受托人原则：一人难侍二主

JPM-BOGLEJPM-BOGLE 10/19/09 10:36 PM Page 15 The Fiduciary Principle: No Man Can Serve Two Masters JOHN C. BOGLE The Journal of Portfolio Management 2009.36.1:15-25. Downloaded from www.iijournals.com by JOHN C BOGLE on 11/04/09. JOHN C. BOGLE I write at a time of financial and economic harm done to a social order founded upon is the founder of The crisis in our nation and around the globe. I ven- business and dependent upon its integrity, Vanguard Group in Valley ture to assert that when the history of the finan- are incalculable. Forge, PA. [email protected] cial era which has just drawn to a close comes A to be written, most of its mistakes and its major las, the words in those two pre-faults will be ascribed to the failure to observe ceding paragraphs are not mine. the fiduciary principle, the precept as old as Rather they are the words of holy writ, that ‘a man cannot serve two mas- Harlan Fiske Stone, excerpted ters.’

No thinking man can believe that an from his 1934—yes, 1934—address at the economy built upon a business foundation can University of Michigan Law School, reprinted permanently endure without some loyalty to in The Harvard Law Review later that year.1 It is illegal to make unauthorized copies of this article, forward to an unauthorized user or to post electronically without Publisher permission. that principle. The separation of ownership But his words are equally relevant—perhaps from management, the development of the cor- even more relevant—at this moment in hisporate structure so as to vest in small groups con- tory. They could hardly present a more approtrol over the resources of great numbers of small priate analysis of the causes of the present-day and uninformed investors, make imperative a collapse of our financial markets and the eco-fresh and active devotion to that principle if the nomic crisis now facing our nation and our modern world of business is to perform its proper world. function.

One could easily react to Justice Stone’s Yet those who serve nominally as words by falling back on the ancient apho-trustees, but relieved, by clever legal devices, rism, “the more things change, the more from the obligation to protect those whose they remain the same,” and move on to a interests they purport to represent, corporate new subject. But I hope financial profes-officers and directors who award to them- sionals will react differently, and share my selves huge bonuses from corporate funds reaction: In the aftermath of that Great without the assent or even the knowledge of Depression and the stock market crash that their stockholders … financial institutions accompanied it, we failed to take advantage which, in the infinite variety of their opera- of the opportunity to demand that those tions, consider only last, if at all, the inter- who lead our giant business and financial ests of those who funds they command, organizations—the stewards of so much of suggest how far we have ignored the neces- our nation’s wealth—measure up to the stern sary implications of that principle.

The loss and unyielding principles of fiduciary duty and suffering inflicted on individuals, the FALL 2009 THE JOURNAL OF PORTFOLIO MANAGEMENT 15 JPM-BOGLE:JPM-BOGLE 10/19/09 10:36 PM Page 16 described by Justice Stone. So, 75 years later, for heav- citizens, over the past few decades the balance between en’s sake, let’s not make the same mistake again. ethics and law, on the one hand, and the markets on the Justice Stone’s stern words force us to fasten on eth- other have heavily shifted in favor of the markets. As I ical dilemmas faced by today’s business leaders. Included have often put it: We have moved from a society in which among these leaders are the chiefs who manage our there are some things that one simply does not do, to one in nation’s publicly held corporations—today valued in the which if everyone else is doing it, I can do it too.

I’ve described stock market at some $12 trillion—and the professional this change as a shift from moral absolutism to moral rel-managers of “other people’s money” who oversee equity ativism. Business ethics, it seems to me, has been a major investments valued at some $9 trillion of that total, casualty of that shift in our traditional societal values. You The Journal of Portfolio Management 2009.36.1:15-25. Downloaded from www.iijournals.com by JOHN C BOGLE on 11/04/09. owning 75% of all shares and therefore holding absolute will hardly be surprised to learn that I do not regard that voting control over those corporations. Like their coun- change as progress. terparts in business, those powerful managers have not At least a few others share this view. In her book only an ethical responsibility, but a fiduciary duty, to those Trust and Honesty, published in 2006, Boston University whose capital has been entrusted to their care.

Law School professor Tamar Frankel provides worthy insights on the diminishing role of fiduciary duty in our FIDUCIARY DUTY society. She is concerned—a concern that I suspect many investment professionals would share—that American The concept of fiduciary duty has a long history, culture has been moving toward dishonesty, deception, going back more or less eight centuries under English and abuse of trust, all of which have come to the fore in common law. Fiduciary duty is essentially a legal relation- the present crisis. What we need, she argues, is “an effec-ship of confidence or trust between two or more parties, tive way to increase trust (by) establishing trustworthy most commonly a fiduciary or trustee and a principal or ben- institutions and reliable systems,” even as she despairs that eficiary, who justifiably reposes confidence, good faith, and the pressures brought out by the stock market and real reliance on his trustee.

The fiduciary is expected to act at estate bubbles have led to “deteriorating public morals … all times for the sole benefit and interests of the principal, and burst into abuse of trust” (p. 99). with loyalty to those interests. A fiduciary must not put per- In Professor Frankel’s view, “we reduced the power sonal interests before that duty, and, importantly, must not of morality in law … emasculated the regulation of trusted It is illegal to make unauthorized copies of this article, forward to an unauthorized user or to post electronically without Publisher permission. be placed in a situation where his fiduciary duty to clients persons (that is, fiduciaries) … abused the laws that govern conflicts with a fiduciary duty to any other entity. fiduciaries’ honesty … and opened the door to enormous Way back in 1928, New York’s Chief Justice Benjamin losses to the public and the economic system” (p.

