Are index funds getting too powerful?

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NEW YORK, NEW YORK - SEPTEMBER 13: Traders work on the floor of the New York Stock Exchange during afternoon trading on September 13, 2022 in New York City. U.S. stocks opened lower today and closed significantly low with the Dow Jones dropping over 1,200 points after the release of an inflation report that showed prices rising more than expected in the last month. The Consumer Price Index released by the Bureau of Labor Statistics showed prices rising 8.3% over the last year, for which economists had predicted an 8.1% increase. (Photo by Michael M. Santiago/Getty Images)
NEW YORK, NEW YORK - SEPTEMBER 13: Traders work on the floor of the New York Stock Exchange during afternoon trading on September 13, 2022 in New York City. U.S. stocks opened lower today and closed significantly low with the Dow Jones dropping over 1,200 points after the release of an inflation report that showed prices rising more than expected in the last month. The Consumer Price Index released by the Bureau of Labor Statistics showed prices rising 8.3% over the last year, for which economists had predicted an 8.1% increase. (Photo by Michael M. Santiago/Getty Images)

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Index funds are a very popular way of investing across the stock market.

"The top four index funds alone – State Street, Vanguard, BlackRock and Fidelity – they control about 25% of all of the stock of every public company," John Coates says.

That's right, a quarter of corporate stock in this country is owned by funds managed by just four companies.

"When you get to 50%, you control the company. There's no fighting anymore. There's not even an argument, and that's really quite troubling. The idea that a small number of people could control every business in the U.S."

Today, On Point: How index funds are shaping corporations and the American economy.


John Coates, John F. Cogan professor of law and economics and deputy dean of Harvard Law School. Former general counsel of the Securities and Exchange Commission. Author of the forthcoming book “The Problem of Twelve: When a Few Financial Institutions Control Everything."


Part I

MEGHNA CHAKRABARTI: "The mutual fund industry has been built, in a sense, on witchcraft." That quip is from John Bogle's 1999 book "Common Sense on Mutual Funds." Bogle had a way with words, just as he had a way of seeing the financial industry. He chafed at the idea that active managers of traditional mutual funds possessed an all-chemical power to beat the market.

Instead, Bogle believed that the only power fund managers actually had was to do worse than the market as a whole and to charge investors a whole lot for the courtesy of the fund's poor performance. So instead, in 1975, John Bogle founded the Vanguard Group and pioneered the index fund. Where retail investors are more or less guaranteed overall market returns or losses, because index funds invest across entire markets and crucially at very low cost.

Or as Bogle put it, quote, "Don't look for the needle in the haystack. Just buy the haystack." This is On Point. I'm Meghna Chakrabarti. Almost 50 years later, Vanguard now manages more than $7.7 trillion in assets. It is second only to one other company, BlackRock Incorporated, which manages more than $8.5 trillion dollars in assets.

Then comes State Street and Fidelity, two other major mutual fund companies who have approximately $4 trillion under management each. But taken together, our guest today says these four companies control 25% of all the stock of every publicly traded company in the United States. Then there are the private equity firms.

It's hard to tell who their investors are. And they successfully avoid regulation, all while taking over companies and withdrawing them from the public eye entirely. In this category of the kings of concentration, we have KKR, Apollo, Blackstone, not to be confused with BlackRock, and Carlisle, which together have more than $2.7 trillion in assets.

And our guest says that private equity controls 15% to 20% of the overall economy. So together, index funds and private equity firms have amassed an unprecedented concentration of power. John Coates says they are shaping corporate America and therefore the American economy. Coates is the deputy dean of Harvard Law School and former general counsel at the Securities and Exchange Commission.

He writes about this problem in a forthcoming book titled "The Problem of Twelve: When a Few Financial Institutions Control Everything." John Coates, welcome back to On Point.

JOHN COATES: Great to be here, Meghna.

CHAKRABARTI: Okay, so anytime we begin with the claim of harm being caused to the American people, and/or the American economy, I like to provide evidence first.

