Jan. 3–California Attorney General Bill Lockyer announced Friday that his office will launch an investigation into whether three large mutual fund companies in the state defrauded investors byfailing to disclose deals with brokers that ensured preferential treatment for the companies’ funds.
The move is the latest in a series of probes into the $7 billion mutual fund industry. The Securities and Exchange Commission and New York Attorney General Eliot Spitzer have conducted high-profile investigations into practices such as market timing and late trading, which erode the profits of some investors while benefiting others.
Lockyer’s office did not name the three companies his staff is investigating. But he said the impetus for the investigation was a Securities and Exchange Commission case two months ago in which brokerage Morgan Stanley paid $50 million to settle charges that it had failed to properly disclose its compensation agreements with certain mutual fund companies.
“Some people were concerned that California investors weren’t adequately represented in the prior settlements,” Lockyer said. “We want to make sure there’s not just a New York focus on remedies, but that California investors also are represented.”
Three California companies — Franklin Resources of San Mateo, Capital Research and Management of Los Angeles and Pimco of Newport Beach — were among those that had special agreements to pay extra compensation to Morgan Stanley in exchange for preferred marketing of their funds.
The practice is known as buying “shelf space” for the mutual funds. The practice itself is not at issue, but rather whether the companies disclosed it to consumers.
Franklin Resources, one of the largest fund companies in the country, confirmed Friday that it had received a subpoena from Lockyer’s office “seeking information on our arrangement with brokers to sell our mutual funds’ shares,” said Franklin spokeswoman Stacey Johnston. Franklin manages more than $300 billion in assets.
Like many other mutual fund companies, Franklin is answering questions from numerous authorities regarding fund trading. The Massachusetts Secretary of the Commonwealth and U.S. attorneys in California and Massachusetts are among those investigating, according to the company’s Web site.
Capital Research and Management, which administers the American Funds, also received a subpoena Friday, said company spokesman Chuck Freadhoff.
“We believe everything we have done as far as dealing with broker-dealers is in accordance with SEC and NASD rules,” he said, referring to industry regulators. Payments made to brokers are “disclosed in the prospectus and statement of additional information for each fund,” he said.
Pimco representatives could not be reached Friday to discuss whether the company was a subject of the investigation.
Lockyer announced the investigation one day after a new law took effect giving him more authority in securities fraud cases.
SB 434 gives the attorney general — along with the state Department of Corporations — the ability to investigate possible violations of the state Corporate Securities Law and to sue alleged violators. Before Thursday, only the Department of Corporations had that power.
“We’re going to aggressively participate in these investigations and possible prosecutions on behalf of California investors,” Lockyer said.
Lockyer said he is contemplating other inquiries into possible financial fraud in the hedge fund and investment banking industries.
There are more than 8,200 mutual funds for investors to choose from, and about 95 million Americans have money in them, according to research by the Investment Company Institute.
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