CAHPTER 4

AT WAR WITH WELLINGTON

Bogle and Riepe were on their way by train to a meeting of the Wellington mutual funds’ board of directors in New York City, armed with a brazen proposal that would, if accepted, convert the previous day’s painful personal defeat into a decisive victory. Bogle’s opponents—“my enemies”—were a majority of the board of directors of Wellington Management. But they were only a minority of the directors of the board of the several mutual fund boards comprising the Wellington Group of Funds.

The funds’ board had 11 fund directors: Bogle, Thorndike, Doran, and eight so-called independent or outside directors. Five of these had previously served as directors only of the Philadelphia fund boards and three had been directors only of the Boston funds. Bogle’s vote-counting estimate of the split among those directors was 6–5 in his favor—himself and the five Philadelphia directors versus Doran, Thorndike, and the three Boston directors. Some of the Philadelphia directors feared that after Bogle’s termination they would be dropped in favor of more Bostonians. That wasn’t the Boston directors’ only disadvantage. The night before the meeting, when Doran and Thorndike arrived in New York’s Knickerbocker Club after driving through a heavy snowfall, no rooms were available, so they had slept on benches in the locker room.

At the meeting, Bogle learned his chances would improve significantly. His friend Charles Root proposed that, given their conflicted interests, Bogle, Doran, and Thorndike should not vote. The funds’ board agreed, and Bogle’s vote count improved significantly, to 5–3. But then the outlook changed again; director Bob Worden called Bob Doran to say he had decided, after a careful review of all the factors, to change his vote. This would have tied the vote count at 4–4, but that night Worden suffered a fatal heart attack. After a pause to acknowledge his passing, the maneuvering continued.

Root, a confirmed Philadelphian,¹ admired Bogle’s abilities, was unimpressed by the skills of the Bostonians, and had the courage to form an independent opinion and hold onto it. He urged the fund directors to choose their own fund chairman and president and then select and contract with whatever investment manager the board might want. As Bogle recalled, “At that marathon 12-hour meeting, as chairman of each of the mutual funds, I proposed that we declare our independence from Wellington Management Company, mutualize our funds, elect our own officers and staff, and empower them to operate the funds on an at-cost basis.” In an industry where the primacy of the management company had never been challenged, such a bold step would be without precedent. So the battle was joined and would be long and hard fought.

Bogle had prepared the ground with the directors of the funds, and when he took his mutualization proposal to them they were interested. This put Wellington Management Company suddenly on the defensive: it would soon be struggling to keep managing the mutual funds, the great majority of its business.

Root was focused on the legal power fund directors had: the power to decide which investment management company to retain as manager of their mutual funds. Given this “hire and fire” power—even if it had rarely been used by mutual fund boards—was it not at least conceptually irresponsible for a fiduciary board of directors not to consider all its options? Why not terminate Wellington and hire a new management organization?

As the board meeting was getting underway, an obvious question was whether Bogle should continue to hold office as the chairman of the mutual funds’ board. Root had already made his position clear: keep Jack Bogle.

Bogle told the board: “This is your corporation. You were elected by the shareholders. You oversee the mutual funds on behalf of those shareholders. Wellington Management Company doesn’t own and doesn’t control the funds. You control them. This is a great opportunity for the funds to have their own voice. You do not have to fire me!”²

He pressed on with his mutualization proposal. Some directors were impressed by his courage, others by his unusual beliefs. Under his plan, the Wellington group of mutual funds would buy all the outstanding shares of Wellington Management Company and continue all its operations with one major change: operations would be conducted at cost. Bogle argued that all mutual funds were inherently and profoundly conflicted. In theory, fund management companies were supposed to serve the interests of investors as professionals and fiduciaries. But in practice they were run as businesses, maximizing profits for the owners of the management companies that sponsored, managed, advertised, and sold mutual fund shares to investors.

