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TIAA-CREF's Version of Democracy Gives Investors Raw Deal

These fund shareholders have learned a lesson in civics they didn't get in school.

Christopher Davis, 03/07/2006

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What if voters came out in droves for the challenger, but the incumbent decided to remain in office? If all you knew about democracy was what you learned as a TIAA-CREF mutual fund shareholder, you might think this implausible scenario was a real possibility.

In July, TIAA-CREF asked shareholders of its actively managed institutional funds to approve plans to more than quadruple management fees. Shareholders voted against the hikes in all but a handful of instances. But then TIAA-CREF took the rare step of scheduling another vote. It got its way in the January revote, with shareholders approving the fee hikes. But even if shareholders hadn't approved the fee increases, the game would have remained rigged in TIAA-CREF's favor: The firm had plans to fold its low-cost institutional funds into a higher-expense lineup of funds that it would have created if shareholders had voted down the fee hikes in January. To avoid that fate, shareholders would have had to vote--yet again--to prevent the mergers. (None of the votes or expense increases affect TIAA-CREF flagship annuity offerings, such as CREF Stock, or its non-institutional mutual funds such as TIAA-CREF Growth & Income TIGIX and TIAA-CREF Bond Plus TIPBX.)

It's ironic that a highly regarded champion of democracy in corporate boardrooms would show such blatant disregard for the will of its own fund shareholders. Had TIAA-CREF-style democracy been in place for the 2004 election, Kerry supporters would have had to go to the polls three times to get their man in the White House.

This isn't the TIAA-CREF longtime observers of the firm know and respect. Vanguard founder Jack Bogle, no admirer of most investment managers, once labeled TIAA-CREF as one of the few he held in high esteem. Its decades-long service to educators and other not-for-profit workers (Albert Einstein was once a shareholder) and its low-cost, investor-first ethic rightfully earned it a squeaky-clean reputation. When it launched its first mutual funds in 1997, it succeeded in bringing its shareholder-friendly culture to a wider audience. While we once regarded that culture as one of the fund industry's best, that's no longer the case.

What Went Wrong?

When current TIAA-CREF CEO Herb Allison came aboard in November 2002, shareholders and fund-industry watchers feared he would take the venerable firm in the wrong direction. TIAA-CREF's core constituency of professors and other educators highlighted Allison's lavish compensation package, which included an eye-popping $24 million severance agreement. And given Allison's experience at traditional brokerage firm Merrill Lynch MER, where he was president until 1999, critics pointed to the potential for a culture clash.

Those worries seemed a bit far-fetched. After all, TIAA-CREF--as a pure investment manager rather than a financial conglomerate--wouldn't face the sorts of conflicts Allison faced at Merrill. In 1998, for instance, Allison called Enron chairman Ken Lay after the energy trading firm purposefully excluded Merrill from participation in an April 1998 stock offering because its Enron analyst gave the company a "neutral" rating, which in Wall Street parlance means "sell." Merrill ultimately got in on the deal, and the analyst resigned four months later, replaced by an analyst who gave Enron a "buy" rating. (For its part, Merrill denied any wrongdoing and noted the analyst who left gave Enron a "buy" rating at his new job a few months later.)

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