NASHVILLE - UBS PaineWebber Inc. will pay $10 million in a settlement about directed brokerage payments in connection with investments of the Nashville & Davidson Metropolitan Benefit Board while PaineWebber was the investment consultant for the now $1.3 billion fund.
PaineWebber was paid through soft dollars or directed brokerage for its consulting from mid-1991 to mid-2000. The settlement includes in its terms W. Keith Phillips, a PaineWebber consultant, who managed the fund's account for the firm.
UBS PaineWebber also agreed to pay $300,000 in legal and related fees to the metropolitan government's law department, which handled the case for the board under the direction of Karl F. Dean, metro director of law.
The Nashville City Council is expected to vote on the settlement Tuesday, said Mr. Dean.
Eric D. Bernstein, assistant general counsel, UBS PaineWebber, Weehawken, N.J., declined to comment, referring calls to Paul R. Marrone, director-media relations, who said officials wouldn't comment.
Mr. Phillips joined Morgan Stanley Dean Witter Inc. in its Brentwood, Tenn., office in March 2000, the same month he left PaineWebber. He declined to comment.
The settlement stems from an audit of the pension fund in 2000 by KPMG Investment Consulting Group, New York, that found inherent conflicts of interests in the consulting arrangement by PaineWebber.
"We believe PaineWebber was overcompensated by the fund," Mr. Dean said. "In the $10 million, we're getting back a large percentage of the commissions we paid PaineWebber." He estimated the fund had paid $10 million to $13 million in commissions to PaineWebber.
David Manning, metro director-finance, said the audit and settlement "demonstrate the inherent conflicts of interests in soft dollars. Pension fund trustees should pay for advice in hard dollars to ensure independence of advice."
"It's a wake-up call" for pension funds and their dealings with consultants, said Jennifer Ann Cooper, principal, Cooper Consultants, Berkeley, Calif., whose firm evaluates consultants. It wasn't involved in the case. "It's a large settlement," she said. "I haven't heard of one that size."
Edward A.H. Siedle, president of Benchmark Financial Services Inc., Lighthouse Point, Fla., who was hired by the metro law department following the audit to make a detailed examination of the trading, likened the situation to the Enron Corp. debacle.
"Like Enron, consulting is a business that has operated in reality very differently from the perception," he said. "The perception is consultants are making money from charging fees for consulting work. But in reality, they are making money from brokerage."
Ms. Cooper added: "We find that brokerage firms that have consulting operations are the least independent of consultants and the ones most likely to have conflicts of interests. It's a challenge for the brokerage firms, whose charge is to sell securities for a profit, to provide objective consulting advice."
Mr. Dean said the settlement was negotiated to avoid the expense and uncertainty of litigation.
Both UBS PaineWebber and Mr. Phillips denied any liability in the settlement, according to the agreement.
Mr. Manning initiated the KPMG audit shortly after being named to the board and questioning its investment activity. He said his concern was especially triggered in December 1999 when PaineWebber recommended the board rebalance the fund and move assets from one equity style to another.
"PaineWebber did not disclose ... that implementing the recommendation would have slightly reduced the fund's returns and slightly increased the fund's risks," the KPMG audit stated. Elsewhere, the audit stated, PaineWebber did not point out the transaction costs involved in rebalancing the portfolio.
"As a result of that rebalancing recommendation, $113 million of investments were transferred, and PaineWebber earned an estimated $300,000 in commissions," the audit stated.
In general, the audit found the metropolitan board "established an investment consulting arrangement with inherent conflicts of interests, then has relied exclusively on the consultant for advice to manage metro's pension investments."
"Metro's investment consultant is not independent and has provided the board with misleading information, resulting in board decisions that generated higher commissions," the audit stated.
"The root cause of this problem" stems from the way the board compensated PaineWebber, the audit stated. "Instead of directly paying PaineWebber a fixed fee to provide the board with independent investment advice, PaineWebber is compensated indirectly through a `soft dollar' arrangement where they earn brokerage commissions from metro's investment managers directing trades through PaineWebber."
In another instance, the audit said the pension fund "would have earned $60 million more than it actually earned through December 1999" if the board "in 1996 invested (a questioned) portion of the portfolio in index funds."
Since the audit, the entire board has been replaced except for Mr. Manning. PaineWebber was replaced by Segal Advisors Inc., New York, which is paid a direct fee by the board and has no involvement in trading. The fund no longer pays in soft dollars.
The fund has now indexed most of its equity investments.