San Diego and Callan trade barbs in lawsuit

Callan Associates Inc., San Francisco, "lied" to clients about its relationship with former brokerage affiliate Alpha Management Inc. so the firm could earn $54 million in fees for providing financial services to Alpha's new owner, BNY Brokerage Inc., according to court documents filed Sept. 21 by the City of San Diego.

The documents charge that Alpha was never owned by Callan but, instead, was owned by Ronald Peyton, Callan's president and chief executive officer, through a family limited partnership. The suit alleges Mr. Peyton's ownership was never disclosed to clients, including the $4.45 billion San Diego City Employees' Retirement System.

However, Callan disclosed in a 1997 addendum to its Form ADV that "the sole shareholder of Alpha Management Inc. is the second largest shareholder of (Callan)" — who was Mr. Peyton.

Paul Renne, an attorney at Cooley Godward LLP, San Francisco, which is representing Callan in the lawsuit, said Alpha had been transferred to Mr. Peyton's family limited partnership to "comply with the regulations for a brokerage firm being connected with Callan."

Mr. Peyton, he said, was the only registered representative among Callan's consulting staff.

But San Diego officials claim Callan failed to adequately disclose the unit's ownership so Callan could pocket $54 million in fees for providing financial information about its clients to BNY, a subsidiary of The Bank of New York, the documents charge. Callan represented that the payments were proceeds from the sale of Alpha.

"The reason Callan lied regarding its relationship with the brokerage firm was so that Callan could deny a conflict of interest existed as a result of it simultaneously rendering services to (and earnings fees from) two conflicting constituencies": a brokerage firm and pension clients, the suit said. "Callan realized it couldn't pull the trick off without denying and recharacterizing its service relationship with the brokerage firm," according to the lawsuit.

Mr. Renne said disclosure of Alpha's ownership was irrelevant.

He said BNY Brokerage bought Alpha's book of business and in return paid Callan an annual service fee, dependent on Callan's revenues.

All Mr. Peyton received as part of the transaction was his "return on capital," which amounted to approximately $500,000 and represented the "hard assets" of Alpha, Mr. Renne said.

Doug McCalla, chief investment officer at the San Diego fund, said in an interview with Pensions & Investments that he was aware Alpha Management was formerly a "division or affiliate" of Callan. But he said he did not know specifics about the "actual legal ownership" of Alpha.

For the year ended June 30, 2003, the most recent data available, BNY "got $105,000 in income from various trades from our various money managers whose charge is to seek best execution," Mr. McCalla said. The fund's managers paid a total of $7.25 million to all brokerage firms with which it did business during the same period.

The new allegations flesh out a lawsuit originally filed by City of San Diego Attorney Michael Aguirre in August 2005, claiming that Callan was negligent in advising the city's retirement system, which was 68.2% funded as of June 30, 2005.

The city's Sept. 22 court documents, filed in response to a July 19 request from Callan to dismiss the suit, provide fresh details about the litigation. California Superior Court Judge Kevin Enright will consider the case at an Oct. 6 hearing in San Diego. A trial is scheduled to begin Jan. 26.

Callan — with 270 plan sponsor clients that have nearly $1 trillion in combined assets — faces similar conflict-of-interest charges in a lawsuit filed Aug. 25 by a participant of the $36.8 billion Illinois Teachers' Retirement System, Springfield. Officials of the Illinois fund terminated Callan as general consultant earlier this year in favor of R.V. Kuhns & Associates Inc., Portland, Ore., and Callan's term as the fund's real estate consultant just expired Sept. 30 (P&I, Sept. 4).

"There is absolutely no merit in either of those suits, and we'll vigorously defend ourselves," said Mr. Peyton. He declined to comment on specifics of either case.

Other new details of San Diego's suit against Callan include a statement from Donald Trone, president and founder of fiduciary consultant Fiduciary360, Pittsburgh, and a former Callan senior vice president who was terminated in 1998. Mr. Trone said Callan charges money managers "10 to 15 times the market value" for educational conferences like the Callan Institute. Those payments amount to "extortion" when compared to similar events hosted by other consultants. Mr. Trone said.

The fees Callan collects from managers for attending educational seminars, including the Callan Institute, totaled as much as $12 million in 2005, or one-third of the firm's revenue, according to court documents.

Investment management firms pay an annual "premium rate" of $54,000 for two executives to attend semi-annual conferences and four regional workshops. As part of that rate, the entire money management firm receives access to additional services such as Callan research, databases and surveys.

Money management marketing executives, who requested anonymity, offered differing views on the annual retainer payments Callan charges for attending the Callan Institute.

Some said the Callan Institute is worth the money because it gives them face-to-face time with Callan consultants and clients.

Other executives said their business dealings with Callan haven't suffered even though they have not attended any fee-based Callan seminars.

The privately held firm derives 60% of its revenue from plan sponsors; 30%, investment managers; and 10%, independent advisers, the fastest-growing business unit, according to Callan's website.