Suit Against Edward Jones Is Dismissed

A state judge has thrown out California’s fraud lawsuit against brokerage firm Edward Jones & Co., in another defeat for Atty. Gen. Bill Lockyer’s attempt to assert authority over mutual fund sales practices.

Superior Court Judge Loren McMaster in Sacramento dismissed Lockyer’s 17-month-old suit against St. Louis-based Jones last week, ruling that California’s case conflicts with a federal law that gives U.S. regulators sole authority to set securities-industry disclosure rules.

Lockyer had alleged that Jones, one of the largest U.S. brokerages, failed to properly disclose sales arrangements it had with a handful of mutual fund companies in recent years. The deals gave the firm a financial incentive to recommend those funds to investors, even if competing funds may have been a better fit, the state alleged.

The sales practices came to light amid a wave of revelations about fund industry improprieties in 2003 and 2004.

Jones agreed in December 2004 to pay $75 million to end a Securities and Exchange Commission investigation into its fund sales arrangements. As part of the settlement, the firm significantly increased its disclosure of details involving its relationships with fund companies.

But Lockyer refused to join that settlement, calling it inadequate. Instead, he sued in state court under a then-new California securities anti-fraud law.

After months of legal maneuvering by both sides, the case was assigned to McMaster for trial. But in his ruling last week, the judge said Lockyer’s case “conflicts with the federal regulation of information provided in mutual fund prospectuses” and therefore was preempted.

A prospectus is a legal document that is supposed to detail an investment’s historical performance, risks, fees and other important information.

In a related fraud suit that Lockyer filed last year against Los Angeles-based mutual fund giant American Funds, a different state judge reached the same conclusion -- that Lockyer was treading on federal turf. That case was dismissed this year.

“The courts are basically saying, ‘Leave it to the federal government,’ ” said Richard Phillips, a securities lawyer at Kirkpatrick & Lockhart in San Francisco.

The purpose of the 1996 federal law that restricted regulation of securities-industry disclosure to federal authorities was to avoid having “50 different regulatory systems” for investments, Phillips said.

“Many believe that he [Lockyer] was trying to regulate the content of prospectuses,” said Jay Baris, a securities lawyer at Kramer Levin Naftalis & Frankel in New York.

But Tom Dresslar, a spokesman for Lockyer in Sacramento, denied that was the state’s intent in bringing the suits against Jones and American Funds.

“We are not trying to dictate in any way what goes into a prospectus,” Dresslar said. “What we’re saying is that you can’t defraud investors. You can’t omit material facts about what investors need to know.”

Federal law permits states to file fraud suits against investment companies, and Dresslar said the state would appeal McMaster’s decision on those grounds. Lockyer has appealed the dismissal of the American Funds suit using the same argument -- that the case is about fraud, not disclosure.

Lockyer’s goal in the Jones and American Funds cases, Dresslar said, was to extract a financial settlement for what the state regards as abuse of investors.

“We want compensation -- damages and restitution,” he said. Lockyer has not named specific dollar amounts of damages in either case, saying the numbers would be determined in court.

Two mutual fund companies -- Franklin Resources Inc. and PA Distributors Inc., which markets the Pimco funds -- in 2004 agreed to pay $18 million and $9 million, respectively, to settle Lockyer’s probes of their sales agreements with brokerages.

In a statement Thursday, Jones said it was “gratified that the court has ruled in our favor and dismissed the suit.”