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Who pays when a money manager makes a bad call?

A case in Florida, which lost $281-million on Enron stock, is expected to clarify the bounds for managers.

By JONI JAMES
Published March 6, 2005

TALLAHASSEE - Few Floridians have heard of Annie Tsao.

But over the next few weeks in a small, nondescript courtroom across the street from Florida's Capitol, the opinions of the Wall Street analyst could mean hundreds of millions of dollars for the state's public employee pension fund.

More than three years after Florida's pension fund lost $281-million on Enron stock at the hands of a single outside money manager, the state's lawsuit against Alliance Capital Management is set to open Tuesday in Leon County Circuit Court.

But the stakes could go far beyond money.

At its core, the case reflects the longstanding debate over what leads to success on Wall Street: Is it the science of research or the art of the hunch? And how much leeway should a money manager have to move between the two, especially when doing so contrasts with the investment strategy laid out for the client?

Through the tale of analyst Tsao and her Alliance Capital colleague, money manager Al Harrison, the pension plan wants jurors to weigh in on how much money managers are obligated to tell their clients about how and why they pick stocks on their behalf.

And even more fundamentally, the jury is being asked to decide whether a money manager is liable for a bad stock pick, even if he has made his client billions of dollars.

Just seven months ago in Connecticut, a jury ruled one of Wall Street's most prominent private equity firms breached its contract when it invested $125-million of Connecticut's state pension fund in two companies that failed. But the jury decided the pension fund was not owed any damages because the state knew of the investments and took no action to stop them. Both sides claim victory.

"You'd think this kind of question had been answered before but the law is very funny and an enormous amount of the time with litigation that's not the case," said William Allen, a financial law professor at New York University.

"The plaintiff seems to have a plausible claim," Allen said last week by phone. "But on the other hand I think the jury may be unsympathetic. (Florida) lost a lot of money, but they also made a lot. That's the way the market works."

Such grand questions seem only fitting for a case born in political intrigue and high-volume recriminations.

Two years ago, when Florida launched its lawsuit at the behest of Gov. Jeb Bush and two other statewide elected officials, no one mentioned Tsao's name.

Instead, Harrison, then 64 years old, took center stage. From Alliance Capital's Minneapolis office, the money manager had built an impressive 17-year track record for Florida's pension fund, as well as dozens of other institutional investors and the company's Premier Growth mutual fund. For institutional investors, his team managed $75-billion.

Harrison's contrarian investment strategy earned billions. He would snatch up stock in big domestic companies that had strong underlying financials but whose stock prices were falling on negative news. Then he'd wait for the market to turn.

Harrison earned $111-million for Florida's pension fund, for example, by buying airline stocks after the 9/11 attacks. A $215-million gain came in November 2001 from his February 1997 investment in Tyco.

Harrison grew $344.1-million in Florida deposits to $3.57-billion. Alliance Capital touts that as $800-million more than the performance of the S&P 100 during the same 17 years. But that record lost its shine by the end of 2001, when Harrison's 13-month Enron buying spree led to $281-million in losses.

On Nov. 30, when Harrison cashed out his clients' shares of Enron, including the 7.6-million he had bought for Florida, the trading price was 28 cents per share. Florida had paid a high of $82 and a low of $9 per share.

Two days later, with federal regulators having only recently begun investigating accounting problems at Enron, the energy giant declared bankruptcy. Enron's leaders, founder Kenneth Lay, former CEO Jeffrey Skilling and chief accounting officer Richard Causey, are scheduled for trial next year to face fraud and conspiracy charges.

Harrison, who had dismissed state employee concerns about the Enron buys starting in October 2001, said he was just like others on Wall Street: He'd been duped by Enron's cooked books and its top leaders, including Lay, whom he'd met with privately as the company floundered.

The explanation did little to tame talk in Tallahassee.

Counting Harrison's holdings, and shares in other pension fund accounts managed by other firms, Florida had lost nearly $330-million on Enron stock, the most of any public pension fund. Few were comforted that in the country's fourth-largest public pension fund, the loss amounted to just a fraction of $96-billion in holdings: just one-third of 1 percent. Other funds lost similarly: Georgia's pension lost one-fifth of 1 percent on Enron; the University of California Regents had lost one-third of 1 percent.

Democrats and state employee unions, hoping to unseat Bush in the 2002 election, openly speculated, without evidence, that the governor had encouraged the buys, noting $6,500 in Enron-related contributions to the governor's 1998 campaign and the close ties to Lay in the White House. Time would show Harrison bought the same for all his clients, including his company's mutual fund.

Then-Democratic Attorney General Bob Butterworth launched a racketeering investigation after learning that Alliance Capital board member Frank Savage also served on Enron's board. A year later, his office said it had found nothing nefarious.

Never in all the noise did anyone mention Tsao, who made her living analyzing energy companies in Alliance Capital's New York office. She and 20-some other securities analysts are the backbone of Alliance Capital's proprietary research team, which was charged with generating the in-house "Alliance 100" list of top companies for Harrison's large-cap growth team.

From the roughly 500 domestic stocks they tracked, the analysts weekly selected about 100 as top performers. Then they made another cut, picking the "Favored 25."

