As the wildfire of corporate scandals rages around us, it's clear itís being
fueled by the dry rot of conflicts of interest: accountants double dipping as
consultants, Wall Street analysts acting as investment bankers, politicians turning
a blind eye on the dirty deeds of their campaign donors. But there is another,
even more combustible conflict of interest that has yet to hit the headlines.
The two-faced status of mutual funds managers.
Mutual funds are now among the largest owners of American corporations --
controlling close to $3 trillion in stock. The 75 largest mutual fund companies
control 44 percent of the voting power at U.S. companies. So there are enormous
consequences for all of us when the owners elect not to act like owners, but like
timorous lackeys desperate to please management.
But that's exactly what's happening because of a gargantuan conflict of interest:
The giant mutual funds are serving two masters. As owners of huge amounts of stock,
it is their job to hold incompetent or self-interested management accountable.
But there are massive fees coming their way when corporate executives award them
401(k) and pension fund assets to invest.
For instance, the nationís largest mutual fund, Fidelity, which owns 5.3 percent
of Tyco's stock, also earned $2 million in 1999 for its part in running Tyco's
401(k) plans. Indeed, last year over 50 percent of Fidelity's $9.8 billion in
revenues was generated by administering 401(k) plans and other employee benefit
services for some 11,000 companies, including Philip Morris, Shell, IBM, Monsanto
Those running the mutual funds know that if they create controversy they jeopardize
their chances of getting the contracts for these services. And it's definitely
controversial to make a stink about excessive CEO pay packages, blank check loans
to senior executives, or abusive accounting strategies. Thatís why the whistle
they should be blowing seems stuck in their throat.
So they hold their tongues, don't ask the tough questions, and time and again
refuse to disclose how they vote on proxy ballots. And as California Treasurer
Phil Angelides told me: "That silence speaks volumes." Angelides is at the forefront
of demanding that mutual funds be more transparent, but, so far, to no avail.
With the monster mutual funds too afraid of losing business to ever rock the
boat -- with ownership essentially AWOL -- irresponsible corporate execs have
been allowed to run wild. This is how this mother of all conflicts of interest
begets her malevolent progeny.
With their financial clout, if mutual funds demanded change they would not
-- indeed, could not -- be ignored. In fact, they could have insisted on -- and
gotten -- all the rules and standards the new corporate reform law imposes. And
much, much more. But because of their competing interests, they didn't -- to their
lasting shame, the detriment of their investors, and, indeed, to the detriment
of us all.
Imagine how different things would be if these funds, instead of abrogating
their responsibility as owners, had embraced it. If you owned hundreds of millions
of shares in a company, would you be sitting on your duff waiting for Harvey Pitt
to rush to the rescue and protect your assets? Or would you be taking matters
into your own hands? Mutual funds are not just sleeping giants. They are giants
with a serious case of narcolepsy.
And it's not like there are no role models. Take the example of Bill Gross,
founder and managing director of Pacific Investment Management Co. (PIMCO), which
manages over $250 billion in bond funds. This spring, after Gross took General
Electric to the woodshed for misleading investors about the company's debt, he
unloaded most of PIMCO's $1 billion in GE bonds.
"I picked on GE," Gross told me, "because I wanted to alert the investment
universe that it wasn't just Enron, Tyco or WorldCom pulling some fast ones, but
GE -- the biggest guy on the block -- and probably everyone in between. GE definitely
changed things in the last six months and I sort of think I nudged them along
He didn't just nudge them along the way. He wounded them enough to force them
to clean up their balance sheet. Gross' speaking out was as remarkable for its
effectiveness as it was for its rarity.
To see how an investment fund that doesn't have its hands tied by conflicts
of interest might operate, take a look at the California Public Employees' Retirement
System (Calpers), the nation's largest pension fund, which manages $137 billion.
Since Calpers gets its money directly from the state of California, it doesn't
have to kow-tow to the whims of corporate bosses dangling the prize of juicy pension
fund management fees. Calpers has announced that it will not do business with
any bank that breeches the Chinese Wall between research and banking, and is considering
Angelides' proposal that it divest from any company that has moved offshore to
avoid paying taxes.
"What we've tried to do," Angelides told me, "is ask the question: how can
we use our power to send a clear message to the market about the importance of
corporate responsibility and conduct?"
The debate over the last few months has focused on accounting firms not mixing
auditing with consulting, and investment banks keeping research independent of
banking. It is now time to hold mutual funds accountable: Isn't their fiduciary
obligation to their investors paramount? Or are they using the money of working
Americans as a come-on to generate more servicing fees?
The biggest mutual funds like to adorn themselves with high-minded monikers
like Fidelity, Puritan, Flagship, and Strong American. They now need to start
living up to their true-blue names.
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