March 25, 2014
Does Your Mutual Fund Have a Religion?
Does your mutual fund have a religion? If so, how would you find out what it is? If it changes, would the fund’s investment adviser have to inform you? These questions came to mind after reading the transcript for today’s argument in the Hobby Lobby and Conestoga Wood cases. Don’t get me wrong. None of the justices or attorneys mentioned mutual funds. But let me explain why they should have.
Mutual funds own approximatley 25 percent of U.S. equities. Thus if a Supreme Court majority determines that corporations may have religious beliefs (for purposes of the Religious Freedom Restoration Act and/or the Free Exercise Clause of the First Amendment), it will be necessary to come up with a methodology for determining what a given corporation’s religion is. If the Court decides that the religion of the shareholders (as opposed to that of its employees, for example) dictates the religion of the corporation, one would need to know who the shareholders are as of the particular point in time when the sincerity of the religious belief is being measured.
Of course this poses challenges in a world of high-frequency trading. But that would not be insurmountable as a practical matter; we do have record dates for other purposes. But it would make a mockery of religious beliefs if they can shift in fractions of a second. And, it becomes additionally complicated when the owners of shares are not real people, but instead institutional investors. About 70 percent of U.S. equities are owned by institutional investors (with mutual funds taking up a large slice).
If religion is determined by shareholder vote, would that be acquired through a management resolution on the proxy ballot? What would happen when even a single corporation in an index held such a vote? Would the funds abstain? Or would the fund that held that corporation’s shares vote in support of management’s religious resolution? If so, would that single vote establish the religion for that fund, thus precluding it from voting in favor of a different corporation’s suggestion religion? Or, can a single fund be one religion for purposes of one stock in its portfolio and a different religion for another? And who decides? Do fund shareholders get a say on the fund’s religion?
This line of thought may seem far-fetched, given that the parties in this case are closely-held corporations owned by family members. Yet Justice Roberts acknowledged that a decision that a for-profit corporation has religious beliefs and rights could go beyond the facts presented today. He said:
“Whether it applies in the other situations is a question that we’ll have to await another case when a large publicly traded corporation comes in and says, we have religious principles, the sort of situation, I don’t think, is going to happen.”
But these are the very real concerns. And, it was associated practical questions that Justice Sotomayor raised with Paul Clement, counsel for the corporations. Sotomayor asked him:
“[H]ow do we determine when a corporation has that [religious] belief? Whos says it? The majority of shareholders? The corporate officers? The––is it 51 percent? What happens to the minority? And how much of the business has to be dedicted to religion? 5 percent 10 percent? 3 percent?”
“You look to the governance doctrines. . .And I think that’s a really critical question, which is ultimately, I think this line of questioning goes to a question of sincerity.”
Am I sincere? This is a thought exercise, and a scary one at that. The idea that the Court may actually permit a for-profit corporation to pierce the veil for purposes of gaining benefits that deprive its employees of rights under federal law, but use the veil to shield its shareholders from personal liability is, in my sincere opinion, absurd.
Update: In response to Ron’s insightful response, I should note that I was referring to “mainstream” mutual funds and not SRI funds. I should have made that more clear, particularly given that I have written about them in the past.
That said, the existence of SRI funds or shareholder activists that invest in or engage with corporations to encourage them to pursue envriomental, social, and/or governance agendas, whether motivated by religious views or otherwise is separate from the problem presented by the case at hand. As noted above, if this door opens, there will be a need to determine whether a corporation’s religious beliefs are sincere and to the extent that involves polling the shareholders, this is fraught with challenges, not the least of which is shareholder turnover. In contrast, the current system which does allow for SRI funds and other activists to influence corporate governance does not require the fiction of a consistent adherence to a particular religious belief system for a legal entity with fluctuating shareholders.
(Cross-posted on the Conglomerate Blog here)