So what is your evidence of harm when it comes to this concentration of power between index funds and private equity firms?

COATES: So harm in a direct financial sense is actually not something that I think is occurring, at least for the index funds. They do a very good job, as you outlined at the outset, of investing for millions of Americans for the long term at a very low cost.

The harm is something that's incipient and political. They've done so well, they've grown so large, they continue to grow, and they continue to grow faster as they get larger. Because what they do really benefits from scale. The result of it is that they're accumulating not simply financial assets and performing a financial service, but they're accumulating direct control of companies and they're having an influence on the way companies' function.

Now you can debate, as with most things in politics, whether that influence is good or bad. But what is indisputable is that it's a very small number of people exerting that influence. And to me, that's the harm, the incipient harm of index funds.

CHAKRABARTI: The incipient harm.

COATES: Correct.

CHAKRABARTI: Okay. Of index funds. I want to emphasize that index funds and private equity are very different investment vehicles, right?

And we're going to talk about their major differences a little bit later because on that point I'm going to press you a bit more on why maybe private equity is potentially worse than index funds. But I wanted to just underscore that. Now to explain a little bit more about what you just said.

How is any major investor that controls a lot of shares in a company directly having an impact on the operation of that company? It's not through direct business decisions, but it's rather through being able to influence who's on the board of a corporation.

COATES: Yes. That's the principle way.

Example No. 1, that is fairly well known now, but worth repeating. Two years ago, roughly, a tiny little hedge fund called Engine No. 1, proposed to put four new people on the Exxon Board, two of them attached to the sustainable energy movement, not something that Exxon was traditionally known for.

And engine No. 1's principle talking point was that Exxon needed to do more to transition to a carbon neutral economy. Again, not something that Exxon had been a leader in. The reason that tiny little hedge fund succeeded in getting three of those people elected, in fact, on the Exxon board, is because BlackRock, Vanguard, State Street, voted with that hedge fund.

They were the ones that tipped the vote over the necessary amount to get those directors elected against the resistance of Exxon itself and their armies of lawyers and advisors. It was a shock, I think, to Exxon. It certainly was a great surprise to the financial markets. And with those people now on the Exxon board, Exxon's behavior has changed.

Now, teasing that out exactly is hard. But they have definitely pivoted in the last couple of years to talking about carbon sequestration, all kinds of ways in which they're sounding at least a lot more friendly to the idea of a transition to a carbon neutral economy. So that's an example.

CHAKRABARTI: This is an example that we talked about actually when we had you back on the show.

What, in 2008. No, actually, maybe it was before that, we had you on the show before the Exxon example came up, but you've been writing about this for a long time, so I'm getting my dates confused. Forgive me about that. But as far as I can tell, and please do correct me if I'm wrong, but the Exxon example seems to be a pretty unique one.

I had difficulty finding a critical mass of other examples that would convince me that Vanguard and Fidelity and BlackRock are behaving in a more activist way when it comes to selecting board members for the companies they own.

COATES: It's true that efforts like the Exxon Board proxy fight are rare.

They're just rare generally, and I don't think index funds have themselves increased the number. But to give you another channel of influence that I think they themselves are clear about, in their own disclosures. Every time a major company wants to do a merger, they typically need a shareholder vote, an approval.

There are hundreds of those, if not thousands every couple of years. Vanguard itself reports having participated in 7,500 merger votes over a couple of year span, and in doing that, they voted no 600 times. That's a significant check on how those companies are governed, how they're functioning, the inability of management to get a merger transaction done unless the big four agree is a major way in which they can exert influence.

And of course, in anticipation of future M & A, merger and acquisition activity, the managers of every company knows they have to maintain good relations with the Big four. I'll take another example, just to illustrate again, on a different dimension. State Street is quite proud of their engagement on the topic of gender diversity.

