Count DC plans among Wells Fargo's enablers

John G. Stumpf, chairman and CEO of Wells Fargo & Co., had some surprising, hidden and unwitting enablers in the fake accounts scandal — participants in defined contribution plans.

How? Every year for more than a decade, large institutional investors have voted at the Wells Fargo annual meeting on a critical issue: whether to install an independent chair rather than allow the CEO to keep that job himself, effectively serving as his own boss.

The right chair could have added muscle to board oversight. A separate chair is an approach used by 46.5% of 256 medium to large U.S. banks, according to MSCI Inc. The structure provides an extra measure of assurance against the risk of misfires by a chief executive.

Every year, a majority of Wells Fargo's largest institutional investors has voted to keep both jobs in the hands of a single individual.

The current two largest institutional investors after Berkshire Hathaway Inc., the largest holder with 9.9% of the stock, are BlackRock Inc., with 5.6% of shares and Vanguard, 5.4%. BlackRock and Vanguard voted at Wells Fargo annual meeting in April against splitting the top two jobs, according to mutual fund proxy-voting records. Mr. Stumpf won re-election to the board by a 94.9% vote in favor.

BlackRock, Vanguard and other managers invest more than $3 trillion on behalf of defined contribution participants, according Pensions & Investments' report on the 1,000 largest retirement funds. Plan participants, in turn, rely on the funds to invest, engage and vote on their behalf to add value and protect against loss.

Of course, there is no guarantee that an independent chair at Wells Fargo could have prevented or stopped the cross-selling scam. But we know the current structure provided few checks on Mr. Stumpf's decision-making. MSCI's research analytics, GMI Analyst, in April gave Wells Fargo a “D” on its governance rating scale, which seeks to gauge board effectiveness.

Wells Fargo counters that it has a lead director, Stephen W. Sanger, who provides independent board leadership equivalent to what a chair is meant to do. But Mr. Sanger was paid just $40,000 for that task in 2015. That's a level more on the scale of a teller than a person presiding over what the Wall Street Journal last year described as “earth's most valuable bank.” By contrast, a full-fledged independent chair at a typical Standard & Poor's 500 company earns an average of seven times more. So perhaps Mr. Stumpf and the board expected much less of the job at Wells Fargo. It's no wonder that GMI's April assessment warned that “directors may not be serving as an effective counterbalance to management.”

Through their votes against independent board chairmanship, some big institutional investors are now vulnerable to accusations that they abetted risky leadership practices that concentrated too much power in Mr. Stumpf. Of course, BlackRock and Vanguard may have had good reasons to oppose an independent chair at Wells Fargo and other firms. Indeed, they each feature respected teams of governance analysts who may have raised concerns about excessive leadership risk in private conversations with company officials. But the way mutual funds typically disclose their perspectives leaves ordinary plan participants who entrust their capital to such managers with little insight on the matter. Their methods are largely a black box.

Current Securities and Exchange Commission rules require funds to release voting records just once a year, and in forms that are sometimes difficult to access and compare. Mutual funds need not explain why they come down one way or another on resolutions addressing independent chairmanship, CEO pay, climate change risk or other factors at a particular company. So it is difficult to determine what information funds used, what factors they weighed or indeed whether any conflicts of interest might have swayed the outcome.

That last part is a real concern. Some academic research has suggested that commercial interests have sometimes been associated with mutual fund voting and investment choices. For instance, the research paper “Do Pension-Related Business Ties Influence Mutual Fund Proxy Voting? Evidence from Shareholder Proposals on Executive Compensation'' — by three academics, Rasha Ashraf, Narayanan Jayaraman and Harley E. Ryan Jr., published in June 2012 in the Journal of Finance and Quantitative Analysis — found that fund families disproportionately voted to back management at companies where they had pension-related business ties.

Plan participants are effectively financial hostages in this arrangement. And when it came to Wells Fargo, like it or not, knowingly or not, their money was used in ballots that set the stage for the cross-selling scam. The value of their holdings, as a consequence of the scandal, has taken a nosedive tracked at nearly $60 billion since the story broke.

So what is the path forward? The Sept. 20 telegenic hearings of the Senate committee on Banking, Housing and Urban Affairs included testimony from Mr. Stumpf and marked the beginning of repair at Wells Fargo. Legislators, corporate directors, shareholders, regulators and prosecutors are now readying penalties and an overhaul of management culture.

But can we reduce the prospect of capital-destroying scandal in the rest of Wall Street and beyond? The answer is yes — if plan participants prompt our big institutional investors to become stronger and more trusted stewards of a well-functioning market. In particular, mutual funds can today take the lead on two transformative actions.

First, they should agree to release in real time, not just once a year, how and why they vote on issues at public companies. Plan participants with mutual fund allocations should be able to log on to their accounts not only to see where their capital is invested, what trades are taking place and how much they pay in fees, but also how their money is voted at the annual meetings of Wells Fargo and other companies. Disclosure could prompt mutual fund managers, conscious that they are continuously monitored, to devote more resources, attention and discretion to watching portfolio companies.

Second, mutual fund managers should replace opaque methods of making voting and stewardship decisions with more open and accountable practices. For instance, fund companies can create and identify panels of plan participants and issue experts to serve as sounding boards on the most difficult voting judgments.

Together these practical steps can help mutual fund managers wield, and be seen as wielding, best-informed, non-conflicted, plan participant-minded clout to ensure Wells Fargo and other corporate boards drive a high-performing, but responsible, market.

Stephen M. Davis is associate director and senior fellow of the Harvard Law School Program on Corporate Governance, Cambridge, Mass. He is co-author of “What They Do With Your Money: How the Financial System Fails Us and How to Fix It,” published by Yale University Press.