HARTFORD, Conn. - One year after Morgan Stanley Asset Management helped Connecticut state Treasurer Christopher Burnham analyze the state's $12 billion pension fund without charge, the firm earned almost $20 million from a principal trade as the fund was restructured.
The New York investment bank's asset management unit also was selected to manage money in a $700 million international equity portfolio.
At least one other money manager, San Francisco-based RCM Capital Management, provided free assistance to Mr. Burnham and Connecticut without being an existing manager for the state fund. It too received a money management assignment.
Other companies that provided free assistance to Mr. Burnham during the early days of his tenure include State Street Global Advisors, Boston, and New York-based J.P. Morgan Investments - both existing fund managers.
Reports support restructuring
The reports from the four managers were used by Mr. Burnham in the early days following his election to justify the restructuring of the pension fund, which he referred to as the worst performing public pension fund in the United States.
State Street Global Advisors analyzed the collateralized mortgage obligations within the fixed-income portfolio, and J.P. Morgan conducted an investment policy analysis. State Street managed international fixed-income assets for the fund and J.P. Morgan was a real estate manager - and representatives of each said it was common to assist a client above and beyond the existing relationship.
Both banks, nevertheless, profited handsomely from the restructuring - State Street picked up an additional $2.5 billion, and J.P. Morgan added $1.9 billion.
But Morgan Stanley apparently was the biggest winner in the fund's reorganization.
Morgan Stanley began its relationship with Connecticut in February 1995, when it analyzed the state's internal fixed-income portfolio. The firm was not a manager for the fund at the time and did not charge for its work.
No competitive bidding
When Mr. Burnham made good on a campaign promise and restructured the pension fund, chopping 36 money managers from its roster, Morgan Stanley's trading desk was selected without competitive bidding to buy and sell securities for the new managers. The New York investment bank's asset management unit also was selected to manage money in an international equity portfolio.
Many of the domestic equities were bought and sold from Morgan Stanley's own account - a principal trade - at 16 cents a share. Commissions paid to Morgan Stanley totaled almost $20 million. The firm's asset management unit received asset management business totaling $700 million.
RCM won a $150 million equity account.
Mr. Burnham flatly denied that Morgan Stanley and the other firms were compensated with asset management and/or brokerage business for the free analysis they provided him during the early days of his administration.
Mr. Burnham cites 'merit'
"They were chosen purely on the merits," said Mr. Burnham about the managers selected. "Not for pro bono work.
"We felt they were the best and the brightest."
The usually compliant Mr. Burnham declined to provide the due diligence analysis of Morgan Stanley Asset Management performed by RogersCasey & Associates Inc., the pension fund's Darien, Conn., consultant. He also did not provide bottom-line figures by other broker/dealers that he claimed to have contacted to transition the securities in the pension fund's portfolio. Wells Fargo Institutional Trust Co., State Street Bank & Trust Co. Bankers Trust Co. and Merrill Lynch submitted generic proposals to Mr. Burnham about their transition capabilities.
Morgan Stanley officials declined to comment, said John Diat, a spokesman for the firm.
The firm's report on Connecticut's fixed-income portfolio was signed by Managing Director Gary Latainer and copies were sent to Gary Crowder, a managing director, and Coleman Lyons, an investment representative.
Patrick O'Neil, a spokesman for Mr. Burnham, said Mr. Burnham does not know Mr. Latainer. Messrs. Crowder and Lyons are acquaintances that Mr. Burnham cultivated during his days as a financial professional before he was elected treasurer in 1994.
Personal relationships key
As with Morgan Stanley, a personal relationship with the treasurer or his inner circle was apparently key to RCM providing its assistance.
Jack Bernard, senior vice president with RCM, said that Steven Hart, the chairman of Connecticut's Investment Advisory Committee and a lifelong friend, asked him to examine the derivatives in the portfolio. The IAC advises Connecticut's treasurer on investments but has no decision-making authority.
