Daniel Calugar strikes again. If there is one name you don't want in your client book of business, aside from Eddie Stern, it is Calugar's. For the second time this summer, Franklin Resources has paid for its dealing with the mysterious Las Vegas investor.
Last week, subsidiaries Franklin Advisers and Franklin Templeton Alternative Strategies agreed to pay a $5 million fine to settle charges brought by the office of the Secretary of the Commonwealth of Massachusetts William Galvin. The charges were originally filed back in February. The recent deal follows a much larger, $50 million settlement by Franklin Advisers with the Securities and Exchange Commission early last month.
According to the Massachusetts settlement documents, San Mateo, Calif.-based Franklin Advisers allowed Calugar to market time its Small-Mid Cap Growth fund in exchange for $10 million in "sticky assets" in the start-up FT Hedge Fund. "Sticky assets" is a term used to describe an arrangement between a management company and an investor in which the investor plunks down a large chunk of money that is to be left in an investment for a determined period of time so that the management company can collect fees on the money under management.
In order to gain the sticky assets, Calugar, the president of Security Brokerage, which subsequently had its registration terminated by the state of Nevada, the National Association of Securities Dealers and the SEC, was promised the ability to market time the Small-Mid Cap Growth fund, which prohibits the activity in its prospectus. An e-mail sent in late August 2001 on behalf of the Franklin executive brokering the deal with Calugar stated: "We understand that your investment in our hedge funds is contingent on your ability to invest in our mutual funds."
For his sticky investment, Calugar was granted permission to execute up to four round-trip exchanges in the fund each month. He was granted permission to exchange up to $45 million in the fund. The prospectus indicates that an investor may be considered a market timer if he exchanges shares out of the funds in excess of two times within a rolling 90-day period.
Calugar was also allowed to circumvent the firm's anti-timing policies by using Franklin's Fund/SERV. According to Franklin's internal policies, market timers are supposed to register with the firm or to place trades through the company's market-timing desk. Additionally, the firm waived the 2% redemption fee imposed upon market-timing trades for Calugar.
Even though Calugar was a known market timer to the firm, Franklin's William Post struck a deal with him because he could provide the sticky assets to the FT Hedge Fund, which Post was responsible for establishing. Post is formerly the senior vice president of Franklin Templeton Trust Co. and vice president of Franklin Templeton Alternative Strategies, the firm's hedge fund subsidiary, among other titles. Once the deal was finalized and Calugar transferred the sticky assets into the hedge fund, he became the hedge fund's first investor. His investment represented about 80% of the fund's total assets at the time.
"This case is another example of a mutual fund having one standard for the ordinary investor and an entirely different one for someone able to move millions and millions of dollars through it in market-timing trades," Galvin said. "The clear language of the prospectus, on which an investor is expected to rely, meant nothing when a high roller came to play."
Meanwhile, on the other front, Calugar wasted little time rapidly trading in and out of the mutual fund. Luck, however, was not on his side during a period of a little more than a month in September and October of 2001. He made three round trips, either over a two- or three-day period each time, and exchanged about $20 million a clip. The trades resulted in a net loss of approximately $700,000.
The Deal
For its part, Franklin seems to just want to put this whole episode behind it. "While Franklin Advisers and FTAS did not admit or deny engaging in any wrongdoing, the company believes that it is in the best interest of the company and its funds' shareholders to settle this issue now and move forward," the firm said in a statement. "The administrative complaint addressed one instance of market timing that was also a subject of the Aug. 2 settlement that Franklin Advisers reached with the SEC." In that case, Franklin agreed to pay $30 million in disgorgement and $20 million in civil penalties.
"Mutual fund companies have a fiduciary responsibility to their shareholders under the law," Galvin said. "This case demonstrates that violations of that responsibility are hardly rarities in the mutual fund industry."
In a document posted on its Web site, Franklin listed several instances where it turned down offers similar to Calugar's deal, in a possible attempt to show the abuses weren't widespread. One such instance displayed is a request from a $3 billion hedge fund about potential sticky assets in exchange for increased trading.
Franklin also said that it has instituted a number of policies designed to improve governance and controls. In January, it standardized its market-timing policy across all of its U.S. funds and amended its prospectuses. It also brought uniformity to its redemption fee policy in 22 funds. In June, it implemented a mandatory redemption fee to be charged on most funds exchanged within five days of NYSE trading.
But despite the settlement and the reforms, there still seemed to be one point of contention. Galvin said the firm admitted guilt, but the firm said it neither admitted nor denied guilt. However, the consent order states: "Solely for the purpose of settlement, the respondents admit to the division's statements of fact set out in the offer and consent to the entry of this order."
