Transition management-it's the term used by custodian banks and other service providers to describe how they move the assets of a pension plan or other plan sponsor from one fund manager to another.

It's typically a routine event, and an uneventful one that could take the transition manager anywhere from several days to several weeks to complete, depending on the size of the book of business and the types of assets involved. That is unless something goes awry, as in the recent case involving State Street Global Advisors and a UK pension plan.

In its case, two top ranking SSGA executives departed, after problems emerged in the way the custodian bank handled the transfer of assets of an unnamed pension fund. The unit of State Street on Oct. 7 admitted to reimbursing a client for overbilling. The State Street unit has also confirmed that Ross McLellan, head of State Street's global transition management team, and Edward Pennings, head of the Europe, Middle East and Africa team, no longer work at the bank.

The result has been plenty of talk in the transition management arena not only about what may have gone wrong but what plan sponsors-and their transition managers-can do to prevent misunderstandings-and potential embarrassment.

Pension plans and other plan sponsors typically hire a custodian bank, broker-dealer, fund manager or consultant as a transition manager to handle the movement of their assets to new fund managers. Allowing the new fund manager to sell the old securities and buy new ones simply isn't cost effective so the transition manager has to step in and figure out how to minimize the costs involved-both implicit as in market impact and explicit as in commissions charged. The lower the costs the greater the potential that the value of the new portfolio will be the same as the value of the old portfolio.

Overbilling is an anathema in the world of asset servicing. Reputation is what gets and keeps business. In a letter to clients, SSGA did not identify either the client or the amount of the reimbursement but it said that the customer was billed both commissions and management fees. That was not consistent to the terms of the agreement. Consultants in the transition management industry questioned by Money Management Executive said that transition managers typically do not charge management fees based on assets under management and never charge both commission and management fees without the explicit consent of the plan sponsor.

In its letter to customers, State Street said it is also investigating the fees charged to other European customers to ensure their accuracy.

Just how can a plan sponsor protect itself? While a common question is whether or not the transition manager will act in the role of a "fiduciary" it shouldn't be. An even better question, said Grant Johnsey, director of transition management for Northern Trust in Chicago, is just how the transition manager earns revenues. "Plan sponsors should understand just what it is going to cost them and why," Johnsey said.

The term fiduciary can be misleading. "Fiduciary can be interpreted as a Big F or a little F. A fiduciary working under the Investment Advisers Act of 1940 has to disclose all potential conflicts of interest, while a fiduciary operating under the Employee Retirement Income Act has to avoid all potential conflicts of interest. These are fiduciaries with a capital 'F'," said Steve Kirschner, director of transition management in the Americas for Russell Investments in Seattle. "Some transition managers also use the phrase fiduciary to refer to the term 'trading fiduciary' which would only compel them to fulfill best execution requirements on a trade by trade basis."

Transition managers can trade either on an agency basis or a principal basis. The agency basis means that the firm will not take on a position on any orders it handles.

Such is often the case when it comes to equities, and the plan sponsor can more easily separate out the price paid for the securities and any commissions charged. That's not the case when it comes to fixed-income assets, which is what the U.K. pension plan served by State Street invested in.

Trades in fixed-income securities, currencies or swaps are often done on a principal basis which means that the bank has actually purchased the financial instrument itself and is holding it in its inventory. Therefore, the principal is taking on more risk than an agent because if the principal must hold the financial instrument for some time before selling it to the end client, the value of the holding could change.

Acting as a principal, the transition manager can charge a markup and that markup could either be a percentage of the value of the trade or a percentage of the yield of the trade. "When the fee is based on percentage of the yield of the trade it could be a lot higher than on the value of the trade if the bond has a long maturity," Johnsey said.

But the plan sponsor may not understand just what it paid. "Fixed-income transactions are often far more difficult to monitor by the plan sponsor than equities because of the lack of transparency inherent in a market where trades are done on a principal basis," said Kirschner. "An agent charging a fully disclosed commission, can add both competition and transparency to fixed-income transactions which often can lead to better execution."

