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Portfolio > Alternative Investments > Hedge Funds

Massachusetts Pension Suit against Mellon Raises N

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NEW YORK (–A lawsuit filed by Middlesex Retirement System, Billerica, Mass., against Mellon Financial Corp., Pittsburgh, centers on the familiar problem of valuing fund assets, in particular options, but it could result in new standards regarding the responsibilities of custodians versus pension trustees.

This is a hot button right now, raising the issue of gross negligence, said Thomas Hickey III of Kirkpatrick & Lockhart LLP, Boston, a lawyer who represents public employee pension funds. Public pension trustees typically do not have investment training, but they might find themselves with personal liability for losses suffered by the retirement system, he suggested, speaking at a hedge fund symposium in New York organized by the Strategic Research Institute.

The combination of boards lacking investment background yet being subject to potential liability complicates hedge fund allocation decisions, and this case might make trustees even more concerned about investing with managers that use non-traditional or unfamiliar instruments.

Trustees have been asking about hedge funds in the past three years because they heard about such investments from their consultants, in Mr. Hickey’s experience. He has prepared reports for clients on what a hedge fund is and what to look for in making investment decisions, emphasizing the issue of gross negligence.

Option Trading Losses

Middlesex hired Cambridge Financial Management, Wellesley, Mass., in 1998 to run a currency hedge portfolio. Pension officers became aware of a loss of US$36 million or more after the fund manager, James Kneafsey, died in late April this year.

Previous reports from Mellon, the custodian, had valued assets at around US$40 million. But a statement after Mr. Kneafsey’s death showed less than US$2 million left in the fund. The losses arose from foreign currency options contracts.

The pension trustees allege that Mellon relied on valuations provided by the manager while as the executing broker-dealer profiting from trades by Cambridge Financial. It was neglectful in its duties as custodian, they claim, and are suing for US$40 million. Boston Safe Deposit and Trust Co., a unit of Mellon, and Russell/Mellon Analytical Services are also defendants in the suit. Middlesex fired Mellon as custodian and replaced it with State Street Bank, Boston.

The case turns on what the appropriate standard of gross negligence is and who has the responsibility. Trustees are considering the possibility that they may have personal liability if Mellon is found to be not liable in this case, Mr. Hickey observed.

Mellon announced that it will vigorously defend itself. Middlesex selected Cambridge Financial, and Mellon’s role was merely to take the values reported by Cambridge and report them to the pension, the bank argues.

For Middlesex trustees, this trouble comes on top of complaints about increased pension assessments and an attempt to replace them with a new board. The retirement system invests US$520 million of public employees’ pensions for 67 towns and local authorities in Middlesex County.

Like many other pension funds, it suffered investment losses in the past three years, necessitating a hike in payments by the members in order to meet future obligations. As a result, some member towns proposed to abolish the board and create a new one. The board has five members of whom one is a town treasurer, two are retired firefighters and one is a retired policeman.

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