The past six months have been filled with headlines about failures of checks and balances in our system of corporate governance. To me, the most troubling was the facts that came out of the challenge to the votes cast in the proposed merger of Hewlett-Packard Co. and Compaq Computer Corp. How did Capital Guardian Trust Co., Vanguard Group and Deutsche Asset Management, among other institutions that manage employee benefit assets for Hewlett-Packard, handle the conflicts of interests arising from the HP merger vote?
Several of the largest shareholders of Hewlett-Packard stock were investment managers subject to the fiduciary standards of the Employee Retirement Income Security Act. The conflicts of these investment managers for HP's plans stem from, on the one hand, their legal obligation to act "for the exclusive benefit" under ERISA for plan participants, as the act states, and, on the other hand, their commercial interest in maintaining excellent relationships with a fee-paying customer. What information is available to a plan participant, or a regulator, who wants to know how the managers handled the conflicts?
The influence of these investment advisers extended beyond the assets that they managed for the company whose shares they were voting. Beyond their investment management of HP pension assets, these institutions managed other accounts with substantial holdings of HP common stock, which they had the power to vote. Capital Management and Research Co., Capital Guardian Trust's affiliate, was the largest shareholder of HP, holding approximately 67 million shares, or 3.45% of the total, while Deutsche is attributed by the judge who ruled on the case with either 17 million or 24 million shares. Vanguard with 32 million shares held 1.64% of the total.
Most troubling was evidence showing that Deutsche entered into an incentive agreement with HP under which it would be paid $1 million for providing proxy services in connection with the proposed merger, which would be doubled in the event of success. Apparently, Deutsche switched its vote following negotiation of this fee and a meeting set up by its investment banking side as a courtesy to its customer, HP.
The one conflict of interests resolved in a manner that was publicly disclosed was at Barclays Bank, with 53 million shares, the second largest holder. Patricia C. Dunn, co-chairman and global chief executive of Barclays Global Investors, was also a director of Hewlett Packard. To deal with this conflict, Barclays delegated its fiduciary discretion in voting to an independent professional, Institutional Shareholder Services Inc.
This is consistent with the ruling in Leigh vs. Engle, which remains the controlling legal standard. When fiduciaries have relationships such that "exclusive benefit" is literally impossible, attention "focuses on the potential for conflict of interest between the fiduciaries and the plan beneficiaries. When the potential for conflicts is substantial, it may be virtually impossible for fiduciaries to discharge their duties with an `eye single' to the interest of beneficiaries, and the fiduciaries may need to step aside, at least temporarily, from the management of assets where they face potentially conflicting interests."
The question is whether Capital Guardian, Vanguard and Deutsche as fiduciaries voting as much as 6% of the total outstanding shares - enough to change the outcome - appropriately dealt with the conflicts of interests each of them had as a result of their duties as fiduciary under HP's employee benefit plans. Ideally, like Barclays, they should have stepped aside. If not, they owe the plan participants whose retirement money they are investing a public statement of their procedures and criteria for determining the appropriate proxy vote in a matter involving a client.
The issue presented to the Delaware Chancery Court was far from the question that should be raised under ERISA. In Delaware, the challenge was to HP management - did the timing of the new million-dollar fee paid to Deutsche just before the vote switch constitute corruption? The standard of proof is so high that it would require documentation of an actual trade of money for votes.
But a challenge under ERISA would put the burden of proof on the conflicted party to demonstrate that their conflicted interest did not impinge on their "exclusive benefit" duty. "Fiduciaries must be able to defend any decision on voting or shareholder issues as having been made solely to further the economic interests of plan participants and beneficiaries," fiduciary expert Betty Krikorian wrote. "If the fiduciary has conflicting interests, the decision will be scrutinized even more carefully."
It is difficult to imagine a clearer instance of conflicted interests or a more investigation-worthy set of events than we saw with Deutsche Bank's vote at HP. I hope and trust that Department of Labor and Securities and Exchange Commission investigators are going through their records already. The provisions in that contract for doubling the fee in the event of success obviate any possible Chinese wall and make impossible the notion of any fiduciary action "for the exclusive benefit" of anyone other than Deutsche employees. The other fund managers may have managed their conflicts better, but they have an obligation to let their plan participants know how they voted and how that decision was made.
If ERISA fund managers want to avoid the scandal and liability of Wall Street analysts, they must act quickly to make sure all conflicts are resolved in favor of plan participants and that all proxy voting policies and all votes in contested matters are disclosed to those for whom they act as fiduciaries.
Post-Enron reforms are putting a lot of pressure on public companies to develop and publish corporate governance policies. They would spell out clearly and comprehensively how the board handles the conflicts of interests that are inevitable in a system where directors acting on behalf of the shareholders are selected and paid by management. I'd like to see institutional investors develop and issue their own corporate governance policies for exactly the same reason - to protect against conflicts of interests and to give investors information that will help them make better choices.
Robert A.G. Monks has a website, www. ragm.com, focusing on global corporate governance. He is the founder of Institutional Shareholder Services Inc., the LENS Fund, Hermes Focus Lens Asset Management and The Corporate Library. He is a former administrator of the Department of Labor's Office of Pension and Welfare Benefits Administration. He is the author of several books on corporate governance; the latest is "The New Global Investors," published by Capstone Publishing Ltd. in 2001.