Even equity transactions are not immune from overcharging if the transition manager acts as a principal or represents the other side of the trade using an internal liquidity pool.

Some transition managers such as Northern Trust and State Street also manage index funds and move funds intended for index funds to their own. For an internalized trade-where a customer order is crossed with an index fund trade, the U.S. Department of Labor requires that the price charged must be the closing price on the day the trade is executed.

"For other internal trades in equity instruments, however, no such rules are mandated and there are often incentives to provide a better price to one side of the trade over the other based on differing commission rates so the impact of uncompetitive pricing on crossed trades can swamp performance," Kirschner said.

Some providers, including Russell, avoid this conflict altogether by acting as a pure agent and do not internalize trading.

But can a plan sponsor or transition manager prevent every potential problem? Not exactly.

The most common errors aren't the result of a dispute over fees, but unintentional trading mistakes made by the transition manager. Those mistakes can easily occur if the transition manager executes the wrong transaction based on the wrong trade model from the new target fund manager.

That manager may also be the new designated fund manager. The new model helps the transition manager decide which securities it should purchase and the value of the trades.

"There is always a review by a portfolio manager between the trades executed by the transition manager and the model portfolio to assure correct positions and commission rates, as well as a review of the overall event by a compliance officer," Kirschner said.

The same applies to any discrepancy in fees. Russell's compliance department will conduct one last verification of the fees charged with those indicated in the contract between the plan sponsor and itself at the conclusion of the transaction.

Northern Trust, Johnsey said, also ensures that every trade executed by the trader on the transition management team is reviewed by an additional three executives-a strategist, a coordinator and a team leader.

The strategist is responsible for ensuring that the costs-or fees-are minimized while the coordinator ensures that the operational work is completed accurately. The means the correct securities and value are traded for the correct plan sponsor. The team leader oversees the work of the strategist and coordinator.

For plan sponsors wanting to rest easy, taking an extra preventative step will help out. That step involves conducting either an internal audit of the fees or hiring a consultancy. In the case of State Street, industry sources with knowledge of its transition management business, said that the discrepancy in fees was caught by Inalytics, a New York and London based transition management evaluation firm. Inalytics declined to comment.

"There is no rule of thumb on the amount of discrepancy between pre-estimated fees and actual fees," Kirschner said. "When there are differences in commission charges for equity trades, the differences should be immediately investigated. The same applies to any differences in fees for fixed-income, foreign exchange or swap trades but it is often harder to distinguish the latter so the plan sponsor may need an independent third-party to help out."

The rule of thumb: buyer beware.

Transition management-it's the term used by custodian banks and other service providers to describe how they move the assets of a pension plan or other plan sponsor from one fund manager to another.

It's typically a routine event, and an uneventful one that could take the transition manager anywhere from several days to several weeks to complete, depending on the size of the book of business and the types of assets involved. That is unless something goes awry, as in the recent case involving State Street Global Markets and a U.K. pension plan.

In its case, two top ranking SSGM executives departed, after problems emerged in the way the custodian bank handled the transfer of assets of an unnamed pension fund. The unit of State Street on Oct. 7 admitted to reimbursing a client for overbilling. The State Street unit has also confirmed that Ross McLellan, head of State Street's global transition management team, and Edward Pennings, head of the Europe, Middle East and Africa team, no longer work at the bank.

The result has been plenty of talk in the transition management arena not only about what may have gone wrong but what plan sponsors-and their transition managers-can do to prevent misunderstandings-and potential embarrassment.

Pension plans and other plan sponsors typically hire a custodian bank, broker-dealer, fund manager or consultant as a transition manager to handle the movement of their assets to new fund managers. Allowing the new fund manager to sell the old securities and buy new ones simply isn't cost effective so the transition manager has to step in and figure out how to minimize the costs involved-both implicit as in market impact and explicit as in commissions charged. The lower the costs the greater the potential that the value of the new portfolio will be the same as the value of the old portfolio.

