Mutual Fund Secrecy

When I founded what is now the country’s second-largest mutual fund organization 27 years ago, I did my best to create a company that would live up to the ideal enshrined in the preamble to the Investment Company Act of 1940: that mutual funds should be managed in the interest of their shareholders rather than in the interest of their managers. Now the industry I helped to create is squandering an opportunity to show the public that this ideal still matters.

Last week was the deadline for comment about the Securities and Exchange Commission’s proposal to require mutual funds to tell the public how they voted their shares in corporate proxy elections. Most of the country’s largest mutual fund companies oppose the new rule. More than 7,000 individual investors, however, wrote to the S.E.C. in support of the requirements, which the commission is expected either to issue or withdraw in the next several weeks. I joined them in this support, casting my lot in opposition to the industry that I’ve been part of for more than a half-century.

While I no longer serve as an officer or director of the Vanguard Group, my views reflect the principles and values that I tried to make manifest in the creation of Vanguard, then as now the only mutual fund group that is truly ”mutual.” (Since its inception, the Vanguard Group has been owned by its mutual fund members, and it serves them on an at-cost basis.)

But whether structured like Vanguard or not, mutual fund directors, officers and managers are the agents; the fund shareholders are the principals. It is management’s responsibility to act solely on their behalf. It would thus seem self-evident that each mutual fund shareholder has the right to know how the shares of the corporations in his or her portfolio are voted. Such shareholders are partial owners of these stocks, and to deny them that information would stand on its head the common understanding of the principal-agency relationship.

Given that relationship, the fiduciary principle underlying the S.E.C’s proposal seems beyond controversy. Nonetheless, when funds are required to report their votes, some business difficulties may arise. Votes against management, for example, may make it harder for fund managers to get information from a corporation or to win the right to advise its pension plan. Controversial votes may draw unwanted publicity.

Yet I am skeptical of other industry claims. While many fund managers claim disclosure would be too expensive, it would be trivial compared with the $75 billion that shareholders paid for fund management last year. Other managers claim it is more effective to work ”behind the scenes” with corporate management. If so, let them present a record of the number of contacts made with managements and the issues discussed. Without these details, such statements lack credibility.

In its 1940 report to Congress, the S.E.C. called on mutual funds to serve ”the useful role of representatives of the great number of inarticulate and ineffective individual investors in corporations in which investment companies are also interested.” With their research, mutual funds ”not only serve their own interests but the interests of other public stockholders.”

When that report was issued, funds owned less than 1 percent of the shares of all United States corporations. Today, funds own some 23 percent of all stocks. Yet this industry has waited far too long to honor that mandate — a role that is not only useful but also required under traditional principles of trusteeship.

By their long forbearance and lassitude on corporate governance issues, mutual funds bear no small share of the responsibility for the failures in corporate governance and accounting oversight that were among the major forces creating the recent stock market bubble and the bear market that followed. If the owners of our corporations don’t care about governance, who else is there to assume that responsibility?

The first step toward greater accountability is for mutual fund agents to disclose how they vote the shares they own on behalf of their shareholder principals. The time has long since come for funds to cease their passivity as corporate owners and to assume the important responsibilities of corporate citizenship.