September 5, 2019

Financial Intermediaries: Strine Says Funds Must Do Better By Their Investors

Last month, Delaware Chief Justice Leo Strine co-authored a NYT opinion piece about the failure of retirement & index funds to approach voting & corporate governance issues with the needs of their own investors – the workers who invest their retirement savings with them – in mind. Here’s an excerpt:

Growing inequality and stagnant wages are forcing a much-needed debate about our corporate governance system. Are corporations producing returns only for stockholders? Or are they also creating quality jobs in a way that is environmentally responsible, fair to consumers and sustainable? Those same corporations recognize that things are badly out of balance. Businesses are making record profits, but workers are not sharing in those gains.

This discussion is necessary. But an essential player is missing from the debate: large institutional investors. For most Americans, their participation in the stock market is limited to the money they have invested in mutual funds to finance retirement, usually in 401(k) accounts through their employers. These worker-investors do not get to vote the shares that they indirectly hold in American public companies at those companies’ annual meetings. Rather, the institutions managing the mutual funds do.

Institutional investors elect corporate boards. Institutional investors vote on whether to sell the company and on nominations for new directors, and whether to support proposed compensation packages for executives. At the average S. & P. 500 company, the 15 largest institutional investors own over half the shares, effectively determining the outcomes of shareholder votes. And the top four stockholders control over 20 percent.

What this all means is that corporate governance reform will be effective only if institutional investors use their voting power properly. Corporate boards will not value the fair treatment of workers or avoid shortcuts that harm the environment and consumers if the institutional investors that elect them do not support them in doing the right thing. And they are unlikely to end the recent surge in stock buybacks as long as there is pressure from institutional investors for immediate returns.

Among other things, Strine and his co-author, Kennedy School senior fellow Andrew Weiss, argue that mutual funds should have voting policies “tailored to the objectives of long-term investors,” and should include “environmental, social, and most important of all, employee factors” in their investment & voting decisions. They’d also like to see a reduction in the number of shareholder votes, noting that each year, mutual funds are required to cast over 30,000 votes at shareholder meetings.

The failure of financial intermediaries to serve the broader interests of the working investors they represent has been a recurring theme for Chief Justice Strine. In one recent article, the Chief Justice called out them out for allowing companies to spend “worker-investors” money on political activities promoting policies that negatively impact those investors. In another article, he criticized the current corporate governance system for giving the most power over corporate decisions to investors like hedge funds – whose interests are least aligned with those of average shareholders.

Financial Intermediaries: 3 Cheers for the Big 3?

Liz recently blogged about research suggesting that the major index funds were “patsies” for management. Between that research, Chief Justice Strine’s critique of their failure to serve the interests of their investors, & concerns expressed over the implications of their ever-growing ownership positions in U.S. companies, BlackRock, State Street & Vanguard could sure use a friend.

It looks like they may have just found one in a new study that says the Big 3 have both the ability & the incentive to police misconduct by their portfolio companies – and that there’s evidence that they’re doing exactly that.  Here’s an excerpt from the abstract:

In this paper, I argue that the remarkable size, permanence, and cross-market scope of the Big Three’s ownership stakes gives them the capacity and, in some cases, the incentive to punish and deter fraud and misconduct by portfolio companies. Corporate governance and securities regulation scholars have argued that these institutions have generally overriding incentives to refrain from meaningful corporate stewardship, but the facts on the ground tell a somewhat different story.

Drawing on a comprehensive review of the Big Three’s enforcement activities and interviews with key decision-makers for these institutions, I show how they have been using engagement, voting, and litigation to discipline culpable companies and managers. I also identify the “pro-enforcement” incentives that explain these actions.

The study bases its conclusions on an analysis of the involvement of the Big 3 in direct securities litigation, litigation arising out of the financial crisis, “just vote no” activism against directors of companies involved in fraud or misconduct, and significant engagements. It’s an interesting perspective – and a much more effective defense of the Big 3 than the specious stuff they’re peddling.

Restatements: 2018’s Scorecard

Audit Analytics recently released its annual report on public company restatements.  Here’s an excerpt from Audit Analytics’ blog with some of the highlights:

– After 12 years of decline, the number of reissuance (“Big R”) restatements increased slightly in 2018.
– Around 70% of restatements disclosed were revision (“Little R”) restatements.
– Total restatements dropped for four consecutive years to an 18-year low.
– There were 171 restatements filed by accelerated filers, and 229 restatements disclosed by non-accelerated filers.
– About 54% of the restatements disclosed by publicly traded companies had no impact on earnings.

John Jenkins