Alliance Capital Management LP is expected to pay a record $250 million in penalties and to cut mutual fund fees by about 20 percent in two precedent-setting deals to settle mutual fund trading investigations by New York and federal regulators, sources familiar with the talks said.
The settlements, due to be announced as soon as Tuesday, would mark the first time a fund company has forked over cash since New York Attorney General Eliot L. Spitzer publicly launched the probe of the $7.1 trillion industry in September. It would also be the first time regulators have used a securities enforcement action to exact future price reductions for consumers.
Although expected to be announced on the same day, the deals highlight differences between Spitzer’s office and the Securities and Exchange Commission, which have been simultaneously competing and trying to work together to bring cases.
Spitzer asked for and apparently received promises of lower fees, but the five SEC commissioners declined to join that part of Alliance’s offer, sources said.
Trading violations “are a manifestation of a larger governance breakdown, and excessive fees flow directly from the same failed governing structure,” Spitzer said in an interview. Alliance has among the industry’s highest fees — an average of 1.63 percent annually, according to research firm Lipper Inc.
An agreement would put pressure on other fund companies now under investigation to lower fees as well. But, because Alliance’s fees are among the highest in the industry, lowering the company’s fees would bring it more in line with many of its competitors, rather than putting pressure on them to charge less, industry analysts said.
SEC officials argue that cutting fees smacks of government price controls and that problems with high or poorly disclosed fees are better handled on an industry-wide basis as part of the regulatory process.
Instead, the SEC’s settlement with the company would hinge on Alliance making management and governance changes and the $250 million payment, the largest penalty ever paid by a fund management company, sources said. That money, which represents 11/2 times what the firm earned last year, would be used to compensate investors.
“Government has not done well when it sets fees. There was a mess in terms of exorbitant fees when the government set fees for broker-dealers” until the SEC ended the practice in 1975, commissioner Harvey J. Goldschmid said in an interview. “The key to enforcement actions is to clean up the problems and take enough from the wrongdoers to create deterrence.”
Neither regulators nor a company spokesman would discuss the Alliance talks, but sources said the SEC and Spitzer have agreed to disagree politely and plan to announce their separate settlements on the same day, the sources said.
Alliance, which had $456 billion in assets under management as of Nov. 30, has acknowledged publicly that it is under investigation for allegedly misleading customers about how it handled a kind of short-term trading called “market timing.” The firm, which is publicly traded but controlled by French giant Axa SA, said last month that it was expecting regulatory action and had set aside $190 million to cover possible costs.
Market timing is a legal trading strategy that involves making short-term investments in a fund when its share price appears to be lagging the value of its underlying assets. Regulators say it is illegal for fund companies to tell the public they crack down on market timing as Alliance did while earning fees for allowing select customers to do it.
Regulators have uncovered e-mails implicating top firm managers in secret deals allowing at least two big investors to engage in market timing. In exchange, those clients made significant investments in Alliance-run hedge funds that allowed the company to profit from higher fees, the sources said. Hedge funds carry higher management fees than mutual funds.
The firm has already ousted several top managers implicated in the e-mails, including former president John D. Carifa and former head of mutual funds Michael J. Laughlin. The SEC and Spitzer’s office are also considering whether to take action against them and several lower-level former executives.
Also yesterday, the Investment Company Institute, the main mutual fund company trade group, asked the SEC to set tighter limits on the ways fund companies compensate the brokers and other securities-industry professionals who provide services to mutual funds. Critics have long argued that some funds keep reported fees artificially low by using “soft dollar” arrangements, in which the fund company steers its stock and bond-buying business to brokers who then provide research, computers and other services. Fund companies are required to tell customers how much they charge for services but are not required to report how much they pay their brokers in commissions the cost of which may be increased to cover such items.
The ICI asked yesterday for stricter limits on soft dollars as well as a total ban on a similar practice of fund companies steering stock transactions to brokerage firms that agree to push the fund company’s products to individual clients. Morgan Stanley paid $50 million last month to settle allegations that its brokers were improperly promoting particular funds to help the firm get trading business from certain fund companies.