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Pimco to Pay $20.6 Million in Settlements

The agreements will end revenue-sharing probes of the fund group. More firms are being targeted under a new state law.

September 16, 2004|Tom Petruno and Josh Friedman | Times Staff Writers

Ending a second government probe into its business, the Pimco mutual fund group agreed Wednesday to pay $20.6 million to resolve federal and state allegations that it failed to properly disclose payments made to brokerage firms that sold its funds.

The Pimco deal marked the first mutual fund enforcement action brought by California regulators under a state anti-fraud law that took effect this year. Other fund giants also are being targeted by Atty. Gen. Bill Lockyer under the law.

The case also is being watched closely because other major fund companies are expected to face similar charges by the Securities and Exchange Commission.

After a joint probe, Lockyer and the SEC said they found that the Pimco group's East Coast units failed to disclose to investors certain practices involving revenue-sharing deals with brokerages that sold the group's funds from 2000 to 2003.

The company's Newport Beach-based bond fund operation, Pacific Investment Management Co., wasn't implicated.

Many mutual fund companies in recent years have had "shelf space" or "pay-to-play" agreements with brokerages, under which the fund companies compensated the brokerages for their sales efforts. Often the compensation was in cash payments from the marketing arms of funds. In other cases, the funds sent brokers commission-generating portfolio stock trades, a practice known as directed brokerage.

Trading commissions are paid from fund assets, so any such payments are a use of shareholders' money. Cash payments from the marketing units, by contrast, do not come out of shareholders' pockets -- at least not directly.

Shelf-space arrangements generally are legal if fully disclosed to investors and fund directors. But the Pimco group didn't tell shareholders that the group's marketing arm was saving some of its own money by having seven Pimco stock funds direct trades to certain brokerages, the SEC said.

In addition, Pimco didn't tell investors in the seven stock funds that their assets helped pay commissions to cover brokerage marketing deals for other Pimco funds, the SEC said.

The Pimco group "failed to ensure that each fund's brokerage commissions were used to support only the distribution of that fund," the agency said.

The SEC didn't identify individual Pimco stock or bond funds that may have benefited from brokers' marketing efforts.

Lockyer's charges took a broader sweep: Citing state law, he said the Pimco group failed to "adequately disclose" to investors the services brokerages agreed to provide Pimco funds in return for cash payments and directed brokerage. Those services included placement of Pimco funds on brokerages' "preferred" sales lists, Lockyer said.

Pimco's marketing arm has paid about $79 million to brokerages for shelf-space deals since January 2000, the state said, most in direct cash payments.

To settle the state's case, the Pimco group agreed to pay $5 million to the state's general fund as a civil penalty and $4 million to cover the cost of Lockyer's probe.

To settle the SEC's charges, the group agreed to pay $6.6 million to the seven stock funds involved. That sum is the amount Pimco management saved itself by having the funds improperly cover shelf-space costs, the SEC said.

The Pimco group also agreed to pay a $5-million civil penalty to the U.S. Treasury.

In both the state and federal cases Pimco did not admit to or deny the charges.

The SEC's case was against PA Fund Management, PEA Capital and PA Distributors. PA Fund Management and PEA Capital, both based in New York, are advisors or sub-advisors to the seven stock funds involved. PA Distributors, based in Stamford, Conn., is the main marketing firm for Pimco funds.

California's case was against PA Distributors.

For Pimco, the deal with the SEC follows a separate $50-million settlement reached Monday to end an investigation into improper trading of the company's stock funds.

About a dozen major fund companies have settled abusive-trading cases in the last year.

By contrast, analysts say the SEC is just getting started in alleging misconduct involving marketing agreements between fund companies and brokerages.

The Pimco case is only the second such case the SEC has brought. In March, MFS Investment Management, parent of the MFS funds, agreed to pay $50 million to settle allegations of inadequate disclosure of shelf-space payments.

The Pimco case "serves to give notice to the industry" as to what kind of possible violations the SEC is studying in shelf-space investigations of other fund firms, said Elaine Greenberg, assistant district administrator in the SEC's Philadelphia office, which investigated Pimco.

Lockyer, whose office also is investigating Los Angeles-based Capital Group Cos., parent of the American Funds, and San Mateo-based Franklin Resources Inc., said he probably would insist on restitution to investors in those cases, rather than just payments to the state.

Both firms paid "substantially more" via directed brokerage than Pimco, Lockyer said in an interview.

"They took commissions out of the mutual funds, in effect," Lockyer said. "It was a more direct injury to the shareholders."

Spokesmen for Capital and Franklin declined to comment.

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