Meeting Room

How Mutual Funds Can Be Advocates For Their Investors

Meeting Room

There has been a growing focus in the area of corporate governance given the numerous and very significant financial events that have happened over the last 15 years like the collapse of Enron, Worldcom, and Tyco as well as the excessive risk taken by the biggest investment banks in the world. Legislation has been passed (Sarbanes Oxley Act of 2002 and Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010) and now mutual fund companies are exercising the authority they have on behalf of their shareholders to make sure that the best interests are always in mind of corporate management.

In a recent Reuters article, it was mentioned that Dimensional Fund Advisors (DFA) has put corporate directors on notice -- if they vote in favor of “poison pill” anti-takeover measures without shareholder approval, they will be blacklisted. For those who are unfamiliar with the term, a “poison pill” is a defensive tactic used by a corporation’s board of directors to prevent some type of takeover, usually by making the value of their stock less attractive. In other words, try to takeover a business and we will ruin it for you. Popular “poison pills” include allowing existing shareholders to purchase more shares of the company at a significant discount to market price or allowing current shareholders to buy the acquiring company’s shares at a discounted price after the merger happens. Either way, the acquiring company’s potential ownership gets diluted.

DFA’s stance might seem strong, but the explanation is very simple. According to Joseph Chi, DFA’s co-head of portfolio management, “DFA is worried that companies too often use measures to deter acquirers and shareholders activists who could benefit shareholders.” The real issue at hand is not the fact that “poison pill” exists; rather, it is more about voting for one without shareholder consent. Since the board of directors of any corporation is there to look out for the best interest of their shareholders, it automatically creates a conflict of interest. Should shareholders as a whole vote for a “poison pill,” then there is not a conflict.

Since DFA’s public announcement of their stance, companies such as Sonus Networks have removed the poison pill provision. Although DFA’s campaign will target approximately 250 companies, some may be slower to act than others. Jack Schuler, a board member of a number of publicly traded companies stated, “I can’t imagine other investors will say, ‘I am going to vote against this director even though I like what they are doing with the company.’” This brings up an interesting conundrum from the perspective of the investor. Even though a board member may be running things efficiently, there is always a provision that possibly protects their interest versus that of the shareholder. If a board member was firmly out to do what is best for the shareholder, they would possibly embrace change when change is needed, or at least ask for permission on behalf of all shareholders for the provision.

As a money manager, DFA is out to increase the overall wealth of their investors. Corporate governance plays a crucial role in furthering that aim. Board members should always be sitting on the same side of the table as their shareholders and any provision without consent is a direct conflict of interest. This, among many others, is why IFA likes to partner with fund companies such as DFA. Not only do they bring value through their academic research and outstanding implementation, but they also advocate for their investors when it comes to keeping corporate America aligned with those they are supposed to serve.