Boston Co., a unit of Mellon Bank, could be facing some tough sledding in its mutual fund servicing business.

Mellon claims that Smith Barney Shearson is violating an agreement stipulating that Boston Co. would continue to service Shearson mutual funds through 1999. The agreement was part of Mellon's purchase of Boston Co. earlier this year from American Express Co.

The Shearson funds account for the bulk of Boston Co.'s $170 million in annual servicing fees. And if Boston Co. can't retain or increase the Shearson business, it will be hard pressed to grow in the servicing field, analysts say.

Technological Advances

Competition in the field: is fierce in the wake of ambitious systems expansions by servicers in the 1980s. The effort left the industry with twice as much capacity as business, said Dave Nadig of Boston-based Cerulli Associates.

Servicing mutual funds involves tasks like administration, custody, and transfer agency. The field is dominated by non-banks

Analysts generally applauded Mellon's purchase of Boston Co. but expressed concern about whether Mellon could maintain the unit's existing business.

Stock Price Hurt

Consequently, when Mellon filed suits Monday alleging that business was being poached by parties it claims are bound by agreements in the purchase deal, Mellon's stock dropped $3.51, to $56.50. On Tuesday, the stock dropped to $55.25.

"There is a fair amount of skepticism in the industry that they can win the suit," said Nancy Bush, a stock analyst who covers Mellon for Brown Brothers Harriman & Co.

If the developments listed in the suit don't change, analysts expect that Boston Co.'s revenues could take a big hit.

Ultimately, Mellon's earnings could be lowered 15 to 20 cents a share, said Ronald I. Mandel at Sanford C. Bernstein.

Culture Clash

Ms. Bush said the merger of Mellon and Boston Co. is also involved difficult issues at the out-set, like reconciling diverse cultures and salary structures.

In its suits, the Pittsburgh based bank said that Smith Barney Shearson willfully violated the competition stipulations of the Boston Co. sale, which was completed in May.

"Smith Barney has it in mind to repudiate the contract," a source close to Mellon asserted.

But, Smith Barney, a unit of Primerica that acquired the Shearson brokerage system from American Express in August, said the suit is "factually incorrect." It did not elaborate.

Mellon called Smith Barney's actions blatant violations.

"Those obligations are clear and explicit, and we have great confidence in the strength of our position," said Frank V. Cahouet, Mellon's chief executive officer.

In May, Mellon and Shearson Lehman Brothers closed the purchase of Boston Co. after signing a contract in Sept. 1992.

When Mellon bought the business "the large majority of [administration services and custody] consisted of providing administration services to mutual funds that had been sponsored or created by Shearson. The Boston Co. serviced those funds that had approximately $50 billion in assets," the suit says.

Hands-Off Policy

To protect the revenue stream from that business, the terms stipulated that either Shearson nor its affiliate would provide any custodial or administrative services to any mutual fund for which Shearson or its affiliates served as investment adviser.

Also, Shearson would recommend Boston Co. as the provider of custody and administrative services for all Shearson funds including those formed in the seven-year period.

Mellon said the deal was broken when Smith Barney "created new mutual funds that are virtual clones" of existing Shearson funds. Those would be service by Smith Barney, the suit said.

One fund with a similar objective to a Shearson fund even has the same portfolio manager, according to the suit.

The suit claims that Smith Barney brokers are soliciting investors in the old funds to "induce them to put money into the new funds, to which the Boston Co. will not provide services."

Case Against Amex

In the other suit, against American Express and its subsidiary Lehman Brothers, Mellon alleges that the speed of Smith Barney's actions after closing the sale of Shearson suggests "that the actions had been planned well before the closing, before the closing of the Mellon-Shearson agreement, and perhaps even before Mellon and Shearson signed their contract in Sept. 1992."

"Those allegations are untrue," a spokesman for Lehman Brothers said.

Hearings will be held Nov. 8 and 9 on Mellon's request for a preliminary injunction to bar Smith Barney from starting new funds and providing custodial and administrative service.

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