Game of Monopoly: ‘Not so fast,’ regulators tell BlackRock (NYSE:BLK) as asset managers buy up shares

The Federal Deposit Insurance Corporation, one of the US agencies tasked with overseeing the country’s banking system, is examining the power index-fund colossuses BlackRock (NYSE:BLK), Vanguard, and State Street (NYSE:STT) have over US banks in an ongoing effort to ensure the “Big Three” asset managers can’t use their substantial holdings to unduly influence the sector that plays a crucial role in the country’s economy.

Shareholders who own more than 10% of a bank are classified as having a controlling interest and subject to strict reporting requirements and restrictions, but asset managers can get exemptions to go beyond that level if they promise to remain “passive” and not exert influence on management or boards. FDIC board member Jonathan McKernan wants to make sure that’s the case. The move is significant as any new efforts to change how asset managers invest and pick stocks have the potential to influence valuations across the market. 

“The FDIC Board will vote soon on my plan to actually confirm the Big Three aren’t using their large stakes to influence policy at FDIC-regulated banks,” McKernan, a Republican, said last week amid reports that the measure had bipartisan support. It’s a message he’s been delivering for months now amid questions about the possible use of social campaigns to influence lending or other practices at the banks. “If the Big Three leverage their purportedly passive index funds to advance ESG or otherwise influence corporate policy, then there is a real problem here, and the FDIC needs to get in front of it quickly,” he said in January.

So-called “environmental, social, and governance” activism by large asset managers who control voting power for shares they hold to back index funds has come under increasing scrutiny in recent months, with Republicans in the House Financial Services Committee forming a working group last year to examine “market participants who misuse the proxy process or their outsized influence to impose ideological preferences in ways that circumvent democratic lawmaking.” It’s a similar concern that was shared by Charlie Munger, the now deceased former vice chairman of Berkshire Hathaway (NYSE:BRK) and longtime business partner of Warren Buffet. “We have a new bunch of emperors,” he said in 2022, “and they’re the people who vote the shares in the index funds.”

BlackRock, Vanguard and State Street acquire substantial voting power in publicly traded firms because of the shares they hold on behalf of their customers who invest in popular index funds as a way to diversify their portfolios and reduce risk. While the customers provide the capital, the asset managers typically retain the voting rights that come with the shares and can acquire enormous influence. Indeed, the three asset managers are the top three investors in US banks, according to S&P Global Intelligence. The FDIC’s McKernan, meanwhile, cited research that suggested the “big three” could control 40% of voting shares in S&P 500 companies.

“The Big Three have shown a willingness to use this voting power to drive change,” McKernan said. “We should also scrutinize how the Big Three coordinate their voting and other investment stewardship activities with each other and with other activist shareholders.”

The scrutiny is notable because the largest asset managers are increasingly buying up shares in everything, versus a more traditional investor strategy used by the likes of Berkshire Hathaway that focuses on picking quality companies. The influence of owning just 10% of a company can sometimes start to look like monopoly power, as many retail investors don’t end up participating in ballot initiatives. That means boards and CEOs can find themselves at the mercy of the biggest asset managers, who can use their voting power to sway outcomes about leadership, activist campaigns or even business strategy. 

The FDIC isn’t the only government agency paying attention. Last year, the Federal Energy Regulatory Commission launched an inquiry to study whether it needed to revise its policy on financial investment and ownership of electric utility companies. Consumer advocacy group Public Citizen had pushed for the review after accusing BlackRock of obtaining “unprecedented control and influence over utilities” that “may be undermining competition and threatening just and reasonable rates.”

For its part, BlackRock says it’s been working to allow its customers to participate in proxy voting processes at companies in which they invest. CEO Larry Fink notably didn’t mention ESG in his latest investment letter, but he did say that “about half of our clients’ index equity assets under management” can access a share voting program. 

“We welcome these additional voices to corporate governance and believe they can further strengthen shareholder democracy,” he wrote. “I believe that more asset owners can participate in this important process effectively if they are well-informed.”

Despite index fund managers’ efforts to expand proxy voting to customers, Harvard Law professor John Coates thinks the increasing concentration of wealth and power can threaten democracy. He detailed the problem in a book titled “The Problem of Twelve: When a Few Financial Institutions Control Everything.”

“Currently around a dozen people running the biggest index funds and private equity funds now have strong influence over every public company in the U.S. and most of our economy,” he said in an interview last year with Harvard Law Today in which he discussed recent involvement by large index funds in matters at ExxonMobil (NYSE:XOM) and Starbucks (NASDAQ:SBUX). “These funds are powerful, and they’re having an impact on companies in real policy battles.”

“Simple solutions are unlikely to work,” he continued. “This is more a dilemma to be managed than solved.”

While Coates thinks reforms can help, he also pointed to the risk democracy can pose to companies, investors and finance firms when the political system starts to respond to increasingly concentrated power, and that threat can affect any side of the political spectrum as voter opinions change with the tides. If lawmakers decide to act to curtail the increasingly monopolistic power asset managers are acquiring, the ramifications across the stock market could be profound.