Fund Scandal Spreads to Sales

Times Staff Writer

The Securities and Exchange Commission is looking into whether 14 of the country’s largest mutual fund companies, including two based in Southern California, engaged in improper sales practices, industry and regulatory officials said Monday.

The disclosure came as brokerage giant Morgan Stanley agreed to pay $50 million to settle SEC charges that it had received substantial hidden fees from the 14 companies in return for promoting their funds to investors over those offered by dozens of competitors.

The Southland firms being looked at by the SEC are Pimco Funds, the Newport Beach-based bond-fund giant, and Capital Research & Management Co. of Los Angeles, which runs the American Funds group.

Sales tactics have received less publicity than so-called late trading and market timing, the twin practices at the heart of the investigation launched by New York Atty. Gen. Eliot Spitzer in early September.


But regulators fear that sales abuses could be widespread and costly to investors and may have existed far longer than late trading and market timing, despite past attempts to stamp out improper sales practices.

The 14 companies were members of Morgan Stanley’s so-called Partners Program.

The companies paid undisclosed fees -- sometimes in cash, but often in the form of commission-generating brokerage business -- for placement on a list of preferred funds that Morgan Stanley brokers recommended to investors, according to administrative actions filed Monday by the SEC and the NASD, formerly the National Assn. of Securities Dealers, a self-regulatory group overseeing the brokerage industry.

The SEC charged Morgan Stanley with failing to disclose the brokerage payments, while the NASD alleged the firm violated rules that forbid brokers from pushing sales of one mutual fund over others in exchange for extra fees.


The SEC said it also was examining 15 other large brokerage firms to determine whether they had abusive sales practices.

Such tactics as being named to preferred sales lists can help fund companies stand out from rivals.

The moves are known in the fund industry as jockeying for shelf space -- a reference to the inducements food and consumer products companies give to supermarkets in exchange for high-profile placement of their goods on store shelves.

The payments by the fund companies were in addition to the usual commissions Morgan Stanley received for selling their funds to investors.


Besides Pimco and Capital, other fund companies in the Partners Program included industry leader Fidelity Investments, Alliance Capital Management, Putnam Investments, AIM Investments, Evergreen and San Mateo-based Franklin Templeton, said Andrea Slattery, a Morgan Stanley spokeswoman.

“We will be looking at all of the fund companies that participated in this program,” said Merri Jo Gillette, associate enforcement director in the SEC’s Philadelphia office.

Securities regulators are looking closely at a variety of fund practices, and simply being investigated does not imply wrongdoing by any fund firm. While some firms may have committed infractions, others probably did not, Gillette said.

Chuck Freadhoff, a Capital Research spokesman, said the SEC asked for information about sales practices two months ago.


The firm’s first priority when directing trades to brokerage firms is assuring the best price for investors, he said. Fund distribution deals are secondary, and are properly disclosed to investors.

“If Morgan Stanley could offer us best execution, only then would we consider sales of our funds in determining where to place a trade,” he said.

A Fidelity spokesman said, “We are not aware of any such investigation.”

Franklin Templeton, in a statement, said, “We are on a number of broker-dealer preferred-vendor lists, a common arrangement in the industry, and we believe that all payments have been made in accordance with existing regulatory guidelines.”


The firm also said the payments had been disclosed to investors.

Putnam, AIM, Van Kampen and Evergreen declined to comment. Pimco couldn’t be reached for comment.

In its action against Morgan Stanley, the SEC alleged that the firm paid higher commissions to sales people and branch managers for selling preferred funds.

In a related infraction, Morgan Stanley also failed to tell clients investing more than $100,000 in the so-called B shares of various Morgan Stanley funds of those shares’ fees compared with A shares, the SEC said.


Morgan Stanley will pay $25 million in fines and return $25 million in profits. The $50-million total will go into a restitution fund for investors.

Morgan Stanley neither admitted nor denied guilt, but agreed to implement reforms, including no longer accepting fund-distribution payments in the form of brokerage commissions.

“I regret that some of our sales and disclosure practices have been found inadequate,” said Philip J. Purcell, Morgan chief executive, in a statement. “We take this most seriously because it strains the bonds we have with our clients and our financial advisors.”

Morgan Stanley’s sales practices already had been targeted twice by regulators this year.


In August, Massachusetts regulators charged the company with fraud.

A month later, the firm was fined $2 million by the NASD for allegedly using forbidden incentives -- including sports and concert tickets -- to get its brokers to push in-house funds over those of rival firms.


Times staff writer Kathy M. Kristof contributed to this report. Bloomberg News was used in compiling it.