Lockyer Cleared to File Fund Suit

A Los Angeles Superior Court judge Tuesday tentatively affirmed the right of California Atty. Gen. Bill Lockyer to sue mutual fund giant American Funds under the state’s corporate securities law, rejecting the fund company’s contention that Lockyer was expressly preempted by federal law.

Lockyer’s suit alleges that American Funds violated state law by failing in its sales prospectuses and other documents to properly tell its 20 million shareholders how it paid brokerages to pitch its products.

American Funds urged Judge Carl J. West to toss out the suit, saying the National Securities Markets Improvement Act of 1996 bars states from creating securities registration requirements that differ from those of the federal Securities and Exchange Commission, which oversees prospectuses for securities such as mutual fund shares.

At Tuesday’s court hearing, Deputy Atty. Gen. Mark Breckler argued that the federal act did not preempt the state from bringing its case.

West ruled that California was not shown to have explicitly overstepped the act. However, West set a hearing for Nov. 9 on a related challenge from American Funds that the state’s case conflicted with Congress’ intention in passing the 1996 law.

“The judge has not yet decided whether the California attorney general has the authority to bring this case,” said American Funds spokesman Chuck Freadhoff. “We look forward to responding to the judge’s request for additional information.”

American Funds, a unit of Los Angeles-based Capital Group Cos., has for years made special marketing-related payments to brokerages that sell its products.

Lockyer’s suit, filed March 24, alleged that American Funds failed in its prospectuses to fully disclose $426 million in such “shelf-space” payments in the last five years, although the firm alluded to them in general terms. As a result, investors couldn’t know that the brokerages had special incentives to sell American Funds, the suit claimed.

In a show of defiance, the firm beat Lockyer to court, filing its own suit against him the same morning.

The suit is one of the first against a mutual fund company since the attorney general was granted authority starting in 2004 to bring suits under the state’s corporate securities law. Lockyer previously used that authority to negotiate settlements with Franklin Resources Inc. and the marketing arm of the Pacific Investment Management Co. mutual funds for similar shelf-space deals.