119). N. Cardozo put it well: We also came to ignore the critical distinction between fiduciary law itself and a fiduciary relationship subject Many forms of conduct permissible in a workaday to contract law. What’s more, she writes, “the movement world for those acting at arm’s length are forbidden from professions to businesses was accompanied by changes to those bound by fiduciary ties. A trustee is held to in the way the law was interpreted” (p. 146). We forgot something stricter than the morals of the market- the fundamental principle expressed by the apostles place … As to this there has developed a tradition Matthew and Luke,3 and repeated by Justice Stone: “No that is unbending and inveterate … Not honesty man can serve two masters.” alone, but the punctilio of an honor the most sensi- My principal objection to moral relativism is that it tive, is then the standard of behavior … Only thus obfuscates and mitigates the obligations that we owe to has the level of conduct for fiduciaries been kept at society, and shifts the focus to the benefits accruing to the a level higher than that trodden by the crowd.2 individual.

Self-interest, unchecked, is a powerful force, but a force that, if it is to protect the interests of the com-It has been said, I think, accurately, that fiduciary duty is munity of all of our citizens, must ultimately be checked the highest duty known to the law. by society. The recent crisis—which I have described as It is less ironic than it is tragic that the concept of “a crisis of ethic proportions”—makes it clear how serious fiduciary duty seems far less imbedded in our society today that damage can become. than it was when Stone and Cardozo expressed their pro-found convictions. As ought to be obvious to all educated 16 THE FIDUCIARY PRINCIPLE: NO MAN CAN SERVE TWO MASTERS FALL 2009 JPM-BOGLE:JPM-BOGLE 10/19/09 10:36 PM Page 17 CAUSES OF THE RECENT CRISIS ments, endorsed—at least tacitly—by their public accountants.

The causes of the recent crisis are manifold. But the failures of our institutional investors go Metaphorically speaking, the collapse in our financial beyond governance issues to the very practice of their system has 1,000 fathers: the cavalier attitude toward risk trade. These agents have also failed to provide the due of our bankers and investment bankers in holding a toxic diligence that our citizen/investors have every reason to mix of low-quality securities on enormously leveraged expect of the investment professionals to whom they have balance sheets; the lassiez faire attitude of our federal reg- entrusted their money. How could so many highly skilled, ulators, reflected in their faith that “free competitive mar- highly paid securities analysts and researchers have failed The Journal of Portfolio Management 2009.36.1:15-25. Downloaded from www.iijournals.com by JOHN C BOGLE on 11/04/09. kets” would protect our society against excesses; the to question the toxic-filled leveraged balance sheets of Congress, which rolled back legislative reforms dating Citicorp and other leading banks and investment banks back to the Depression years; “securitization” in which the and, lest we forget, AIG, as well as the ethics-skirting sales traditional link between borrower and lender—under tactics of CountryWide Financial?4 Even earlier, what which lenders demanded evidence of the borrowers’ ability were these professionals thinking when they ignored the to meet their financial obligations—was severed; and reck- shenanigans of “special purpose entities” at Enron and less financial innovation in which literally tens of trillions “cooking the books” at WorldCom? of dollars of derivative financial instruments (such as credit default swaps) were created, usually carrying stupefying THE ROLE OF INSTITUTIONAL MANAGERS levels of risk and unfathomable levels of complexity.

The radical increase in the power and position of the But the failure of our newly empowered agents to leaders of corporate America and the leaders of investment exercise their responsibilities to ownership is but a part of America has been a major contributor to these failures. the problem we face. The field of institutional invest-Today’s dominant institutional ownership position of 75% ment management—the field in which I’ve now plied of the shares of our (largely giant) public corporations my trade for more than 58 years—also played a major, compares with only about 8% a half-century ago. This if often overlooked, role. As a group, we veered off-course remarkable increase in ownership has placed these man- almost 180 degrees from stewardship to salesmanship, in agers—largely of mutual funds (holding 25% of all shares), which our focus turned away from prudent management It is illegal to make unauthorized copies of this article, forward to an unauthorized user or to post electronically without Publisher permission. private pension funds (12%); government retirement funds and toward product marketing.

We moved from a focus (9%); insurance companies (8%); and hedge funds and on long-term investment to a focus on short-term spec-endowment funds—in a position to exercise great power ulation. The driving dream of our advisor/agents was to and influence over corporate America. gather ever-increasing assets under management, the better But they have failed to exercise their power. In fact, to build their advisory fees and profits, even as these poli-the agents of investment in America have failed to honor cies came at the direct expense of the investor/principals the responsibilities that they owe to their principals—the whom, under traditional standards of trusteeship and fidu-last-line individuals who have much of their capital wealth ciary duty, they were duty-bound to serve. committed to stock ownership, including mutual fund Conflicts of interest are pervasive throughout the shareowners and pension beneficiaries.

The record is field of money management, albeit different in each clear that, despite their controlling position, most insti- sector. Private pension plans face one set of conflicts (i.e., tutions have failed to play an active role in board struc- minimizing plan contributions helps maximize a corture and governance, director elections, executive poration’s earnings), public pension plans another (i.e., compensation, stock options, proxy proposals, dividend political pressure to invest in pet projects of legislators). policy, and so on. And labor union plans face yet another (i.e., pressure to Given their forbearance as corporate citizens, employ money managers who are willing to “pay to these managers arguably played a major role in allowing play”). But it is in the mutual fund industry where the the managers of our public corporations to exploit the conflict between fiduciary duty to fund shareholder/clients advantages of their own agency, not only in executive often directly conflicts with the business interests of the compensation, perquisites, and mergers and acquisi- fund manager. tions, but even in accepting the “financial engineering” Perhaps we shouldn’t be surprised that our money that has come to permeate corporate financial state- managers act first in their own behalf.