Marketing documents distributed to clients in March 2000 by Alliance Capital - and submitted as evidence in the trial - suggest that Harrison's large-cap growth team used the "Favored 25" list to pick up to 65 percent of the holdings in a portfolio. Ten percent would come largely from the "Alliance 100" list, the materials say. The final 25 percent were described as coming from "manager discretion from Alliance (top) rated stocks."

That stock-picking process forms the heart of the state's allegation that Alliance Capital defrauded the state pension plan.

Florida didn't know it until after suing, but Tsao had begun expressing her doubts about Enron as early as August 2001, months before Harrison's Enron buying spree. CEO Jeff Skilling had resigned after just six months and Tsao didn't buy Skilling's explanation that he was leaving for "personal reasons." She downgraded the stock, making it ineligible for the Alliance 100 list, much less the Favored 25.

The state argues Harrison should have avoided Enron stock after it fell off the Alliance 100 list. It also argues that he had a fiduciary responsibility to disclose the conflicting opinions inside Alliance about Enron, particularly after pension employees questioned his Enron buys on Oct. 24, 2001.

Instead, in the weeks immediately after the U.S. Securities and Exchange Commission announced an investigation of Enron on Oct. 22, Harrison added 2.7-million Enron shares to bring to 7.6-million the number of shares in Florida's portfolio. He said news that Enron's chief rival Dynergy was planning to buy the company sparked him to move. He believed Enron's financials were sound.

"He did not tell them the truth about Annie Tsao," said Tampa attorney Guys Burns, who is representing the state pension plan in the suit. "A huge part of their pitch and presentation to the state was that they did all this research and had this system that created value.

"And then Harrison just ignored it."

But Alliance lawyers say it's the state's contract with Alliance, not its marketing materials, that are binding. And the most recent contract, dated 1998, did not restrict money managers to top-rated stocks. The company has filed a counter-claim seeking more than $1-million in unpaid fees.

In a pretrial ruling last month, Leon Circuit Court Judge Nikki Ann Clark agreed that investments in non-top-rated stocks didn't constitute a "breach of contract," but left open the question of whether the marketing materials were misleading.

Alliance attorneys also argue that even if the marketing materials are binding, they carry an important disclaimer: "The Favored 25 process is evolutionary."

Just a look at Harrison's buying record - transmitted in daily, weekly and monthly trade reports to state pension plan managers - was enough to see that Harrison didn't stick to only top-rated stocks, Alliance contends.

"This is one page of a document taken out of context that the State Board of Administration never cared about in 17 years," said Barry Richard, a Tallahassee attorney on the Alliance Capital team. "They didn't hire the analyst, they hired Al Harrison. Never in 17 years did they ask what an analyst thought, they wanted to know what Al Harrison thought because Al Harrison made them money."

The state contends Harrison's sins didn't begin with Enron. Court documents show the state wants to collect as much as $1-billion in compensatory damages because of losses on other stocks that weren't part of the Favored 25 or Alliance 100 list when Harrison bought them.

The state is also expected to raise questions of conflict of interest because Frank Savage served on the boards of Alliance and Enron. Savage and Alliance Capital, however, have argued there is no evidence Savage used his Alliance position to affect Enron buys. To have done so, Alliance Capital notes, would have amounted to a violation of the federal insider trading law.

It won't be the only potential conflict of interest in the courtroom.

The state is expected to rely heavily on Tsao's videotaped depositions that she made clear her misgivings about Enron to her employer and Harrison specifically. Tsao still works as an analyst for the company; Harrison retired in December.

Alliance Capital is expected to rely heavily on current and former state pension plan employees who have said they thought Harrison did nothing wrong.

Even news outlets have had an interest in the case. Times Publishing, the company that owns the St. Petersburg Times, sought to intervene in the case in December 2002, opposing Alliance Capital's petition for a confidentiality order that would have restricted public access to business documents presented in the case. The court denied Alliance Capital's request the next month.

And in a city filled with government workers, Clark has been gearing up for this trial for months. She cleared six weeks from her schedule and ordered summons for more than 1,400 potential jurors. To help whittle the list to six jurors and at least four alternates, she included a nine-page questionnaire asking prospective jurors if they were a state employee, if they were a member of the state pension fund or if they had other investments. It also asked if they had any hardship that would prevent them from serving for a full trial.

Florida's public pension plan serves employees of more than 845 state and local government agencies statewide, including school districts. It's membership includes 225,000 retirees and 650,000 active employees.

Noting that no individual employee was hurt by the Enron loss, Clark has ruled no juror can be dismissed simply because they were a member of the state pension plan. Florida state law guarantees pension members benefits, regardless of the pension plan's investment performance. At the time of the loss, the plan's assets included an actuarial surplus.

NYU's Allen is making no guesses how the case will play out. "It's hard to know how a jury is going to respond to things," he said.

Researcher Carolyn Edds contributed to this report. Joni James can be reached at 850 224-7263 or jjames@sptimes.com

The state pension fund is suing Alliance Capital for heavily investing in Enron Corp. as allegations of accounting fraud unfolded. The state contends the investment violated the strategy outlined in Alliance marketing materials. Alliance says it used the same strategy it always had, but was duped by Enron.

The state is seeking more than $1-billion in compensatory damages, and Alliance has a counter-claim for more than $1-million in unpaid fees. But experts say the implications could be significant for money managers because Florida wants to hold Alliance liable for making an ill-timed stock buy.

[Last modified March 6, 2005, 00:13:18]