Abstract: I. INTRODUCTION Holding more than $10 trillion in assets,1 the fund industry is a powerful financial force in this country. Ninety-one million individual shareholders own funds, representing about one in every two American households.2 The vast majority of Americans who invest in the equity markets do so through stock funds; fewer than half of the nation's equity investors own stock directly.3 The fund industry's stunning growth led one government official to muse: Could fund assets surpass the value of all U.S. public companies? Probably yes, and in the not so distant future.4 Though it was singled out by Congress for special legislation in light of serious fiduciary duty abuses uncovered in the aftermath of the 1929 stock market crash,5 the investment company industry prospered following enactment of the Investment Company Act of 1940.6 Captained by lavishly compensated fund sponsors and their powerful trade association, the Investment Company Institute (ICI), the fund industry enjoyed six full decades of growth and scandal-free operations. Lately, however, both the fund sponsors and the ICI have experienced a fall from grace. For both leadership groups, the decline is traceable to a common failing: conflicts of interest.7 The fund sponsorship industry revolves around accumulating assets in separate funds, selling advisory, distribution, and administrative services to those funds, and thereby extracting fee income. More dollars in fee income for the sponsor translates into fewer dollars of assets for the funds being served. Fund sponsors' dealings thus epitomize a classic conflict of interest.8 We shall see that it is this nettlesome conflict of interest that explains fund managers' penchant for improperly draining assets from funds to generate greater income for the managers at fund shareholders' expense. The sea change in how fund leaders are viewed occurred suddenly. Not too long ago, hubris was the order of the day when fund industry leaders held forth. As recently as February of 2003, the ICI's president was writing Congress extolling the industry's embrace of transparency and accountability principles and proclaiming that the mutual fund industry's governance and investor protection standards 'read like a blueprint for the guidelines publicly traded companies are only now being urged to follow.'9 Three months later, on May 22, 2003, ICI Chairman Paul Haaga lamented that the fund industry's supposedly shining examples of rectitude and faithful stewardship had not been unanimously praised. Like younger siblings, the fund industry has benefited from numerous and effective critics over the years-but they've never been more active than in the recent down market. Former SEC chairmen, members of Congress and their staffs, academics, Bards of Omaha, journalists, television talking heads, competitors-even a saint with his own statue-have all weighed in about our perceived failings. We've heard high-level rebukes, mid- and low-level rebukes, and rebukes where we couldn't even figure out what they wanted us to do. It makes me wonder what life would be like if we'd actually done something wrong.10 Fund industry leaders' smugness and arrogance is less evident today, with good reason. Fund sponsors today find themselves called to answer for business practices that formerly went undetected or unchallenged by regulators and plaintiffs' lawyers. These practices all revolve around a single subject and a single crucial weakness in fund industry governance. The subject is money being diverted from the holdings of fund shareholders into the pockets of those who advise, sell, or service funds. The weakness relates to the governance model that is both the fund industry's hallmark and its stigma-conflicted fund management by separate external advisers.11 Conventional fund distribution fees, in the form of front-end sales loads and other direct payments for sales effort, tend to be disclosed to fund purchasers and shareholders, though the quality of this disclosure is poor. …
Publication Year: 2007
Publication Date: 2007-07-01
Language: en
Type: article
Access and Citation
Cited By Count: 7
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