Lawsuit by Top Manager Is Latest Blow to Pilgrim Baxter

Pilgrim, Baxter & Associates' attempts to hang on to prized portfolio manager Jim McCall may end up hurting the firm more than helping it. Lawsuits filed by both parties in the dispute over McCall's desire to depart Pilgrim for rival Merrill Lynch (MER Quote) offer a behind-the-scenes glimpse at the troubled mutual fund firm, and the view is anything but pretty.

McCall sued Wayne, Pa.-based Pilgrim and parent United Asset Management (UAM Quote) in Massachusetts state court Friday, as reported in the Wall Street Journal. The portfolio manager alleges breach of contract, fraud and "interference with advantageous business relations" by Pilgrim in its efforts to stymie his plans to accept a portfolio manager position with Merrill.

Pilgrim claims McCall's employment by Merrill would violate a non-compete agreement McCall signed. The firm followed McCall's suit with its own complaint, which seeks to prevent McCall from "accepting an offer of employment from a direct competitor in violation of the non-competition provisions of his employment contract with Pilgrim Baxter."

"[McCall] feels very strongly that the contract is unenforceable, and that he has the right to leave and was, in essence, given permission to leave by Pilgrim Baxter in December of 1998," says McCall's lawyer Steven Manchel of Manchel & Associates in Needham, Mass.

Pilgrim Baxter declined to comment on McCall's complaint. But in its complaint, the firm accused McCall of trying to avoid his contractual obligations and attempting to place Pilgrim Baxter chairman and chief executive Harold Baxter in "an unfavorable light in the eyes of the investing public."

The complaints are peppered with talk of manipulation, nepotism and failure to live up to agreements. McCall alleges that despite a standout year in 1997, he received the lowest bonus among his peers while Christine Baxter, a Pilgrim portfolio manager and daughter of Harold Baxter, received the highest bonus. His complaint also alleges that another Baxter daughter, Patricia, was paid about $100,000 to supervise the Pilgrim Baxter's move to a new building in 1997, and that she performed "poorly."

Regardless of the outcome, it's enough finger-pointing to paint a truly unhappy picture of a mutual fund firm that is already sagging under the weight of a recent management shakeup, a failed product line, a collapsed sale deal and the lagging performance of its funds. It's again up for sale, but the question is, who'll buy?

All of Pilgrim's PBHG mutual funds trail the S&P 500 over the last three years, according to Lipper. The firm's flagship (PBHGX Quote)Growth and (PBEGX Quote)Emerging Growth funds have double-digit negative returns for the period. Total assets in PBHG funds have shrunk from $8.7 billion in March 1998 to $6 billion by the end of March 1999, according to Financial Research Corp. in Boston.

PBHG Funds
Fund	Assets in millions*	Manager	One-year return**
(PBHGX Quote)Growth	$3,263	Gary Pilgrim	-10.2%
(PBEGX Quote)Emerging Growth	761.5	Christine Baxter	-14.9
(PBHLX Quote)Large Cap Growth	144.2	James McCall	15.7
(PBHEX Quote)Select Equity	236.5	James McCall	7.5
(PBCRX Quote)Core Growth	87.4	James McCall	10
(PBLDX Quote)Limited	108.2	Erin Piner	-2.3
(PLCPX Quote)Large Cap 20	604	James McCall	46.6
New Opportunities	n.a.	Frank Slattery	n.a.
(PBTCX Quote)Technology and Communications	517.7	Jeffrey Wrona	60.7
(PSSCX Quote)Strategic Small Company	48.2	Gary Haubold, Jim Smith	-5.9
(PBHIX Quote)International	13.9	Rodger Scullion	3.6
(PLCVX Quote)Large Cap Value	44.9	Gary Haubold	26.2
(PBMCX Quote)Mid Cap Value	57.1	Gary Haubold	15.5
(PBSVX Quote)Small Cap Value	67.5	Gary Haubold	-12.7
Focused Value	n.a.	Gary Haubold	n.a.
S&P 500	n.a.	n.a.	24.1
*Assets on March 31, **Return through May 13. Source: Lipper.

Pilgrim has just nine portfolio managers to run the firm's 15 equity mutual funds. McCall runs four of those funds totaling $1.2 billion or 17.9% of the firm's retail assets. His $144.2 million (PBHLX Quote)Large Cap Growth fund is Pilgrim's top diversified stock fund over the last three years. His $604 million (PLCPX Quote)Large Cap 20 fund is the firm's best diversified fund so far this year. Clearly, McCall is an integral player on a team with a thin bench. Losing him would make the firm less attractive to potential buyers.

"It is a well known fact in the mutual fund industry that the success of a mutual fund company can be highly dependent upon the talent and reputation of its portfolio mangers," states Pilgrim in its complaint, adding, "By 1996 McCall was among the top tier portfolio managers at Pilgrim Baxter."

But even if Pilgrim manages to hold on to McCall, the damage to a potential sale may already be done now that the dirty laundry is aired.

Firms like the acquisitive Liberty Financial (L Quote) in Boston -- which snapped up Crabbe Huson and Progress Investment Management late last year -- might be less inclined to jump on a deal that is so reliant upon unhappy talent. "We would probably not want to make an acquisition unless we felt the senior investment talent was excited about the merger and shared our enthusiasm for it," says Peter Morgan, a senior vice president at Liberty.

All the nastiness isn't likely to endear the firm to investors either, as a post on a popular Internet message board suggests:

"I'm becoming VERY concerned with PBHG as a company. They seem to be falling apart. They sell out big, then less than a year later, want to be up for sale again ... Please. Then I read yesterday that (arguably) their one best manager James McCall, is suing and being sued by PBHG because he wants to leave to go to Merrill Lynch. My God. Does this sound like a solid fund firm? Does this sound like a firm to give your money too?" exclaims the message, posted Thursday to the Mutual Funds Interactive Web site by Eric D. Routenberg, who identified himself as a PBHG investor.