Corporate Governance

It?s a Wonderful Lie: Mutual Fund Advocacy for Shareholders? Rights, part 3

By Jennifer S. Taub

Many investors are surprised to learn that they profit from genocide in Sudan through mutual fund investments. You might be one of those investors. Accordingly you might expect your mutual fund adviser to challenge the corporations for you. But this happens rarely, if at all. Mainstream mutual fund advisers often claim they cannot address social issues because they put their investors' economic interests first. Yet, ironically, even in economic matters, some have put their own economic interests over their legal obligations to investors.

In research sponsored by the Millstein Center for Corporate Governance at Yale, I studied the top ten mutual fund families ('operators'). I found that the more assets they had gathered through 401(k) and similar plans, the less likely they were to support shareholder-sponsored proposals such as requiring executive pay to tie to performance and other tools for shareholder empowerment. (This article Able but Not Willing: The Failure of Mutual Fund Advisers to Advocate for Shareholders' Rights was published in the spring of 2009 in the Journal of Corporation Law.)

There are many possible explanations for why the mainstream fund operators are more likely to oppose shareholder empowerment efforts the more dependent they are upon retirement plan assets. The most promising one relates to how they earn fees. Mutual fund operators are paid based upon the amount of assets they gather. A promising place for asset gathering is corporate retirement plans. There's just a limited menu of mutual funds within a 401(k) plan. Every fund operator wants to be included there – so the funds it manages can gain access to a trillion dollar market. This focus on asset gathering does not necessarily harm investors, but it does not help them either. What can damage investors is what the fund operators do in order to attract these assets. The evidence suggests that in order to get on the 401k menu and stay there, operators may have to reject policies that would strengthen shareholders' rights. Even the act of supporting shareholders of one company might alienate the managers of another. As a result, main stream fund operators overwhelmingly side with corporate management on matters of ethics and economics.

As a mainstream fund owner, since your fund operator is unlikely to voluntarily divest, your second choice is to pressure the fund operator to divest from corporations involved in atrocities. The advocacy group, Investors Against Genocide, has introduced shareholder resolutions on the ballots at fund company shareholder meetings beginning in 2008. This gives fund investors the opportunity to vote on whether their fund operator like Fidelity or Vanguard should avoid companies that contribute to genocide, egregious human rights violations, or crimes against humanity.

As it happens, though, some of these mainstream fund families have actively opposed these resolutions. First, the fund boards have recommended to shareholders that they vote against the proposal. The vote against recommendation is prominent on both the ballot card and in the voting materials. Second, they have solicited investors in order to gain enough votes for a quorum. This in and of itself is not a problem, but records show that some telemarketers who call investors ask leading and misleading questions and either delay those who wish to support the resolution or attempt to badger them into changing their votes. According to a David Weidner of MarketWatch, when he was called about voting, 'Never was I told the issue Fidelity was calling about.' Upon inquiring, he was told it concerned 'a bureaucratic board, higher costs and activists.' He then realized that 'Fidelity wanted me to vote against a resolution making it harder to invest in companies linked to genocide.' The operator asked a leading question: "Can I put you down for a no?' meaning in opposition to the shareholder proposal against genocide.

In addition to this, though there are only records of a few incidents, it might indicate a widespread practice that should be examined. Notwithstanding these pressures, the anti-genocide proposal has received extremely large supporting votes typically of more than 20% and as high as 31.44% at Fidelity and averaging roughly 10% at Vanguard. These figures need to be placed in the context typical retail investor voting behavior.

Many mutual fund owners are not entitled to vote. For example, the mutual fund shares that one 'owns' through a 401k plan are voted by the plan trustee for the entire plan, not by the individual investors. And, those direct mutual fund owners who throw away the envelope or just forget to vote are typically voted by the brokerage firm who holds the account. This silence is translated into a vote not supporting the recommendation that mutual funds avoid profiting from genocide.

Clearly voting with one's feet (i.e. selling ones shares) can be a possibility for some mutual fund investors. If there is a socially responsible investment fund on the menu at ones' 401(k) plan and that fund screens for corporations that profit from genocide, and meets other investment criteria, this could be a reasonable alternative. And, those who invest through other channels can also choose that path. However, investors who wish to remain invested with a mainstream fund family and to exercise their shareholder franchise should vote and continue to spread the word that their votes can make a difference.

Adapted from 'Able but Not Willing: The Failure of Mutual Fund Advisors to Advocate for Shareholders' Rights,' Journal of Corporation Law, Vol. 34, Issue 3 (2009).

Full post as published by The Race to the Bottom on August 18, 2009 (boomark / email).