Regulator in Mass. subpoenas Fidelity

2 other firms also served papers in trading probe

By Andrew Caffrey, Globe Staff, 10/17/2003

Fidelity Investments and two other investment companies were served subpoenas yesterday as the snowballing investigation of abusive trading practices has now ensnared some of the most prestigious names in the mutual fund industry.

A spokesman for Secretary of State William F. Galvin confirmed that his securities division subpoenaed employees of Fidelity, Franklin Templeton Investments, and Morgan Stanley. An investigator involved in the probe said the state is asking whether salespeople at the three firms helped brokers at the Boston office of Prudential Securities evade the mutual fund companies' prohibitions against market timing, the practice of quickly darting in and out of mutual funds to take advantage of price inefficiencies.

For example, Massachusetts is trying to determine whether the salespeople warned the Prudential brokers away from trading in certain accounts that were under heightened scrutiny by the mutual funds for market-timing trades, and instead advised them to trade in smaller amounts to avoid such scrutiny and disclosed other internal practices intended to prevent such trades, the investigator said.

The subpoenas seek sworn testimony from one current or former salesperson at each of the three firms. These wholesalers, as they are known in the industry, generally market company mutual funds to securities brokers and investment advisers, and are often paid or receive bonuses based on how much money they bring in, which investigators believe could serve as an inducement for them to conspire with market timers.

Galvin's office already has taken sworn testimony from current and former Prudential employees and officials, and it has subpoenaed company documents as part of its investigation into market timing at the firm's Boston office. The information obtained from those depositions led Massachusetts investigators to the three mutual fund companies.

Two weeks ago, five Prudential brokers targeted in the market-timing probe, as well as the manager of the Boston office were asked to resign by Wachovia Corp., which recently purchased Prudential's securities business.

Fidelity, Franklin, and other fund companies had previously received subpoenas from New York Attorney General Eliot Spitzer that they had termed a general inquiry about trading practices and policies. But the subpoenas from Galvin yesterday indicated Massachusetts is looking for specific involvement from employees at the three fund companies in either originating or accelerating market timing trades, the investigator involved in the probe said.

"This suggests that the problem is more widespread than had previously been recognized and that will hopefully lead to action to halt practices which have hurt individual investors," said Harry Miller, a securities attorney at the Boston firm of Perkins, Smith & Cohen, LLP.

The latest disclosures, coupled with other probes of mutual fund companies by federal, state and industry regulators, could further challenge the industry's image as a trustworthy guardian of investors' money.

The public's "faith in the almighty fund industry is not only capable of being shaken, but is quite literally being shaken as we speak," said James Lowell, editor of newsletter Fidelity Investor. "This has to be incredibly sobering days for any management involved in the fund industry."

Fidelity, the number two mutual fund company in terms of assets under management, has been a leading voice in the industry against market timing because it raises fund expenses for all shareholders and disrupts portfolio managers' investment strategies. Like other firms, Fidelity's fund prospectus warns it will close accounts of investors suspected of market-timing, and it also imposes fees for frequent trading and other restrictions intended to prevent the activity.

"All we know is that a Fidelity employee was sent a subpoena requesting the employee give information regarding the Prudential Securities matter," said Fidelity spokeswoman Anne Crowley. "We expect every employee to act consistently with the firm's policies and if we find at time any of our policies have not been followed, then appropriate action is taken."

Franklin Templeton, the nation's fourth largest mutual fund manager, said in a statement yesterday that it had received a subpoena from Massachusetts "addressed to a former Franklin Templeton employee related to the Prudential Securities matter." The employee left the firm in February and Franklin declined further comment.

Yesterday's subpoena was but the latest trouble for Morgan Stanley, which is the target of multiple investigations by Massachusetts, New York, and federal regulators over its mutual funds business.

Galvin has charged that Morgan Stanley failed to disclose that brokers in its Boston branch received incentives to sell in-house funds over other mutual funds, and on Tuesday Morgan Stanley disclosed in a regulatory filing that the Securities and Exchange Commission is considering "recommending enforcement action" in connection with the company's mutual fund sales practices.

In September, Morgan Stanley agreed to a $2 million fine by the National Association of Securities Dealers, which alleged the company engaged in improper contests to sell mutual funds.

Morgan Stanley spokeswoman Andrea Slattery said only that the salesperson subpoenaed by Massachusetts "has no involvement with" the company's "US registered mutual funds." She declined to comment on the employee's involvement in Morgan Stanley's overseas registered funds. The company, Slattery added, is cooperating with various regulatory probes of market timing.

Andrew Caffrey can be reached at caffrey@globe.com.