Franklin Advisors Announces $20M Settlement
This practice is known as compensating brokerage firms for “shelf space.” As part of the settlement, Franklin agreed to pay $1 in disgorgement and a $20 million penalty as well as undergo certain compliance reforms.
The Commission’s order finds, and Franklin neither admits nor denies, that between 2001 and 2003, FTDI had shelf space agreements with 39 broker-dealers pursuant to which FTDI allocated $52 million from brokerage commissions related to trades of fund shares (which were fund assets) to the broker-dealers in exchange for shelf space. Franklin did not adequately disclose these agreements to the fund boards or the fund shareholders.
The use of brokerage commissions to compensate brokerage firms for marketing created a conflict of interest between FA and the funds because FA benefited from the increased management fees resulting from increased fund sales. Mutual funds that follow this practice of using brokerage commissions for marketing have an incentive to do their fund portfolio trading through brokerage firms that might not be the best choice for fund shareholders. FA was required, but failed, to disclose adequately the arrangements to the boards so they could approve this use of fund assets, and to shareholders so they could be informed when making investment decisions.
FTDI aided and abetted FA’s violations. FTDI benefited from the arrangements by avoiding paying for shelf space out of its own assets. FTDI had the opportunity to disclose these agreements to the boards but failed to do so.
Linda Chatman Thomsen, Deputy Director of the SEC’s Division of Enforcement, said, “This settlement reiterates the importance of proper disclosure to the fund boards. Franklin’s boards did not have sufficient information to assess the effectiveness of the advisers and distributors hired on behalf of the fund shareholders.”
Helane L. Morrison, District Administrator of the Commission’s San Francisco District Office, stated, “Franklin’s inadequately disclosed practice of using fund assets to compensate brokerage firms for shelf space interfered with the boards’ ability to protect the interests of the fund shareholders. We think this settlement sends a strong message regarding the importance of full disclosure.”
The $20 million civil penalty will be distributed to the Franklin funds whose assets were used to pay for shelf space. Franklin will also undertake compliance measures designed to protect against future violations. These measures include retaining an Independent Distribution Consultant to develop a Distribution Plan to distribute the total penalty ordered and appointing an employee to design and implement policies and procedures governing Franklin’s shelf space arrangements.
The order finds that FA violated Section 206(2) of the Investment Advisers Act of 1940, and that FA and FTDI violated Sections 34(b) and 17(d) of the Investment Company Act of 1940 and Rule 17d-1 thereunder, and requires FA and FTDI to cease and desist from violating these provisions. FA and FTDI consented to entry of the order without admitting or denying the findings.
FA and FTDI are wholly owned subsidiaries of Franklin Resources, Inc., a Delaware corporation headquartered in San Mateo, Calif. Franklin Resources, Inc. and its subsidiaries operate under the name “Franklin Templeton Investments.” Through its subsidiaries, FT provides a broad range of investment advisory, investment management, and related services to open-end investment companies, including a family of over 100 retail mutual funds.