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Family tightens grip on Fidelity

Maneuver reduces ranks of shareholders and may cut tax bill

The family of Fidelity Investments chairman Edward C. "Ned" Johnson III is shrinking the ranks of private shareholders, a step that will help tighten its grip on the closely held firm and potentially allow it to lower Fidelity's corporate tax bill by hundreds of millions of dollars a year.

The streamlining continues a series of moves Johnson has taken in recent years to cement the family's hold on the mutual fund giant. But the latest actions provide no clues about future leadership of the company. Johnson, who turns 77 tomorrow , has not disclosed succession plans, and Fidelity would not discuss its long-term strategy.

Some private shareholders last week approved a measure to turn in stock in exchange for cash and debt notes, which former employees said is part of a pattern of shareholder pruning. Fidelity made similar moves in December.

"This is a way to simplify the company's capital structure," said Fidelity spokeswoman Anne Crowley , discussing the swaps. She would not confirm shareholder reductions or discuss other key details.

Crowley declined to discuss the tax implications for the company, which earned $1.2 billion in profit last year on $12.8 billion in revenue. State and federal tax officials also would not discuss Fidelity's taxes, citing policies intended to protect taxpayer privacy. Fidelity, with more than 40,000 employees worldwide and about 13,000 in Massachusetts, is one of the state's largest firms.

Former employees who spoke on condition of anonymity, because they weren't authorized to speak publicly, said the company is working on a plan to eliminate all but one class of stock and cut the number of private shareholders to fewer than 100, which would qualify Fidelity for federal "S corporation" tax status.

Under Subchapter S of Internal Revenue Service rules, companies and their shareholders avoid double taxation by eliminating both corporate taxes and taxes on dividends.

Instead, profits pass directly to shareholders and are taxed once, as personal income. It is a well-trod path for corporations of many sizes, according to specialists.

But the majority of S corporations are small companies with less than $50 million in annual revenue, according to the IRS. In 2004, just 177 finance and insurance companies with revenue of $50 million a year or more filed under Subchapter S.

Many other kinds of corporations, including some professional sports teams, are organized as S corporations, said Robert Willens , a corporate tax specialist and managing director at Lehman Brothers.

Another recent example of a conversion is Tribune Co., which owns the Los Angeles Times , the Chicago Tribune , and the Chicago Cubs . Willens said Fidelity, with a small number of shareholders to begin with, makes an obvious candidate for S corporation status.

"The vast majority if not all of Fidelity's ongoing taxable income will no longer be taxed at the corporate level, which is quite an advantage," he said.

As a private company, Fidelity is under no obligation to disclose the potential savings. The potential for a large benefit to the corporation, however, can be verified in past statements. In 2001, a year when Fidelity had profits close to 2006 levels, the company said it set aside $623 million to pay its federal and state corporate taxes, according to confidential debt offering documents.

One analyst estimated that its corporate tax expense remains well into the hundreds of millions of dollars based on 2006 data.

Massachusetts laws allow companies that qualify for federal Subchapter S status to enjoy reduced state corporate taxes of 4.5 percent, discounted from the usual 9.5 percent rate.

How much progress Fidelity has made toward pruning its corporate ownership to fit under S corporation rules is unclear. Fidelity spokeswoman Crowley would not say how many people hold shares of the company following Friday's shareholder vote.

The tax changes would place family members and other shareholders in a better position to stave off a huge federal tax bill if they ever sold the company. But they would have to wait 10 years from the date of conversion to realize sale-related tax benefits, said Bentley College law professor Joseph Newpol , a specialist in tax rules who has advised S corporations.

Distributing profits directly to shareholders could reduce the possibility of conflict among Johnson family members over how to invest the company's profits in the future, Newpol said.

"You can probably eliminate some of the internecine disagreements that are bound to come up," he said.

The streamlining follows other steps in the last two years that have placed family members in key positions within the company.

In April, Johnson himself took back control of the core mutual funds business. His daughter Abigail Johnson , 45, often viewed by many as the heir apparent, has rotated through a series of high-level jobs and in May 2005 was placed in charge of a rapidly growing division that manages corporate retirement plans.

And last year, Edward C. Johnson IV , 42, an executive in Fidelity's real estate division, joined his father and sister on Fidelity's board of directors.

Johnson has made these changes as Fidelity's core mutual fund business has suffered through several years of mediocre performance. It lost its dominant position to Vanguard Group Inc. of Pennsylvania, Capital Group Cos.' American Funds of Los Angeles, and other firms that have posted better returns.

By reducing and strictly limiting the number of shareholders, Fidelity is removing a key performance incentive for its high-ranking executives and mutual fund managers, said Geoff Bobroff , president of Bobroff Consulting Inc., an investment management consulting company in East Greenwich, R.I. Fidelity must devise new ways of providing incentives, he said.

"That will be their biggest challenge," said Bobroff. "A stake in the business is an important element." But the substantial tax savings, he added, could provide a big boost: "You can pay a lot of bonuses out of that."

Christopher Rowland can be reached at crowland@globe.com; Ross Kerber at kerber@globe.com. Beth Healy of the Globe staff also contributed to this report.

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