Deutsche Bank's DWS Fund: Beyond the Ethical Edge

Includes: DHG, GCS, SRQ
by: Gwailo

Part 1 described some of the troubles now ailing Deutsche Bank (NYSE:DB), its DWS fund management arm and the DWS closed-end funds. Part 2 recounted how the independent Directors of those funds, who also govern 118 other funds at DWS, passively accepted poor performance and trading discounts that meant losses for their investors. However, when faced with proxy challenges to their own position and authority, these same Directors responded vigorously to entrench themselves in office, by altering fund bylaws and concocting "poison pills", despite an official policy against such acts when committed by others.

Perhaps our independent Directors just need to be reminded who they represent. An expert on fund governance and business ethics explains:

As a director, I believe that the first and primary obligation of a board should be to ensure that its structure and operation are of the highest standards for integrity. If the board is vulnerable to charges of unethical conduct, it will have little credibility in its oversight role. In many cases, a board's ethical weakness most often emerges in cases of conflict of interest between the directors and the institution they govern.

The fund company is managed for the benefit of the shareholders, not for the investment adviser that created, staffed, and operates the funds.

The most effective way to bring about an ethical board may be the combination of shareholder activism and sunshine - shareholders who know and care who their directors are, and reports, newsletters and even an inquiring financial media that help reveal information about who directors are and what they do.*

Alternatively, the convoluted history of DWS fund governance might be to blame. Since 1991, Deutsche Bank has acquired five different fund management companies: Kemper, Scudder, Morgan Grenfell, Bankers Trust and Alex Brown, all now jumbled together with the Bank's in-house management group under the DWS label. The result has not been one big, happy family, judging by reports in Fund Directions (a mutual fund trade newsletter). As recently as February 2006 there were three different main boards and some lesser ones for the various funds in the complex, but "in order to standardize and simplify everything across the funds," the "Boston board" (a Scudder, legacy) was merged into the "New York board" (think Bankers Trust). The next month "Scudder Closed-end Board Loses Power" headlined a report that the "cluster" board which watched the five Scudder closed-end funds would be replaced. The next shoe fell early in 2008, with the news that the "Chicago board" (a Kemper legacy) would be swallowed up by the "New York board". The February 2008 issue of FD hints at some discord: "In addition to all that [the co-ordination problems], the directors had to overcome the prejudice of existing board members who remembered the pain of two prior failed merger attempts."

But how could one board with just 13 directors oversee all 129 funds effectively? Director and current Chair Paul Freeman (a Chicago board alumnus) told FD in February 2008 that the trick was to divide the funds into groups of about 15-18 portfolio managers or styles, and have one committee of the board oversee each cluster. But in an interview three months later, former chair Dawn-Marie Driscoll (New York board) described a very different structure:

The board of the DWS Scudder funds has six committees besides the required audit committee, including equity oversight, fixed-income and quant oversight, marketing and shareholder services and operations committees. "I can't imagine how it would work without having very vibrant committees" said Dawn-Marie Driscoll, chairman. "There is so much that a board has to do even though we have meetings that last several days."

Driscoll explained her board's assortment of committees act as triage on the important issues. Committee members are able to pick out a topic they initially thought might just be a routine item and bring it in front of the entire board, since the committees meet first. This is especially the case with Scudder's investment oversight committees, Driscoll said. "If there is a fund that's a 'problem child' we have that portfolio manager come in front of the full board to have 12 sets of eyes looking at him instead of just six."

Three months later, readers of FD's August '08 issue learned of yet another change. A contracts committee would now "be responsible for all financial interaction between the funds and the advisor. 'We're trying to centralize anything with fees to one committee' said Paul Freeman, chairman.... 'The contract committee is not only for 15(c) but rather a repository for all financial dealings'". But then Lehman Bros. failed, and the financial markets plunged. FD reported in November '08 that the DWS Board was now moving to re-arrange its agenda so senior personnel from DWS and the Bank could join in and discuss trends in the industry and how they were affecting the advisor:

To compensate for these additions, Freeman said they may spend less time on other regularly scheduled topics... It's hard to have a big discussion with a portfolio manager on why a fund is down when the entire market has declined 20%, he said.

