Feb. 19–Mutual fund giant Franklin Resources Inc. fired back at Massachusetts Secretary of State William F. Galvin, saying it did not commit fraud when it allowed a wealthy investor to make moremarket-timing trades in one of its mutual funds than permitted by company policies.

This month, Galvin accused Franklin, based in San Mateo, Calif., of securities fraud for allegedly striking a deal with Las Vegas broker Daniel Calugar that it wouldn’t give to other investors, and of violating company policies on market timing. With more than $330 billion in assets under management, Franklin is the biggest mutual complex to be targeted in the investigations of improper trading roiling the industry.

Galvin said Franklin allowed Calugar to make up to 12 round-trip trades, or in-and-out transactions, over a 90-day period in a small-cap stock fund in exchange for his investing $10 million in a Franklin hedge fund. Company policies consider any investor who makes more than two round-trip trades in a 90-day period to be a potential market timer.

But in an answer to Galvin’s complaint filed this week, Franklin said company officials could allow investors to trade more frequently so long as they determined the trades would not harm the fund or its other shareholders.

Franklin said the $20 million trades Calugar made were such a small percentage of the $8 billion fund that his trades “could not possibly harm management of the fund.” Moreover Franklin said Calugar eventually made just three $20 million round-trip trades in the fund in the fall of 2001, and wound up losing $700,000 “and caused no harm to any other fund investor.”

Also, Franklin said it refused to waive early-withdrawal penalties on Calugar’s investment in the hedge fund, proof that the company did not strike a quid pro quo with the investor. Franklin said it further rejected Calugar’s request to invest more in the hedge fund in exchange for being able to market time international funds.

However, Franklin’s legal response revealed that the company’s co-chief executive, Gregory Johnson, was involved in the Calugar arrangements in 2001, when he was chairman of Franklin’s sales organization. For example, Franklin said Johnson “did not consult” the company’s prospectus language on market-timing limits when he appeared to bless the Calugar deal, but relied on advice from the fund manager that the trading would not harm the fund.

“While Franklin and Greg Johnson certainly wish that he had carefully reviewed the prospectus and received advice” on Calugar from Franklin’s market-timing cops, “his failure to do so does not constitute a violation of law.”

This week Franklin disclosed in a separate filing that the US Securities and Exchange Commission’s enforcement staff is intending to file civil charges against Johnson and the company over “instances of alleged market timing by a limited number of third parties that ended in 2000.”

Johnson is the latest top executive targeted in the industry scandal.

Two weeks ago, the SEC forced the CEO and president of MFS Investment Management to serve suspensions of up to three years for their roles in allowing market timers to trade up to $2 billion in 11 of the Boston firm’s mutual funds.

If the MFS case is any guide, Franklin may have trouble arguing that it had discretion to allow traders to exceed market-timing limits.

Though not an exact parallel, the SEC rejected MFS’s argument that when it allowed timers to trade the 11 funds in excess of company policies, it did not commit fraud because the funds were too big to be hurt by such activity. MFS agreed to a $350 million settlement with federal and state regulators in the case.

Galvin’s office declined to comment. Calugar and his firm, Security Brokerage Inc., were charged with fraud by the SEC in December for allegedly making $175 million in illegal late trades and improper market-timing trades at mutual fund companies, including MFS. Calugar’s attorney, Colin H. Murray, declined to comment.

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BEN, SLF,