And reports routinely engaging thousands of companies about whether their boards are sufficiently diverse as a gender matter, and that 43% of the time that they talk to them, the companies respond by either adding a female director or committing to do, so that's another type of influence.

Again, a different type of influence, different channel. I don't think that's going to change capitalism as we know it, but it is a way in which these companies are forced to do things they would not otherwise be doing.

CHAKRABARTI: Okay. So I guess what you're saying is when it comes to the index funds, and again, we will talk about private equity, for sure.

That what you're asserting here is that even though index funds are, by definition, the fund itself is passively managed most of the time. Which is why they're index funds. They are being more active in their influence on the corporations held within those funds.

COATES: I think that's right. I think their own clients and customers want them to be, to some significant extent. They're marketing themselves to some extent as being responsible stewards of the money they control. And part of that is not simply remaining totally passive and ignoring what companies are doing, but in fact using the voting power they've accumulated in ways that they think they can defend and articulate.

Now, one other proof of their influence, by the way, you ask for evidence, is that the political system is already reacting. So last summer, the Senate, 20-some Republicans introduced a bill to take away all their voting power, which wouldn't happen if what they were doing was benign and unimportant.

From their perspective.

CHAKRABARTI: Yeah, I was going to say there's a difference between benign and unimportant, right?


CHAKRABARTI: And as for my insistence on evidence, you are a very sharp legal mind, Professor Coates. So you know that a case can't be made without offering of evidence here. So the fact is, whether or not the examples that you provided listeners here as evidence of index funds. You do make the unassailable point that the percentage of corporations and publicly shared, publicly traded stocks owned by these index funds is huge.

It is very large. So when we come back, we're going to shift gears a little bit and talk about what the problem is with the small number of private equity firms that we mentioned at the top of the show, and then get a little deeper into, okay, if there's a dilemma here. Can it be solved? So we'll be right back.

 Part II

CHAKRABARTI: Now, Professor Coates, you were also former council at the SEC, so you know better than almost anyone how private equity presents a different set of problems.

You said a little bit earlier, or actually you told our producer earlier, that you estimate that private equity might control 15% to 20% of the economy. So A, check me on that. And B, how are we to know that, if by definition, private equity can avoid a lot of regulatory scrutiny?

COATES: That number is right. At least close. The reason we know that is that while private equity has structured itself very carefully, to avoid as many regulations as possible. Many of them are, ironically themselves, publicly held companies, the advisory businesses, not the companies they control, but KKR's advisory business, that's a public company, so they have to report some information about their total scale, and you just take that information plus some private industry statistics that are put out by consulting firms.

And you compare that to what the Fed reports about the size of the economy and how much of it is owned by corporations. And that's where you get the 15% to 20% number. And I'll note that's been growing at a very fast pace, much faster than the overall economy for the last 25 years, just as with index funds.

CHAKRABARTI: Okay, so they're owning more than of the economy with every passing year.

COATES: Correct. Right. The trend is in a direction, and that's, to me, why they also pose a problem of 12.

CHAKRABARTI: Okay, so by the way, we should say the problem of 12 is a phrase that has its origins, not in your book.

You're using that as a title. Why 12?

COATES: It's a nice number. (LAUGHS)


COATES: It's a notional number that captures the idea of 12 people sitting in a room that's about the size of a typical board. There were 12 disciples. I'm sure there are other examples. It's just the idea of a small group of people.

CHAKRABARTI: Okay. Got it. But of course, the difference, one of the biggest differences between the index funds that we were talking about, versus private equity is that index funds, they are regulated by the SEC, therefore there is some degree of transparency that's required by the government.

Whereas for private equity firms, I'm not even sure there's any way for us to know who are the investors in those firms.

COATES: That's right. Private equity firms go around raising money from, and they're careful about this, from either very wealthy individuals, but more actually from other institutions, pension funds, endowments, sovereign wealth funds, and the like.

