(FORTUNE Magazine) – WHEN PRESIDENT SEAN HARRIGAN was ousted from the board of the $177 billion Calpers pension fund in December, some consumer, labor, and environmental groups theorized that he was being swept out in a backlash against corporate governance activism. Harrigan himself told the Los Angeles Times that a cabal of past corporate foes and their ascendant Republican Party allies were out to get him.

On the other hand, a great many within the institutional investor community suspect Harrigan's booting was an overdue, internally driven cleaning of house. They argue Calpers was tarnishing its prestige by stooping to unseemly political grandstanding while neglecting core priorities.

Maeley Tom, the Democrat who cast the vote that cost Harrigan his job, insists that neither view is right and that in this case, the cigar was just a cigar. Tom, like Harrigan, sits on the state personnel board, which sends one member to the Calpers board each year. Tom says she just wanted to give another SPB colleague--in this case a Republican--a chance to serve.

Wherever the truth lies, the controversy reveals a painful coming of age in the funds community--one whose repercussions are being felt far beyond the bounds of that once-rarefied world. As politicians and others have come to appreciate the power lurking in these funds--due to their enormous aggregations of shareholder voting power--they are now vying with one another to seize that power and turn it to unaccustomed ends. Though Calpers has been regarded historically as one of the nation's foremost guardians of good corporate governance, Harrigan epitomized a strain of fund activism that has veered toward political causes only tangentially related to the maximization of shareholder value.

In the 1980s fund staffers began to realize the power they commanded. They applied it toward corporate governance objectives that served fund beneficiaries. Gradually, however, politicians and labor officials saw an opportunity to wield that power for other purposes. One could see the change, recalls Sarah Teslik, the former head of the Council of Institutional Investors, just in the way funds were covered in the press. A couple of years ago, stories about Calpers would quote staff members. Today they typically quote board members--say, state treasurer and aspiring gubernatorial candidate Philip Angelides or labor leader Harrigan. The post of pension fund trustee had become a political launch pad.

Harrigan's eventful year as president of Calpers exemplifies the transition. On the one hand, Calpers led victories that were widely admired and applauded, helping topple NYSE chairman Richard Grasso and holding Disney CEO Michael Eisner's feet to the fire. Yet at the same time Harrigan--a senior official with the United Food & Commercial Workers union--also allowed Calpers to wade into a UFCW dispute with Safeway, where Harrigan once worked. Calpers vainly tried to dump Safeway CEO Steven Burd in May.

In addition, Calpers espoused such dogmatic rules that it futilely opposed Warren Buffett's reelection to the Coca-Cola board--a move so ill-considered that some claim it backfired, imperiling adoption of an SEC proposal to grant shareholders greater access to proxies. More troubling still, the Calpers board has never endorsed forcing companies to expense stock options, a measure favored by its staff (and, indeed, by Harrigan), raising the question of whether certain board members could be caving in to Silicon Valley lobbyists.

Critics also accuse Harrigan of a bullying manner that allegedly reached its nadir this past July at a meeting of the International Corporate Governance Network in Rio de Janeiro. The group's nominating committee had recommended that a Pfizer vice president be elected to its board. Harrigan opposed her on perfectly defensible grounds--had it ended there. But four people at the meeting say that Harrigan and other Calpers representatives were understood to have threatened financial retribution against firms who voted for the nominee. She was elected anyway. "I wasn't a party to, or witness to, any threat whatsoever," asserts Harrigan, who calls the story a "rumor." Later that same month, at a Calpers off-site in Lake Tahoe, Richard Koppes, the former Calpers general counsel, forcefully urged the board to clean up its act on an array of issues lest it alienate allies and undermine its credibility.

In the wake of Harrigan's departure, the Calpers board remains overwhelmingly Democratic and pro-labor, and no one expects its commitment to corporate governance activism to slacken. The question is whether, in the face of the trustees' agendas, ambitions, and potential conflicts of interest, Calpers can ever reclaim the moral high ground it once held. Frankly, it's hard to see how it can.

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