The Securities and Exchange Commission may take civil action against one of the top executives of a mutual-fund company, Franklin Resources of San Mateo, for permitting at least one investor to make questionable trades in mutual funds, the company disclosed Tuesday.
It is the first time an official of Franklin, the fourth-largest fund company with more than $340 billion under management, has been named as a potential regulatory target over an issue that regulators charge harms small investors by skimming their profits and adding unnecessary fees.
Regulators from the SEC, California, New York, Florida and West Virginia are investigating Franklin over the trading issue, and Massachusetts filed a civil fraud complaint Feb. 4.
Franklin acknowledged in its quarterly financial report Tuesday that the possible SEC action could come against Gregory Johnson, president and co-chief executive. Johnson is one of the sons of Franklin’s chairman, Charles B. Johnson.
The company’s statement called the potential SEC action “unwarranted.”
And in a legal response to the Massachusetts complaint, filed by Franklin on Tuesday, the company defended Gregory Johnson, who at the time was the president of Franklin’s mutual-fund sales division.
A Vegas investor
In 2001, Johnson approved letting a Las Vegas investor, Daniel Calugar, trade up to $45 million in and out of an $8 billion small-stock mutual fund four times a month. Such a practice would normally get Calugar kicked out of the fund for “market timing,” because it can shortchange other investors.
According to the legal response, Johnson believed he was following fund rules allowing such investments if they were so small they wouldn’t harm other investors, the company said.
However, in its Feb. 4 complaint, Massachusetts charged that Franklin allowed Calugar to market-time in order to obtain a $10 million investment from him in a new Franklin hedge fund. If true, such a “sticky asset” arrangement is a more serious matter, experts say.
Market-timing is not typically illegal, but legal experts say recruiting an investor to a hedge fund by allowing him to market-time a mutual fund could violate securities laws.
In its response Tuesday, Franklin said that although the two investments were “related,” Franklin “made sure that Calugar understood that the investments were independent of each other.”
Franklin spokeswoman Lisa Gallegos said Tuesday that the company believes “there is nothing that forms a basis for Greg Johnson to be suspended” or put on leave.
Still, the SEC’s investigation isn’t limited only to the Calugar arrangement, according to Franklin. It also focuses on “other instances of alleged market-timing by a limited number of third parties that ended in 2000,” the company said.
Franklin also is being investigated for its past practice, common in the industry, of steering trading commissions to brokerages like Morgan Stanley that agreed to recommend its funds to clients. Clients usually didn’t know their broker had an incentive to push the funds, regulators charge.
Franklin, which discontinued such deals in November, said it always disclosed to investors that it sometimes chose brokerages based on their willingness to promote Franklin funds and always sought the best commission prices.
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