If some Board members find "big discussions with portfolio managers" overly depressing, then maybe a trip abroad will help cheer them up. According to FD's February '08 report: "The directors of the DWS Scudder funds ventured to Germany in September (just missed Oktoberfest!) to meet with senior management at Deutsche Bank, the fund group's parent, when its advisor brought up the idea of introducing fund concepts already in place overseas." One year later, in February '09 FD reported that the Board "is planning to ship out to Germany to hold one formal board meeting a year at the Frankfurt-based headquarters of Deutsche Bank, its parent company.... [F]or the next two years the board plans to head overseas for one meeting a year, most likely in May." Ah! May in München, when the Bratwurst is in bloom.

One gets the impression that concern for fund investors got lost somewhere between the vibrantly triaging committees, the foreign junkets and the Machiavellian maneuvering for control.

So much conflict! Conflict within boards, conflict between boards, conflict with activist proxy opponents, conflict between shareholder friendly policies and shareholder-hostile new bylaws. Let's see what our ethics expert has to say about the need for fund Directors to recognize their own conflicts of interest and to deal with them in a way that restores investor trust:

Understanding conflict of interest is important because it is this conflict that colors one's independence. Yes, we all know that an "independent-on-paper" director may be ineffective (see Enron) and someone with close ties to management or the company may be the most ornery, persistent, diligent, and independent acting director on the board. But unfortunately, in this time of heightened scrutiny no board can afford to have its directors subject to negative attention because of suspicion about their motives.

... [I]f you don't see your conflict or don't think you have one, you can't or won't avoid it. This problem is fairly common and an all too-explainable human reaction. After all, we believe we are upstanding, ethical, and moral. We deny that our opinion could be influenced by our casual relations with someone else. In fact, we're outraged. How dare they suggest that? We feel attacked and get defensive.

"In this climate of ethical sensitivity, conflicts of interest demand our care and understanding. To restore investor trust, we need to restore investor confidence in director independence and that must necessarily start with attention to conflicts of interest involving directors.**

Guess what? Our anonymous "ethics expert" is the very same Dawn-Marie Driscoll who last year was paid $292,500 for chairing those 129 fund Boards at DWS. She has been a director in the Scudder fund complex since 1987 and has co-authored a variety of articles on business ethics and fund governance. Here is her resume, readers can decide for themselves if her approach to "business ethics" is as vapid and vacuous as it seems. Ms. Driscoll preaches "trust" and "confidence" with a high ethical tone, and she has been well paid for these sermons. But can investors be confident that the DWS Board will now put their interests first and foremost, when they look at the way the Board acted when she led it? How much trust can shareholders place in Directors who lost an election but still hold over in their seats? There is an unpleasant word for folks who profess lofty goals but whose actions are just the opposite. =====>.

If there is any truth in the inspired visions of the ancient poets, a sad fate awaits Dawn-Marie Driscoll, Paul Freeman and their associates. Dante placed the hypocrites far down in the Eighth Circle of his Inferno. There they are condemned to trudge along for all eternity, cloaked in garments that shine like Infernogold but are far heavier than lead. Canto 23:066

Di fuor dorate son, sì ch'elli abbaglia;

ma dentro tutte piombo, e gravi tanto,

che Federigo le mettea di paglia.

Outside, these cloaks were gilded and they dazzled;

but inside they were all of lead, so heavy

that Frederick's capes were straw compared to them.***

Repent, Dawn-Marie! Repent, Paul! Repent, Fund Directors! Your pathway to eternal perdition runs through the Deutsche Bank!


* "Ethics and Corporate Governance: Lessons Learned from a Financial Services Model" by Dawn-Marie Driscoll Business Ethics Quarterly, Vol. 11, No. 1 (Jan., 2001), pp. 145-158

** Dawn-Marie Driscoll, "Rethinking Conflict of Interest" in Directors Monthly, July 2003

*** An expert on medieval torture explains the reference to 'Frederick's capes': "Emperor Frederick II was well-known for his lead capes with which he punished various criminals. He had a leaden cover made for the condemned man, to cover him entirely. The cover was about an inch thick. Then, he had the man placed in a cauldron, and the leaden cape put over him. Then he had a fire made under the cauldron. The heat melted the lead which took the skin off piece by piece. Finally, both the lead and the condemned man boiled".

Disclosure: long DHG, SRQ, GCS