FIDUCIARY BLIND SPOT: THE FAILURE OF INSTITUTIONAL INVESTORS TO PREVENT THE ILLEGITIMATE USE OF WORKING AMERICANS' SAVINGS FOR CORPORATE POLITICAL SPENDING.

• Author: Strine, Leo E., Jr.

ABSTRACT

For decades, American workers have been subjected to increasing pressure to become forced capitalists, in the sense that to provide for retirement for themselves, and to pay for college for their children, they must turn part of their income every month over to mutual funds who participate in 401(k) and 529 programs. These "Worker Investors" save for the long term, often hold portfolios that are a proxy for the entire economy, and depend on the economy's ability to generate good jobs and sustainable growth in order for them to be able to have economic security. In recent years, there has been a heartening improvement in the self-awareness of the major mutual fund families--BlackRock, Vanguard, State Street, and Fidelity (the "Big Four")--that have Worker Investors' capital. This Big Four has grown enormously because of the legal pressures that generate capital inflows to them every month from Worker Investors. To their credit, the Big Four recognize that they have a duty to think and act in a way aligned with the interests of Worker Investors by encouraging the public companies in which they invest to implement business plans that will generate sound long-term growth. In fact, the Big Four have recently recognized that unless public companies act in a manner that is environmentally, ethically, and legally responsible, they are unlikely to be successful in the long run. Thus, the Big Four are more willing than ever to second-guess company management to fulfill their fiduciary duties.

In one area, however, the Big Four continue to have a fiduciary blind spot: they let corporate management spend the Worker Investors ' entrusted capital for political purposes without constraint. The Big Four abdicate in the area of political spending because they know that they do not have Worker Investors' capital for political reasons and because the funds do not have legitimacy to speak for them politically. But mutual funds do not invest in public companies for political reasons, and public company management has no legitimacy to use corporate funds for political expression either. Thus, a "double legitimacy" problem infects corporate political spending. This Article identifies and illustrates this double legitimacy problem, and shows why unconstrained corporate political spending is contrary to the interests of Worker Investors. Precisely because Worker Investors hold investments for the long term and have diversified portfolios that track the whole economy, political spending by corporate managers to tilt the regulatory playing field is harmful to them. Worker Investors are human beings who suffer as workers, consumers, and citizens when companies tilt the regulatory process in a way that allows for more pollution, more dangerous workplaces, less leverage for workers to get decent pay and benefits, and more unsafe products and deceptive services. But even as diversified investors, unconstrained corporate political spending is likely to create harm, as both common sense and empirical evidence suggest. Not only that, there is no danger that public companies would have too little voice in the political process if their spending were subject to constraint by stockholders. Corporations have many other tools, including their own Political Action Commitees ("PACs") funded by voluntary contributions, their lobbying expenditures, and the influence they wield as employers and taxpayers--tools that made business interests predominate in political spending even before Citizens United let them free to spend treasury funds without inhibition. For these reasons, the case against unconstrained corporate political spending is very strong.

As of now, however, the Big Four refuse to even support proposals to require the very disclosure they would need if they were to monitor corporate political spending. And their capacity to monitor if they have the information is lacking. But, if the Big Four open their fiduciary eyes and follow the recommendation of the late industry icon Jack Bogle, and vote to require that any political spending from corporate treasury funds be subject to approval of a supermajority of stockholders, they alone could cure the double legitimacy problem of corporate political spending. Because of their substantial voting power, the support of the Big Four would ensure that this check on illegitimate corporate political spending would be put in place and thus make an important contribution to restoring some basic fairness to our political process.

Distinguished Jurist Lecture The Institute for Corporate Governance & Finance New York University School of Law New York, New York