Indeed, as Vice FALL 2009 THE JOURNAL OF PORTFOLIO MANAGEMENT 17 JPM-BOGLE:JPM-BOGLE 10/19/09 10:36 PM Page 18 Chancellor Leo E. Strine, Jr., of the Delaware Court of our underlying attitudes toward investment and specula-Chancery has observed, “It would be passing strange tion in common stocks” (p. 563). He further commented: if … professional money managers would, as a class, be less likely to exploit their agency than the managers of In the past, the speculative elements of a common the corporations that make products and deliver ser- stock resided almost exclusively in the company itself; vices” [2007, p. 7]. In the fund industry—the largest of they were due to uncertainties, or fluctuating ele-all financial intermediaries—that failure to serve the ments, or downright weaknesses in the industry, or interests of fund shareholders has wide ramifications. the corporation’s individual setup … But in recent Ironically, the failure has occurred despite the clear lan- years a new and major element of speculation has The Journal of Portfolio Management 2009.36.1:15-25.

Downloaded from www.iijournals.com by JOHN C BOGLE on 11/04/09. guage of the Investment Company Act of 1940, which been introduced into the common-stock arena from demands that “mutual funds should be organized, man- outside the companies. It comes from the attitude and aged and operated in the best interests of their share- viewpoint of the stock-buying public and their holders, rather than in the interests of (their) advisers.”5 advisers—chiefly us security analysts. This attitude may be described in a phrase: primary emphasis upon THE TRIUMPH OF SPECULATION future expectations … The concept of future OVER INVESTMENT prospects, and particularly of continued growth in the future, invites the application of formulas out of higher As control over corporate America moved from mathematics to establish the present value of the owners to agents, our institutional money managers favored issues. But the combination of precise for-seemed to forget their duty to act solely in the interest of mulas with highly imprecise assumptions can be used their own principals, those whose savings were entrusted to establish, or rather to justify, practically any value to mutual funds and whose retirement security was one wished, however high … Given the three ingre-entrusted to pension plans.

These new investor/agents dients of a) optimistic assumptions as to the rate of not only forgot the interests of their principals, but also earnings growth, b) a sufficiently long projection of seemed to forget their own investment principles. The pre- this growth into the future, and c) the miraculous dominant focus of institutional investment strategy workings of compound interest—lo! the security ana-turned from the wisdom of long-term investing, based lyst is supplied with a new kind of philosopher’s stone It is illegal to make unauthorized copies of this article, forward to an unauthorized user or to post electronically without Publisher permission. on the enduring creation of intrinsic corporate values, to which can produce or justify any desired valuation the folly of short-term speculation, focused on the for a really ‘good stock.’ Mathematics is ordinarily ephemeral prices of corporate stocks.

The own-a-stock considered as producing precise and dependable strategy of yore became the rent-a-stock strategy of today. results; but in the stock market the more elaborate In what I’ve called “the happy conspiracy” between and abstruse the mathematics the more uncertain corporate managers, directors, accountants, investment and speculative are the conclusions we draw there-bankers, and institutional owners and renters of stocks, all from … Whenever calculus is brought in, or higher kinds of bizarre financial engineering took place. Man- algebra, you could take it as a warning signal that the agement became the master of its own numbers, and our operator was trying to substitute theory for experi-public accountants too often went along. Loose accounting ence, and usually also to give to speculation the standards made it possible to create, often out of thin air, deceptive guise of investment … Have not investors what passes for earnings, even under GAAP standards.

One and security analysts eaten of the tree of knowledge good example—which is already sowing the seeds of yet of good and evil prospects? By so doing have they another financial crisis that is now emerging—is hyping not permanently expelled themselves from that Eden the assumed future returns earned by pension plans, even where promising common stocks at reasonable prices as rational expectations for future returns deteriorated. could be plucked off the bushes (pp. 563–572)? Here, again, we can’t say that we hadn’t been warned well in advance. Speaking before the 1958 Convention This obvious reference to Original Sin reflected of the National Federation of Financial Analysts Soci- Graham’s deep concern about quantifying the unquaneties, Benjamin Graham, legendary investor and author tifiable (and doing so with false precision). The implica-of the classic The Intelligent Investor, described “some con- tions of that bite into the apple of quantitative investing trasting relationships between the present and the past in were barely visible when Graham spoke in 1958.

But by 18 THE FIDUCIARY PRINCIPLE: NO MAN CAN SERVE TWO MASTERS FALL 2009 JPM-BOGLE:JPM-BOGLE 10/19/09 10:36 PM Page 19 the late 1990s, this new form of investment behavior had corporation’s stock—the triumph of perception over become a dominant force that continues to be a major reality. We live in a world in which it is far easier to hype driver of the speculation that has overwhelmed our finan- the price of a company’s stock than it is to build the cial markets. intrinsic value of the corporation itself. And we seem Consider with me now how the erosion in the con- to have forgotten Benjamin Graham’s [2003] implicit duct, values, and ethics of business that I have described caution about the transience of short-term perception, has been fostered by the profound—and largely unno- compared to the durability of long-term reality: “In ticed—change that has taken place in the nature of our the short run, the stock market is a voting machine; in financial markets.

That change reflects two radically dif- the long run it is a weighing machine” (p. 531).

The Journal of Portfolio Management 2009.36.1:15-25. Downloaded from www.iijournals.com by JOHN C BOGLE on 11/04/09. ferent views of what investing is all about, two distinct markets, if you will. One is the real market of intrinsic THE MUTUAL FUND INDUSTRY business value. The other is the expectations market of momentary stock prices. The British economist John My strong statements regarding the failure of Maynard Keynes [1964 (1936)] described this dichotomy modern-day capitalism are manifested in grossly excessive as the distinction between enterprise—“forecasting the executive compensation; financial engineering; earnings prospective yield of the asset over its whole life”—and “guidance,” with massive declines in valuations if it fails to speculation—“forecasting the psychology of the markets” be delivered; enormous, casino-like trading among insti-(p. 155). Just as Keynes forecast, speculation came to over- tutional investors; staggering political influence, borne of whelm enterprise, the old ownership society became huge campaign contributions; and, in the financial arena, today’s agency society, and the values of capitalism were bestowal of wealth to traders and managers that is totally seriously eroded. disproportionate to the value they add to investors’ wealth.

