Franklin Resources, the San Mateo mutual fund giant that was charged with fraud last week by Massachusetts regulators for giving preferential treatment to a wealthy Las Vegas investor, disclosed on Monday that it faces a possible suit by the Securities and Exchange Commission and an investigation by Florida regulators.
In a regulatory filing, Franklin, the nation’s fourth-largest mutual fund operator, said the SEC is considering filing an action against a subsidiary of the company and two unnamed senior officers.
Franklin, parent of the well-known Franklin Templeton fund family, also said it is trying to work out a settlement with the federal agency. It cautioned that the discussions are preliminary and could not predict whether they would be successful.
Last week, Massachusetts Secretary of the Commonwealth William Galvin accused Franklin of engaging in a “blatant quid pro quo” by allowing investor Daniel Calugar, president of Security Brokerage, to make frequent short-term trades in one of Franklin’s mutual funds in exchange for parking $10 million in a Franklin hedge fund. Galvin’s office also uncovered e-mail indicating that several senior Franklin executives, including members of the Johnson family that controls the mutual fund firm, appeared to be aware of the arrangement.
Although not illegal by itself, Galvin asserted that Calugar’s rapid trading, also known as market timing, violated the funds’ written prospectus a charge that Franklin denied Monday and gave Calugar an unfair advantage over other investors.
Last week’s charges against Franklin were the latest in series of accusations against investment firms for allowing improper trading of mutual funds.
Many mutual fund companies, including Franklin, have restrictions against frequent-trading strategies, because they can drive up fund expenses and dilute the profit for other investors.
However, some fund traders have engaged in market timing to take advantage of stale mutual fund prices, which aren’t adjusted quickly enough to take into account the changing markets around the globe.
In addition, regulators are examining other issues, such as whether funds allowed some investors to make trades after trading had officially closed for the day. That would allow them to lock in favorable prices after fresh news broke that would almost certainly change the price of the funds the next day.
At the same time, the SEC and Congress are attempting to tighten rules covering mutual funds. Several senators are drafting a bill that would ban fund companies from paying brokers to steer clients toward specific funds. The House has already passed narrower legislation, which would require mutual fund companies to disclose more information about their fees and operations.
“We’re taking the brokerage community off the gravy train,” Sen. Peter Fitzgerald, R-Ill., said at a news conference, according to the Associated Press.
In Franklin’s case, both the Massachusetts charges and the SEC’s planned action focus on market timing
Franklin also said it has received requests for information from the Florida Department of Financial Services, but did not give details. An agency spokeswoman could not immediately provide more information.
Franklin disclosed the news Monday in an 8-K, the form companies file with the SEC to report significant events.
Franklin previously disclosed that it is facing queries from California Attorney General Bill Lockyer, New York Attorney General Eliot Spitzer and the U.S. attorneys in Northern California and Massachusetts. Lockyer is focusing on whether Franklin and two other California fund companies fully disclosed payments they made to brokers to sell their funds to investors, a scheme his office referred to as “pay to play.”
“While the attorney general believes market timing and late trading are abuses that should be subject to enforcement actions, we believe the pay-to- play problem has a more direct and broader effect on investors,” said Lockyer spokesman Tom Dresslar.
Franklin’s stock price, which dipped last week after the Massachusetts charges became public, shrugged off the latest news. Shares closed at $56.84, down 18 cents on Monday. The company also said it had $343.4 billion in investor assets under management at the end of January, up 2 percent from December.
But Franklin’s business could be hurt if the charges prompt mutual fund investors to shift their money to other firms. The California Public Employees’ Retirement System, the nation’s largest pension fund, is scheduled to consider terminating Franklin’s contract on Tuesday.