CA Attorney General Probing Fund Sales Misdeeds

January 2, 2004 ( - Mirroring activities by colleagues in other states, California Attorney General Bill Lockyer is now investigating whether three California-based mutual funds didn't disclose receiving compensation for recommending certain mutual funds.

Lockyer wouldn’t name the fund targets, but did disclose that his office also may become more aggressive in investigating other securities-related issues, Reuters reported. San Mateo, California-based Franklin Resources Inc. later confirmed it was one of the companies subpoenaed by Lockyer, according to the report.  Reuters also reported that Los Angeles-based Capital Group Companies confirmed that they had been subpoenaed by Lockyer’s office – just a day after a new law took effect granting the California attorney general authority to pursue violations of the state’s securities law and bring civil lawsuits for violations.

“We want to make sure California investors receive any benefits of restitution and reform,” Lockyer told Reuters. “It’s to show aggressive interest but also to inform whistle-blowers to inform us with vital tips.”

Lockyer, a possible candidate for California governor in 2006, said his probe is similar to a recent action by the US Securities and Exchange Commission (SEC), which investigated mutual funds sales practices by Wall Street giant Morgan Stanley. Morgan Stanley in November agreed to pay $50 million to settle federal charges for not telling investors about compensation it received for marking particular funds (See  Morgan Stanley Confirms Spitzer, SEC Fund Probe Ties ).

The three fund companies are considered the probe’s “initial subjects,” but the investigation may expand to other fund companies and broker-dealer firms who sell mutual funds to consumers, the AG said in a statement ( Attorney General Lockyer Launches Investigation of Fraudulent Sales Practices by Mutual Funds ). The practice targeted by Lockyer’s probe is known in the industry as “selling shelf space.” The phrase refers to spots on broker-dealers’ list of recommended buys which mutual funds secure by paying broker-dealers cash or commissions.

Lockyer’s probe is not currently focused on alleged abuses of “market timing” or “late trading,’ according to a statement.  The “shelf space” problem, he explained, has broader implications for investors. “We’re going after fraud at the front end,” said Lockyer. “Misleading investors strikes at the heart of our laws and the consumer protections those laws provide.”   

Franklin Resources’ internal probe of potential trading abuses has pinpointed instances of frequent trading in shares of certain funds by two current or former employees in their personal 401(k) accounts, including one trader and one officer of its funds.    Both employees have since been placed on administrative leave and the officer has resigned from his position with the funds (see  Franklin Templeton Finds Two Market Timing Problems ).