It is little short of amazing how long ago these pre- Indeed, the financial sector actually subtracts value from scient warnings were issued. Justice Stone warned us in our society.

1934. John Maynard Keynes warned us in 1936. Benjamin Finance is what is known to economists as a rent-Graham warned us in 1958. Isn’t it high time for us to heed seeking enterprise, one in which our intermediaries— the warnings of those three far-sighted intellectual money managers, brokers, investment bankers—act as agents giants? Isn’t it high time we stand on their shoulders and for parties on both sides of each transaction. Our interme- It is illegal to make unauthorized copies of this article, forward to an unauthorized user or to post electronically without Publisher permission. shape national policy away from the moral relativism of diaries pit one party against another, so what would other-peer conduct and greed and short-term speculation— wise be a zero-sum game becomes a loser’s game, simply gambling on expectations about stock prices? Isn’t it high because of the intermediation costs extracted by the var-time to return to the moral absolutism of fiduciary duty, ious croupiers. (Other examples of rent-seekers include to return to our traditional ethic of long-term investment casinos, the legal system, and government. Think about it!) focused on building the intrinsic value of our corpora- I know something about how the financial system tions—prudence, due diligence, and active participation works, for I’ve been part of it for my entire 58-year career. in corporate governance? The mutual fund industry—in which I’ve spent my entire So, yes, now is time for reform. Today’s agency career—is the paradigm of what’s gone wrong with cap-society has ill-served the public interest. The failure of italism. Here are just a few examples of how far so many our money manager agents represents not only a failure fund managers have departed from the basic fiduciary of modern-day capitalism, but a failure of modern-day principle that “no man can serve two masters,” despite capitalists. As Lord Keynes warned us, “when enter- the fact that the 1940 Act demands that the principal prise becomes a mere bubble on a whirlpool of spec- master must be the mutual fund shareholder: ulation, the job of capitalism will be ill-done” (p. 159).

That is where we are today, and the consequences have 1. The domination of fund boards by chairmen and not been pretty. chief executives who also serve as senior executives In all, our now-dominant money management of the management companies that control the sector has turned its focus away from the enduring funds, an obvious conflict of interest and an abro-nature of the intrinsic value of the goods and services gation of the fiduciary standard. created, produced, and distributed by our corporate 2. Focusing on short-term speculation over long-term businesses, and toward the ephemeral price of the investment, the ultimate triumph of expectations FALL 2009 THE JOURNAL OF PORTFOLIO MANAGEMENT 19 JPM-BOGLE:JPM-BOGLE 10/19/09 10:36 PM Page 20 investing over enterprise investing, resulting in great obtained from existing fund shareholders. Much financial benefits to fund managers and brokers, and of this spending was to promote exotic and untested commensurately great costs to fund investors. “products” that have proved to have far more 3. Failure to exercise adequate due diligence in the ephemeral marketing appeal than enduring invest-research and analysis of the securities selected for ment integrity. fund portfolios, enabling corporate managers to 10. Lending securities that are the property of the fund engage in various forms of earnings management portfolios, but siphoning off a portion of the profits and speculative behavior, largely unchecked by the from lending to the adviser. professional investment community.

The Journal of Portfolio Management 2009.36.1:15-25. Downloaded from www.iijournals.com by JOHN C BOGLE on 11/04/09. 4. Failure to exercise the rights and assume the respon- Given such failures as these, doesn’t Justice Stone’s sibilities of corporate ownership, generally ignoring warning that I cited at the outset seem even more pre-issues of corporate governance and allowing cor- scient? Let me repeat the key phrases: “The separation porate managers to place their own financial inter- of ownership from management, … corporate strucests ahead of the interests of their shareowners. tures that … vest in small groups control over the 5. Soaring fund expenses. As fund assets soared resources of great numbers of small and uninformed during the 1980s and 1990s, fund fees grew even investors, … corporate officers and directors who faster, reflecting higher fee rates, as well as the failure award to themselves huge bonuses[,] … financial insti-of managers to adequately share the enormous tutions which consider only last, if at all, the interests economies of scale in managing money with fund of those whose funds they command.”

Just as we shareholders. For example, the average expense ratio ignored the fiduciary principle all those years ago, we of the 10 largest funds of 1960 rose from 0.51% to have clearly continued to ignore it in the recent era. 0.96% in 2008, an increase of 88%. (Wellington Fund The result in both cases, using Justice Stone’s words was the only fund whose expense ratio declined; is “the loss and suffering inflicted on individuals, the excluding Wellington, the increase was 104%.) harm done to a social order founded upon business 6. Charging fees to the mutual funds that managers and dependent upon its integrity, are incalculable.” control that are far higher than the fees charged in Today, as you know, much of that harm can be calcu-the competitive field of pension fund management. lated all too easily, amounting to several trillions of It is illegal to make unauthorized copies of this article, forward to an unauthorized user or to post electronically without Publisher permission.

Three of the largest advisers, for example, charge an dollars. So, this time ‘round, let’s pay attention, and average fee rate of 0.08% of assets to their pension demand a return to fiduciary principles. clients and 0.61% to their funds, resulting in annual fees of just $600,000 for the pension fund and A PIECE OF HISTORY $56 million for the comparable mutual fund, and presumably holding the same stocks in both port- While the overwhelming majority of financial folios (Bogle [2005, p. 199]).6 institutions operate primarily in the interests of their 7. Diluting the value of fund shares held by long-term agents and at the expense of their principals, not quite investors, by allowing hedge fund managers to all do. So I now draw on my personal experiences in the engage in “time zone” trading. This vast near- mutual fund industry to give you one example of my industry-wide scandal came to light in 2003.

