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Attorney General Lockyer Announces $9 Million Settlement with PA Distributors in PIMCO Fund Case

Broker Payments And Conflicts Of Interest Inadequately Disclosed To Investors
Wednesday, September 15, 2004
Contact: (415) 703-5837

(SACRAMENTO) – Attorney General Bill Lockyer today announced a $9 million settlement of a lawsuit against PA Distributors (PAD) that alleged the firm violated state securities law by not adequately disclosing payments and conflicts of interest related to deals made with broker-dealers to sell PIMCO mutual funds.

"California workers and retirees deserve complete honesty and full disclosure when they make decisions to invest their hard-earned money," said Lockyer. "Our securities laws rest on that foundation. To protect investors, strong enforcement of these laws is crucial. That's why we brought this case, and that's why we will continue to investigate and prosecute violations."

Lockyer today filed in Sacramento County Superior Court the settlement of the complaint against PAD – formerly known as PIMCO Advisors Distributors – along with the complaint itself. PAD is the distributor and principal underwriter of PIMCO Funds, including the Pacific Investment Management Series family of mutual funds. The court approved the settlement, which takes effect immediately.

The California settlement requires PAD to pay $5 million in civil penalties, and another $4 million to cover costs. The $5 million in penalties will go to the state general fund. A separate federal settlement announced today by the U.S. Securities and Exchange Commission (SEC) requires PAD and affiliated entities to pay $11.6 million. Lockyer's office and the SEC worked jointly on the PAD case.

Aside from monetary terms, the state's settlement memorializes voluntary reforms adopted by PAD in response to Lockyer's investigation. PAD will more fully inform investors about so-called "shelf space" arrangements it enters with broker-dealers to secure either sales of PIMCO funds or spots on lists of recommended buys. These procedures will require PAD to disclose both shelf space payments and the services those payments buy from broker-dealers. Additionally, PAD will take steps to enter written shelf space agreements that detail the terms of the arrangements.

Pursuant to its own action, and a subsequent ban approved in August by the SEC, PAD has ended its practice of directing commission payments for its portfolio transactions to broker-dealers in return for sales of PIMCO mutual funds. The practice is known as directed brokerage. Regulators and law enforcement officials view directed brokerage as particularly harmful to investors because, unlike cash payments for shelf space, commissions come out of mutual funds' assets.

The settlement also requires PAD to cooperate with Lockyer's ongoing probe into mutual fund sales practices. Evidence provided by PAD can be used in other enforcement actions.

Lockyer's investigation has helped expose shelf-space agreements as a universal practice in the $7 trillion mutual fund industry, and helped put an end to the most egregious arrangements, such as directed brokerage. The agreements have huge implications for investors because they create incentives for broker-dealers to base investment recommendations on their own interests, rather than consumers'.

From January 2000 through the present, PAD paid broker-dealers about $79 million under shelf-space agreements, according to the complaint. The $79 million included roughly $8.1 million in directed brokerage, the complaint alleges. During this period, PAD maintained shelf space agreements with some of Wall Street's biggest names.

The PAD case is the first enforcement action Lockyer has taken against a mutual fund firm using a law he sponsored which took effect January 1, 2004. The statute, SB 434, expanded the Attorney General's authority in securities fraud cases. Specifically, the law grants the Attorney General concurrent jurisdiction with the Commissioner of Corporations to investigate violations of the state Corporate Securities Law (CSL) and to bring civil enforcement actions for such violations.

Wielding his new authority, Lockyer immediately launched his wide-ranging, ongoing investigation into mutual fund sales practices. Lockyer said the investigation will remain aggressive, and he predicted it will continue to be productive. Two other major, California-based mutual fund families –Franklin Templeton Funds and American Funds – are under investigation. The probe also is targeting broker-dealers.

The CSL prohibits fraud in the sale of securities, including mutual funds. Under the CSL, fraud includes failure to disclose material facts that a consumer would consider important to know in deciding whether to make a particular investment.

The shelf space arrangements qualify as such material facts, Lockyer's complaint states, because they "create an incentive for a broker-dealer to highlight, feature or recommend funds that best compensate the broker dealer or to meet other promises rather than to recommend investments that meet the customer's personal investment needs." The complaint adds, "The failure to adequately disclose these agreements prevents the prospective mutual fund investor from recognizing this potential and/or actual conflict of interest."

The complaint alleges PAD failed to adequately disclose, among other material facts: the existence of the shelf space arrangements; and broker-dealers' various obligations under the agreements, including the requirement to tout PIMCO mutual funds, via placement on intranet web sites or "preferred" or "recommended" lists.

Employees of mutual funds or broker-dealers who have knowledge of securities law violations by their companies should contact the Attorney General's Whistleblower Hotline at 800-952-5225 (for California residents) or 916-322-3360 (for out-of-state residents).

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