Billions at Stake as Calpers Weighs Money Managers

It hasn't waded into the fund scandal yet, but when it does, look out.
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The California Public Employees' Retirement System terminated its contracts with

Putnam Investments

(MMC) - Get Report

this week and

Alliance Bernstein

(AC) - Get Report

,

Franklin Advisors

(BEN) - Get Report

and

BlackRock International

(BLK) - Get Report

could well be next on the agency's hit list.

Calpers withdrew $1.2 billion from Putnam Tuesday after a review found that former senior managers of the company failed to put an end to an unethical arbitrage strategy known as market-timing, despite being alerted to it. The

Securities and Exchange Commission

has reached a partial settlement with Putnam and federal and state regulators are investigating.

But Calpers has yet to withdraw any money from other external managers like Alliance Bernstein, Franklin Advisors or BlackRock International, whose parent companies are all under investigation for improper mutual fund trading.

Alliance CEO Lewis Sanders said his firm is "in need of repair" and that he has been trying to sustain relationships with state pension funds that represent "substantial business" for the firm.

And because Alliance and Franklin have performed much better than Putnam, there's a chance Calpers will overlook the allegations of wrongdoing. But Calpers is reviewing its external money managers, their codes of ethics and their connection to any ongoing investigations.

"No decisions have been made but our board is meeting with Alliance over the course of the next couple of weeks and we'll have some recommendations in December," said Brad Pacheco, spokesman at Calpers.

Calpers' board of administration, which is the final authority on hiring and firing managers, next meets on Dec. 15. BlackRock is in a particularly precarious position because its performance has been less than inspiring, having underperformed its benchmark since Calpers invested money with it in July 2001.

Calpers doesn't own any mutual fund shares and therefore isn't at risk of losing money as a result of market-timing or late-trading. But that doesn't mean its cash hasn't been misused in other ways. At firms like Alliance, Franklin and BlackRock, the cloud of suspicion has suddenly been cast on all money managers, not just those in charge of mutual funds.

In a letter to its external managers, Calpers said it is concerned that "this type of behavior represents very loose and ineffective Codes of Ethics as well as poor compliance procedures in the industry at large that could spillover to harm accounts managed for Calpers' benefit."

Alliance Capital manages about $823 million in U.S. domestic equities for Calpers and $606 million in emerging market stocks. Franklin and BlackRock handle $755 million and $287 million for the agency, respectively.

With almost $149 billion in assets, Calpers is the biggest pension fund in the nation, and over the years it has become a powerful force in corporate governance. Still, the agency has come under fire from some critics for acting too slowly in withdrawing money from controversial investment firms and for continuing to maintain a relationship with Wilshire Associates, a company that, according to news reports, engaged in rapid-fire trades that generated huge returns for the firm at the expense of long-term mutual fund investors.

Pacheco said it has not been proven that Wilshire, which has been a consultant to Calpers for more than 17 years, has done anything wrong and Wilshire says it has not violated any laws.

"We've been in communication with them and our board feels confident in their ability," Pacheco said. "They gave a full explanation about what's been written about them."

Still, some critics aren't happy about the connection given Calper's reputation as a leader on issues of corporate responsibility. In addition, they complain that Calpers still owns a 10% equity stake in Thomas Weisel, a California investment bank that was allegedly part of the government's investigation into conflicts of interest and has yet to reach a settlement with regulators.

"When these situations arise we monitor them closely but I believe from our conversations with them we were satisfied with what was occurring," Pacheco said.

Thomas Weisel would not confirm whether it is under investigation and the SEC declined to comment.

Charles Elson, director of the Weinberg Center of Corporate Governance at the University of Delaware, said Calpers is so large that it is bound to have connections with at least one controversial firm but he believes the agency is "very careful" and has acted appropriately so far.

"Their obligation is to protect the assets of their investors and they have to act judiciously," he said. "A mass liquidation of all your holdings and all your funds would cost your holders quite a bit and I think you have to evaluate each situation on a case-by-case basis."

While Calpers must evaluate which funds, if any, to withdraw money from, it must also evaluate where to reinvest that money, and that could be tricky right now. "What happens if you move out of one fund into another and then find out that firm is suddenly implicated," he said. "Until it's over, we don't know who else is going to be drawn in."