APRIL 5, 2010
Critics Say Funds
Should Do More to Police Corporate Pay
To the millions of Americans wondering how
Wall Street's compensation culture got so brazen, one part of the answer may
come as a surprise: It's your mutual fund.
Many Main Street investors have fumed at the
huge bonuses paid to Wall Street executives and traders following a
government bailout of the financial industry. Yet directors at companies
Goldman Sachs Group Inc. and
Morgan Stanley are mostly expected to sail to re-election in proxy
voting this month and next—and among the parties casting the most votes will
be fund-management companies.
Over the past 30 years, as retirement plans
such as 401(k)s replaced pension funds as the retirement engine for millions
of Americans, mutual funds became the largest shareholders at most big U.S.
corporations. Eighteen of the top 20 shareholders at Morgan Stanley and
Bank of America Corp. are asset-management companies, as are 19 of the
top 20 at Goldman Sachs, according to
FactSet Research Systems Inc. That clout has given fund firms a central,
if sometimes overlooked, role in overseeing public companies and policing
corporate pay practices.
Not only do they and other corporate
shareholders get to vote on company directors, who approve
executive-compensation deals, they sometimes have a nonbinding say on pay
matters as well. Because funds' annual proxy votes are cast by
fund-management companies—Vanguard Group for the Vanguard funds or
BlackRock Inc. for the BlackRock and iShares funds—and not individual
investors, the market, at least in theory, is relying on fund firms to use
their power to vote out directors who approve exorbitant pay packages. But
for a range of complicated reasons—from passive-minded investment strategies
to insider-trading rules to funds' own close ties to Wall Street—funds
rarely muster the will to challenge corporate chiefs, critics say.
"Directors are asleep at the switch because
mutual funds are asleep," says Jack Bogle, retired founder of Vanguard
Group, one of the largest mutual-fund groups, and a frequent critic of Wall
Street. "If mutual funds got together and said, 'We're not going to stand
for it anymore,' the world would change."
The Securities and Exchange Commission in
2003 began requiring funds to issue formal proxy-voting policies as well as
to disclose their votes in individual corporate elections. The move, partly
in response to that era's corporate-governance scandals, was made over
objections from the fund industry, which argued disclosure could make it a
target of special interests.
Individual investors can find mutual funds'
votes through form "N-PX" on the SEC Web site. Watchdogs such as the
Corporate Library and Web sites like
Proxydemocracy.org help investors keep tabs on the behavior of
individual fund families. Fund firms' proxy-voting guidelines, meanwhile,
can usually be found on their Web sites.
Among the fund families the Corporate Library
calls "pay enablers," consistently failing to use their voting power to rein
in executive pay, are AllianceBernstein LP; Barclays Global Investors, now
owned by BlackRock; and
Ameriprise Financial Inc. Among those it ranks as more aggressive are
T. Rowe Price Group Inc. and
Franklin Resources Inc.'s Templeton Funds. BlackRock and
AllianceBernstein say they strive to cast votes in shareholders' best
interests. Ameriprise declined to comment.
The benefit of SEC disclosure has limits,
however. Investors are confronted with so many variables when purchasing
funds, it may be a reach to assume voting records will play a big role in
their decisions. Further, while proxy elections are held in the spring,
often in April and May, mutual funds don't disclose their votes until much
later, usually August.
"By the time shareholders get a picture of
what a fund is doing, it's long past the time when it's relevant," says
Stephen M. Davis, executive director of Yale University's Millstein Center
for Corporate Governance and Performance.
For its part, the Investment Company
Institute, the mutual-fund industry's trade group, says the notion that
mutual funds reflexively bow to management in proxy contests is false. In
2007, for example, funds voted in favor of proposals offered by shareholders
almost 40% of the time, the ICI says.
