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Fund Firm Reveals Frequent Trading

Dec 23, 2003 | CONTRA COSTA TIMES

San Mateo mutual fund giant Franklin Resources Inc. revealed Monday that it has suspended three employees being investigated for potentially improper trading practices and has received subpoenas from federal prosecutors in California and Massachusetts who are probing trading abuses in the $7 trillion mutual fund industry.

The internal probe is ongoing at the nation's fourth-largest mutual fund company the latest to become embroiled in allegations of improper trading since New York Attorney General Eliot Spitzer began investigating the industry in September.

An executive and a trader were placed on administrative leave for short-term trading in their 401(k) retirement plans, Franklin Resources said in its annual report filed Monday with the Securities and Exchange Commission. The executive resigned as an officer of the funds. A third employee, an officer at one of the company's subsidiaries, also was put on leave. The company did not disclose the identities of the employees.

"We have identified various instances of frequent trading where we have questions about the propriety of what occurred," Franklin Resources said in the filing.

Franklin Resources, which oversees the Franklin and Templeton fund families, said so far it has found no instances of inappropriate mutual fund trading by a portfolio manager, investment analyst or officer in reviewing whether employees or shareholders engaged in "late trading" or "market timing" transactions.

Late trading, which is illegal, allows favored customers usually wealthy clients or institutional investors to buy and sell shares after trading officially closes, hurting smaller investors. Market timing, also called rapid trading, is a gray area: It allows investors to get in and out of funds before the prices can catch up to the value. It can be illegal if the fund bans the practice in its prospectus.

Gregory Johnson, one of two chief executive officers of Franklin Resources, told the San Francisco Chronicle last month that the mutual fund company has prohibitions against market timing in its prospectuses.

Franklin, which at the end of last month managed more than $300 billion, said it would reimburse investors for "any unlawful or inappropriate conduct that caused losses to our funds."

An erosion in public trust in the company could result in a "significant decline" in assets under management and in an "adverse effect on future financial results," the company said in the filing with the SEC. The federal inquiry into the mutual fund industry also may increase costs and reduce revenue, the company said. Franklin Resources shares fell 40 cents, less than 1 percent, to $50.70.

A Franklin spokeswoman would not discuss the internal probe or the federal investigation.

Federal prosecutors in San Francisco are investigating trading practices at several mutual fund companies in Northern California, the Los Angeles Times reported last week.

Franklin Resources previously disclosed that it had received subpoenas from the Securities and Exchange Commission and other government agencies in their probe of trading practices.

"These requests for information and subpoenas do not imply any wrongdoing, and neither Franklin Resources Inc., nor any of our subsidiaries or personnel, has been named in any complaint by the SEC or any other government agency in connection with these ongoing investigations," Franklin Resources said in a statement on its Web site.

Franklin said it also has been questioned in connection with an SEC investigation of an undisclosed sales promotion program at Morgan Stanley.

Though the company provided few details about alleged trading abuses by employees, analysts downplayed the significance. Calling Franklin Resources a "gold standard" in the industry, Franklin Morton, senior vice president at Ariel Capital Management in Chicago, said he expects the company to take swift action.

"Every mutual fund company has been looking under every rock to find anything in the last three months," said Morton, whose firm owns just under 4 million shares of Franklin Resources, the largest publicly traded U.S. mutual fund company. "This was limited to a small handful of employees timing their own 401(k)s. In terms of percentage of assets, this was absolutely inconsequential. Not to say that it's right. But for this little to come out this late in the game, I don't think it's a major issue."

That employees could circumvent Franklin Resources' controls raises a red flag, said Roy Weitz, publisher of FundAlarm.com in Los Angeles. "The key is how they got around the controls," he said. "I hope they make public what they plan to do to tighten up controls in the future."

"We are carefully evaluating whether there are additional steps we can take to further protect the interests of our fund shareholders," the company said in a statement.


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