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What Were They Thinking?

In the heady world of finance, there are powerful players. Some of them believe the rules do not apply to them -- or maybe they just weren't thinking. Here are some current examples.
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The title for this week's column was inspired by John Edwards.

Let's forget whether the "love child" really is his. Let's ignore the denials of any knowledge about payments made to his mistress by his finance chairman. Let's also acknowledge that private conduct should remain private.

After the affair, Mr. Edwards decided to run for president. When he made that decision, his private conduct became fair game.

What was he thinking? That the rabid press corps would not find out? That it would not affect his candidacy?

In the heady world of finance, there are powerful players. Some of them believe the rules do not apply to them. Or maybe they just weren't thinking. Here are some current examples:

1. David Aufhauser: Before his resignation, Mr. Aufhauser was a Managing Director of UBS, which describes itself as "one of the world's leading financial firms." He was also General Counsel of UBS' Investment Bank and a member of the Group Managing Board of the company.

Mr. Aufhauser has a very distinguished background. He earned an MBA from Harvard and a law degree from the University of Pennsylvania. Prior to joining UBS, he was the General Counsel of the U.S. Department of Treasury. Among other duties, he supervised the Enforcement Division.

According to a complaint filed by the New York Attorney General, "Executive "A" at UBS unloaded his personal holdings in auction rate securities shortly after learning that the market was in trouble--at a time when UBS continued to aggressively market these securities to its retail customers. The Wall Street Journal reported that sources familiar with the matter identified Mr. Aufhauser as "Executive A."

Mr. Aufhauser was not charged with any wrongdoing and he was not alone in his conduct. Other executives of UBS dumped $21 million of these securities.

But I have to single out Mr. Aufhauser because he was a highly trained lawyer and the General Counsel of the Investment Bank. Where was his moral compass?

He knew there was a problem with auction bonds. He thought the problem was severe enough that he should rid himself of his entire holdings of $250,000. Yet, apparently, he did nothing to alert actual or prospective retail customers of UBS.

I have to ask: Mr. Aufhauser, What were you thinking?

2. Thomas DiNapoli: Mr. DiNapoli is the Comptroller of the State of New York. He has a great idea. He would like to make up for current losses in public pension funds by taking bigger risks in hedge funds and real estate. His goal is to have the authority to invest more than 25% of fund assets in "alternative investments."

Mr. DiNapoli has obviously not considered the data on hedge funds.

One study of the performance of 1917 funds found that only 17.7% beat a simple S&P 500 index fund.

Another study co-authored by Burton Malkiel (the author of A Random Walk Down Wall Street) concluded that investors in hedge funds "... take on a substantial risk of selecting a very poorly performing fund or worse, a failing one."

While Mr. DiNapoli risks compounding losses by investing in highly volatile funds, the Commonwealth of Massachusetts is moving in the opposite direction.

Its pension fund fired the "legendary" Bill Miller of Legg Mason, and other active managers who managed $1.8 billion of its domestic stock portfolio. It is putting $1.4 billion into an index fund. While the Massachusetts pension plan also invests in hedge funds, it is moving away from retaining active managers for its U.S. stock portfolios.

I understand what the Massachusetts pension plan fiduciaries were thinking. They were responding to overwhelming data and their own experience.

But Mr. DiNapoli, what were you thinking?

3. Unnamed major brokerage firm (you know who you are!): A reader of The Smartest 401(k) Book You'll Ever Read changed jobs. She called you to discuss rolling over her 401(k) which you manage for her former employer. She wanted to open an account with Vanguard and invest in a globally diversified portfolio of low cost index funds recommended in my book, consistent with her asset allocation.

Here is what you told her: "Low fees mean low returns."

Surely you know that the opposite is true: Lower expense ratios are strongly related to higher returns. This is not a subject of serious debate. Many studies demonstrate this fact.

I think I know what you were thinking.

4. Readers of this column: Wachovia, Citigroup Inc., UBS AG, JP Morgan Chase & Co. and Morgan Stanley have all settled claims that they misled investors in connection with the purchase of auction rate securities. Most observers believe this is the tip of the iceberg.

It seems clear that the culture of greed and disdain for the welfare of retail clients pervades Wall Street.

If you have an account with a brokerage firm, let me ask you this:

What are you thinking?

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.

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