HARRISBURG, Pa. -- Pennsylvania State Treasurer Barbara Hafer and State Street Bank executives are in a brutal, public fight over custody of $64 billion in state pension assets.
In a rare move, State Street Bank & Trust Co., Boston, has taken the matter to court. Ms. Hafer, meanwhile, has accused bank officials of being underhanded in signing, just before she became treasurer, a virtually non-revocable contract in which custody fees rose five-fold.
Relations typically are cordial, at least publicly, between big custody banks and pension funds because they work so closely together, but those relations have become openly combative in Harrisburg.
State Street Bank President David Spina is trying to walk a tightrope between keeping the contract for the bank and minimizing public relations damage with other clients.
And six other big custody banks have entered the fray, trying to win the lucrative contract. State Street is one of seven bidders for its own contract.
Trouble began in January when Ms. Hafer insisted she had the right, under Pennsylvania law, to invalidate a $1.5 million-a-year contract with State Street for securities lending and custody of the state's three largest pension funds -- the Pennsylvania Public School Employees', Pennsylvania State Employes' and Pennsylvania Municipal retirement systems.
The original contract with State Street and then Treasurer Catherine Baker Knoll was for two years ended Dec. 31, 1996, with the cost of custody at $250,000 a year.
The current contract extension was signed in the fall of 1996, effective Jan. 1, 1997, by Ms. Knoll, shortly before Ms. Hafer assumed office. The extension carried two nonrevocable and automatic extensions through 2002, if contract terms were met, specifically concerning revenue earned on securities lending, according to court records. State Street's custody fee in the first year of the extension rose to $1.5 million a year from $250,000.
No information was available from State Street officials on the specific terms of the contract.
Ms. Hafer said the State Street extension was signed before she was in office and lasts beyond her first, and potentially last, term in office even though she is the custodian of the $64 billion in assets.
While State Street was to be paid $1.5 million in custody fees in 1997, it would receive, under the contract terms, another $5 million for securities lending, according to Robert R. Gentzel, a spokesman for Ms. Hafer.
According to consultants, the way some custody contracts are written, the significant money a custodian makes doesn't come from fees for custody, but fees for securities lending.
The custody/securities lending contracts aren't easily decipherable because revenues made on lending partly have to do with agreed-to risks taken in lending, extent of lending on a portfolio, and the securities' owner's faith in the abilities of the lender as a safe lender.
MS. HAFER'S WARNING
Ms. Hafer warned State Street executives last year and early this year that she was going to ask for new bids on the custody and securities lending contract. She asked for the bids Jan. 9; State Street executives three days later asked the Commonwealth Court of Pennsylvania in Harrisburg to declare the existing contract valid.
State Street's petitioning of the court infuriated Ms. Hafer.
She publicly blasted State Street, contacting the news media and charging that Ms. Baker Knoll signed a "sham" contract with the bank. She said State Street officials agreed to modest compensation in the first two years of the contract, with the knowledge they would be "taken care of" in a subsequent "secret" contract.
In the first two years of the contract, State Street, said Ms. Hafer, accepted $250,000 in annual compensation each year, but now gets $1.5 million a year.
In her answer to the State Street petition, Ms. Hafer also charged Ms. Knoll promised to "steer other lucrative commonwealth business" to State Street, although that other business didn't happen.
"I will not allow my hands to be tied, and I will not be a part to a secret deal that rewards this Boston bank with a five-fold increase (in fees) at the expense of Pennsylvania taxpayers and pensioners," stated Ms. Hafer.
SILENCE BROKEN
Charges that one of the largest custody banks is doing secret deals, signing sham contracts and bilking taxpayers were enough for State Street's Mr. Spina to break his normal public silence about a dispute with a major client.
The risks tied to the fight are severe for State Street because a large part of the bank's business is trust and custody, and because charges of being underhanded are difficult to defend against.
Mr. Spina claims, in an interview, the contract signed with Ms. Knoll wasn't secret or a sham. "We believe that what we conducted was an arms-length negotiation with the Commonwealth of Pennsylvania and took the additional step of having the contract and extension approved by the attorney general of the Commonwealth of Pennsylvania," said Mr. Spina.
As to charges that the original $250,000-a-year contract was signed with the understanding that State Street later would get a big increase in compensation, Mr. Spina said, "Well again, we say it was an arms-length negotiation. I think beyond (saying) that, we really can't comment on the economics of individual customer deals."
Asked to explain the difference in pricing, he said, "Again, I wouldn't want to comment on customer pricing."
But Mr. Spina did add that in any large contract, such as with Pennsylvania, State Street is providing multiple services and "any one element of the pricing or the revenue may not be indicative of the total service relationship compensation."
FEES DON'T TELL STORY
While the contract fee numbers are accurate, Mr. Spina said, "they don't represent the entire picture, but I am afraid I can't comment on the entire picture."
He said State Street Bank doesn't try to sell itself as the "cheap" servicer, but the "high-quality servicer. I certainly think there is value in the pricing that we are offering."
During the past year, Mr. Spina said State Street has tried to resolve the issues quietly with Ms. Hafer. "I did go to Harrisburg to meet with the treasurer in 1997 in an effort to find any areas where we could agree to resolve the situation, and as a followup to that, I asked our general counsel to get involved as well. So we have made a number of efforts to try and resolve this situation," he said.
He said a custodian filing a suit in court against its client is uncommon, but added in his 26 years at State Street, the bank has had disputes with customers before.
Mr. Spina said he couldn't predict whether this fight will damage State Street's relations with the state. "I guess I hope, with a capital H, that we are still looking for a way to resolve some of the concerns the treasurer has. We still feel that we have a valid contract."
He said State Street's new bid for the contract "is a show of good faith and we are trying to make every effort we can to cooperate with the Commonwealth . . ."
EXPENSIVE RELATIONSHIP
The existing relationship with Pennsylvania has cost State Street a substantial amount of money, although Mr. Spina wouldn't give an exact figure. He said State Street opened an office in Harrisburg a couple of years ago and "spent a lot of time and money."
"We never like to lose any client, and certainly not one like the Commonwealth of Pennsylvania," Mr. Spina said. However, he said State Street has $3.9 trillion in custody assets, and no one customer represents more than 1% to 1.5% of custody assets. "But obviously, from a business point of view" the bank doesn't want to lose the contract.
According to Ms. Hafer, she has a right to end the custody and securities lending contract with State Street. Under Pennsylvania law, the state treasurer can be held personally liable for losses. But if the State Street contract stands, she would have no say, she said, over a core area of responsibility during her four-year term as treasurer.
The next step in the case is for State Street to reply to Ms. Hafer's response to State Street's court petition. However, State Street lawyers have decided not to respond because they think her answers are beyond the scope of the original petition, said State Street spokesman Greg Ahern.
They have asked the court to produce a summary judgment saying that the contract is valid. The judgment can come any time, but may take 30 to 60 days, Mr. Ahern said.
