The biggest asset managers in passive investing have an overlooked role as corporate enforcers that merits attention from regulators, according to research from Harvard University.
Index fund managers BlackRock, Vanguard Group, and State Street vote 25 percent of the stock in the largest U.S. public companies, a portion that could soon rise to 40 percent, according to a draft paper published last month by Alexander Platt, a lecturer at Harvard Law School. With policymakers and scholars in “heated debate” over the influence of these giant asset managers, Platt suggests considering reforms that strengthen their overlooked roles as corporate enforcers.
“The problem of corporate fraud might be ameliorated by a dramatic consolidation of shareholder power,” Platt said in his paper. “The remarkable size, cross-market scope, and permanence of the Big Three’s ownership stakes could give them a unique capacity to overcome collective action problems and impose meaningful accountability and deterrence.”
Platt reviewed the index fund managers’ enforcement activities in litigation, voting, engagement, and guidance, drawing on data as well as conversations with their counsel. He found that “in an important minority of cases” they acted to hold companies and their managers accountable for fraud and misconduct — a “social benefit” that policymakers should weigh before potentially restricting their influence with new regulation.
“The Big Three have pursued a moderate slate of non-class litigation against portfolio companies, have used their substantial power to vote against culpable directors in the wake of high-profile corporate misconduct, and have regularly engaged with portfolio companies in the aftermath of corporate scandals to gather information and demand action,” Platt said in the paper.
Vanguard has recovered well more than $100 million for its investors in the last two years through non-class securities fraud litigation, while BlackRock recovered billions of dollars by similarly pursuing litigation on behalf of its investors, including cases targeting misconduct relating to the financial crisis, according to his paper.
And “after the disclosure of Wells Fargo’s fraudulent practice of creating fake accounts,” Platt said the Big Three each voted against members of the bank’s board of directors, “causing several to step down from leadership roles.” In another example of their influence, he pointed to votes against several Exxon Mobil Corp. directors following reports the oil company “suppressed critical information” about the threat of climate change.
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While conventional wisdom early this century cast institutional investors as slow to fill meaningful roles in corporate governance, that view is now changing, according to Platt. Their power to influence companies’ conduct is recognized by civil society groups, which increasingly have turned to the Big Three to advance their progressive policy agendas, he said.
Platt’s paper said incentives giant index fund managers may have to remain passive and refrain from corporate stewardship are overcome by “pro-enforcement” incentives. That’s a different view than that of other corporate governance scholars, who argue that low-fee index managers have little to gain from spending money on stewardship because the cost could hurt their competitive position, according to his paper.
As the debate over index fund regulation continues, Platt said the enforcement role of the BlackRock, Vanguard and State Street should be part of the discussion.
“As policymakers weigh these proposals, they should not overlook the important social benefit — punishing and deterring corporate fraud and misconduct — that the Big Three may provide through their influence over portfolio firms,” he wrote. “The Big Three are not yet living up to their full enforcement potential.”