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Attorney General Lockyer Files Major Securities Fraud Lawsuit Against Edward Jones

Documents Detail How Secret Mutual Fund Payments Conflicted With Investors' Interests
Monday, December 20, 2004
Contact: (415) 703-5837

(SACRAMENTO) – Attorney General Bill Lockyer today filed a securities fraud lawsuit against Edward D. Jones & Co. (Jones), alleging the St. Louis, Missouri-based broker dealer failed to tell investors about "shelf space" payments it received from seven mutual funds to recommend and sell those funds.

"Edward Jones broke the law, and broke faith with the working families of California who placed their trust in the company's investment recommendations," said Lockyer. "The documents we have obtained show Jones blatantly disregarded investors' interests as it collected some $300 million in secret payments from mutual funds. California law requires full disclosure of information that raises questions about whether broker-dealers' recommendations serve clients' best interests. Investors deserve nothing less. I will settle for nothing less from Edward Jones."

The lawsuit filed in Sacramento County Superior Court seeks disgorgement of all profits Jones gained as a result of violating anti-fraud provisions of the state Corporate Securities Law (CSL). It also seeks restitution and damages for investors who bought mutual fund shares from Jones. Additionally, the complaint asks the court to impose civil penalties for each violation of the CSL. The maximum civil penalty for each violation is $25,000.

Lockyer also seeks "injunctive relief" requiring Jones to fully disclose to investors, at the point of sale, the incentive payments it receives from mutual funds. Stressing the disclosure requirements will be stringent, Lockyer said, "California will demand full honesty from Edward Jones in its dealings with this state's investors."

Under the "shelf-space" agreements at issue in the case, seven mutual funds paid Jones either cash or "directed brokerage" commissions (on portfolio transactions) to sell those funds, place them on lists of recommended buys or obtain other preferential treatment. From January 2000 through the present, Jones extracted approximately $300 million in shelf space payments, according to the complaint, with cash comprising the bulk.

The complaint alleges the seven mutual funds (called "preferred funds" by Jones) that maintained shelf space arrangements with Jones include: American Funds, Federated Investors, Goldman Sachs, Hartford, Lord Abbett, Putnam Funds, and Van Kampen Investments.

The sale of these preferred funds comprised about 98 percent of all Jones' mutual fund sales from January 2000 through the present, according to the complaint. Sales of just one preferred fund – American Funds – accounted for 50 percent of all Jones' sales during the same period, the complaint alleges. In California, Jones' sale of the preferred funds totaled an estimated $5.8 billion from January 2000 through October 2004, said Lockyer. As of October 2004, he added, Jones had about 294,000 California customers, representing more than 177,000 households.

Evidence obtained by Lockyer's office to support the complaint includes internal emails and other documents that show: Jones maintained policies and procedures, including incentives, to ensure its "investment representatives" sold only the seven preferred funds; and Jones sold the preferred funds to investors despite knowing the funds underperformed.

" ‘Who pays us the most – who helps us the most' seems to be all I ever hear about funds and their wholesalers," one email states. "What about ‘Who makes our clients the best returns with the least risk?' Maybe it's time the SEC shook up the fund business. When everyone except the client wins-there's something wrong."

In a March 27, 2001 letter to its preferred fund partners, Jones attached a spreadsheet detailing their poor performance during the prior year. "We at Edward Jones do not want to be in the business of explaining to our customers that one of their funds has lost one-half or three-quarters of its value," the letter states. Yet, despite the poor performance, Jones continued to sell the preferred funds to investors while collecting shelf space payments.

Jones violated the CSL's anti-fraud provisions, the complaint alleges, by failing to tell investors about the existence of the shelf space arrangements, and failing to disclose the potential conflict of interest created by the arrangements. The CSL requires broker-dealers to disclose all material facts that investors need to make informed decisions.

Regarding conflict of interest, the complaint states, "Shelf space payments create an incentive for a broker-dealer to highlight, feature or recommend funds that best compensate the broker-dealer or to meet other secret promises rather than to recommend the best performing investments and/or investments that meet the customer's personal investment needs."

The Jones lawsuit is the third enforcement action taken by Lockyer under a law he sponsored which took effect January 1, 2004 and which gave his office authority to file civil enforcement actions for violations of the CSL. Lockyer launched an investigation of shelf space arrangements between mutual funds and broker-dealers one day after the law took effect. In two previous actions, Lockyer settled shelf space complaints against the distributor of PIMCO mutual funds, PA Distributors (on September 15, 2004) and Franklin Templeton Distributors, Inc. (on November 17, 2004). Investigations remain ongoing of California-based American Funds, as well as several other broker-dealers.

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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