Mr. Hart, who was not a member of the IAC at the time Mr. Bernard performed the analysis, said he did not ask Mr. Bernard for his assistance. "I never called him about the derivatives," said Mr. Hart.
Mr. Hart added he didn't consider it wrong for IAC members to recommend that money managers meet and assist the investment staff. "I do it frequently," he said.
Mr. Hart was appointed to the IAC in August 1995 by Republican Gov. John Rowland.
Mr. Hart, who said he has known Mr. Burnham for six years, also contributed $500 to Mr. Burnham's campaign for treasurer, according to campaign finance records.
Mr. Bernard admitted he provided the free analysis with the hope that it would result in getting business.
"If I ran marketing, I would instruct people to do it (provide free assistance to pension funds)," said Mr. Bernard.
But he doubts his work for Connecticut influenced the manager selection process because RCM received an equity assignment instead of fixed income, his specialty.
Proposals make 'no difference'
According to Mr. Burnham, "We receive these proposals all the time, (and) it makes no difference to us how we choose money managers."
"J.P. Morgan offered to do an analysis to see if it was the asset allocation that made us the worst performing pension fund in the nation," said Mr. Burnham. "It determined that it was the poor management selection.
"As far as trading was concerned, we received proposals from Morgan Stanley, Wells Fargo and State Street," said Mr. Burnham. "Clearly, Morgan Stanley was the better firm."
Thomas Cadigan, assistant treasurer with IBM Corp. and a member of Mr. Burnham's "blue-ribbon" panel of institutional investors, recommended Morgan Stanley, said Mr. Burnham.
"They (Morgan Stanley) did transition (work) for IBM (pension fund)," said Mr. Burnham. "We are proud of the job they've done. They transitioned it almost flawlessly. It made us a lot of money."
Connecticut's two trading options to accomplish the transition were to do an agency trade or a principal trade.
In an agency trade, a broker/dealer acts on behalf of the client, executes the trades in the open market and earns a commission. This trade was risky for Connecticut because the large number of transactions would have attracted attention, causing other traders to act to the detriment of the pension fund.
Lower risk, higher cost
In a principal trade, the stock is bought and sold from the account of the broker/dealer. It eliminates a lot of market risk but is more expensive to execute because the broker/dealer assumes all the risk. The 16 cents-per-share commission that Morgan Stanley earned also is known as a risk commission.
The risk to the broker/dealer could be minimized if the trader is familiar with the investor's portfolio.
According to Connecticut treasury records, domestic equity purchases totaled about $4.5 billion, of which $3 billion was crossed from existing portfolios, and the remaining $1.5 billion was done through a principal trade. The commission to Morgan Stanley was $7.6 million.
Sales of domestic equities totaled $2.1 billion and were done via a principal trade with Morgan Stanley, at a cost to Connecticut of $8.9 million.
The balance of Morgan Stanley's $20 million commission came from the restructuring of the international equity and fixed income and domestic fixed-income securities.
Big deal for Morgan Stanley
According to Connecticut Chief Investment Officer Robert Evans, it was "the largest total transaction handled by Morgan Stanley in a restructuring."
Edward Siedle, president with New York-based broker/dealer Anvil Institutional Services and a former attorney with the Securities and Exchange Commission, doesn't dispute the appropriateness of using a principal trade to transition the portfolio, saying that price is but one criteria of best execution.
Concentration of brokerage is also an issue, said Mr. Siedle, noting that former (Connecticut) treasurers spread around the brokerage - paying generally four to five cents per share for agency trades - with an internal trading desk that Mr. Burnham dismantled once he took office.
Mr. Siedle said that at the recent conference of the National Association of State Retirement Administrators, a number of administrators confided they were surprised at the decision to hire a single broker for the entire transaction.
"One can dispute any of these things since there is no legal definition of best execution," said Mr. Siedle.
"Brokerage is an art, not a science," he added.