Overbilling is an anathema in the world of asset servicing. Reputation is what gets and keeps business. In a letter to clients, SSGM did not identify either the client or the amount of the reimbursement but it said that the customer was billed both commissions and management fees. That was not consistent to the terms of the agreement. Consultants in the transition management industry questioned by Money Management Executive said that transition managers typically do not charge management fees based on assets under management and never charge both commission and management fees without the explicit consent of the plan sponsor.

In its letter to customers, State Street said it is also investigating the fees charged to other European customers to ensure their accuracy.

Just how can a plan sponsor protect itself? While a common question is whether or not the transition manager will act in the role of a "fiduciary" it shouldn't be. An even better question, said Grant Johnsey, director of transition management for Northern Trust in Chicago, is just how the transition manager earns revenues. "Plan sponsors should understand just what it is going to cost them and why," Johnsey said.

The term fiduciary can be misleading. "Fiduciary can be interpreted as a Big F or a little F. A fiduciary working under the Investment Advisers Act of 1940 has to disclose all potential conflicts of interest, while a fiduciary operating under the Employee Retirement Income Act has to avoid all potential conflicts of interest. These are fiduciaries with a capital 'F'," said Steve Kirschner, director of transition management in the Americas for Russell Investments in Seattle. "Some transition managers also use the phrase fiduciary to refer to the term 'trading fiduciary' which would only compel them to fulfill best execution requirements on a trade by trade basis."

Transition managers can trade either on an agency basis or a principal basis. The agency basis means that the firm will not take on a position on any orders it handles.

Such is often the case when it comes to equities, and the plan sponsor can more easily separate out the price paid for the securities and any commissions charged. That's not the case when it comes to fixed-income assets, which is what the U.K. pension plan served by State Street invested in.

Trades in fixed-income securities, currencies or swaps are often done on a principal basis which means that the bank has actually purchased the financial instrument itself and is holding it in its inventory. Therefore, the principal is taking on more risk than an agent because if the principal must hold the financial instrument for some time before selling it to the end client, the value of the holding could change.

Acting as a principal, the transition manager can charge a markup and that markup could either be a percentage of the value of the trade or a percentage of the yield of the trade. "When the fee is based on a percentage of the yield of the trade it could be a lot higher than on the value of the trade if the bond has a long maturity," Johnsey said.

But the plan sponsor may not understand just what it paid. "Fixed-income transactions are often far more difficult to monitor by the plan sponsor than equities because of the lack of transparency inherent in a market where trades are done on a principal basis," said Kirschner. "An agent charging a fully disclosed commission, can add both competition and transparency to fixed-income transactions which often can lead to better execution."

Can a plan sponsor or transition manager prevent every potential problem? Not exactly.

The most common errors aren't the result of a dispute over fees, but unintentional trading mistakes made by the transition manager. Those mistakes can easily occur if the transition manager executes the wrong transaction based on the wrong trade model from the new target fund manager.

That manager may also be the new designated fund manager. The new model helps the transition manager decide which securities it should purchase and the value of the trades.

"There is always a review by a portfolio manager between the trades executed by the transition manager and the model portfolio to assure correct positions and commission rates, as well as a review of the overall event by a compliance officer," Kirschner said.

The same applies to any discrepancy in fees. Russell's compliance department will conduct one last verification of the fees charged with those indicated in the contract between the plan sponsor and itself at the conclusion of the transaction. Northern Trust, Johnsey said, also ensures that every trade executed by the trader on the transition management team is reviewed by an additional three executives-a strategist, a coordinator and a team leader. MME

Subscribe Now

Access to premium content including in-depth coverage of mutual funds, hedge funds, 401(K)s, 529 plans, and more.

3-Week Free Trial

Insight and analysis into the management, marketing, operations and technology of the asset management industry.