Analysis: When it comes to corporate governance, can disclosure ever be a bad thing?

February 2003

by Jon Entine

Could new pressures over information admission discourage an increase in corporate ethics? Jon Entine investigates

The answer apparently is “yes” if you happen to be a bigwig in the US mutual fund business. That’s hardly earthshaking news. Few expected the industry to applaud when the Securities and Exchange Commission proposed last autumn that funds might soon have to disclose how they cast votes in corporate proxy contests. But almost no one anticipated such fierce opposition from leading voices of corporate reform. That includes the nation’s largest pension system, the Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF), and Vanguard, the efficiently run, low-expense and admirably transparent fund giant.

A first reaction – certainly mine – was to assume that industry opposition reflected nothing more than brazen self-interest. You have to laugh, sadly, when the industry’s lobbying arm, the Investment Company Institute, reflexively dismisses disclosure, saying that it does not help investors to choose between funds, a dubious conclusion presented without any evidence.

But such bumbling defensiveness threatens to obscure a genuine debate over the wisdom of this measure. A dispassionate examination of the facts and a nod to the law of unintended consequences suggests that some caution is in order here. Although proxy disclosure is a good thing in principle, the devil is in the detail. That’s why the arguments of TIAA-CREF and other critics merit a fair hearing.

US stock funds, representing 93 million investors, manage over $3 trillion in assets, nearly one third of all outstanding shares in the marketplace. When companies put questions to shareholders, it’s the managers of the funds who decide how to vote those shares, not investors. As of now, funds are not required to reveal their votes.

Voting disclosures

Under the SEC proposal, funds and investment advisers would have to disclose how they vote, including on issues where shareholders and fund managers might disagree, and to flag any votes that don't follow their publicised guidelines. Mutual funds would supply information on proxy voting to the SEC twice a year, including it with certified financial results.

Based on letters posted to the SEC website, public reaction is running 100 to one in favour. The most vocal support comes from powerful labour unions, some of which bring a fundamental cynicism about the investing business. For example, the AFL-CIO contends (with no evidence presented) that funds regularly cosy up to corporations, putting the interests of executives or the funds themselves ahead of shareholders’.

Social investors are more recent passengers on the disclosure bandwagon. For example, born-again transparency convert Amy Domini, founder of the Domini Social Index Fund, argues, “disclosure is the greatest protection investors have and that no area of disclosure is irrelevant.” Who could argue against that?

Well, pretty much everyone in the mutual fund industry. John Biggs, who recently stepped down as chairman of TIAA-CREF, notes the proposal pits two treasured ethical principles – transparency and confidentiality – against each other. A long-time good-governance advocate who regularly criticised other fund companies for not using their proxy votes to minimize corporate abuses, Biggs said that confidentiality in voting allows firms to vote in shareholders' best interest without worrying about outside pressure.

"Big institutional investors believe anonymity is important,” says Barry Barbash, a former SEC attorney now with the Washington law firm Shearman & Sterling.

Biggs is hardly an apologist. It was widely assumed that he was passed over as a choice to head the accounting industry standards board for fear he would be too tough. TIAA-CREF has long endorsed unpopular views within its industry, such as expensing executive options and strengthening the independence of auditors. But Biggs, like executives at other fund giants like Vanguard, Fidelity and Schwab, fear that corporate proxy statements could become a political battlefield for extremist groups pushing pet social projects.

"This would be a complete invitation to politicise the mutual- fund process," says an industry insider with a mutual-fund trade group, who asked that his name be withheld fearing retaliation. "It would exert pressures on fund groups by people who wouldn't necessarily have the interests of shareholders at stake. A mutual fund is designed to make money for its investors. But managers would be looking over their shoulders at political issues instead."

Proxy votes for social issues

In fact, some social investing activists use proxy votes as public relations weapons on contested social issues, such as global warming, genetically modified organisms or animal testing. They often have little interest in seeing that the companies at which they are raising proxy fights prosper or even change.

Moreover, labour unions and activists face their own potential conflicts of interest. If a union is pressing funds to disclose proxies, it is reasonable to assume the same union might pressure the fund to abandon stocks that the union has contract issues with. Funds might find themselves targets of unions, religious groups or activists who represent a tiny minority of shareholders but would wield outsized PR clout – the ability to embarrass. Disclosure could devolve into a political tool, a tyranny of the minority.

Domini, for one, dismisses this concern as overblown. ''I am willing to take the risk that there will be the occasional time when a fund manager has to push back against shareholders -- or outsiders who are speaking their mind -- and say: `I hear your concern, but I'm not addressing it.' Hopefully, funds will vote for what they believe in, and we'll all benefit from seeing exactly what that is.''

Last November, TIAA-CREF's shareholders, long considered among the most liberal in the United States, strongly backed their leadership’s cautious approach on this issue. Shareholders voted 76.5% against a measure that would have urged annual disclosure of how it voted proxies on social and environmental issues. “Disclosing our votes might be misleading because there are cases when we agree with the basic issues that are the subject of a proposal, but find the details would be impractical to enact,” argued Herbert Allison, who succeeded Biggs as chairman. Allison says that TIAA-CREF has demonstrated that if can more effectively bring changes in corporate behaviour by working behind-the-scenes – a less confrontational approach than that advocated by labour unions and social activists.

The reality is that the line between political action and seeking better corporate governance is a lot blurrier than Domini and others are willing to grant. "If we were to publicly announce that we have voted against management on some proxy issues, it could have a negative effect on the company's share price, which would negatively affect our own shareholders," notes Vincent Loporchio, a Fidelity spokesman. For all the talk about addressing broad stakeholder issues including social and environmental concerns – the target interest of most social investors – the most critical stakeholder at mutual fund companies are its shareholders.

Still, and despite all the potholes going forward, more public disclosure of governance activities including proxy voting is a healthy and inevitable trend. The issue now is managing the movement in such a way that respects the rights of all stakeholders, including and especially investors.

Jon Entine is scholar-in-residence at Miami University (Ohio) and adjunct fellow with the American Enterprise Institute in Washington, DC. Jon is also an award-winning freelance journalist.

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