Sunday, September 03, 2006

 

The Power of Institutional Investors: What the Swissfirst – Bellevue Scandal Tells us about Corporate Governance in Switzerland

A new full-scale corporate scandal has emerged in Switzerland a couple of weeks ago. This scandal around the merger between the Swissfirst Bank and the Bank am Bellevue touches some of the most central questions in the debate about good corporate governance: equal treatment of shareholders, insider trading, and the role of pension funds and their managers.

In fact, just before the merger of the two investment companies in September 2005, five large pension funds and two insurance companies sold their stakes in Swissfirst to this bank (NZZ, no 175, July 31, 2006). This allowed the Swissfirst to conclude the deal with Bellevue without capital increase, which led to a 50% increase in the Swissfirst share price after the announcement of the deal. At the same time, this implied that the future pensioners that were affiliated to the pension funds in question faced a loss of profits of about 20m CHF (the NZZ am Sonntag, July 30, 2006, estimates the loss of profits even at 33m CHF). This raises of course an important question: why were the managers of the pension funds ready to abstain from realising these considerable profits? The answer that the press gives is that the management of Swissfirst created incentives in order to convince the pension fund managers to sell their shares. In other words, some newspapers hold the view that the fund managers were bribed. Most likely, however, the incentives took simply the form of in-advance information about the merger (which is as illegal as bribing). Thus, several fund managers, while selling the stake of the pension funds they managed, bought privately Swissfirst shares and options just before the deal was concluded.

The suspicion of insider trading is supported by the fact that during the month preceding the announcement of the merger the price of stock-options of Swissfirst evolved independently from the price of the underlying share. In fact, from the beginning of August 2005 through September 9, 2005, the price of the option raised from CHF .21 to CHF .65 even though the share price remained fairly stable (NZZ am Sonntag, August 27, 2006). This hints of course at insider trading, since people who new about the imminent merger were ready to pay more for the stock options than what they were worth at the time. It is proved that mangers of Swissfirst – but also pension fund mangers – were among the buyers of stock options before September 9, 2005, the last trading day before the announcement of the merger.

One of the fund mangers appears to have increased hundredfold his personal fortune between 2001 and 2002. Following these revelations, the largest Swiss newspaper – the tabloid Blick – started a campaign against this fund manager. Front-page pictures showing the villa of the manager with headlines reading “That’s how the perkiest Swiss pension-fund manger lives” were published the following days and the integrity of the Swiss business elite as a whole was once more put into question.

But what does this episode tell us about corporate governance in Switzerland independently from the polemic it triggered? As any corporate scandal, this episode allows us to better understand the functioning of the Swiss economy. A very interesting question in this respect is the question of the role of institutional investors – and more precisely pension funds – in corporate governance.

In the US pension funds are mainly seen as powerful and active shareholders with considerable monitoring power over the management. This does not seem to be the case in Switzerland. In the US, CalPERS and other pension funds make headlines with their very active policy in proxy fights and during annual shareholder meetings. In Switzerland, on the other hand, there is not much ‘shareholder activism’ by pension funds, not even by public ones (one of the pension funds, which was involved in the scandal was Publica, the pension fund of federal civil servants). Except for the Ethos foundation, which explicitly pursues an active investment strategy and tries to exercise a certain influence on the management, most Swiss pension funds are very complaisant, follow buy-and-hold strategies and do not actively monitor companies’ management. A recent study by the Federal Office of Social Insurances shows that most Swiss pension funds do not exercise their voting rights during the AGM. Thus, during the period 1998 and 2000, only 5% of the interviewed pension funds said that they exercised their voting rights systematically. 50% answered that they exercised them never (Bulletin de la prévoyance professionnelle No 59, OFAS, 10.12.2001).

Two reasons explain this complaisance of Swiss pension funds towards companies’ management. Firstly, there is a built-in lack of independence of private pension funds from companies’ management. In fact, the foundation board of a private fund is composed of representatives of the employees and of managers of the company it belongs to, which makes a critical stance towards the management of course unlikely. Yet there is a second reason why critical voices are rare in Switzerland, i.e. the country’s small size. The small size of the country implies that the business elite is also small, which entails a situation where everybody knows everybody. Hence, ties between members of the business elite are very narrow. These close social ties render control by pension funds and other institutional investors difficult. This can be illustrated by the close personal ties that existed between the main actors of the Swissfirst – Bellevue scandal: the father of the CEO of Swissfirst was during long time manager of one of the pension funds, which sold its stake before the merger (NZZ am Sonntag July 30, 2006). A manager of another pension fund that was involved in the scandal was himself member of the Swissfirst board of directors until approximately one year before the merger. The chief investment officers of two of the pension funds sat together on the board of Cat Group, an investment company in which one of them held privately a considerable stake. The Cat Group, in turn, managed the savings of the pension fund in which its director was chief officer. Finally, one of the external investment advisors of another pension fund that sold its stake in Swissfirst, – a Member of Parliament from the Swiss People’s Party – was until May 2006 board member of Swissfirst and, at the same time, member of the investment board of another investment foundation that was involved in the scandal.

These multiple personal ties between the actors in the Swissfirst scandal are typical for the very coherent Swiss business elite. It reminds also the Swissair debacle, where the board of directors was composed of the most illustrious personalities from business and politics, which met in different places of sociability. Such ties are one of the reasons why critical voices are very rare and why it is difficult for individual members of the elite to denounce wrong-doings. In fact, due to this coherence social control is strong, imposing a set of common values – such as loyalty – on the members of the business elite. This is of course not new in Switzerland. The ‘sleaze’ composed of people close to the Swiss Radical Democratic Party was often held responsible for malfunctions in the Swiss economy. Notably the People’s party accused the radical democrats of nepotism and cronyism. What is new, however, is that this time it seems rather to be the People’s party, which is at the centre of the scandal.


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