And because they're only raising money from what the law treats as large, sophisticated investors, they're able to not have to file reports about their fundraising, about their funds, mostly, for the most part, the identity of their investors. And ironically, a lot of those investors are, in fact, ultimately millions of individuals.

But those individuals are pensioners and workers whose money isn't being invested on their behalf without their knowing about it. And we don't know about it as members of the public either.

CHAKRABARTI: Oh, okay. That's interesting. Because then that's another major difference between the index funds and private equity, because index funds, as Bogle created them.

The late now, John Bogle, created them in 1975. The idea was this fund is just going to take the S&P for example, or the Dow or any other index, and just invest in every company in that index and buy and hold. Index funds are in it for the long run, which is different than how I understand private equity works.

Private equity A) buys an entire company. Most of the time, pulls it out of the public view by turning it private and then doesn't really have an interest in managing it for the long term.

COATES: That's right. The traditional private equity model, which sort of originated in the go-go years of the '80s was to buy, strip, meaning cut a lot of costs.

Use the increase in cash flow to pay down the debt they used to borrow, to buy the company to begin with, and then eventually sell it. Traditionally, they sold it back into the public market. That was the way they functioned, temporary reengineers of companies, but then returning to the public market, that's changed.

And over the last 25 years, not only has the industry grown, but the typical exit for a private equity ownership is to another private equity fund. So they not only are taken over by private equity, they're run for a five-year, 10-year period, and then they're sold on to some other non-disclosing private equity fund to run for another five to 10 years.

So companies are continually being flipped from one to another.

CHAKRABARTI: Okay. So we have a couple examples of the various sectors in which private equity is investing, or I should say more accurately, buying companies outright. For example, here is Shirley Smith. She's a former employee at Art Van Furniture in Detroit, and also a leader with the group, United for Respect.

And she appeared at a 2021 Senate subcommittee hearing talking about how Art Van Furniture was taken over by a private equity firm called T H Lee in 2017, and how the business completely changed under T H Lee's leadership.

SMITH: The first thing they did was sold the real estate, made back the money that they spent buying the company, and then they started destroying the company.

They got rid of all of our top leadership and brought in, as I said, people that didn't know the company, didn't know the furniture industry at all. They hired the worst CEO, someone that was rated the worst CEO in the nation in 2016 to run the company. And some could say he didn't do his job, but I'll say that he did his job very well.

He was hired to run his company out of business, and that's what he did.

CHAKRABARTI: So that's Shirley Smith, a former employee at Art Van Furniture at a 2021 Senate Subcommittee Hearing. Here's Peggy Malone. She also appeared at a 2021, probably the same 2021 Senate hearing on private equity, and she's talking about the impact that a private equity firm had in health care.

And this is a sector that private equity has been moving into rather aggressively over the past several years. Malone is a nurse. At Crozer-Chester Medical Center in Pennsylvania, and she talked about the changes that happened in her hospital since private equity took over.

PEGGY MALONE: They have destroyed our hospital. They have destroyed the fiber of what we are as health care professionals. Prospect Medical Holdings, which has 17 hospitals across the country, they were given $173 million of COVID relief money. None of which we have seen in the hospitals. We take care of patients every day. And I understand some of you are very pro private equity.

I'm going to tell you that it wasn't, families were not allowed in the hospital. You did not see what was going on in there during this pandemic.

CHAKRABARTI: So Professor Coates, what I wonder is, in the book, aside from the fact that Index funds and private equity are amassing more and more ownership and therefore power in corporate America.

They seem to be so different to me that I'm not sure they belong in the same book. Can you tell me why you lumped them together?

COATES: Yeah, it's a fair point. They are very different in the way they function. The way they share something though is they're new in how important they are in becoming, they're both asset management industries.

They manage other people's money and they, I think, are growing and concentrating so rapidly that separate from your view about any particular buyout or index fund investment, they represent a threat to our overall system of democracy and capitalism. And regulated capitalism because of their sheer scale.

