VideoWhile federal investigators focus on conflicts of interest at the heart of the darkness created by former Enron CFO Andrew S. Fastow, Congress has moved on to interwoven interests of other corporate insiders. But one group of market participants, institutional investors, has all but escaped notice--until now. Corporate-governance watchdogs and shareholder activists are calling on regulators and lawmakers to look into possible conflicts of interest on the part of fund managers.
For evidence they point to recent proxy contests, at such companies as Bank of America, Halliburton, and Hewlett-Packard, in which fund managers have sided with corporate management on shareholder resolutions whose passage might have benefited plan participants. The critics contend that when push comes to shove, fund-management groups often vote the interests of their corporate parents--the banks and insurers that do business with the companies in question.
Both mutual funds and corporate retirement plans are often managed by subsidiaries of commercial and investment banks and insurance companies. Thus, while fund managers are paid by their employers to judge the performance of corporate managers, the banks and insurers that own the fund companies are paid by some of the same corporate managers for securities and loan underwriting as well as other financial services.
Some institutional investors, including those that manage large pension plans, such as the California Public Employees' Retirement System or TIAA-CREF, have avoided trouble, thanks to tight restrictions on their ability to act against the interests of plan participants. But mutual fund companies often lack such restrictions and so may take actions that conflict with the interests of plan participants.
Proxy Poopers
Take, for example, Putnam Investments, the investment-management subsidiary of professional services provider Marsh & McLennan. In 2001, Putnam voted its proxy against resolutions favoring the use of performance-based stock options at such companies as Bank of America, Halliburton, and Office Depot. A Putnam spokeswoman wouldn't comment on its individual votes in these cases, but said the fund company generally votes as an interested shareholder and takes its fiduciary responsibilities "very, very seriously."
Or consider the acrimonious proxy battle earlier this year between Hewlett-Packard Co. and board member Walter B. Hewlett over the proposed acquisition of and merger with Compaq Computer Corp. After a shareholder vote in favor of the deal last March, Hewlett filed suit, charging that HP improperly coerced the parent company of Deutsche Bank Asset Management, which had voted its HP shares against the deal, to switch its vote before the polls closed.
The plaintiffs alleged that after selecting Deutsche Bank to help arrange a multibillion-dollar credit line only to see the fund managers vote against the deal, HP management offered the bank other business in exchange for a change of heart. As evidence, Hewlett's lawyers submitted a tape of a voice-mail message from HP purporting to show CEO Carly Fiorina instructing CFO Robert Wayman to offer such business to Deutsche Bank if its fund managers switched their votes. Then, according to the complaint, Fiorina held the proxy polls open until the fund managers switched their votes to HP management's side. (A spokesman for HP denies the charges; Deutsche Bank declined comment.)
Last April, a Delaware court ruled in favor of HP. It dismissed Hewlett's claim that the company's dealings with Deutsche Bank amounted to vote buying, because it said the evidence was circumstantial. But critics have lambasted the decision, with some finding the Department of Labor's decision not to intervene particularly outrageous.
"It makes your stomach turn," says Robert Monks, a shareholder activist and former DOL official credited with bolstering employee pension protection when he issued an opinion letter in 1990 stating that money managers must act "solely" for the "exclusive benefit" of plan participants. Monks calls HP's actions in the proxy battle nothing less than "a bribe."
Nell Minow, Monks's partner at The Corporate Library, a Web site devoted to corporate governance, testified before a recent congressional hearing that the outcome of the case reflected the "corrupt" state of the U.S. financial system. Although the House and Senate have been examining conflicts of interest in the banking industry, they have shown little interest so far in this one.
Show Us the Votes
The Securities and Exchange Commission has shown little interest as well. Indeed, the SEC has yet to take action on a long-standing petition by the AFL-CIO, which is supported by Monks and Minow, to require disclosure of proxy votes by companies that sponsor mutual funds. Monks says such disclosure is "essential" to promote better corporate governance.
The SEC, to be sure, is investigating the issues surrounding disclosure of the proxy-voting procedures of such investment companies, but that requirement will likely stop far short of mandating disclosure of the actual votes. In a letter dated last February 12 to another petitioner, SEC chairman Harvey Pitt explained that the commission typically defers to state authorities on issues relating to corporate governance, though he noted that the SEC does step in when cases raise questions having to do with the antifraud provisions of federal securities laws.
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