TCS Daily

The Market as Judge

By John E. Tamny - June 23, 2004 12:00 AM

As Chairman of the House Financial Services committee, Rep. Michael Oxley is probably more aware than most of the positive impact broad stock ownership would have on the U.S. economy. Voters that are owners of the capitalist system are clearly more likely to approve of legislation that reduces taxes and regulations. This in mind, investors should hope that he'll rethink supporting an SEC proposal that would require mutual fund chairmen to be independent.

For historical context, two years ago Rep. Oxley and Maryland Senator Paul Sarbanes co-authored an amendment that promised to "reinforce corporate integrity and enhance investor confidence" in public companies. While well intentioned, and certainly popular amidst the hysteria surrounding the collapses of Enron and Worldcom, the legislation ultimately had the effect of scaring investors who feared that the Sarbanes-Oxley amendment would bury CEOs in paperwork as opposed to profit maximizing strategies. The Dow dropped 1,400 points around the time of the bill's passage.

Returning to mutual funds, Rep. Oxley and SEC Chairman William H. Donaldson argue that fund chairmen are conflicted by arrangements that allow them to serve both fund investors and the investment advisor. By their lights, chairmen with a stake in the management company's profits have less incentive to root out the above-mentioned abuses. More realistically, an independent chair requirement could lead to more of the dubious practices that they want to eradicate.

While there are no hard and fast statistics about the independent/non-independent ratio of fund chairmen, it is known that 20% of the 8,000+ mutual funds are affiliated with a bank, and as such were required until recently to have independent chairmen. The rest of the mutual fund world does not labor under this requirement, and to this day is allowed arrangements like the one at Fidelity Investments where non-independent Chairmen Ned Johnson III is "Interested -- and proud of it!"

Despite the fact that a majority of mutual funds are headed up by non-independent Chairmen such as Fidelity's Johnson, three of the first eight fund families (NationsFunds, BancOne, and Putnam) implicated in the market-timing scandals had the very independent chairs that Oxley has deemed so essential to the mutual fund industry's health, and investor confidence.

As for the makeup of independent chairmen, many are chaired by people like Marvin Mann. When asked by the Wall Street Journal's George Anders how many funds he headed up, the ex-Lexmark chairman cited an incorrect number. It turns out that many fund chairmen are similar to Mann; as in they come from non-investment backgrounds and frequently oversee many funds; sometimes so many that they don't even know how many they're policing.

Anders went on to point out that "independent trustees must juggle boardroom commitments with full time jobs," while Princeton's Burton Malkiel acknowledged in the same article that "as many as two to three years may pass between face-to-face meetings with specific portfolio managers."

While Rep. Oxley calls Richard Strong of Strong Funds (which were recently implicated in the mutual fund scandal) "the poster child for why we need independent chairmen," it could be argued that his plan to nurse the mutual fund industry back to health could lead to far less scrutiny of the kinds of dubious practices that he would like to see reduced. Judging by assets under management at Fidelity, many investors seem to prefer non-independent chairmen like Ned Johnson who have a financial stake in the health and reputation of the funds they oversee.

In a February Wall Street Journal editorial Johnson noted, however, that there is no evidence "that having an independent chairperson is always a bad choice." Johnson understands that markets are the best judges of the right management structure for mutual funds, with investors having the ultimate say over what is correct. Indeed, in the aftermath of the market-timing scandals, independent and non-independent mutual funds alike were victims of the marketplace's rough justice as investors punished the alleged wrongdoers, and rewarded funds thought to be clean.

Michael Oxley knows that an investor nation would have an immense impact on our nation's economy. Here's hoping he and Chairman Donaldson recognize that free and unfettered markets are the surest path to achieving the ownership society that they desire. Shelving regulations that would require all funds to be headed by independent mutual fund chairmen would be just the kind of laissez-faire signal from Washington that would cheer investors, all the while setting a market-based example that other policy-makers would follow.

John Tamny resides in Washington, D.C., and spent four years in the brokerage business. He can be contacted at


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