It's one thing for there to be fights about particular acquisitions and mistakes, maybe. PE thrives on risk. They push the risk when they take over companies by borrowing a lot, and that forces them to get really tough about some decisions and sometimes they get it wrong. Now you can have, again, fights about that on a particular company.

That's one thing, but it's another thing to say they're taking over 20% of the entire economy and running it that way. And doing it at a scale where the biggest of them is getting bigger, faster than the smaller ones.

CHAKRABARTI: You point out a tension though in American history that's playing out also through this issue, and that is the tension between capitalism, which always yearns towards scale.

And the idea of American democracy, which is a fair distribution of power. So you also point out in the book that this has happened before, that the tension between capitalism and small D democracy has reached a breaking point, which might be instructive for how we might think about the problem of 12 as you define it today.

So take us back in time a little bit to what the late 19th century, through the Depression, what was the problem of 12 back then?

COATES: Yeah. The U.S. has gone through cycles of concentration of capital, followed by political and legal restrictions. So late 19th century actually, there were long forgotten now, insurance companies started taking over the economy. They were allowed at the time to buy stock of companies. They did. They started buying lots of stock of lots of companies, and they got to a scale that triggered a massive political reaction resulting in pretty much state by state insurance companies now are either forbidden from owning stock or are greatly limited in how much stock of other kinds of businesses they can own.

And so that's what's taken insurance out of the market, that index funds and private equity now are coming into. We had the same experience with banks earlier. As well as subsequently at different times and even today, even though banks are blamed for a lot of things appropriately, one thing that you can't say about them is that they control other businesses.

They're forbidden largely from taking over health care or furniture makers.

CHAKRABARTI: But in the book, you point out that it crosses over from an economic problem to a political problem because the consolidated power of these corporations in the late 19th and early 20th century and especially after the depression, really undermined the public's confidence and the legitimacy of American business, right?

And it was a governmental reaction to that lack of confidence that really gave us the regulatory regime we've had in the subsequent 100 years. You point out some congressional investigations, supervised by Ferdinand Pecora in 1932 to '34, who called who called the concentration of economic power, in the hands of a few, incomparably, the greatest reach of power in private hands in our entire history, and thereafter comes the SEC.

COATES: That's right. The Securities and Exchange Commission, which I happily worked for a couple of years ago, and all of the laws that it administers are the product of that earlier political fight slash reaction to the earlier problem of 12 that led up to the Great Depression.

It coincided, I don't think coincidentally, with the Great Depression, a period in which the entirety of capitalism was called into question, when so many people had so little wealth and so little prospect of developing wealth that most of the country thought seriously about socialism as an alternative. The response ultimately was, as we all know, the New Deal, which was heavy regulation, protection for labor, but also continuation of capitalism. And protecting that blend, I think the securities disclosures rules that large businesses were required to follow is a big piece of that.

That's partly why I think private equity is so troubling. It's displacing that transparent system of ownership of business that helps create a sense of confidence that post aided World War II and continued on for the last 50 to a hundred years. Now, there are lots of problems with the way that system has evolved over time.

Lots of fights, but by and large it has delivered a great deal of wealth to a great number of people, and I worry that if more and more of the economy is completely dark to the American public, there will be a rise in further populous pressures to do something radical, whether it's in the right direction or the left direction, frankly.

CHAKRABARTI: But again, you're going to have to forgive me for being a stickler about this. When you say completely dark, that's because of private equity, whereas the influence exerted by the index funds isn't necessarily as in the dark, because they are regulated by the SEC.

COATES: That's right. Private equity is much darker, if you will. There's virtually no information coming out of the portfolio companies that they control other than incidental investigation by journalists and the like, or a congressional hearing. Index funds, I will say, are much more transparent about what they do.

They disclose their votes, for example. So that's how we know about the things I was talking about earlier. They are, however, a little still opaque about how they go about developing the positions they take on our behalf with our money. Earlier, I was giving examples, I'll give one more. In the recent labor fights involving Starbucks, there was a shareholder resolution put forward that was voted on recently.

