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Franklin Forks Over $50M to Settle Fraud SEC Offers Praise for its Pursuit of Timers


Franklin Advisers wiped away some of the muck from the mutual fund trading scandal last week after agreeing to a $50 million settlement with regulators for its involvement in inappropriate trading of mutual fund shares.

The Securities and Exchange Commission said San-Mateo, Calif.-based Franklin, the advisor for the Franklin and Templeton mutual funds, permitted more than 30 favored clients to engage in market timing from 1996 through 2001, a pattern of behavior that contradicted the language found in fund prospectuses.

The case marks the 10th settlement by a mutual fund company since last September, when an emboldened New York Attorney General Eliot Spitzer launched a full-scale investigation into what has been a train wreck of abusive mutual fund trading practices. Under the terms of the settlement, Franklin will pay $30 million in disgorgement and a $20 million civil penalty. The financing for the settlement has already been accrued in the form of a $60 million charge taken in the second quarter.

The SEC also mandated that Franklin beef up its compliance and reporting procedures including a biannual review by an independent third party. The hired consultant will be tasked with developing a plan to distribute the recouped $50 million to fund shareholders. "We are fully committed to making any necessary policy changes that will help us better serve our shareholders," said Martin Flanagan, co-CEO of Franklin Resources, parent company to Franklin Advisers. Franklin didn't admit or deny any wrongdoing.

The punishment was less severe than at other high-profile fund shops such as Alliance Capital, Bank of America/Fleet and Putnam Investments. In fact, in a departure from its typical language, the SEC made a point to acknowledge that Franklin "as a whole has generally sought to detect, discourage and prevent market timing in its funds." The SEC further noted that Franklin increased its efforts to curtail market timing in 1999, at a time when many other mutual fund companies were encouraging timers. "Franklin has rejected many potentially lucrative proposals from market timers," the SEC wrote in a cease-and-desist order.

Cara Robnett, branch chief of the enforcement division at the SEC's San Francisco district office, told Money Management Executive, "One of the differences we noticed was that Franklin was taking more steps to curb market timing earlier than other funds. Some other funds were seeking out market timers, and that wasn't the case here. So we took that unusual step of presenting some of the countervailing facts."

Still, the SEC determined that serious sanctions were warranted. After other identified market timers were told to stop their activities in September 2000, Franklin let one preferred client continue to time $75 million in assets with unlimited trades for several more months, according to the complaint. Franklin also gave known market timer Daniel Calugar permission to time a mutual fund that prohibited rapid in-and-out trades in exchange for a $10 million investment in an upstart Franklin hedge fund. Calugar's Security Brokerage had its registration terminated by the state of Nevada, the National Association of Securities Dealers and the SEC last November.

"The SEC, in particular, seems to be differentiating clearly among the different types of situations that exist among the companies that have been involved," said Don Cassidy, senior research analyst at Lipper of New York. He also noted that the Franklin settlement sends a signal to other funds that haven't been named yet or are still in the process of working with regulators as to what kind of cooperation is the best kind. In that, he was referring to Invesco, which initially fought back against allegations and now is being slapped with a second round of charges. Often, the attitude or approach a firm takes in responding to allegations can factor into the outcome of a settlement.

Since being formally accused of fraud, Franklin has weathered some outflows but not nearly to the extent of its scandal counterparts. In the second quarter, Franklin-distributed funds lost $147 million in assets compared to a net gain of $4.3 billion in the first quarter, according to Financial Research Corp. of Boston. Shares of publicly traded Franklin Resources have plummeted more than 15% in the five months since the charges were handed down.

Wall Street's sell-side analysts viewed the settlement positively, even as a vindication of sorts, citing the SEC's attempt to distinguish Franklin from the more egregious instances of fraud in the fund industry. "These were very minor transgressions. It was certainly not a broad-based conspiracy to bring in market timers. I think the size of the fine reflects that," said Jeff Hopson, an analyst at A.G. Edwards of St. Louis, Mo. "The impact will be relatively small in the scheme of things."

Merrill Lynch Analyst Guy Moszkowski said, in a note to clients, "We view the settlement positively in that it removes an overhang on [Franklin] shares, supports the SEC's opposition to market timing, but also supports Franklin's claims that it has been tougher on market timers than many firms in the past few years. This, in turn, could reassure institutional clients, restoring net flows." Both Moszkowski and Hopson have a buy rating on the stock.

But Franklin is not out of the woods yet. Civil fraud charges brought by Massachusetts Secretary of the Commonwealth William Galvin in February are still pending. On top of that, the SEC is probing more than 20 of the biggest mutual fund complexes, including Franklin, regarding payments made to 401(k) plan sponsors to feature their funds in its investment lineup. In anticipation of further sanctions, the company took a $21.5 million charge against second-quarter earnings to cover any future revenue-sharing settlements. Fund tracking firm Morningstar of Chicago maintains a "proceed with caution" recommendation on all Franklin and Templeton mutual funds.