Abstract
Indirect investors—especially mutual fund investors—are often low-dollar, low-incentive, rationally apathetic investors facing enormous information asymmetries and collective action problems. These traits raise difficult corporate governance questions about how indirect investors exercise or should exercise their right to vote in fund elections, obtain fund-related information, and pursue litigation against the fund. These questions are all the more important in light of how many indirect investors own mutual funds through employer-sponsored defined contribution retirement plans.
John Morley and Quinn Curtis’s 2010 article, Taking Exit Rights Seriously, offers a clear answer to this problem. They assert that the best solution for all mutual fund investors in an unsatisfactory high-fee fund is simply to exit. They argue that the mechanisms traditionally suggested for curbing fees—board meetings, shareholder votes, or 36(b) fee litigation—are red herrings at best and expensive placebos at worst. They instead focus on the competition produced by exit, or the threat of exit, arguing that competition is the key to regulating the mutual fund market. Exit is, in their view, the remedy for all indirect investors who are paying high mutual fund fees. The corporate literature has accepted the exit option as a clean solution to a tricky problem, largely ignoring the conundrum of indirect ownership and the stress it places on traditional theories of shareholder governance.
But what if some mutual fund investors are stuck and exit is, for them, an empty option? Such is the case for the fastest growing group of new securities investors: those who enter the securities market through self-directed, defined contribution retirement plans—such as a 401(k)—and who invest heavily in mutual funds and other securities. I call this group the citizen shareholders (CSHs). As an investor class, CSHs are often low-dollar (due to contribution limits); long-term (due to tax penalties on preretirement-age withdrawals); and unsophisticated in account allocation strategies and management. For these investors, exit is not a feasible option. Morley and Curtis’s original theory, elegantly simple, overlooks the unique constraints of CSHs.
This Essay considers the implications of Morley and Curtis’s theory for CSHs, drawing upon more recent scholarship by Ian Ayres and Quinn Curtis that shows the continuing problem of high mutual fund fees. Part I reviews the arguments advanced by Morley and Curtis, and Part II explains the flaws of their model as applied to CSHs. The Essay challenges the widely accepted view that exit is the best strategy for all mutual fund investors by showing that exit is not a viable option for CSHs and that the exit of other investors actually creates a competitive disadvantage for CSHs. Many CSHs, relative to other mutual fund investors, are locked into high fee funds and frozen out of the benefits that result from fee competition.
Repository Citation
Anne M. Tucker,
Locked In: The Competitive Disadvantage of Citizen Shareholders
, 125 Yale L.J. Forum 163
(2015),
Available at: https://digitalcommons.law.uga.edu/fac_artchop/1825