Mutual funds are under pressure to accept new federal requirements to publicly disclose their proxy votes on shareholder resolutions. The rule would also require mutual funds to disclose their holdings every three months, up from the current requirement of six months. If such requirements are implemented, the future performance of mutual funds will be jeopardized as the investment portfolios of millions of Americans are subjected to pressure tactics and politicized agendas of special interest groups.
By investing in a mutual fund, small investors entrust fund managers with the responsibility of voting proxy shares in the best interests of shareholders. Forcing fund managers to report every proxy vote to every shareholder would be a large and costly administrative burden, particularly for index funds that own shares in hundreds of companies. The Investment Company Institute estimates the price tag at $42 million per year, a cost that would be borne by the fund shareholders themselves. Shareholders are not exactly clamoring to pay higher fees or to receive voluminous mailings about their investments.
The AFL-CIO recently picketed the Boston headquarters of Fidelity Investments, demanding that the mutual fund company support the new requirements proposed by the Securities and Exchange Commission (SEC). Since proxy votes determine the outcome shareholder resolutions and the composition of boards of directors, this lobbying effort is cleverly disguised as a way to promote corporate reform. The union implies darkly that mutual funds collaborated in bad corporate governance and accounting scandals. Yet there is absolutely no evidence that institutional investors – who had the most to lose – knew anything about these misdeeds in advance. A handful of crooked corporate executives are solely responsible for the accounting scandals, which thankfully remain few in number despite sensational headlines.
The real reason Big Labor wants mandatory disclosure of proxy votes is to further politicize shareholder meetings. Unions want to pressure mutual funds to vote on social and public policy issues such as raising wages, postponing layoffs, and other measures beneficial to unions. A chief union cause is preventing companies from reducing corporate tax burdens by locating facilities abroad. Obviously, proxy disclosure is not just an investment reform, but a sneaky way to further the labor unions’ agenda through an SEC mandate.
Converting mutual funds into agents of labor and political activism would be a big mistake. A fund manager’s primary fiduciary duty is to maximize returns for the investor, not to judge the merits of special interest claims. Introducing political factors into the equation would distract fund managers from the crucial role of portfolio management. Indeed, they are likely to find their offices picketed by labor unions, animal rights activists, or environmentalist pressure groups. Confidentiality in proxy voting is necessary to ensure that mutual funds can vote in the shareholders’ best interest without outside pressure. Encumbering investment funds with politics threatens to imbue corporate shareholder meetings with all the controversy of a Florida election.
The proposal to force mutual funds to disclose their holdings every three months also sounds innocuous enough. Shouldn’t investors see how their money is being invested? The central issue is really whether mutual fund managers should be forced to disclose portfolio composition against their will. Plenty of mutual funds already disclose this information voluntarily. Investors, if they prefer to see the holdings, are free to invest in funds that disclose. The SEC proposal would deprive all mutual funds of the freedom to choose.
Fund managers have legitimate reasons to keep their holdings confidential. Large funds, in particular, would suffer lower investment returns if their holdings were published on a frequent basis. Disclosing holdings effectively discloses a fund manager’s strategy, which ought to be proprietary information. A considerable amount of research effort goes into the selection of stocks for an investment portfolio. There is little reason for customers to pay for a mutual fund’s services if that fund must give away its investment strategy for free. The proposed SEC rule, by requiring more frequent disclosure, makes it harder for good stock pickers to ply their trade.
There is also the problem of "front running." Day traders and hedge funds, for example, could take advantage of frequent holdings disclosure to trade "in front" of mutual funds. That means buying or selling right before the mutual fund makes its own trades. A mutual fund’s performance will suffer if outsiders are given the information necessary to anticipate its future investments. Mutual fund investors may well want their money invested with managers whom they feel have superior stock picking talent. The proposed SEC rule would diminish an investor’s ability to profit from that talent by making the fund manager’s stock selections available to non-investors in the mutual fund. This is ironic considering that the measure is advertised as a way to empower mutual fund investors.
Special interest-inspired requirements on the investment management industry will harm the millions of shareholders of mutual funds. The Bush administration is wisely seeking ways to provide tax relief to investors. A good investor-friendly measure would be to cancel the SEC’s proposed disclosure rules for mutual funds altogether.
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James M. Sheehan is an adjunct scholar of the Mackinac Center for Public Policy. He has written several Mackinac Center environmental policy commentaries, and he is the author of Global Greens (Capital Research Center, 1998), a study of the funding and tactics of environmentalist groups.