As Bogle explained to the fund directors, if the several mutual funds in the Wellington Group bought in all the stock of Wellington Management Company, Wellington—and only Wellington—would be organized as a mutualized mutual fund organization owned by the investors in those same mutual funds and governed solely by the funds’ board.^* That distinction could, with time and persistence, be converted into a decisive competitive advantage for the future Wellington.

Unfortunately for Bogle, all this was too much too soon for the fund directors despite their initial interest. They were properly conservative, none as daring nor as desperate as Bogle. They were deadlocked and unable to decide. Further study was a cozy way to avoid a difficult decision.

Before that crucial meeting of the funds’ board was over, the independent directors had decided on a study of how the Wellington organization should be structured. It was to be done by Bogle, at his regular salary, plus directors Root, Barbara Hauptfuhrer, and Joseph Welch. After one meeting as a committee, they would be joined by the full board of fund directors to study strategic options ranging from no change at all to the mutualization of the funds’ services to acquiring Wellington Management Company.

As would only be understood many months later, that single board meeting reversed the power relationship. Bogle, exhausted by another “near death” experience, burst into sobs on the train back to Philadelphia with Jim Riepe. But they had not lost, he quickly insisted. Now, with the right moves, they could start winning.³

While the reasons Bogle gave the board for each step were plausible—“modernizing,” “streamlining,” “simplifying”—the main motivation, never stated, appeared in retrospect to be preparing the way for his campaign to convert all the funds into a mutual organization of mutual funds with himself in control. In March 1974, with help from Riepe, Bogle put out a 45-page confidential memo to the fund directors with a summary and conclusions on “The Future Structure of Wellington Group of Investment Companies,” beginning with five goals: appropriate business independence, highest-quality investment services, optimum cost-effective administration, ability to attract and retain qualified people, and a corporate structure consistent with a future environment of consumerism and increasing regulatory surveillance. The report offered seven possible future structures, focusing on three as the least radical and the least disruptive. The emphasis was on one central objective: independence.

The memo showed how much could be saved by adopting option 2, internalizing administration costs and not paying Wellington’s 40 percent profit. Option 3 would internalize distribution (sales) and would achieve even greater savings. The prospect of going no-load was clearly stated. Option 4 would have the funds acquire Wellington Management Company. The memo declared, “Our detailed studies demonstrate that it is economically desirable, organizationally feasible, and legally permissible.” It added that the purchase price for Wellington Management would be quickly repaid through annual savings.

Riepe and Bogle’s long memorandum concluded that “the funds have already begun the first step toward self-sufficiency” and “the remainder of this first step—internal administration by completing option 2—is small in terms of people, but large in terms of dollars and important in terms of concept.”

Doran and Thorndike responded with strong arguments in a memo that ran nearly 100 pages. Their extensive analysis led to four major conclusions:

•   The mutual fund and institutional investment advisory activities of Wellington could not be unscrambled without harm.

•   Wellington had provided outstanding administrative services and highly credible investment performance.

•   Savings paled compared to the risks of impaired returns.

•   Internalization would not increase independence or diminish conflicts of interest. It would only make the funds substitute new conflicts for well-recognized and regulated ones.

Recognizing that Wellington Management was sure to lose at least some of its business with the funds, it sent a team of Doran, Thorndike, and Jim Walters to make presentations to the fund directors. Walters focused on one core proposition: if the fund directors took over more than fund administration, mostly bookkeeping, they risked violating their fiduciary duties by taking on responsibilities beyond their capabilities. This worried the directors and also concerned the directors’ new special counsel, Richard Smith, who was understandably cautious in a fast-changing, unprecedented situation.⁴

After six months of discussion and analysis, the directors chose the least invasive changeover: administration. They voted to adopt option 2: internalizing administration costs. The choice made the organization unique. Importantly, it would put Bogle in control of shareholder communications. Still, he was disappointed. He had hoped to control not just administration but also distribution, his career focus. Administration was the part of the funds’ business he had always been least interested in—close to “washing the dishes and sweeping the floors”—and where he had little experience. But at least it was a start.