It own encounter with this issue. As far back as 38 years involved some 23 fund managers, including many of ago, I expressed profound concern about the nature and the largest firms in the field—in effect, a conspiracy structure of the fund industry. Only three years later, my between mutual fund managers and hedge fund convictions led to action, and 35 years ago this Sep-managers to defraud regular fund shareholders. tember, I founded a firm designed, to the best of my 8. Pay-to-play distribution agreements with brokers, in ability, to honor the principles of fiduciary duty. which fund advisers use fund brokerage commissions I expressed these principles when doing so was (“soft” dollars) to finance share distribution, which distinctly counter to my own self-interest. Speaking to primarily benefits the adviser. my partners at Wellington in September 1971—1971!— 9. Spending enormous amounts on advertising— I cited the very same words of Justice Stone with which almost a half-billion dollars in the last two years I opened my remarks this evening.

I then added: alone—to bring in new fund investors, using money 20 THE FIDUCIARY PRINCIPLE: NO MAN CAN SERVE TWO MASTERS FALL 2009 JPM-BOGLE:JPM-BOGLE 10/19/09 10:36 PM Page 21 I endorse that view, and at the same time reveal an we had created the world’s first index mutual fund, run ancient prejudice of mine: All things considered, absent by Vanguard. a demonstration that the enterprise has substantial Then, early in 1977, we abandoned the supply-capital requirements that cannot be otherwise ful- driven broker–dealer distribution system that had been filled, it is undesirable for professional enterprises to operated by Wellington since 1928 in favor of a buyer-have public stockholders. This constraint is as applic- driven “no load” approach under our own direction. Later able to money managers as it is to doctors, or lawyers, that year, we created the first-ever series of defined-matu-or accountants, or architects.

In their cases, as in ours, rity bond funds, segmented into short-, intermediate-, it is hard to see what unique contribution public and long-term maturities, all focused on high investment The Journal of Portfolio Management 2009.36.1:15-25. Downloaded from www.iijournals.com by JOHN C BOGLE on 11/04/09. investors bring to the enterprise. They do not, as a quality. In 1981, Vanguard assumed responsibility for pro-rule, add capital; they do not add expertise; they do viding the investment advisory services to our new fixed-not contribute to the well-being of our clients. Indeed, income funds as well as our established money market it is possible to envision circumstances in which the funds. (As you can imagine, none of these moves was pressure for earnings and earnings growth engendered without controversy!) by public ownership is antithetical to the responsible Since our formation in 1974, the assets of the Van-operation of a professional organization.

Even though guard funds have grown from more than $1 billion to the field of money management has elements of both, some $1 trillion currently, now the nation’s largest man-there are, after all, differences between a business and ager of stock and bond mutual funds. Some 82% of that a profession … [So we must ask ourselves this ques- $1 trillion—$820 billion—is represented by passively mantion]: if it is a burden to our fund and counsel clients aged index funds and “virtual” index funds tightly linked to be served by a public enterprise, should this burden to various sectors of the fixed-income market. Some 25 exist in perpetuity? external investment advisers serve our remaining (largely actively managed equity) funds, with Wellington Man-My candor may well have played a supporting role agement advising by far the largest portion of those assets. in my dismissal as chief executive of Wellington Man- Most of these funds have multiple advisers, the better to agement Company in January 1974.

While it’s a saga too spread the risk of underperformance relative to their peers. complex to detail in this article, my being fired gave me More than parenthetically, that long string of busi- It is illegal to make unauthorized copies of this article, forward to an unauthorized user or to post electronically without Publisher permission. the chance of a lifetime—the opportunity to create a new ness decisions was made in a situation in which Van-fiduciary-focused structure for our funds. I proposed just guard’s very existence was in doubt, because the Securities such a structure to the directors of the Wellington funds.7 and Exchange Commission had initially refused to Wellington Management Company, of course, vigorously approve Vanguard’s assumption of marketing and distrib-opposed my efforts. ution responsibilities. But after a struggle lasting six (inter-Nonetheless, after months of study, the directors of minable!) years, the SEC reversed itself in February 1981. the funds accepted my recommendation that we sepa- By unanimous vote, the Commission declared that rate the activities of the funds themselves from their adviser and distributor, so that the funds could operate [t]he Vanguard plan is consistent with the provi-solely in the interests of our fund shareholders.

Our new sions, policies, and purposes of the [Investment structure involved the creation of a new firm, The Van- Company Act of 1940]. It actually furthers the Act’s guard Group of Investment Companies, owned by the objectives … enhances the funds’ independence … funds, employing their own officers and staff, and oper- benefits each fund within a reasonable range of fair-ated on an at-cost basis, a truly mutual mutual fund firm. ness … [provides] substantial savings from advisory While Vanguard began with a limited mandate— fee reductions [and] economies of scale … and pro-to provide only administrative services to the funds— motes a healthy and viable mutual fund complex in I realized that, if we were to control our own destiny, which each fund can better prosper (p. 128). we would also have to provide both investment advi-sory and marketing services to our funds.

So, almost A PRESCIENT SEC? immediately after Vanguard’s operations commenced in May 1975, we began our move to gain substantial con- The SEC’s words now seem prescient. With few trol over these two essential functions. By year’s end, exceptions, the Vanguard funds—and their shareholders— FALL 2009 THE JOURNAL OF PORTFOLIO MANAGEMENT 21 JPM-BOGLE:JPM-BOGLE 10/19/09 10:36 PM Page 22 have prospered. Measured by Morningstar’s peer-based TO BUILD THE FINANCIAL WORLD ANEW rating system (comparing each fund with other funds having distinctly comparable policies and objectives), Van- Creating and restructuring Vanguard was no easy guard ranked first in performance among the 50 largest task. Without determination, expertise, luck, timing, and fund complexes (Bogle [2008, p. 14]). the key roles played by just a handful of individuals, it Vanguard has also provided shareholders with sub- never could have happened. So when I suggest that we stantial savings from advisory fee reductions and economies must now go beyond restructuring the nature and values of scale, in fact, the lowest costs in the field.

