Atlanta Vs Hamlin

The year 1994 began with promise for both Hamlin Dewey, Inc. ("Hamlin") and Atlanta

Park Medical Center ("Atlanta Park").

Founded in Atlanta, Georgia, in 1894, Hamlin had become one of the nation's

premier full-service investment companies. A brokerage subsidiary, Hamlin Securities, Inc.,

offered financial services to the public through 87 retail offices in 14 states across the South and

Southwestern United States. Hamlin also comprised an investment management subsidiary,

Hamlin Asset Management, which managed over $17 billion in mutual funds and private

accounts. One of the mutual funds, the Hamlin Dewey Solid Government Fund (HDSG) had just

run up returns exceeding 20% in each of the last three years, far outpacing the average 6.4%

annual return of the typical government bond fund over this period. At the helm of HDSG was

Hamlin's star portfolio manager,a gentleman by the name of Jackson Montgomery.

Montgomery was named fixed income portfolio manager of the year1993 by Capital

Magazine, his portfolio having beaten the competition by a sizable margin. Hamlin also had

subsidiary units engaged in equity and bond underwriting. Hamlin was a regional powerhouse.

Atlantans admired and trusted their hometown investment bank and many would think of doing

financial business with no one else.

Atlanta Park was a not-for-profit research and teaching hospital. Since its inception in

1954, the hospital had become a leader in research and clinical programs to combat cancer,

asthma, diabetes, and heart disease. They also sponsored a pre-natal counseling program. The

organization had 190 employees, an annual budget of $14.3 million, and assets of $21.2 million.

What Went Wrong

Over the course of 1994, the HDSG fund and other accounts managed by Montgomery

lost 36% of their value. Hamlin lost over $800 million of investors' money. $660 million of the

losses were from HDSG.They claimed that they had no idea a bond fund could suffer such

large losses. Neither the fund's sales materials nor its prospectus warned of the risk of such a

decline. The damage was attributable to investments in volatile derivatives that

the claimants argued were not adequately disclosed to investors. The 5.500 HDSG fund

investors joined in a class action lawsuit against Hamlin seeking restitution. Some investors

brought individual lawsuits. The Georgia Symphony Orchestra, for example, lost $7 million and

brought legal action for return of this money. Alamo State University in Texas sued for return of

the $15 million it lost. Plaintiffs included all types, running the gamut from private individual

investors to corporations, pension funds, non-profit institutions, any municipalities.

The threat to Hamlin extended beyond the damages sought by the bond fund investors.

Its image tarnished, Hamlin suffered a drop in its other business lines as well. Assets under

management fell from $17 billion to $10.5 billion. Net income in fiscal 1994 was $27.05

million, down 38% from the $43.86 million earned in 1993. As a result of the turmoil. Hamlin's

stock price declined from a high of $67.75 per share to $34.63 by the end of 1994. Shareholder

equity on the books at the end of fiscal year 1994 (September) stood at $155 million.

Hamlin's shareholders also alleged mismanagement and filed lawsuits against the

company; such problems did not go unnoticed by regulatory agencies. The National Association

of Securities Dealers (NASD), the Securities and Exchange Commission (SEC), and the Georgia

Department of Commerce each began investigations into Hamlin' business dealings.

History

Prior to September of 1991, Atlanta Park's endowment fund was managed internally by

its own executives. Atlanta Park's President, Michael Leone, was a medical doctor and also had

an MBA from the University of Chicago. The Executive Vice President received an MBA, with

a specialty in finance, from Boston University. Atlanta Park's Treasurer had three years work

experience as an equity analyst at Fidelity Investments. Major decisions had to be approved by

the hospital's board of trustees.

Atlanta Park's board of trustees was a diverse group,representing the business community, the medical profession, and local government officials.

Many of the trustees were successful business people, and some workspecifically in thefinance industry.

Endowment funds had been invested in United States Treasury notes and bank

certificates of deposits (CDs), which were insured by the federal government. Many of the notes

and CDs were coming due in 1991, and executives would soon have to decide how to reinvest

the funds. Interest rates had fallen considerably in recent years, and it appeared that the rate of

return on endowment investments would subsequently slow. The managers and trustees of

Atlanta Park concluded that given the increasing size of the endowment fund and the more

challenging nature of the investment environment, a prudent course of action would be to retain

professional money management services.