The funds would be served by a new organization that would have a small staff of 28 accountants and clerks serving the mutual fund shareholders with administrative services and developing an arms-length relationship with Wellington Management. Bogle still had a job, so he said, “It was a victory of sorts but, I feared, a Pyrrhic victory.”⁵ The work the small new unit had ahead of it was limited to internal operations that Bogle would depend on Riepe to manage, while Bogle focused on strategy.^*

Bogle was already looking ahead to the next step. This was option 3 from the Future Structure Study: internalizing distribution. “While not accepted now, it may well be only a matter of time, perhaps within two or three years, when it will be, given the truly massive challenge to be faced in fund distribution.” As his memo had concluded, “Perhaps, then, the issue is not ‘whether,’ but only ‘when’ [the funds] will become completely independent,” breaking the remaining formal ties with Wellington Management.

A crucial initial step had already been taken back when Bogle was still at Wellington. All the Wellington mutual funds had been reincorporated as Maryland corporations. In addition, the “Philadelphia” and “Boston” fund boards had been consolidated into one common board of fund directors. This had required three layers of time-consuming approvals. First, each of the respective boards had to agree on which directors would stay and which would go. Second, a vote of the shareholders of each mutual fund had ben required. Third, approval by the federal regulators at the SEC had been needed. Astute observers might have noticed what would become important: a solid majority of the combined board just happened to be consistently supportive of one person—Jack Bogle.

Disputes during the breakup with Wellington Management were both legal and emotional. One early fight was over the Wellington name. Both sides wanted it. When Bogle heard he could not, for regulatory reasons, use the Wellington name, he exploded. “This is the last straw. This is stupid. I’m out of here! I’m going to resign and leave the whole business.” Charles Root called him the next morning: “Forget the name! A name is not important. You can call your new firm by any name you want and then make it the best name in the whole mutual fund industry!”⁶

A few days later, Bogle’s rage had faded. He was looking for an answer to an important question: What name to use? By good fortune, an antique print dealer called on Bogle, a history buff, and sold him four prints, each depicting one of Great Britain’s major sea battles in the era of Nelson, Wellington, and Napoleon, including one entitled “The Battle of the Nile.” Following that battle and his decisive victory, Nelson’s dispatch to the British Admiralty celebrated his flagship: “HMS Vanguard dispatch at the mouth of the Nile.” Bogle immediately saw the significance of the traditional meaning of the word vanguard—leadership of a new trend—and seized the name for his small new venture. “We had considered a name like Mutual Fund Service Company of America,” he recalled. “By comparison, Vanguard sure looked good. So our decision was easy. But would shareholders approve?”

Yes, they would. As a first step, on August 20, 1974, the fund directors, persuaded—or worn down—by Bogle’s tenacity, unanimously agreed to form a new firm to be wholly owned by the mutual funds.⁷ By the funds’ board decision, the new firm would administer the funds’ affairs—option 2 of Bogle and Riepe’s array of choices—but would be explicitly precluded from providing either investment advisory services or marketing and distribution services.⁸ Thus would begin the beginning of Vanguard and a four-year running battle for control of each of the major functions of the mutual fund business.

Vanguard was incorporated on September 26, 1974, just a few weeks before one of the worst bear markets in US history at last came to an end. Vanguard began its administrative operations on May 1, 1975.

^* While two other fund groups were internally owned in those days, both would soon shift to the traditional ownership structure including a management company that could be sold.

^* Bogle’s situation might be compared to that of Vice-Admiral William Bligh (1754–1817), who served under Captain Cook in 1776 and was the officer in command of HMS Bounty in 1789 when Fletcher Christianson and others mutinied. On April 28, Bligh and 18 loyal crewmen were put in a 23-foot launch with no charts and only one week’s supply of food and water. After 47 days and remarkable celestial navigation, Bligh and his men reached Timor, 4,164 miles away. They had each lived on one-twelfth pound of bread per day for 25 days. Bligh would later serve under Nelson at Copenhagen in 1801 and was appointed Governor of New South Wales in 1805. Three years later he was arrested by Major Johnston and a contingent of 400 in another mutiny called the Rum Rebellion.