Institutions Asleep at the Wheel

This story is part of a special series by TheStreet.com investigating shareholders' reaction to corporate corruption on Wall Street. Click here to see a full listing of stories.

Almost nobody on Wall Street escaped blame in the wake of the recent season of corruption. But how many have complained about the true guardians of investor wealth -- institutional shareholders?

These supposed advocates of shareholder rights control huge sums of other people's money but were no more effective at stopping the carnage on Wall Street than the smallest of individual holders.

"As long as the piper gets paid and it appears as if everything's OK, very few were asking the tough questions," said Bill Smith, a professor of management at Towson University. "That's a lesson for us all."

Where Were They?

While activism on the part of institutional holders was once viewed as a nuisance, in retrospect it's clear that pension funds and labor unions could have done more to prevent these past few years' debacle. Although some of their weapons, specifically nonbinding resolutions, lack teeth, these investors wield enormous power when it comes to pressuring companies to change their governance structure.

Jeff Gates, president of the Shared Capitalism Institute, argues that pension trustees like the California Public Employees Retirement System, or Calpers, failed to protect investors because they opted for a financial model that focuses on short-term gains with little regard for the longer-term benefits.

No one could have predicted the extent of the fraud that took place in recent years. But it's been reported that Calpers, which was an investor in Enron, apparently knew about some of the dubious financial partnerships arranged by the company and yet failed to alert anyone. Moreover, Calpers, and others like it, were big investors in WorldCom, despite some obvious corporate governance concerns prior to the firm's meltdown.

Among pension funds, Calpers has been one of the more outspoken critics of excessive executive pay and has publicly advocated greater independence by corporate boards and accounting firms. Because the fund gets its money directly from the state of California, it isn't beholden to corporations and doesn't rely on them for management fees.