INTRODUCTION I. THE ODDMENT OF BIG FOUR POLITICAL SPENDING POLICIES: THE PERSISTENCE OF OLD-SCHOOL DEFERENCE TO MANAGEMENT DESPITE OTHERWISE INDEPENDENT AND SKEPTICAL VOTING POLICIES A. The Big Four's Increasing Clout and Skepticism of Management B. The Big Four's Perplexing Total Deference to Managers on Political Spending II. FORCED CAPITALISTS: WHY WORKER INVESTORS GIVE THEIR MONEY TO THE BIG FOUR III. THE DOUBLE LEGITIMACY PROBLEM IN CORPORATE POLITICAL SPENDING A. The First Layer: Mutual Funds Don't Have Worker Investors' Capital for Political Reasons B. The Second Layer: Public Corporations Don't Have Equity Capital Because They Are Instruments for Stockholder Political Sentiment C. Two Layers; Neither Solid D. A Lack of Disclosure Means a Lack of Accountability E. The Big Four's Failure to Press for Disclosure and How Their Vote Would Change the Tide IV. THE BIG FOUR'S LACK OF CAPACITY TO MONITOR POLITICAL SPENDING PRACTICES V. REASONS WHY POLITICAL SPENDING DOES NOT BENEFIT DIVERSIFIED INVESTORS A. Disclosure as a First Step B. Worker Investors Are Hurt by Externalities and Do Not Benefit from Rent Seeking C. Corporate Political Spending Is Unlikely to Even Benefit the Corporations Doing the Spending D. Business Leaders' Political Spending Does Not Mirror Society's Views E. Business Leaders Often Wish They Could "Just Say No" F. Human Investors Have Other Values at Stake VI. HAVE NO PITY FOR THE HAVES Conclusion: The Big Four Have the Power to Improve the Integrity of Our Democracy and Public Corporations by Constraining Undisclosed and Unauthorized Political Spending INTRODUCTION

One heartening development in corporate governance has been Americans' increasing willingness to embrace a rational approach to investing by forsaking a futile search for alpha. Instead, more and more Americans are holding baskets of securities that are a proxy for the entire market, and seeking a sustainable increase in their wealth tied to the economy's overall growth. (1) These "Worker Investors" save primarily for two long-term purposes: to pay for college for their children and retirement for themselves. But American workers' rejection of alpha chasing and focus on index investing is not just driven by rational self interest. Rather, these "Worker Investors" are "forced capitalists" (2) in the sense that they must turn part of their income every month over to the mutual funds who participate in the 401(k) and 529 programs that Worker Investors are encouraged by federal tax policies to use for these long-term purposes.

In partial recognition of this reality, institutional investors are becoming more aware of their fiduciary duty to match their responsibilities as voters and monitors of portfolio companies with the long-term goals of the Worker Investors whose capital they control. Unlike day traders, Worker Investors do not jump in and out of stocks but instead hold a portfolio that is a rough proxy for the overall economy. They, therefore, cannot profit from bubbles that burst, but only from durable increases in corporate profits. That is, Worker Investors need companies to make money the old fashioned way: by selling useful products and services, rather than by using gimmicks or by slighting things like environmental compliance and worker safety to get a short-term edge.

For too many years, institutional investors did not take into account the unique perspective of stuck-in, long-term investors. Instead they voted their shares in a manner more consistent with the momentary impulses of alpha chasers and folks more focused on the next trading day rather than the next year or the next decade. (3) The awareness of institutional investors that they need to better align their behavior as fiduciaries with the economic interests of Worker Investors is not just welcome, but long overdue.

And the center-of-plate investment funds also deserve credit for increasing their focus on sustainable, responsible corporate growth. These institutional investors have recognized that Worker Investors do not benefit when corporations engage in regulatory short-cuts to gain advantage, rather than outcompeting other businesses by delivering a better product or service. (4) Short-cuts get found out. And companies that externalize costs to society and other companies do not benefit Worker Investors who pay for those externalities as investors in a portfolio reflecting the entire market, and as human beings who breathe air, consume products, and pay taxes. (5)

But institutional investors need to do more to fulfill their fiduciary duty to align their voting policies with the interests of the Worker Investors whose capital they control. In virtually every other area, institutional investors have applied increasing scrutiny to the behavior of corporate managers.

But in one area, institutional investors have a huge fiduciary blind spot and still let corporate managers run free of responsible oversight. That area is incredibly important to whether our economy and society works for everyone: political spending.

1. THE ODDMENT OF BIG FOUR POLITICAL SPENDING POLICIES: THE PERSISTENCE OF OLD-SCHOOL DEFERENCE TO MANAGEMENT DESPITE OTHERWISE INDEPENDENT AND SKEPTICAL VOTING POLICIES

   1. The Big Four's Increasing Clout and Skepticism of Management

      To provide context for discussing...