American pension funds will not get a penny of the $399m accused restitution fund paid by 10 of the biggest Wall Street firms found ‘guilty’ of conflicts of interest. In fact the settlement between them and the US government, following New York State Attorney General Eliot Spitzer’s investigation, should benefit only individual investors in terms of restitution of ‘unfair’ profits. But that does not prevent pension funds from suing investment banks for misleading stock recommendations.
The nearly $100bn (E86bn) New York State Common Retirement Fund, for example, is leading the class action lawsuit against Salomon Smith Barney (Citigroup), which allegedly misled investors promoting WorldCom securities while WorldCom was engaging in accounting violations. Former SSB telecommunications analyst Jack Grubman stayed bullish very long on WorldCom (and the other stocks he covered) because – so goes the accusation – he was more concerned about his firm’s underwriting the telecom shares. The New York State pension fund estimates it lost more than $300m as a result of the alleged wrongdoing and its sole trustee Alan Hevesi has been appointed lead plaintiff in the litigation.
Hevesi’s fund and two other mayor public schemes – the $130bn CalPERs (California public employees’ retirement system) and the $45bn North Carolina state retirement system - have been big supporters of Spitzer’s since last July, when they adopted the Investment Protection Principles (IPP), which were shaped by the first settlement with Merrill Lynch. “The principles’ first part applies to broker/dealers and requires firms to separate their investment banking activity from research in order to work for us,” explains Julie Ann White, director of communications at the Office of the North Carolina State Treasurer. “We have suspended the application of these provisions and are waiting to see if the SEC adopts rules that will apply the settlement term to all firms before we decide our next course of action.”
The IPP’s first part reads: “Every financial organisation that provides investment banking services and is retained or utilised by the pension fund should adopt the following principles: sever the link between compensation for analysts and investment banking; prohibit investment banking input into analyst compensation; create a review committee to approve all research recommendations; require that upon discontinuation of research coverage of a company, firms will disclose the coverage termination and the rationale for such termination; disclose in research reports whether a firm has received or is entitled to receive any compensation from a covered company over the past 12 months; and establish a monitoring process to ensure compliance with the principles”.
The second part of the principles applies to equity money managers: it requires them to certify that their portfolio managers are not being compensated from cross-selling products or services to portfolio companies; to weigh the degree of accounting transparency and good corporate governance in conducting their research, and requires financial conglomerates to demonstrate the proper separation between their money management units and other subsidiaries. “All our money managers have agreed to abide by the principles and have made the necessary certifications,” says White. “We have conducted in-depth face-to-face reviews with most of our managers (several reviews are still pending) to discuss their implementation of the principles. All our firms have undertaken real efforts. For example, many are engaged in evaluating databases and new reporting services that rate corporate governance. A couple of firms have engaged forensic accountants to help dissect complicated financial data. One firm has hired private investigators to do background work on corporate officers. Most firms have decided not to invest or divest of one or more investments with questionable accounting or corporate practices. A number of firms have taken much more active stances with management about accounting or corporate practices. Several firms are conducting research or helping us survey the academic literature.” White stresses that for many of the firms these types of activities pre-date the principles and are one reason they were hired in the first place. She concludes: “No new manager will be hired unless they agree to the principles up-front and we review their processes as part of our due diligence.”
Also, Calpers has formally surveyed its 44 external money managers regarding implementation of the principles. A few managers told Calpers they were concerned that some disclosures could violate client confidentiality requirements. The problem was especially with the following principle: “Money management firms must disclose any client relationship, including management of corporate 401(k) plans, where the money manager could invest the fund’s assets in the securities of the client.” In response, Calpers staff recommended an alternative that requires disclosure when any position in the portfolio where the manager has a client relationship is greater than 1.5 times the benchmark weighting or – if the security is not held in the benchmark – the position is greater than 2% of the portfolio.

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