Advisers Sanctioned For Prohibited Transactions, Procedures Failure

Two firms are named as Respondents in the Order, Franklin Advisers, Inc., or FAV, and Franklin Templeton Investments Corp. or FTIC. The former is a registered investment adviser. The latter is a subsidiary of Franklin Resources, Inc., Toronto, also a registered investment adviser.

The proceedings here center on Section 12(d)(1)(A) of the Investment Company Act which, generally, limits an investment firm’s ownership interests in other investment companies. Over an eleven month period, beginning in December 2014, the Allocation Funds (a particular series of Templeton funds) and eight LifeSmart Retirement Target Date Funds (another series) purchased shares of three ETFs each of which is a registered unaffiliated investment company. FAV sought to rely on Section 12(d)(1)(F) to exceed the limits of Section 12(d)(1)(A)(iii). The former permits a registered investment company to invest in unaffiliated investment companies in excess of certain limits if the acquiring company and its affiliates do not own more than 3% of the outstanding shares of the acquired company. The latter prohibits the purchase when the “acquisitions results in the acquired company and all other investment companies having an aggregate value of more than 10% of the total assets of the acquiring company” – a pyramiding limitation. The provisions of 12(d)(1)(F) could not be relied on, however, since FAV’s aggregate purchases of the three ETFs caused the Franklin Funds to exceed the firm wide 3% ownership limits of Section 12(d)(1)(F) for each ETF.

At the time of the transactions FAV was responsible for implementing written policies and procedures designed to ensure compliance with the sections cited above. In late November 2015 the compliance department discovered the breach of the statutory limits. The client positions were reduced, generating losses of over $2.1 million for ETF No. 1 and gains of over $3.7 and $4.7 million for ETFS Nos. 2 and 3 respectively.

FAV assessed the situation and decided not to reimburse the losses. That determination created an undisclosed conflict and was contrary to its disclosed policies and procedures that required reimbursement. There was no disclosure until mid 2016. The Order alleged violations of Investment Company Act Section 12(d)(1)(A) and Advisers Act Sections 206(2) and 206(4). After the Commission’s investigation began Franklin Funds’ board fully reimbursed the losses of the Allocation Funds, including interest.

After taking certain remedial procedures, Respondents each resolved the proceedings. FAV consented to the entry of a cease and desist order based on the sections cited and a censure. FTIC also consented to the entry of a cease and desist order but only one based on the Investment Company Section cited. FAV also agreed to pay a penalty of $250,000 while FTIC will pay $75,000.