Though he did not get much credit for it, one of Harvey Pitt’s last acts as SEC chairman was to hand a tremendous victory over the mutual-fund industry to the AFL-CIO. The SEC commissioners decreed that mutual funds must henceforth disclose how they cast their proxy votes on such corporate-governance issues as executive pay and dodging taxes by reincorporating in Bermuda. The end of secrecy will put managers of major mutual funds in the cross-hairs of investor controversy, because the funds have routinely voted their massive holdings with the corporate managements and against the interests of ordinary investors, including the workers whose savings and pensions are invested in the funds.
The decision was a man-bites-dog story that got scant notice, but shareholder activists celebrated because it represents another critical step toward reining in unaccountable corporations and out-of-control CEOs–the concentrated insider power that produced Enron and the many other scandals. Mutual funds collectively own around 23 percent of all publicly traded companies, so how they vote their shareholdings is often decisive. Their cozy alliances with CEOs are one reason labor, environmentalists and religious groups seldom prevail in shareholder challenges aimed at cleaning up a company’s behavior.
The CEO can count on the big funds’ support in these fights because the CEO gives them a ton of business managing corporate-controlled investments. You don’t vote with the CEO, you lose his business. In a financial system always boasting about its transparency, this profound conflict of interest has been protected by secrecy–a contradiction that even Pitt couldn’t abide in the present climate of skepticism toward Wall Street. It perhaps also helped that Pitt received some 7,000 supporting comments from investors, thanks to efforts by the AFL’s unions and other shareholder activists.
“This is our money, they’re managing it and they are in the pockets of industry,” said Ron Blackwell, corporate affairs director at the labor federation. “And this is how we got into this corporate mess in the first place. The mutual-fund industry is riddled with conflicts of interest, and it is essentially an unregulated industry. In particular, they manage money for these companies that they also own as shareholders [on behalf of the mutual-fund investors], and so they vote with the management on the corporate-governance issues. If the company gives its business to Fidelity–managing 401(k) money or pension plans–then Fidelity votes with the management. That’s the deal. So we are rolling back the rock and forcing them into the sunshine. That’s the predicate for holding these fiduciary institutions accountable.”
The AFL’s campaign singled out Fidelity Investments, based in Boston, the country’s largest mutual fund, among many thousands. Fidelity predictably rejected demands for voluntary disclosure. Among many issues, the one that really ignited public anger and built political support was the decision of Stanley Works, a venerable tool manufacturer in New Britain, Connecticut, to turn itself into a Bermuda corporation to avoid $30 million in US taxes. The company needed shareholder approval and won the first vote, but the results were set aside after Connecticut Attorney General Richard Blumenthal alleged irregularities. Organized labor mobilized potent demonstrations against the company in New Britain and also against Fidelity (which itself is organized as a Bermuda corporation) at its Boston headquarters. Stanley canceled its trip to Bermuda. The second shareholder vote was abandoned.
Given the secrecy, the AFL activists could not prove definitively that Fidelity had voted with the Stanley management, but the relatively close tally indicated that Stanley could not have won without it. (The fact that Fidelity would not disclose its voting was also instructive.) When the AFL petitioned the SEC to issue its disclosure rule, the mutual fund industry tried to organize a political defense. The CEOs of Fidelity and Vanguard, the second-largest mutual fund, jointly bylined an op-ed piece in the Wall Street Journal, warning America about the dangers of full disclosure. “The threat is so severe that we, the leaders of the fund industry’s two largest competitors, come together now, for the first time ever, to speak out publicly against it,” wrote John Brennan (Vanguard) and Edward Johnson 3d (Fidelity).
But they were smartly trumped by a much more impressive voice from finance–John Bogle, the legendary founder of Vanguard and an industry pioneer, now retired. Bogle wrote a countering declaration of support for the SEC rule in the New York Times and explained that he founded Vanguard on this principle: “Mutual funds should be managed in the interest of their shareholders rather than in the interests of their managers. Now the industry I helped to create is squandering an opportunity to show the public that this ideal still matters.” Bogle also essentially confirmed labor’s complaint about the conflicted interests that disclosure will expose. “Some business difficulties may arise,” he said. “Votes against management, for example, may make it harder for fund managers to get information from a corporation or to win the right to advise its pension plan. Controversial votes may draw unwanted publicity.”
Yes, that is exactly what the AFL’s Office of Investment and other shareholder campaigns have in mind. With disclosure of how a mutual fund actually went in the tank for the CEO, its investors can be mobilized to protest or withdraw their money and park it somewhere else. The $400 billion in union-sponsored pension funds will provide the leading edge in this leverage, followed by the much larger public employee funds, with $2.6 trillion.
This fight may not be over. The Investment Company Institute, political mouthpiece for the mutual funds, vows to ask the new SEC chairman to revisit the issue, perhaps when it thinks no one is watching. But if shareholder activists can hold on to their victory, they will be fighting now on a broader and more promising battlefield. “If we’re trying to get pension funds to act in the longer-term interests of their owners, the workers, then pulling the mutual funds into the sunlight matters too,” Blackwell said. “This compels both the mutual fund industry and pension funds to be enormously powerful advocates for corporate accountability, instead of a force that supports corporate insiders to the disadvantage of the people whose money is invested.”