Massachusetts Hits Franklin with Fraud Charges

February 4, 2003 ( - Massachusetts securities regulators have charged mutual fund company Franklin Resources and William Post, a former Franklin official, with fraud for their role in an improper trading scheme.

The suit filed by Secretary of the Commonwealth William Galvin alleged that, in 2001, Post made an agreement with Daniel G. Calugar of Las Vegas, president of Security Brokerage, Inc., in which Calugar would make a $10 million investment in Franklin Templeton Hedge funds in return for being allowed to market-time Franklin Templeton mutual funds.   The complaint goes on to note that the prospectus for the fund that was market-timed specifically prohibited market timing.

E-mail Trail

Franklin e-mails made it apparent that several Franklin employees were aware of the agreement between Post and Calugar, according to a statement from Galvin’s office.   That statement noted that an e-mail of August 29, 2001, sent to Calugar on behalf of Post confirmed the agreement and stated, “We understand that your investment in our hedge funds is contingent on your ability to invest in our mutual funds.”   On September 6, Calugar wired $10 million to Franklin for the Franklin Templeton Strategic Growth Fund, L.P., a hedge fund. That investment constituted 59% of the funds in FTSG.   Three days later, Calugar’s firm, SBI, “opened an account with the Franklin for the sole purpose of making prohibited market-timing trades in the Franklin Small-Mid Cap Growth Fund,” the complaint charged.

Other e-mails released by Massachusetts securities regulators as part of the complaint note that as early as March of 2001, senior Franklin executives were courting Calugar’s limited partnership, DCIP, as an investor, although they were aware that he was a market-timer, according to the complaint.   Then, on April 6, Calugar set up a $30 million profit-sharing account with Franklin under the name of his broker-dealer, Security Brokerage Inc. – at which point he began lobbying for special privileges to time the firm’s Small-Mid Cap Growth Fund in exchange for parking money in the Franklin Templeton Strategic Growth Fund LP.

Those negotiations initially involved Post, but eventually resulted in a favorable hearing from Charles E. Johnson, a member of Franklin’s office of the president and son of founder Charles B. Johnson, according to the complaint.

Executive Concerns

Several Franklin executives expressed concerns with the arrangements, according to e-mails provided in the complaint, including Peter Jones, president of Franklin/Templeton Distributors, and Tom Johnson, a sales executive, who at one point said the proposed arrangement “doesn’t pass the smell test.”

Despite those concerns, Franklin Templeton ultimately relented, allowing Calugar, through his broker-dealer, to make four round-trip exchanges in and out of the Small-Mid Cap Growth Fund a month, in violation of the fund’s prospectus, according to the complaint. Franklin also agreed to waive the 2% redemption fee it normally charged investors who made more than two round-trip exchanges per month.

The complaint goes on to outline the contents of an August 17, 2001, e-mail from Calugar to Post where he stated, “I would like to give (portfolio manager) Ed Jamieson a call ( to) make sure that he feels comfortable with the timing investment that we plan to make in the Franklin Small Cap Fund. I know you have discussed this issue with both Ed and (another executive), but I think it would be helpful for me to put in a personal call to the fund manager to give him the chance to ask any questions he might have and make sure that we are all on the same page.”

OnSeptember 6, 2001, Calugar wired the $10 million toFranklinfor investment in the hedge fund, and three days later opened an additional account withFranklinfor the sole purpose of making market-timing trades in the mutual fund, according to the complaint.   Calugar continued to market-time the Small-Mid Cap Growth Fund through late 2002.