"The closer you get to the fire, the more you get burned, but that won't happen to us, because it's always been a matter of trust." -- Billy Joel
WASHINGTON -- The words of this famed Long Island crooner have a striking resemblance to the attitude of the mutual fund industry prior to the market-timing and late-trading scandals that were exposed last year. But that so-called trust has since been shattered by a wave of egregious behavior, and the fund community now must take action to rebuild its relationship with investors who have been burned. In other words, it's gut check time.
A panel of fund industry leaders sat down at the Investment Company Institute's General Membership Meeting here to discuss the recent scandals and their impact on regulatory movements and the resulting initiatives to restore the faith. The theme of the conference was aptly named "A Matter of Trust." The roundtable discussion kicked off with moderator Jason Zweig, a columnist for Money magazine, asking the panelists if they saw the writing on the wall ahead of New York Attorney General Eliot Spitzer's famed press conference last Sept. 3.
"Market timing and late trading were not on my radar," said John Brennan, chairman and CEO of low-cost indexing maven The Vanguard Group. Brennan conceded that he was more concerned about fund sales practices and overall business operations. But he was careful not to admit that it was something he should have known. "It is unfair to imply that [it] was a well-kept secret that funds were complicit in facilitating market timing."
"Late trading shocked me," said Dawn-Marie Driscoll, an independent director for the Scudder Funds. "Market timing was something we discussed on our boards. I wish we had pushed harder."
Robert Dow, managing partner at Lord Abbett, was less apologetic about the trading abuses, saying that one shouldn't paint a company with the same brush when it was really the work of a few individuals.
According to the e-mail traffic Spitzer uncovered, there were a number of lower-level employees questioning some of the trades that were being placed, but senior executives turned a blind eye to the warning signs. Driscoll acknowledged this breakdown and urged funds to shore up their ethics and compliance infrastructure. "The board needs to be more involved, decide what's best for shareholders and evaluate management and portfolio managers' behavior," she said.
Independent Thinking
Specifically, the panel debated the merits of several SEC proposals that are in the pipeline including a discussion of the independent chairmen rule, which has incited quite a bit of consternation among industry leaders such as ICI President Matt Fink and Ned Johnson, CEO and chairman of Fidelity Investments. The ICI chief believes the rule will be "a blow to independent directors" in the sense that it would imply that the board cannot be trusted to choose a viable candidate. Johnson's argument is that there is no proof funds that have had independent chairmen perform better and that some have actually been involved in the trading scandal.
Lord Abbett's Dow told the audience that following the regulatory probes of abusive trading practices, he asked the trustees if he should resign to eliminate the appearance of a conflict of interest. The board told him no because they didn't think that was appropriate. Dow believes that the independent chair rule would effectively "lull people into a false sense of security."
"No one has explained why this is a good idea," said Driscoll, who believes that a lead independent director would serve the same purpose. She further noted, "People are not going to buy and sell a fund based on the board." Vanguard's Brennan echoed that sentiment, saying, "I'm not a big fan of cosmetic change."
The heightened profile and responsibility that fund boards now bear has raised concerns about the personal liability of the board of trustees. "Anecdotally, directors are considering the prospect of the job not being worth it as more and more chores fall under their bailiwick," Brennan said.
PM Pay Flap
Another critical issue the panel addressed was the disclosure of portfolio managers' compensation and personal holdings. The SEC has proposed that fund skippers disclose the details of their pay deals and their stake in the funds they manage. "Publishing that information will have an adverse effect," Dow said. "It has no relevance to the performance of the fund and [will lead to] an industry-wide brain drain." Zweig countered that investors deserve to know if their portfolio managers "eat their own cooking," a step he believes would better align managers' and shareholders' interests.
Brennan had a more middle-of-the-road take on the matter. He said that the structure of the compensation should be disclosed but not the specific dollar amounts. Essentially, he suggested disclosing whether they are paid based on their performance relative to a certain benchmark over a three- or five-year period or total return of the fund. Driscoll, on the other hand, called the compensation rule "totally unnecessary."
Five Simple Rules
In an earlier session, Jeff Immelt, CEO of General Electric, delivered the keynote address that outlined a series of rules for building a "great and good" company. Central to his message was the idea that good governance is a product of good leadership and good compliance forged through the culture of the firm. "It's about what we do, not what we think," he told attendees. "Trust can't be rebuilt by speeches, but through good leadership. There's a lot of things I don't delegate, and our image with shareholders is one of them."
The five rules he outlined are as follows: Build a strong independent board, align executive compensation with shareholders by linking it to performance, talk about the company externally the way you run it internally and develop a strong and vibrant culture. Immelt specifically noted that his own compensation is directly tied to the success of GE's businesses. If he doesn't deliver, he said, he deserves to lose his job. He urged attendees not to tolerate underachievement and complacency within their respective firms. "We don't think about what we're going to do about poor performers, we fire them."
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