Index Fund Enforcement

Abstract

Corporate America today is astonishingly beholden to three large financial institutions: BlackRock, Vanguard, and State Street Global Advisors. As investors have moved their money into low cost, highly-diversified investment vehicles known as index funds, the so-called “Big Three” institutional fund managers that dominate the index fund industry have grown rapidly and accumulated unprecedented economic power and influence. For instance, these three institutions now vote one out of every four shares of stock issued by large U.S. companies. Policymakers and scholars have begun to sound the alarm about this concentration of corporate ownership, and have proposed reforms to reduce or eliminate these institutions’ influence over portfolio companies.

But concentrated power has its benefits, too. In this paper, I argue that the remarkable size, permanence, and cross-market scope of the Big Three’s ownership stakes gives them the capacity and, in some cases, the incentive to punish and deter fraud and misconduct by portfolio companies. Corporate governance and securities regulation scholars have argued that these institutions have generally overriding incentives to refrain from meaningful corporate stewardship, but the facts on the ground tell a somewhat different story. Drawing on a comprehensive review of the Big Three’s enforcement activities and interviews with key decision-makers for these institutions, I show how they have been using engagement, voting, and litigation to discipline culpable companies and managers. I also identify the “pro-enforcement” incentives that explain these actions.

Policymakers and scholars are now engaging in a heated debate over indexation and the future of the Big Three. To date, however, participants have overlooked the potentially beneficial role these institutions may play in the enforcement ecosystem. This paper corrects this oversight, bringing Index Fund Enforcement into focus. Policymakers should embrace regulatory reforms designed to enhance Index Fund Enforcement, not weaken it.

Keywords: index funds, enforcement, securities litigation, common ownership

JEL Classification: K22, G23, G28