Atlanta Park's board and executives interviewed many potential candidates to oversee

investment of the endowment. Large and small firms were invited to make presentations, as

(were local and distant firms. Atlanta Park emphasized to every candidate that their preference

was for conservative investments. Preservation of capital was of paramount concern. The

following written guidelines were presented to every candidate:

"The primary objective for investment of Atlanta Park Medical Centerendowment funds will be preservation of capital. A secondary objective issufficient capital appreciation to maintain a growing fund in real terms.Consistent with prudent standards for preservation of capital and maintenance ofliquidity, the goal of the Atlanta Park Medical Center is to earn the highestpossible total rate of return within the hospital's tolerance for risk

With their solid local reputation, Hamlin Dewey was the early favorite. A Hamlin

account executive by the name of Nancy Andrews made the sales pitch. Atlanta Park executives

and trustees met with Ms. Andrews on numerous occasions. Notes taken during these meetings

indicate that Ms. Andrews understood well Atlanta Park's low tolerance for risk. She assured

them that Hamlin would use prudent investment principals in selecting, diversifying and

managing assets to reduce risk. Hamlin would work closely with Atlanta Park to understand its

It's needs.

The Events of 1994

A series of unprecedented and unforeseen events conspired against the bond market in

1994. According to surveys conducted at the end of 1993, economists expected interest rates to

remain low throughout 1994. However, on February 4, the Federal Reserve voted to raise

interest rates in a preemptive move against possible inflation. Whereas in the past the Federal

Reserve would reveal policy changes only after a one or two month delay, this time it broke with

tradition and announced that interest rates would immediately be pushed upward. These moves

rattled bond traders. Long-maturity as Yell as short-maturity interest rates rose, and bond prices

began to fall. From January 31, 1994 to February 28, one-year Treasury bill yields rose from

3.51% to 3.83%. Ten-year rates rose from 5.75% to 5.97%.

Throughout the year, interest rates kept rising.The Federal Reserve raised rates six

separate times over the year, an absolutely unprecedented and unexpected occurrence. By

December 31, 1994, the one-year Treasury bill rate had hit 7.15%. This rate had more than

doubled since January. The ten-year rate rose 206 basis points to 7.81% (note: a basis point is

01% of yield). From January through December, the 3-year rate rose 323 basis points, from

4.48% to 7.71%. The continued rise in interest rates repeatedly surprised the economic pundits.

When asked by the Bloomberg Economic Survey in December 1993 what +h ay forecasted the 30-

year interest rate would be three months later, leading economists predicted a 6.2% level. The

actual rate turned out to be 6.91%. When asked to update their forecast for the following three

months, in light of the realized surprise, the experts forecasted a 6.82% rate. They were wrong

again as the 30-year rate came in at 7.40%. Their next forecast was for 7.36%, but they were

wrong again as the true rate turned out to be 7.71%o. The spike in interest rates caught virtually

everybody off guard.

Though all bond prices fell as rates rose in 1994, those bonds that were most sensitive to

interest rates were hit the hardest. Collateralized mortgage obligations (CMOs) in particular

suffered, and the HDSG fund was invested chiefly in CMOs.

To make matters worse, the infrastructure of the CMO market began to unravel. The

Askin Capital Management Granite funds had borrowed heavily to invest in CMOs. When CMO

values declined, lenders called in their loans. But Askin did not have liquid funds to pay back

the debt. As a result, creditors forced Askin to liquidate its CMO holdings.

This suddendumping of CMOs on the marketplace pushed prices down further. Institutions panicked andtried to unload their CMO portfolios onto the already stressed marketplace. Soon there were fewbuyers and an oversupply of sellers.

Atlanta Park stayed in until October 1994. By then, having lost over $3 million since

January, they had had enough. They withdrew their investment from Hamlin Dewey, redeeming

their HDSG fund shares at $22.80.

