In the latest legal blow to a major mutual fund company, Massachusetts regulators accused the parent company of Franklin Templeton Investments of fraud, alleging the firm let a Las Vegas businessmanmake $45 million worth of improper mutual fund trades in exchange for his $10 million investment in a Franklin hedge fund.
The allegations concern dealings between Franklin and Las Vegas securities broker Daniel Calugar, who had already been accused by the Securities and Exchange Commission of earning $175 million from improper trading in mutual funds managed by Alliance Capital Management and Massachusetts Financial Services.
In a civil complaint filed Wednesday, the Massachusetts Securities Division contended Calugar made a similar deal with Franklin Templeton, the No. 4 mutual fund company with $337 billion assets under management.
The complaint names only San Mateo, Calif.-based Franklin Resources and its subsidiaries as respondents, but says that Calugar’s activities were known to top management, including William Post, who until mid-December was president and chief executive of the northern California region for Templeton/Franklin Investment Services.
“Senior Franklin Templeton executives had knowledge of and furthered the activity and were reluctant to pass up the profits generated by courting multimillion dollar hedge fund clients,” the complaint states.
Franklin, however, released a statement saying the proposal was “unauthorized and rejected by management.”
“Franklin Resources’ first priority is to protect the best interests of our funds’ shareholders and our clients, and we are confident that none of them was harmed by these investments,” the statement said. The company said that previously disclosed discussions with the SEC and other regulators continue.
The SEC has not formally charged Franklin with any wrongdoing, but an SEC official familiar with the investigation said Thursday the Commission had completed a broader investigation that “documented market timing beyond Calugar” at Franklin and that the parties were in settlement talks. A settlement was expected within a few weeks, the official said, speaking on condition of anonymity.
An SEC spokesman declined to comment. Scott Frewing, an attorney for Calugar, declined to comment.
Post, who is not formally accused of wrongdoing, could not be reached for comment. According to the complaint, he was placed on administrative leave Dec. 15 “because of questions concerning the completeness of his cooperation in an internal investigation regarding market timing.”
Calugar’s legal troubles are the latest in the improper fund trading scandal that has quickly spread across the $7 trillion fund industry. The investigation by state and federal authorities has expanded to dozens of other fund companies including Alliance Capital Management, Invesco Funds Group, Putnam Investments, Strong Investments and Prudential Securities. In December, Alliance agreed to $600 million in settlements with state and federal regulators over charges of improper trading.
According to e-mails included in the complaint filed Wednesday, a company salesman, Tom Johnson, recommended against setting up a profit-sharing plan in which Calugar was the sole participant on the grounds “it doesn’t pass the smell test.”
But the arrangement went forward, with Calugar writing Post on Aug. 13, 2001, and explicitly describing a “market timing approach” to the $45 million investment in the Franklin Strategic Small Cap Growth Fund, which apparently allowed him four exchanges or “round trips” per month and waived the fund’s 2 percent redemption fee for market timing trades.
“I recognize that market timing is a privilege and not a right,” Calugar wrote.
In the same document, Calugar wrote his company would “keep the hedge fund positions for at least as long Security Brokerage is permitted to have the timing allocation in Franklin Templeton mutual funds.” Calugar redeemed his $10 million investment in the hedge fund in August 2002.
Market timing is a type of quick, in-and-out trading that is prohibited by many fund companies because it skims profits from other shareholders. Unlike late trading, which occurs after markets have closed, market timing is not illegal. But regulators have contended that companies who officially forbid the practice but made exceptions for certain clients committed fraud.
“This case is another example of a mutual fund having one standard for the ordinary investor and an entirely different one for some able to move millions and millions of dollars through it in market timing trades,” Massachusetts Secretary of State William Galvin said.
Franklin is the No. 4 fund company in assets behind Fidelity Investments, Vanguard Group and American Funds, according to Financial Research Corp.