Last year, over of a single firm to restructuring the nature and values of all, our funds’ aggregate operating expense ratio came to the entire money management business—to build the The Journal of Portfolio Management 2009.36.1:15-25. Downloaded from www.iijournals.com by JOHN C BOGLE on 11/04/09. 0.20% of average assets, compared to 1.30% for the average financial world anew—I am well aware of how difficult mutual fund. That 1.1 percentage point saving, applied to it will be to accomplish that sweeping task. $1 trillion of assets, now produces savings for our share- And yet we dare not stand still. holders of some $11 billion annually. And, as the world of investing is at last beginning to understand, low costs are For we meet at a time when, as never before in the the single most reliable predictor of superior fund perfor- history of the country, our most cherished ideals mance.

As we read in Homer’s The Odyssey, “fair dealing and traditions are being subjected to searching crit-yields more profit in the end” (p. 421). icism. The towering edifice of business and industry, If you are willing to accept—based on these data— which had become the dominating feature of the that Vanguard has achieved both commercial success (asset American social structure, has been shaken to its growth and market share) and artistic success (superior per- foundations by forces, the full significance of which formance and low costs), you must wonder why, after 35 we still can see but dimly. What had seemed the years of existence, no other firm has elected to emulate our impregnable fortress of a boasted civilization has shareholder-oriented structure. (A particularly ironic developed unsuspected weaknesses, and in conse-outcome, as I chose the name Vanguard in part because of quence we are now engaged in the altogether whole-its conventional definition as “leader in a new trend.”)

The some task of critical re-examination of what our answer, I think, can be expressed succinctly: under our at- hands have reared (Stone [1934, pp. 1–2]). cost structure, all of the profits go to the fund shareholders, It is illegal to make unauthorized copies of this article, forward to an unauthorized user or to post electronically without Publisher permission. not to the managers, resolving the transcendent conflict of As you may have suspected, I’ve once again cited a interest of the mutual fund industry. In any event, the leader, section of Justice Stone’s 1934 speech, and it’s high time as it were, has yet to find its first follower. we take it seriously. For the fact is that there has been a Vanguard represented my best effort to align the radical change in our investment system from the own-interests of fund investors and fund managers under estab- ership society of a half-century ago—which is gone, never lished principles of fiduciary duty.

I leave it to wiser— to return—to our agency society of today—in which our and surely more objective—heads than mine to evaluate agents have failed to serve their principals—mutual fund whether or not I overstate or hyperbolize what we have shareholders, pension beneficiaries, and long-term accomplished. But I freely acknowledge that we owe our investors. Rather the new system has served the agents accomplishments to the three simple principles: the firm themselves—our institutional managers. is 1) structurally correct (because we are owned by our Further, by their forbearance on governance issues, fund investors); 2) mathematically correct (because it is a tau- our money managers have also served the managers of cortology that the lower the costs incurred in investing, the porate America. To make matters even worse, by turning higher the returns); and 3) ethically correct (because we exist to short-term speculation at the expense of long-term only by earning far greater trust and loyalty from our investment, the industry has also damaged the interests of shareholders than any of our peers).

Measured by repeated the greater society, just as Lord Keynes warned. evaluations of loyalty by independent research firms, there Yet despite the extraordinary (and largely unrecoghas been no close rival for our #1 position. Please be nized) shift in the very nature of corporate ownership, appropriately skeptical of that self-serving claim, but look we have failed to change the rules of the game. Indeed, at the data. In a 2007 survey, one such group concluded, in the financial sector we have rolled back most of the “Vanguard Group generates far more loyalty than any historic rules regulating our securities issuers, our other company” (Coleman [2007, p. C13]).8 exchanges, and our investment advisers. While we should have been improving regulatory oversight and adminis- 22 THE FIDUCIARY PRINCIPLE: NO MAN CAN SERVE TWO MASTERS FALL 2009 JPM-BOGLE:JPM-BOGLE 10/19/09 10:36 PM Page 23 tering existing regulations with increasing toughness, both ilance” over other people’s money that once defined the have been relaxed, ignoring the new environment, and conduct of investment professionals. therefore bear much of the responsibility for today’s crisis.

So what we must do is develop a new fiduciary society Of course American society is in a constant state of to guarantee that our last-line owners—those mutual flux. It always has been, and it always will be. I’ve often fund shareholders and pension fund beneficiaries whose pointed out that our nation began as an agricultural savings are at stake—have their rights as investment prin-economy, became largely a manufacturing economy, then cipals protected. These rights must include: largely a service economy, and most recently an economy in which the financial services sector had become the 1. The right to have money manager/agents act solely in their principals’ behalf. The client, in short, must The Journal of Portfolio Management 2009.36.1:15-25. Downloaded from www.iijournals.com by JOHN C BOGLE on 11/04/09. dominant element. Such secular changes are not new, but they are always different, so enlightened responses are be king. never easy to come by.

Justice Stone [1934], once again, 2. The right to rely on due diligence and high profes-recognized that new forces demand new responses: sional standards on the part of money managers and securities analysts who appraise securities for prin-It was in 1809 when Jefferson wrote: ‘We are a cipals’ portfolios.10 rural farming people; we have little business and 3. The assurance that agents will act as responsible few manufactures among us, and I pray God it corporate citizens, restoring to their principals the will be a long time before we have much of either.’ neglected rights of ownership of stocks, and Profound changes have come into American life demanding that corporate directors and managers since that sentence was penned. [These] inex- meet their fiduciary duty to their own shareholders. orable economic forces, [create] public problems 4. The right to demand some sort of discipline and [that] involve an understanding of the new and integrity in the mutual funds and financial products complex economic forces we have created, their that they offer. relationship to the lives of individuals in widely 5.