A month after Atlanta Park pulled out, the fund began to stabilize and then recover. By

August of 1995, the fund's shares stood at a value of $29.16, up 28% from the low. The surge in

interest rates subsided in January of 1995. By May of 1995 the one-year Treasury rate had fallen

once again below 6%, and by February of 1996 the rate fell below 5%. By December of 1995,

the ten-year Treasury rate had returned to the same level observed in January 1994, just before

the Fed tightened. As rates fell, CMO prices rebounded. Many investorswho bought CMOs atthe market bottom booked handsome profits. Liquidity returned to the market, and investors

trickled back.

Atlanta Park's Complaint

Atlanta Park filed for arbitration before the National Association of Securities Dealers

(NASD).

NASD bylaws stated that member firms are bound by the decisions of NASD

arbitrators. An NASD hearing followed many of the same rules as a court trial, with a binding

decision rendered by a panel of three adjudicators. For all practical purposes, the NASD tribunal

would thus serve as the court for Atlanta Park's complaint.

In its statement filed with the NASD, Atlanta Park claimed that Hamlin Dewey breached

a fiduciary responsibility. Hamlin invested the Atlanta Park endowment in unsuitable securities.

The HDSG fund was far too risky for Atlanta Park, and was completely inconsistent with the

investment objectives agreed upon. Moreover, Hamlin had a self-serving reason to place Atlanta

Park's funds into the HDSG fund. As managers of the HDSG fund, Hamlin collected an annual

management fee from the fund of .5% of the fund's total assets. This compensation was in

addition to the .5% fee Atlanta Park directly paid Hamlin to manage the endowment account.

Had Hamlin chosen a more appropriate fund, managed by another firm, Hamlin would not have

been able to double dip.

Atlanta Park claimed that they were never told of the risks inbedded in the HDSG fund.

On the contrary, the fund's sales literature and prospectus implied that the fund was safe and

conservative. Hamlin's sale representatives and account executive described the fund as safe.

The AAA rating was emphasized. These representations were intentionally deceptive, according

to Atlanta Park. Jackson Montgomery knew full well that he was making speculative bets on

interest rates. He knew that if rates would rise, the fund would fall.

Atlanta Park alleged that Hamlin Dewey took advantage of its trust. The discretionary

account agreement documented that Atlanta Park had put full faith into Hamlin Dewey

delegating Hamlin Dewey as a fiduciary to protect Atlanta Park' interests, and find appropriate,

conservative, and safe investment vehicles. For these services, and to take this fiduciary

responsibility, Atlanta Park paid Hamlin Dewey well.

Hamlin Dewey's Defense

In its response filed with the NASD arbitrators, Hamlin Dewey emphasized that they

were not hired to manage Atlanta Park's endowment.

On the contrary, executives of Atlanta

Park managed the endowment, and allocated the funds to two separate firms. Atlanta Park

opened an account at Hamlin Dewey, but they also had an account at Kennesaw Associates. The

allocation of the Atlanta Park money was made after deliberations with Atlanta Park executives,

and with their full consent. Hamlin Dewey was the investment agent for Atlanta Park

executives, not their fiduciary portfolio manager.

At least four times each year, Hamlin's account executive met with Atlanta Park's

executives to explain how the money was invested. Written reports also detailed the fund

allocation, right down to an account of which securities were owned and in what quantities.

Atlanta Park's executives and board of directors are a sophisticated group of business

professionals, highly experienced in financial matters. They understood as well as anybody the

risks of the HDSG fund. They understood that there is a risk-return tradeoff in the financial

marketplace. The fact that the HDSG fund posted unusually high returns between 1991 and

For three years, Atlanta Park reaped high returns from the HDSG fund.

Those highreturns were compensation for bearing added risk. Atlanta Park understood that there were risks,

but they judged the high returns ample compensation. In the last year they lost money.

Atlanta Park's Dilemma

On January 12, 1995, Hamlin Dewey negotiated a settlement with the 5,500 investors

who joined together in the class action lawsuit. Hamlin Dewey offered, and the class accepted, a

payment of 40 cents for every dollar lost since January 1, 1994.

Legal analysts noted that thiswas an unusually large offer. Generally, a 15-cent reimbursement was more typical.Atlanta Park was given the opportunity to drop its suit againstHamlin and join the classaction.

Atlanta Park now had to decide whether to join the class and receive the 40%

reimbursement or, alternatively, to permanently opt out of the class, and pursue an individual

lawsuit, seeking treble damages.

What course of action should Atlanta Park take?