Vanguard's founder, JohnBogle promoted the idea that index funds such as the Vanguard 500can outperform most actively managed funds because they have lowermanagement fees and trading costs.

Here's what I think the mutual fund industry fears aboutretired Vanguard founder and CEO John Bogle:He's one of them. He knows where all the skeletons are hidden. Andhe's not afraid to reveal those hiding places.

Among the many surprising skeletons Bogle revealed in my recentconversation with him (see “Exclusive Interview with John Bogle: Industry'Crying Out for Change'; says Fiduciary Rule 'a TurningPoint',” FiduciaryNews.com, June 21, 2016) was hisadmission that, while he tried to make Vanguard a fiduciarybusiness, it remains to this day a marketing business. In doing so,he exposes the ultimate fiduciary dilemma: The client isn't alwaysright.

Before we get to that, though, let's explore the significance ofBogle's executive experience within the mutual fund industry. Remember, beforeVanguard went “mutual,” it was a publicly held management company.Bogle led the transition away from serving the public company'sshareholders towards serving the investment company's (i.e., mutualfund's) shareholders. In doing so, he rejected the parameters andbenchmarks of public companies.

Let's restate what this means. The shareholders of the publiccompany demand, expect, and, indeed, are entitled to a fair andreasonable return on their investment. In the same manner, theshareholders of the investment company demand, expect, and areentitled to a fair and reasonable return on their investment. Whathappens if the best interests of one constituency conflict with thebest interests of the other constituency?

This is not merely some philosophical question. It is thedefinitive quandary of corporate governance regarding any publiclytraded company. Whose best interests should a company likeMcDonald's serve? Should it be the company shareholders? In thiscase, it would seek to maximize profits by charging high prices andkeeping expenses low. Should it be the company employees? In thiscase, it would seek to maximize expenses (i.e., employee salaries)by charging high prices and keeping profits low. Should it be thecompany's customers? In this case, it would seek to charge lowprices by keeping both profits and expenses low.

Are you beginning to see the problem here? It's like a tube oftoothpaste. You can squeeze the tube to push all the gel to oneend, or you can squeeze the tube to pull all the gel to the otherend. It's a zero-sum game. The only way you're going to pay Peteris to rob Paul – and vice-versa.

Now, let's say you want to pick one side of this multi-lateraldilemma. In our McDonald's example, we can make it be thecustomers. We want the customers to enjoy the cheapest prices. Inorder to make the business “sustainable” (i.e., make enough moneyto stay in business), we know we cannot give away those hamburgers.The question then becomes, what's the least we can charge and stillpay enough to the employees so they stick around and produce enoughprofits to continue to attract shareholders to buy and hold thecompany stock.

OK, you have your assignment. So who do you hire to get itdone?

You bring on someone with in-depth experience running a publiclytraded fast food company. Theoretically, he knows what costs can becut, what costs are essential, and exactly what threshold theshareholders will bear before dumping the stock. That's thedefinition of the perfect insider. He knows where all the skeletonsare hidden.

Which brings us back to why the industry considers Bogle such asdangerous commodity. In saying mutual funds need to only serve thebest interests of mutual fund shareholders, we are tellingMcDonald's it's only job is to keep prices low for its customers.And if that's the sole objective of investment companies, whobetter to assign the task of outing all the unnecessary costs thanan experienced mutual fund executive (such as John Bogle). It's thesame reason why computer security companies hire hackers and thepolice trying to solve a bank heist often hire former bank robbersas consultants. If you want to disassemble a system, hire the guywho built it.

What does this have to do with the “ultimate fiduciary dilemma”?According to Bogle, mutual fund companies are marketing companiesin that they continually offer new mutual funds that no fiduciarywould offer. Why do they do this? Because the market demands it.Why must they do what the market demands? Because that's the waythey stay in business. In other words, in order to continue tooffer the proper “fiduciary” mutual funds and stay in business,they need to offer improper “non-fiduciary” mutual funds.

If your brain hurts, then you understand.

Author's note: I operate my own family of mutual funds. I'vechosen a business model that allows the business to sustain itselfwithout straying from the “fiduciary” mutual fund imperative. Ienjoy it and our shareholders seem to like it, too (the funds havevery little shareholder turnover). There's a trade-off, though.Everything is very small, too small, in fact, to be attractive tomost mutual fund companies. I can get away with it because I livein a low cost-of-living region (i.e., greater Western New York) andhave only modest material needs (why else would I spend so muchtime writing?). So, it is possible to have a pure “fiduciary”mutual fund company. It's just not very profitable. (Hmm, isn'tthat the very thing mentioned in the McDonald's example?)