And here, the index fund split. State Street supported the resolution, which called for Starbucks to get an independent assessment of the labor practices at Starbucks. BlackRock, and Vanguard voted against that. In the end, it passed. So now Starbucks is going to have to cope with the fact that most of their shareholders have told them to do something.

But what's interesting to me is that it's difficult, if not impossible, if you went back to January, February to get any information out of the index funds about how they were thinking about that upcoming vote. They weren't real time communicating with their own investors about the issues that labor struggles raise at a company like Starbucks.

So private equity, I agree, darker more troubling, in need of greater disclosure, in my opinion, index funds, better, but still they have some work to do, too, in the disclosure.

CHAKRABARTI: And to be clear about that Starbucks examples, excuse me, example. It was regarding a shareholder resolution that forced Starbucks to, in the words of the resolution, to acknowledge its own belief in human rights.

And so therefore allowing employees to unionize. And that was what the split was over. But we've got to take a quick break in about 15 or 20 seconds here, Professor Coates, I just want to know, is it common practice for people, or owners in a shareholder vote or board resolution to publicly talk about their positions before taking the vote?

COATES: No, but that's fine when it's your money, when it's other people's money and you're voting for them, that's where I think they should do more ahead of time.

Part III

CHAKRABARTI:Today we're speaking to John Coates.

His new book is “The Problem of Twelve: When a Few Financial Institutions Control Everything." And Professor Coates, we're getting some reaction or quite a bit of reaction actually, to your thesis here. And even we received a call from Karen who lives in Milwaukee, and she said to us that "Mr. Coates seems to be making the case that the fact that index funds have all this power is a bad thing.

And every example that's been brought up is an example of good things that need to happen to control the giant corporations." What's your response to that professor?

COATES: That's part of why I brought up the Starbucks example, which maybe came in after her call. The index funds do sometimes lean in directions that personally I think are great but sometimes they don't.

Vanguard, for example, recently was reported by Morningstar as having voted against every non climate environmental resolution that was up for a vote this spring. There's a resistance among the index funds to asking companies like Exxon, and Apple and so on to disclose their own political activity, which has grown a lot over the last 20 years at the corporate level.

So there are things that I agree with the index funds about. There are things that I disagree. What's troubling to me is that they're not quite as open as they should be in my view. And certainly, could be, about how they come to those decisions and then allow their own investors to participate.

CHAKRABARTI: Also good is in the eye of the beholder, right? Good or bad things are definitely subjective evaluations. This might irk, Karen a little bit, but the same control that happened in the Exxon case could happen, say index funds voting for board members who might support a company's decision to remove, I don't know, insurance coverage for birth control, right?

It can work either way.

COATES: Correct. Power is power. Concentrated power is concentrated power, and the fact that the current leadership at any given time might be somebody that you agree with, doesn't mean that they'll stay that way. BlackRock, in particular, since Exxon, has backed away from some of its more climate forward approaches, in part because of the criticism it received from, among others, Republican state governors.

So it's already a political battle going back and forth. And my only point really is not that it's good or bad ultimately, but rather that it is important and it's one that investors largely don't know about, and they need to. There's an irony here, which is, if you don't mind, people choose index funds because they're safe.

Put your money there. And then ignore them. Sorry guys. You got to pay attention because what they're doing on the political side can be just as important as what they're doing on the financial side.

CHAKRABARTI: What I wonder is the true problem, not necessarily the concentration, but the power that concentration gives, that may be exploited, perhaps not by the fund managers themselves, who you know, are technically voted into power at the fund by the funds' millions of shareholders. We can come back to that in a minute, but could the problem actually be activist shareholders themselves? Who you talked about Engine No. 1 and the Exxon case. In other cases, there might be all other activist shareholders that see this concentration amongst the index funds and just have to go to a couple of board members at Vanguard or BlackRock to have an impact.

