … James Hawkes … $ 3.8 million … minus 38.4%
Federated … John Donohue … $ 3.6 million … minus 40.6%
T. Rowe Price … George Roche … $ 2.0 million … minus 40.3%
Neuberger Berman … Jeffrey Lane … $ 1.6 million … minus 36.4%
Waddell & Reed … Keith A. Tucker … $ 1.1 million … minus 47.1%
Rip-off? You bet. Not only did these guys lose boatloads of their investors’ money, while filling their own pockets, every one lost more than the market! And many continued on through the recent credit meltdown. They treat mutuals funds as their personal piggy banks.
Bottom line: Fidelity CEO’s claim was not credible
Ned Johnson’s claim that his “personal, professional and financial interests are directly aligned with those of the Fidelity shareholders” does not square with the facts. He not only had a clear conflict of interest, but he had a credibility problem. And worse yet, the SEC was, in effect, protecting him, and with rare exceptions, the game went over the heads of the media and press.
During the crucial bear market years from 2000-2002 not only were the interests of fund industry insiders in significant conflicts with their own investors, but as we saw, Fidelity’s two major owners realized a 10 percent gain while Fidelity’s shareholders experienced a 37 percent loss of asset value. So, as much as we may admire Fidelity’s founder, Mr. Johnson, for building one of the biggest financial empires in American history, his claim was not credible. His interests clearly conflicted with Fidelity’s fund shareholders—and serve as an example of an attitude pervasive throughout the fund industry.