California Settles Probe of Franklin
California regulators on Wednesday settled their investigation of mutual fund giant Franklin Resources Inc. after the company agreed to pay fines and restitution, and to tell investors more about its marketing agreements with brokerages.
The settlement, details of which initially were disclosed last week, is the latest by state and federal regulators in their year-old drive to reform fund industry practices viewed as potentially harmful to investors.
San Mateo, Calif.-based Franklin will pay a $2-million civil penalty to the state’s coffers, $2 million to cover the costs of Atty. Gen. Bill Lockyer’s investigation, and $14 million in restitution to be distributed among Franklin funds that have incurred certain costs under the company’s practices.
Franklin, which manages $371 billion and is the fourth-largest U.S. fund company, did not admit or deny wrongdoing. The firm said it believed that “settlement of this matter is in the best interests of the company and its fund shareholders.”
The state’s case centered on so-called shelf-space arrangements Franklin has had with brokerages that sell its funds under brand names including Franklin and Templeton. The arrangements obligated Franklin to compensate brokerages that agreed to highlight the company’s funds in sales efforts.
The payments, either in cash or via commission-generating stock trades sent to the brokerages by Franklin funds, were in addition to whatever fees individual brokers earned for sales.
Although such arrangements have long been commonplace in the fund industry, federal and state regulators have taken a closer look over the last year, focusing on whether fund companies properly disclosed the agreements to investors.
Lockyer, in a complaint filed in Superior Court in Sacramento in conjunction with the settlement, alleged that Franklin’s disclosure was inadequate, and that investors therefore may not have understood potential conflicts of interest -- for example, the risk that a brokerage would “recommend funds that best compensate the broker-dealer ... rather than to recommend investments that meet the customer’s personal investment needs.”
Regulation of mutual funds has primarily been the responsibility of the Securities and Exchange Commission. But Lockyer said early this year that he was investigating practices of California fund companies under a new state anti-fraud law.
In September, Lockyer and the SEC jointly agreed to a settlement with the marketing arm of the Pimco mutual funds over disclosure of shelf-space arrangements. Pimco agreed to pay $9 million to California, $5 million to the federal government and $6.6 million in restitution to seven of its stock funds.
Franklin has said it is in negotiations to settle an SEC probe of its shelf-space arrangements. The Times reported last week that Franklin is likely to pay about $18 million to resolve the SEC investigation. The SEC declined to comment Wednesday.
Franklin noted that it halted one shelf-space payment practice a year ago: It no longer directs trades to brokerages as compensation for marketing.
Franklin agreed in its settlement to improve disclosure of specific marketing agreements with brokerages.
Separately Wednesday, the brokerage industry’s chief regulatory group, the NASD, recommended that the SEC order more disclosure of so-called soft-dollar agreements -- arrangements by which brokerages provide free research and other services to mutual funds in return for a certain volume of trading business.