Moreover, there is a long-standing argument
that voting records are essentially a red herring and that market forces
shape the way companies are governed because funds that don't like how a
firm is managed can sell shares and invest elsewhere. But Wall Street's case
is unusual. For years, these firms' shareholders overlooked lavish
compensation packages on the assumption that the financial wizardry of
executives and traders was what made the companies wildly profitable. Now
that those profits seem largely driven by risk-taking, it may be time to
strike a new bargain, some critics say.
Some observers say that although mutual funds
are the largest shareholders of most big corporations, individual funds
rarely amass large enough stakes to make it worth their while to lead
expensive proxy battles over directors or give them power to dictate
business strategy from the background.
J.P. Morgan Chase & Co., the largest Wall Street firm, has a market
value of about $178 billion. BlackRock, the largest fund manager by assets,
is J.P. Morgan's largest shareholder, but it owns only about 5.6% of the
"I've never heard of a major proposal put up
by a mutual fund that had bite or substance," says Russ Wermers, a finance
professor at the University of Maryland's Smith School of Business who
studies mutual funds. "It isn't worth their while to stir the pot."
Size isn't the only thing that makes it
difficult for fund firms to challenge company managers. SEC rules designed
to guard against insider trading prevent funds from using tactics often
employed by activist investors, such as demanding board seats.
Either sitting on a company's board or
amassing a stake of more than 10% triggers strict limits on when an investor
can trade shares. Such limits would pose huge risks for mutual funds, which
need constant flexibility to unload shares because their own investors can
cash out on a single day's notice, says Glenn Booraem, Vanguard's head of
proxy voting and corporate governance.
"We've tried to communicate our perspective
through proxy voting," Mr. Booraem says. Still, independence on an issue
like pay "is easy to assert on paper, but difficult to evaluate in real
life, especially if you are not in the boardroom."
Challenging company management also doesn't
mesh well with many funds' investment philosophies.
Index funds, for example, buy stocks based
simply on market values. Employing platoons of analysts to research and
possibly challenge management arguments—much less wage costly proxy
campaigns—would undermine their main mission, which is keeping investing and
trading costs as low as possible.
Indexers such as Vanguard, BlackRock and
State Street Corp., which rank among the largest holders at many
companies, say they work hard to fulfill governance duties despite making
these trade-offs. Vanguard, for example, says it talks to hundreds of
companies a year about its concerns.
Ties That Bind
Mutual funds' business and cultural ties to
the companies in which they invest also may make them less than ideal at
Some analysts say that because retirement
plans such as 401(k)s are a key source of investment dollars for mutual
funds, some fund firms may be reluctant to anger company managers by getting
into disagreements with them over issues such as pay.
A frequently cited 2007 study by Gerald Davis
and Han Kim at the University of Michigan concluded that mutual-fund firms
with extensive 401(k) businesses tend to have the most management-friendly
voting habits. "The more a fund family relies on pension-plan business, the
bigger suck-ups they are," Mr. Davis says.
The finding is particularly significant
because handling 401(k) plans gives some of the largest fund firms—like
Fidelity Investments, Vanguard and T. Rowe Price—a lot of extra clout at the
corporate ballot box.
Fidelity and T. Rowe Price say employees that
handle 401(k) clients don't mix with those that cast proxy votes. Vanguard
says the University of Michigan study focuses too narrowly on certain
shareholder votes and overlooks areas like director elections.
Finally, although mutual-fund companies are
supposed to represent the interests of millions of Americans at the
corporate ballot box, they may have more in common with Wall Street than
with the average investors. Portfolio managers' careers, much like those of
Wall Street traders, hinge on their skill in valuing various securities. If
anyone is likely to think this skill is worth millions of dollars a year, it
is people whose own livelihood also depends on it.
"They all drank the same Kool-Aid," says
Simon Johnson, a former chief economist of the International Monetary Fund,
who has been critical of the financial-services industry's ability to police
itself. "I wouldn't hold my breath for them to be the ones to weigh in on
—Mr. Salisbury is a
reporter for Dow Jones Newswires in New York. Email:
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