Investor Angst Prompts Funds to Speak Up
By ROBERT D. HERSHEY Jr.
Mutual funds used to avoid direct confrontation with the management of their portfolio companies when they were unhappy about, say, executive pay or director independence. Instead, the funds would quietly sell their shares.
But many of the biggest fund companies, including Fidelity and Vanguard, are beginning to publicly oppose management on matters of corporate governance.
"Managers have gotten burned" from exposure to such disasters as Enron, WorldCom, Tyco International, Global Crossing and Adelphia Communications, said Matthew McGinness, senior analyst at Cerulli Associates, a Boston consultant. "They're feeling heat from shareholders."
Patrick S. McGurn, director of corporate programs at Institutional Shareholder Services, an influential adviser to large investors, agreed. "Some mutual funds are losing that tag of being the reluctant activist," he said. "It's not only the right thing; it's good business. Investor angst is very, very high right now."
Sliding markets have driven some investors to the sidelines. But specialists say the main contributors to investors' ire have been the implosion of Enron, reports of accounting and other scandals and the outrage aroused by option-inflated pay packages that lavish tens of millions of dollars on poorly performing executives.
And mutual funds are serving as powerful and handy cudgels. "A growing number of investors are thinking they're not big enough by themselves to make a difference and are interested in having mutual funds step up and become their spokesman," said Burton Greenwald, a former industry official who is now a consultant in Philadelphia.
Taking their cue, independent directors are showing more interest than ever in governance issues, asking about procedures for evaluating proxy questions and whether funds should disclose how they vote their blocks of stock, Mr. Greenwald added.
Other frequently cited problems include deceptive accounting of earnings; failure to rotate accountants, to assure that audits are impartial; and the establishment of takeover obstacles that keep shareholders from receiving maximum value.
While there is yet no ground swell, various portfolio managers are withholding votes for directors who have approved of what the funds consider as overly generous options packages on which shareholders have no say.
Bill Miller of Legg Mason Value Trust, who has beaten the Standard & Poor's 500 for 11 consecutive years, has refused to support six management slates this year, including those of the MBNA Corporation and Starwood Hotels and Resorts Worldwide, after backing management 100 percent in 2001. Last month, he endorsed a total ban on stock options.
Fidelity, the biggest mutual fund company, has begun to change its approach, as well. "We are thinking about more things than we have in the past and that may translate into an incrementally greater activist role," said Eric D. Roiter, senior vice president and general counsel for Fidelity Management and Research.
As part of a reconsideration of its proxy voting guidelines, Fidelity decided this spring to oppose any company's plan to reprice options that increased their value.
Stock option plans raise "immediate, and serious, issues of accountability and proper alignment of interests between management and employees on the one hand and shareholders on the other," Mr. Roiter said in May.
While he would not confirm this, people in the industry say Fidelity is considering disclosing proxy votes before company meetings, putting its guidelines on its Web site and even creating a fund that would invest only in companies with superior governance.
Asked about vote disclosure, Mr. Roiter said such a move, which could influence legions of other investors, "may be a burdensome exercise" in light of Fidelity's holdings of thousands of stocks.
Others who are speaking out include Warren E. Buffett, whose investment company, Berkshire Hathaway, has jettisoned at least one stock because of high executive compensation; William H. Gross, managing director of Pacific Investment Management, known as Pimco; and John C. Bogle, the Vanguard Group founder and former chairman and a longtime industry scold. Mr. Bogle has derided what he calls a "happy conspiracy" of corporate officers, Wall Street, mutual funds and pension managers to elevate prices over the short term, at the long-term expense of shareholders.
"Executive pay is out of control because compensation committees aren't doing their job," Mr. Bogle said in a blistering Wall Street address as the annual-meeting season was about to begin. It was titled "Just When We Need It Most Is Corporate Governance Letting Us Down?"
Vanguard's current management has been quieter on these issues. John Woerth, a spokesman for the company, said: "We've been quite active on the corporate governance scene. It's just that we're not at the forefront of beating our chest about it."
TIAA-CREF, the huge pension fund manager that also offers mutual funds to the public, has worked behind the scenes on governance issues for many years. It recently enlarged its staff devoted to corporate accountability and has become more willing to make its case openly when private persuasion fails. "People are much more aware of the failings of our corporate governance system," said Ken Bertsch, director of this operation. "A lot of focus is going into bolstering independent directors, a mega-issue."
Barclays Global Investors, a giant manager of institutional money known for its exchange-traded funds, is also stepping up its governance pressure under the direction of Linda Selbach, manager of the company's global proxy group.
The Calvert Group of funds in Bethesda, Md., is adding governance, especially disclosure issues, to its focus on the environment and other social concerns. Julie Gorte, its director for social research, said, "It's pretty obvious that there are a lot of messes to clean up."
"This is a meteor," she added, noting a continuing reluctance of many fund sponsors to join the fray. "We're still measuring the depth of the crater."
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