The advent of mutual fund proxy voting disclosure has brought executive compensation abuse under greater scrutiny and further emboldened the nation's largest labor union to take aim at the biggest names in the asset management business.
The AFL-CIO recently issued a report card evaluating how the 10 largest mutual fund families voted on shareholder proposals, calling for the trimming of excessive CEO pay packages. The report ranks each fund complex according to how often fund management voted against the shareholders of a cross-section of 12 S&P 500 companies the AFL-CIO deemed to have "clearly excessive CEO pay" and "poor performance."
The report alleges that mutual fund companies often have an economic interest in voting with management even if those votes may not be in the best interest of fund shareholders. "This conflict of interest stems from mutual fund firms' desire to sell lucrative 401(k) management and other financial services to the same companies at which they vote proxies on behalf of mutual fund investors," the AFL-CIO said. "It is this conflict of interest that lead mutual funds to act as rubber stamps for corporate management."
Breaking down the scores, American Century was at the head of the class, notching a perfect 100% on proposals involving CEO abuses. Vanguard took second place by voting with shareholders 75% of the time. Even tainted growth shop Janus Capital fared well, posting a 71% score. On the flip side, Fidelity Investments placed ninth, with a poor 25% voting score, while Putnam Investments brought up the rear, with a mere 20% score. Fidelity, one of the most vocal opponents to the Securities and Exchange Commission's proxy disclosure rule, voted against all eight shareholder proposals to rein in runaway CEO pay, the report said. Vanguard and American Century, on the other hand, stand out as the only two fund families to vote against all four management proposals seeking excessive pay for chief executives.
"There is absolutely no correlation between how Fidelity funds vote their proxies and anything having to do with a company that is a client of Fidelity," a spokesman for Fidelity said. "We have extensive proxy-voting guidelines that have been approved by our board of trustees, and they lay out a number of instances in which we'll vote against company management."
For each of the 12 votes, the AFL-CIO offers a case study describing the abuse and the issue on which shareholders were asked to vote. The eight shareholder proposals evaluated included initiatives to expense stock options, implement performance-based pay, executive pensions and golden parachutes. The remaining set of proposals put forth by corporate management dealt with stock incentive and capital accumulation plans.
In the case of pharmaceutical company Allergan, executives receive a disproportionate amount of stock options, with the five highest-paid executives receiving nearly 23% of all stock options granted to employees in 2003. The Irvine, Calif.-based company has more than 4,900 employees. David Pyott, Allergan's chairman, president and CEO, alone received about 14% of all stock options. As of Dec. 31, 2003, Pyott held over $33 million in unexercised in-the-money options.
Now here's the rub. Allergan execs received this generous stock option perk following a period of underperformance, having been ranked by Business Week 446th in the S&P 500 and 15th out of 16 in the pharmaceuticals and biotech industry. The magazine also graded Allergan an F' for one-year and three-year profit growth, net margin and return on equity. As for Pyott, he raked in nearly $11 million in 2003.
The AFL-CIO argues that keeping stock options off the books has artificially inflated Allergan's profit reports and further contributed to higher executive pay. Indeed, if the company had expensed options in 2003, the AFL-CIO said, another $36.4 million would have reduced its net earnings. Struck by the total potential dilution from stock options and Pyott's egregious pay deal, Allergan shareholders voted at its 2004 annual meeting in April 62% in favor of requiring that options be expensed. Yet, Fidelity, AIM, Janus, Putnam and T. Rowe Price all voted against limiting such an excessive compensation package.
But given its clearly separate agenda, the AFL-CIO may not be providing a representative sample. "We voted against more than half of all stock compensation, stock award and stock option plan proposals put before us during the most recent proxy season," the Fidelity spokesman said. "[And] if we believe a company is not well-run, we have the option to sell our shares." A comprehensive list of how Fidelity voted its proxies last year can be found on its Web site, although there is no link on the home page.
Another AFL-CIO case study involved telecom gear maker Lucent Technologies, which gave its CEO Patricia Russo one heck of a golden parachute. If Russo is terminated as the result of the company being sold or through no fault of her own, she is entitled to immediate vesting of 1,220,000 stock options and 550,000 restricted shares, two years' salary plus target bonus, continued benefit coverage and equity vesting for two years. Her potential severance is worth at least $10 million at a time when the company is trimming the benefits for ordinary workers, the report noted.
To say that Lucent's performance has been less than stellar would be like saying Gerry Cooney took a few punches. In fact, the struggling company topped the Wall Street Journal's list of the worst five-year performers. Business Week ranked Lucent 473rd in the S&P 500 and 30th of 35 in its industry.
The AFL-CIO believes that requiring shareholder approval of executives' contracts is a good way to keep golden parachutes in check--not to mention that lofty severance packages can significantly increase the cost of firing an underperforming CEO and reward that officer for poor performance leading up to termination. At Lucent's annual shareholder meeting in February, 67% voted in favor of a proposal to require shareholder approval of golden parachutes. Still, Fidelity, AIM, Franklin Templeton Investments and Oppenheimer Funds voted to block the initiative.
While the AFL-CIO applauded the SEC's move to disclose proxies, the labor group outlined one shortcoming of the rule: It does not require mutual funds to disclose their business relationships with portfolio companies. The AFL-CIO conducted its own research to discover that Fidelity has eight business relationships with portfolio companies, while Vanguard has four.
Overall, the AFL-CIO stressed that the conflicts of interest outlined in the report not only underscore the importance of proxy voting transparency but also suggest that even more disclosure may be prudent. That alone is enough to make fund executives groan.