The establishment of advisory fee structures that meet separated communities engaged in widely dif- a “reasonableness” standard based not only on rates but fering activities, and the adaptation to those forces dollar amounts, and their relationship to the fees and of old conceptions developed in a different envi- structures available to other clients of the manager.

It is illegal to make unauthorized copies of this article, forward to an unauthorized user or to post electronically without Publisher permission. ronment to meet different needs (p. 5). 6. The elimination of all conflicts of interest that could preclude the achievement of these goals.

To deal with the new and complex economic forces More than parenthetically, I should note that this final our failed agency society has created, of course we need provision would seem to preclude the ownership of money a new paradigm: a fiduciary society in which the interest management firms by financial conglomerates, now the of investors comes first, and ethical behavior by our busi- dominant form of organization in the mutual fund industry. ness and financial leaders represents the highest value. Among today’s 40 largest fund complexes, only 6 remain privately held. The remaining 34 include 13 firms whose shares BUILDING A FIDUCIARY SOCIETY are held directly by the public, and an astonishing total of 21 fund managers are owned or controlled by U.S. and While the challenges of today are inevitably different international financial conglomerates—including Goldman from those of the past, the principles are age-old. Con- Sachs, Bank of America, Deutsche Bank, ING, John sider this warning from Adam Smith way back in the 18th Hancock, and Sun Life of Canada. Painful as such a sepa-century: “Managers of other people’s money (rarely) watch ration might be, conglomerate ownership of money over it with the same anxious vigilance with which … managers is the single most blatant violation of the prin-they watch over their own … [T]hey very easily give ciple that “no man can serve two masters.” themselves a dispensation. Negligence and profusion must Of course it will take federal government action to always prevail” [1776, p. 800].9 And so in the recent era, foster the creation of this new fiduciary society that I negligence and profusion have prevailed among our money envision. Above all else, it must be unmistakable that gov-manager/agents, even to the point of an almost complete ernment intends, and is capable of enforcing, standards of disregard of their duty and responsibility to their princi- trusteeship and fiduciary duty under which money man-pals. Too few managers seem to display the “anxious vig- agers operate with the sole purpose and in the exclusive FALL 2009 THE JOURNAL OF PORTFOLIO MANAGEMENT 23 JPM-BOGLE:JPM-BOGLE 10/19/09 10:36 PM Page 24 benefit of the interests of their beneficiaries—largely the And so I await—with no great patience!—the return owners of mutual fund shares and the beneficiaries of our of the standard so beautifully described by Justice Cardozo pension plans. As corporate reformer Robert Monks all those years ago, excerpts from his words cited earlier in [2002] accurately points out, “capitalism without owners my remarks: will fail.”

While government action is essential, however, the Those bound by fiduciary ties … [are] held to some-new system should be developed in concert with the thing stricter than the morals of the marketplace … private investment sector, an Alexander Hamilton-like a tradition unbending and inveterate … not honesty sharing of the responsibilities in which the Congress alone but the punctilio of an honor the most sensitive … a level of conduct … higher than that The Journal of Portfolio Management 2009.36.1:15-25. Downloaded from www.iijournals.com by JOHN C BOGLE on 11/04/09. establishes the fiduciary principle, and private enterprise establishes the practices that are required to observe it. trodden by the crowd.

This task of returning capitalism to its ultimate owners In his profound 1934 speech that has been the will take time, true enough. But the new reality— inspiration for this article, Justice Harlan Fiske Stone increasingly visible with each passing day—is that the made one further prescient point on serving the concept of fiduciary duty is no longer merely an ideal common good: to be debated. It is a vital necessity to be practiced.

So a lot is at stake in reforming the very nature of our In seeking solutions for our social and economic mal-financial system itself, which in turn is designed to force adjustments, we are too ready to place our reliance reform in our failed system of governance of our business on what (the policeman’s nightstick of ) the state may corporations. The ideas I’ve passionately advocated in this command, rather than on what may be given to it as article, however, are hardly widely shared among my col- the free offering of good citizenship … Yet we know leagues and peers in the financial sector. But soon, perhaps, that unless the urge to individual advantage has other many others will ultimately see the light; for example, in curbs, and unless the more influential elements in March 2009, the idea of governance reform received society conduct themselves with a disposition to pro-encouraging support from Professor Andrew W. Lo of the mote the common good, society cannot function … Massachusetts Institute of Technology, one of today’s most especially a society which has largely measured its respected financial economists: rewards in terms of material gains … We must [square] It is illegal to make unauthorized copies of this article, forward to an unauthorized user or to post electronically without Publisher permission. our own ethical conceptions with the traditional ethics … [T]he single most important implication of the and ideals of the community at large. [There is] financial crisis is about the current state of corpo- nothing more vital to our own day than that those rate governance … a major wake-up call that we who act as fiduciaries in the strategic positions of our need to change [the rules]. There’s something fun- business civilization, should be held to those standards damentally wrong with current corporate gover- of scrupulous fidelity which [our] society has the right nance structures, [and] the kinds of risks that typical to demand (pp. 4, 10, and 13). corporations face today (p. R2).

