BOSTON -- More punches are being thrown in a hotly contested fight over money managers' noncompete agreements.
Frank Russell Co. and Utah Retirement Systems are suing Wellington Management Co. to release former partner Arnold Schneider from an agreement that prohibits him from working with former Wellington clients Russell and Utah.
And if Wellington won't budge, Russell and Utah want their former manager to pay "transition" costs, the cost to move their money to another firm.
Russell estimates it will cost $20 million to move its approximately $1 billion account; Utah estimates its price tag at $9 million for a $500 million portfolio.
Each has asked for $1 billion in punitive damages.
Mr. Schneider has been ordered by a Massachusetts judge to give up by April 17 the accounts of three former Wellington clients that he took with him to his new firm.
Russell and Utah -- along with RJR-Nabisco Inc.'s pension fund -- moved a total of $1.4 billion to Schneider.
Executives at Russell and Utah are trying to halt that decision. (RJR has not filed suit, and executives there won't respond to telephone calls seeking comment.)
Following Mr. Schneider's departure and the defection of the three clients, Wellington sued Mr. Schneider in Massachusetts Superior Court.
Middlesex Superior Court Judge James McHugh ruled in February that Mr. Schneider had violated his noncompete arrangement and had to give up the three clients.
Mr. Schneider's attempts to buy himself out of the agreement have been unsuccessful.
Now, Russell and Utah are fighting back. Representatives at the two funds claim, among other things, that Wellington has violated the Employee Retirement Income Security Act.
A third party -- Wellington in this case -- should not be allowed to interfere with a fiduciary's hiring of an investment manager, said Randy Lert, Russell's chief investment officer.
Russell argues that Wellington punished Russell for terminating its contract and moving to Schneider by blocking Russell's hiring of Mr. Schneider.
Such a punishment is an ERISA violation, said Douglas Spaulding, an attorney with the Washington firm Reed Smith Shaw & McClay LLP, which is handling the Russell case.
"The court recognizes there is a continuing fiduciary obligation" to protect the interests of the beneficiaries even after a contract is canceled, Mr. Spaulding said.
Ultimately, Wellington put its own business interests ahead of the beneficiaries Russell represents, who were harmed by the unresolved conflict between Wellington and Mr. Schneider, according to Russell.
Wellington denies the complaints. "These arguments are not only thin, but transparent," said Cynthia Clarke, a partner in Boston-based Sullivan & Worcester LLP, the law firm handling the Wellington case.
"They are stretching the notion of a fiduciary pretty far," Ms. Clarke said.
Russell also contends Wellington violated the Investment Advisers Act of 1940 by failing to disclose the noncompete clause and Wellington's intention of upholding it.
"It is unreasonable that our investors might well have to bear the costs of resolving this dispute," said Mr. Lert. "Our obligation is to our investors who, like us, are innocent bystanders to what is basically a complex employment disagreement.
"Frank Russell is not a litigation-happy firm, but we are fighting over principle here," Mr. Lert said. "We had lots of sessions with Wellington on this topic and we wouldn't resort to this if we didn't feel we had to. We've never run into a noncompete this restrictive. I think it's nonstandard in the industry."
WHY THEY SUED
Wellington's leaders say if a former client finds itself in a bad position, the blame rests on the shoulders of Arnold Schneider. Wellington executives ask: Shouldn't he have told his clients he was unavailable?
Russell and Utah Retirement both filed complaints in federal courts asking for injunctions to stall the April 17 deadline. They are expected to go to court this week to argue for a more permanent order to relieve them of the Massachusetts decision.
Mr. Schneider is appealing the Massachusetts case.
The use of noncompetes is not uncommon, but Wellington's enforcement is, Mr. Lert said.
"Most firms choose not to interfere because they view it as an inappropriate step to take. It's better business policy not to pursue it," he said.
Some industry observers wonder whether Russell and Utah Retirement are trying to protect themselves from the wrath of investment boards that will have to approve paying the transition costs.
Said one attorney: "It's no small thing to go to bed with someone who is stealing clients and has a noncompete. How can these people claim to be fiduciaries and not know these things? They may be trying to divert attention from their own lack of judgment from not intervening in the case or keeping on top of this."
Executives with Russell and Utah deny they made their decisions lightly or did not stay abreast of the matter.
'WE'RE RIGHT,' UTAH SAYS
"We've spent a lot of time trying to get to the bottom of this," said Kevin A. Howard, attorney for Utah Retirement. "We had hoped we could work out an arrangement, behind the scenes, working with Wellington, but their position is absolute. We had Mr. Schneider before the board two weeks ago and we are convinced that we and Mr. Schneider are right."
The former clients claim Wellington was obligated, as a fiduciary, to have warned them that Mr. Schneider had a strict noncompete and that Wellington would enforce the clause.
Both clients say Mr. Schneider told them of the agreement when he announced he was leaving Wellington. But, they said, Mr. Schneider also said he didn't think it would be a problem.
Russell took the gamble. Utah officials asked Wellington what to do and Wellington executives told them they were free to hire the manager of their choice, according to Utah's complaint.
"At the same time, Wellington partners were making these representations to the Utah Retirement System, they were formulating a strategy to prevent Utah from exercising that choice," according to a Utah statement.
"We don't get involved in the internal business relationships of our advisers," Mr. Howard said.
"Traditionally, that has been none of our business. Our fiduciary responsibility goes to their investment expertise. We don't look at how they are structured employee by employee in terms of their compensation agreements."
OTHER IMPLICATIONS
The Wellington-Schneider dispute could "change the way some people do business or how the covenants are written," said David Silvera, a senior consultant with Investment Counseling Inc., an industry research firm in West Conshohocken, Pa.
"If anything, this may cause plan sponsors to begin asking these kinds of questions" about internal business matters of the money manager, said Richard Ennis, a consultant and principal at Ennis, Knupp & Associates Inc., Chicago.
Russell's Mr. Lert said Russell already has made a reactive change.
"Having experienced this, in all our investment management agreements, we (now) require disclosure of any such covenant and demand to examine it" to determine the risk, he said.
Tacoma, Wash.-based Russell is suing on behalf of two trusts: the Frank Russell Trust Co. Commingled Employee Benefit Funds Trust, with about $20 billion of U.S. institutional tax-exempt assets; and the Frank Russell Investment Management Co. mutual fund trust, which has nearly $14 billion in assets.
The Salt Lake City-based Utah Retirement Systems pension plan has about $11 billion in assets, of which about $10 billion is defined benefit.