Is it activism overall that's the issue?

COATES: Yeah, so, it's an interesting question. I do think it's true that the index fund growth and their concentration of ownership has made activism in some sense easier. Engine No. 1 knew they only had to convince the people at these index funds plus a few other shareholders to get to a majority.

That's very different than the world 25 years ago, when the same contest would've needed to convince hundreds, if not thousands of different people to go along with it. So the concentration means it's easier for any type of activist, whatever their perspective, to exert control, if they can flip the switch, so to speak, at the index fund complex.

CHAKRABARTI: A little earlier, as we move towards talking about solutions, you said that like in the 1930s, what we're seeing now is government paying attention to this problem of concentration. And so therefore if government's paying attention, that perhaps in and of itself is evidence of a problem.

Although I would say sometimes that because of politics, politicians may pay attention to problems that don't exactly exist, don't actually exist. They're just seeking for a way to advance their political point of view. But I will take your point for now that the recent activity, both on scrutiny of private equity and scrutiny of index funds, is indicative of something.

For example, here is a moment from 2022 when, as you had mentioned, Professor Coates, a group of U.S. Senators, Republicans, introduced a bill The Investor Democracy is Expected or (INDEX) Act. And it was aimed at controlling how index funds could vote in corporate shareholder meetings. So here's former Pennsylvania Republican Senator Patrick Toomey, who co-sponsored the INDEX Act at a Senate Banking Committee hearing in June, 2022.

TOOMEY: Congress needs to address the problems of the largest asset managers, voting other people's shares, and their consolidation of corporate voting power. In my view, the solution is to return voting power to the true investors in a company. The people who put their own money at risk, the INDEX Act requires any asset manager of a passive index fund with more than 1% of a company's voting shares, devote those shares in accordance with the instructions of the fund's investors, not at the discretion of the asset manager, or they could choose to not vote at all.

CHAKRABARTI: Now John Coates, you were at that same Senate hearing, banking hearing, you testified as well. What do you think of the idea of the INDEX Act?

COATES: You could, listeners can find, get me going on in great length about this there. But the bottom line is that it's a bad idea. It's a bad idea because the practical effect of that law, as written, if it were approved, would be effectively to take away the votes from the index funds.

And while it might sound like I'm worried about them and therefore why not take away their votes? If you take away their votes, then the remaining shareholders in effect get more power. And it would really distort the relationship between ownership and influence to take out 25, 30 growing percentage of the votes altogether.

A better solution is one that the index complexes themselves, at least three of them, Fidelity, I haven't seen doing this yet, but the others are starting to ask their investors not for vote instructions, because as a practical matter that's not realistic. There are 4,000 plus companies. There's shareholder resolutions, many of them every year.

There's no way that most Americans are going to be paying attention to that much detail. But they're asking, instead, for policies. Tell us which policy you want us to follow. And then they've got a little family of policies that you can go look up on a website. I think it's going to take time to work out how these pass throughs are going to work.

A lot of risk of slippage in the details, I will say. I think the families need to be held, their feet need to be held to the fire to make sure they do this in a real and honest way. I think that's a better approach than the one that the Senate bill included.

CHAKRABARTI: Professor Coates, as I was preparing for this show today. I was reading through all the notes that my producer, Claire Donnelly gave to me after she spoke with you. And this idea came up in the notes. And I will admit to you, professor, that in the margins I wrote, "Sounds like a super terrible idea."


CHAKRABARTI: (LAUGHS) Because first of all, we're talking about millions of potential investors having their say or telling the index fund what to do. And second of all, how can that do anything but introduce more politics into this problem of concentration?

COATES: We are in a moment politically where politics has become a kind of dirty word because of how fraught and unpleasant it has felt over the last, whatever, six years. But actually, politics is just another way of saying democracy. And if we want to hold onto our democracy, we have to be prepared to get to the issues and to think about them and to use the money that we are accumulating for our retirement. And the power that conveys through ownership to have the influence that we want.