The 75th anniversary of Justice Stone’s landmark In sum, the change in the rules that I advocate— speech reminds all of us engaged in the profession of applying to institutional money managers a federal stan- investment management how far we have departed from dard of fiduciary duty to their clients—would be designed, those standards of scrupulous fidelity, and gives us yet one in turn, to force money managers to use their own more opportunity to strengthen our resolve to meet that ownership position to demand that the managers and test, and build a better financial world. directors of the business corporations in whose shares they invest also honor their own fiduciary duty to the holders ENDNOTES of their shares. Finally, it is these two groups that share the Mr. Bogle is the founder and former chairman of The responsibility for the prudent stewardship over both cor-Vanguard Group of Investment Companies. This essay is drawn porate assets and investment securities that have been largely from his April 1, 2009, lecture on business ethics at the entrusted to their care, not only reforming today’s flawed Columbia University School of Business. The views expressed and conflict-ridden model, but developing a new model in this essay do not necessarily reflect the views of Vanguard’s that, at best, will restore traditional ethical mores. present management.

24 THE FIDUCIARY PRINCIPLE: NO MAN CAN SERVE TWO MASTERS FALL 2009 JPM-BOGLE:JPM-BOGLE 10/19/09 10:36 PM Page 25 Harlan Fiske Stone [1872–1946] received his law REFERENCES degree at Columbia in 1898, and served as dean of Columbia Law School from 1910 to 1923. In 1925, President Calvin Bogle, J.C. The Battle for the Soul of Capitalism. Yale University Coolidge appointed Stone as Associate Justice of the United Press, 2005.

States Supreme Court. In 1941, President Roosevelt ——. “A New Order of Things: Bringing Mutuality to the appointed him as Chief Justice of the United States, and he ‘Mutual’ Fund.” Speech at George Washington University, served in that position until his death in 1946. A curious February 19, 2008. coincidence is that Justice Stone appeared on the cover of Time magazine on May 6, 1929, just two days before my Coleman, M. “Few Firms Earn Loyalty of the Wealthy— own birth on May 8. In its profile story, Time accurately Well-Heeled Investors Search for Consistency; Vanguard The Journal of Portfolio Management 2009.36.1:15-25. Downloaded from www.iijournals.com by JOHN C BOGLE on 11/04/09. speculated that one day Stone would become the Chief Jus- Rates Highest.” Wall Street Journal, March 15, 2007. tice, in part because (in those backward sentences that dis- Frankel, T. Truth and Honesty: America’s Business Culture tinguished the early style of the magazine), “Well he has at a Crossroad. Oxford University Press, 2006. always tackled the public interest.”

Meinhard v. Salmon, 164 N.E. 545 (N.Y. 1928). Graham, B. The Intelligent Investor, rev. ed. Reprinted by See Luke 16:13 and Matthew 6:34 of the King James HarperBusiness, 2003.

Version of the New Testament.

I’m speaking here of the buy-side analysts employed Graham, B., and D. Dodd. Security Analysis. New York, NY.: McGraw-Hill, 2002. First published in 1934. directly by these managers. The conflicts of interest facing Wall Street’s sell-side analysts were exposed by the investi- Homer. The Odyssey. Translated by Robert Fitzgerald. The gations of New York Attorney General Spitzer in Odyssey: The Fitzgerald Translation. New York, NY.: Farrar, 2002–2003. Straus and Giroux, 1998.

The Vanguard Group, Inc., 47 S.E.C. 450 (1981).

These figures are based on 2002 data. The Supreme Keynes, J.M. The General Theory of Employment, Interest, Court will consider the issue of the effectiveness of the process and Money. Harcourt, Brace and Company, 1964. First published in 1936. by which mutual fund managers set the fee rates that they charge to the funds under their control with the oral arguments in Lo, A.W. “Business Insight (A Special Report): Executive Jones v. Harris Associates scheduled for November 2, 2009. My Briefing—Understanding Our Blind Spots: Financial Crisis amicus curiae brief in favor of overturning that decision was filed Underscores Need to Transform Our View of Risk.” Wall It is illegal to make unauthorized copies of this article, forward to an unauthorized user or to post electronically without Publisher permission. with the Court on June 15, 2009. Street Journal, March 23, 2009.

The lecture at Columbia University, on which this article is based, is essentially the third part of a trilogy that Monks, R., and A. Sykes. Capitalism Without Owners Will Fail. Centre for the Study of Financial Innovation, 2002. chronicles the development of the fund industry and of Van-guard itself. The first two parts of the trilogy were my speech Murray, A. “Future of Finance (A Special Report)— “Re-Mutualizing the Mutual Fund Industry—The Alpha Principles for Change: Peter Fisher on How to Avoid and the Omega” at Boston University Law School on January Financial Crises in the Future.” Wall Street Journal, March 21, 2004, and my speech “A New Order of Things: Bringing 30, 2009.

Mutuality to the ‘Mutual’ Fund” at George Washington University on February 19, 2008. All three are available on my Smith, A. The Wealth of Nations. Reprinted in 1994 by Random House. First published in 1776. eblog at www.johncbogle.com.

Figures are based on data from Cogent Research. The Stone, H.F. Address to the University of Michigan School of Vanguard loyalty score (percentage of strong supporters minus Law on June 15, 1934, reprinted in the Harvard Law Review, strong detractors) was a positive 44. The fund industry scored a 1934. pathetic negative 12.

In those days, profusion was defined as a “lavish or Str ine, L.E. “Toward Common Sense and Common wasteful expenditure or excess bestowal of money, substance, Ground? Reflections on the Shared Interests of Managers and Labor in a More Rational System of Cor porate etc., squandering, waste” (Oxford English Dictionary, 2nd ed., Governance.” Journal of Corporation Law, Fall 2007.

Vol. XII, 1989, p. 584).

Peter Fisher, widely respected BlackRock executive and former Treasury Department official, believes we should To order reprints of this article, please contact Dewey Palmieri at force institutional investors to do a better job of analysis, and [email protected] or 212-224-3675. establish demanding minimum standards of competence (Murray [2009]).

FALL 2009 THE JOURNAL OF PORTFOLIO MANAGEMENT 25