A 3rd Generation CEO’s Conflict of Interests – The Troubling Story of Fidelity Investments

By Grk1011 [CC BY-SA 3.0 (https://creativecommons.org/licenses/by-sa/3.0) or GFDL (http://www.gnu.org/copyleft/fdl.html)], from Wikimedia Commons

The challenge that a third generation family business CEO has in keeping the empire afloat in an environment far different from that of its founder is no small feat. Of course, in the case of Abigail Johnson, the empire in question is not your average run-of-the-mill business. She is the CEO and 3rd generation family owner of Fidelity Investments, one of the largest and most iconic financial institutions in the United States.

A Family Business in Finance

Fidelity Investments was founded in Boston by Johnson’s grandfather, Edward Johnson II in 1946. The founding Johnson family owns stock representing a 49% voting interest in the company and have signed agreements pledging to vote all their shares as a bloc. The majority of the remaining 51% are owned by company employees, but thanks to the power of the Johnson family, Fidelity is still considered to be a family owned corporate entity.

Today, Fidelity Investments employees more than 45,000 people who work in one of three main sectors: Investment Management, Mutual Funds, and Online Brokerage Services. All in all, the company has more than $2.1 trillion in assets under management (AUM).

The Troubles

So with a pedigree like that, what could be giving Abigail Johnson so many headaches? The answer is the same thing that can be found in any company with a long history of doing things a certain way – slow response to rapidly changing times. In this case, it was a failure to react quickly enough to the “seismic shift” in the financial services industry towards passively managed index funds.

According to a 2016 story by Reuters, “During the 12-month period that ended Sept. 30, for example, investors made nearly $41 billion in net withdrawals from Fidelity’s stable of actively managed mutual funds, according to Morningstar Inc. By contrast, Vanguard’s passive funds collected $234.1 billion in net deposits during that period.”

Johnson has tried to right the ship by launching new passive funds and, as of last October, they totalled assets of $241 billion. This is still dwarfed but the fund totals of their major competitors.

Conflicts of Interest

Adapting to a rapidly changing landscape is only part of the challenges Abigail Johnson must deal with. Perhaps more significant is an image problem that potentially undermines one of Fidelity’s founding principles. As part of their mission statement on integrity, the company proudly declares:

“Acting in good faith and taking pride in getting things just right. The commitment each of us makes to go the extra mile for our customers and put their interests before our own is a big part of what makes Fidelity special.”

However, according to an October 2016 Reuters investigative report, some of Fidelity’s business practices have cast serious doubt on their claim to “put (customers) interests before our own,” and the Johnson family has been accused of becoming richer at the everyday investors’ expense, even those who are Fidelity customers.

Take the case of F Prime Capital, a private venture capital arm of the Johnson family. F Prime Capital has come under fire for competing directly for lucrative deals against the Fidelity mutual funds in which millions of Americans put their nest eggs, posing a troubling conflict of interest.

In one infamous case, F Prime Capital invested $11 million in Ultragenyx Pharmaceutical Inc, a biotech start-up, prior to their IPO. But the investment prevented Fidelity’s mutual funds from investing until the firm went public, due to laws that prohibit affiliated entities from buying large stakes in the same company at the same time. F Prime bought in at a price of $3.55 per share. When the mutual fund bought in three months later, it was over $41 a share.

Yale law professor John Morely told Reuters that while the practice is not illegal, it is certainly questionable from a business strategy perspective.

“What they’re doing is not illegal, not even unethical,” Morley said. “But it’s entirely appropriate for mutual fund investors to take their money elsewhere because Fidelity has made a decision to take away some of their potential returns.”

A Time for Leadership

For 3rd generation and current CEO Abigail Johnson, who has been running the show since 2014, the pressure is on. Having experienced no shortage of highs and lows throughout her years in the finance industry and facing accusations of unethical behaviour, all eyes are on whether she will be able to lead with purpose and ensure that the 3rd generation curse of the family business doesn’t manifest in Fidelity.

For her part, she seems up to the challenge. As she told Forbes, “There’s a time that may come in an organization where leading by influence is not enough. When things are not going the way they need to go, there’s a time when one has to step up… to set the organization back on the right direction.”

And in a time when disruption is actively redefining industries the family business is under pressure, it would appear that the time to step up is now.