Otherwise, somebody's going to do it for us. And to some extent, people will do that. I think practically what will happen is that individuals won't all individually come up with 10 million different ideas about how to run companies. There will be a small number of approaches. And they're going to range across different choices on different issues.

And people are then going to pick those policies and those policies then are going to guide the index funds more than they have been in the past.

CHAKRABARTI: Yeah. Can I just jump in here? Because my concern is that this leads to an oversimplification of guidance to the index funds. Which works against the whole idea of what an index fund is.

As you pointed out, some of these funds are investing in thousands of companies and as an individual investor, oneself, a person might think for the companies in this sector, I would advise the fund do X, right? Make certain climate choices. And companies in health care, I'd advise something else. It's, I think people are much more diverse in their personal opinions and personal values than a slate of one individual slate of values might suggest.

Like for example, you pointed out to us that BlackRock in terms of its choices of values to follow, is including the U.S. Catholic Bishops, because they've formulated a voting policy. What if someone agrees with part of what the bishops advise but disagrees with another part. Do you see the risk I'm talking about of oversimplification?

COATES: So I think that's inherent to, again, democracy, to go from, again, 300 million people, 200 million voters, go from 200 million different worldviews to choosing a law in any given moment for Congress, involves simplification. That's what the parties do. They can be very frustrating. We are often frustrated with the soundbite simplifications of politicians, but that is the way in which we function as a democracy, and I think the same thing in a different way could be happening on the corporate side.

Now just to illustrate, I don't again think that BlackRock is going to follow the view of each individual shareholder on each individual vote. I think the likely outcome is they're going to have greener or browner, if you will, climate policies to follow. They'll look at how many of their investors choose one of the other, and then they'll take that into account in how they vote overall.

They will probably end up no longer voting as monolithically. They'll probably vote in different ways, they can do that. They can vote some shares one way and other shares a different way, which will effectively represent then the perspective of their own customers. And I think that in the end will alleviate the fear that Larry Fink, who runs BlackRock all by himself, off in a room with 11 other people, are determining the future of the economy.

Because if that happens consistently over time, I think the index funds will get blown up. And I think they're great. Like so for me, it's worth accepting a little bit of political mess in order to preserve what is a very effective financial institution.

CHAKRABARTI: Ah, okay. Interesting. Because you had also said that we could maybe potentially head towards a world where the index funds formulate voting policies based on what people submit to them. And you told our producer that you predict that Trump and Trump supporters could come up with a voting policy, and so suddenly our political battles would now spill over into this investment arena.

Which really sends a chill down my spine that politics becomes the primary means of decision making, versus just the fiduciary responsibility that the managers of the funds have to their investors. But before we run out of time, Professor Coates, I don't want to ignore private equity, obviously.

Because we talked about the extent of its influence and power, what should be changed or what could be done to make what private equity does more transparent or less consequential to the operational operation of the American economy as a whole?

COATES: Yeah. I may be sounding like a broken record here, because I worked at the SEC. My solution is often more disclosure, and that's what I think. Now, I think for private equity, the challenges that they're raising money from, as I mentioned, say pension funds.

The pension funds are in between the ultimate individuals who they're supposedly representing in their investment, and the private equity folks. I think the law needs to adapt to that reality and require there to be up and down the chain reporting, at least about the basic impacts of how private equity is functioning.

So if it's true that it's having a terrible effect on the health care industry, as some people really believe, I think more disclosure about that would be appropriate from the private equity folks, out to their pension fund investor first layer, and then by the pension fund folks out to their pensioners, who obviously are often directly affected by health care outcomes. So disclosure up and down that chain would do a lot, I think, to restore the legitimacy of that industry.

This program aired on August 7, 2023.

Claire Donnelly Producer, On Point
Claire Donnelly is a producer at On Point.


Meghna Chakrabarti Host, On Point
Meghna Chakrabarti is the host of On Point.



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