John Bogle’s “Croupiers”

by Jacob Zamansky on April 28th, 2009 at 12:14 pm : Comments 000

The current outrage over the New York State pension fund and the use of placement agencies reminds me of comments I read a few months ago made by John Bogle, the legendary investor advocate and founder of Vanguard Mutual Fund Group.

Bogle argued that a silver lining to the financial crisis is that it will root out a cottage industry of middle men who earn huge fees without providing any value.  In a Forbes op-ed Mr. Bogle wrote:

Last year a substantial sum, $620 billion by my rough calculation, poured into a system that supports the money shufflers and middlemen, whom I call the “croupiers,” of the financial services industry. That’s a lot to pay for financial intermediation.

“…I do not wish suffering on the people of New York City. But maybe we should be grateful for any shrinkage in a system that has too many people engaged in shuffling the assets owned by the rest of us.

It’s as if Attorney General Cuomo read Mr. Bogle’s October 2008 op-ed and decided to do something about it.  Placement agents like those involved in his investigation and those that employed them, including The Carlyle Group and Quadrangle Group, allegedly bought and sold access to public pension funds.  The fees come directly out of the pocket of individual investors and contributing employees.

Another form of Mr. Bogle’s “croupiers” are the so called feeder funds, also known as fund-of-funds.  Feeder funds are suppose to conduct due diligence on investment managers and make tax-concious decisions on behalf of their well-healed clients.  As the Madoff Ponzi scheme has taught us, many of these funds allegedly ignored their responsibility to conduct due diligence and/or lied to investors about their diversification strategies.

In actuality, Bernie Madoff’s “logitament” business falls into this category.  This is how Fortune Magazine described the business:

Rather than taking a fee for trading stocks, as NYSE specialists did, Madoff paid firms like Charles Schwab and Fidelity a penny or two a share for their orders, a practice known as “payment for order flow.” In those days, there was a prevailing spread of at least 12.5¢ between the price that a “market maker” like Madoff’s firm paid to buy shares and the price at which it would sell the same shares.

Sadly, this is perfectly legal.

So Bernie’s days are gone, the feeder funds have been forever tarnished and Mr. Cuomo’s taking care of the placement agents.  Where else do the croupiers do business?

The municipal finance industry is ripe with these sorts of operators.  A popular way for former government officials to earn fees is to help Wall Street investment banks gain access to government debt issuers.  Others include specialist stock traders, commodity futures speculators and even proxy advisory firms.

Basically, on Wall Street, whenever a large sum of money is transacted, or wherever important decisions are made, croupiers are lurking.

Filed under Wall Street