Compliance December 4, 2006

More Details Emerge in Fidelity Fraud Probe

In court papers filed last week, the Securities and Exchange Commission (SEC) revealed for the first time details of its two-year probe into possible fraud at Fidelity Investments.
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The Boston Globe reports the SEC said in the court filing that Fidelity “may have, directly or indirectly” defrauded some clients or prospective clients during a two-year period starting in 2002. The SEC said actions by Fidelity may have prevented customers from getting the best deals on stock trades.

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Among other activities, the court filing revealed the SEC is investigating whether former Fidelity trader David Donovan Jr. or members of his family used inside information to profit from stock trades, according to the Globe. The SEC said, on August 5, 2003, Donovan accessed internal information which showed Fidelity had pending orders to buy nearly 2 million shares of Covad Communications Group Inc. Donovan accessed information about Fidelity’s trading plans for Covad over 40 times even though he had no responsibility for trading Covad shares at the time.

According to the court papers, following access to the information, Donovan placed calls to his parents’ home, and within 15 minutes of two of the calls, trades in Covad were credited to a brokerage account in the name of Donovan’s mother. The SEC said, during a three-day period in August 2003, a total of 55,000 Covad shares were bought for Donovan’s mother’s account for less than $2 per share. The shares were sold a month later for an $89,775 profit, the newspaper said. Prior to that, the last trades in the account of Donovan’s mother took place in 2001.

The court filings do not accuse Donovan, his parents, or Fidelity of improper or illegal activity. In March 2005, Donovan told the Globe his mother’s trades in Covad had nothing to do with him and he did not profit from them.

In December 2004, the Globe reported the SEC was investigating whether Donovan steered business to his brother Peter Donovan who handled Fidelity business at Banc of America Securities in Boston. The investigation also looked into whether traders at Fidelity received free trips on private planes to Las Vegas, the Super Bowl, and golf courses in Florida, expensive wine, and other lavish perks from brokers who handled stock trades from the mutual fund company.

Compliance December 4, 2006

A.G. Edwards Excessive 401(k) Fee Suit Passes First Hurdle

A federal judge has cleared the way for a former employee of A.G. Edwards to continue pressing forward with his Employee Retirement Income Security Act (ERISA) fiduciary breach lawsuit over excessive 401(k) fees.
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Chief US District Judge G. Patrick Murphy of the US District Court for the Southern District of Illinois rejected a company request to throw out the suit filed by Gerard Boeckman.

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Boeckman charged that A.G. Edwards did not do everything it could to minimize the participant fees in its A.G. Edwards, Inc. Retirement and Profit Sharing Plan, including directly hiring its own money managers in order to avoid fund fees altogether or at least opt for less expensive fund institutional shares.

In his ruling, Murphy rebuffed A.G. Edwards’ argument that the suit should be dismissed because Boeckman waived his right to bring fiduciary breach claims by signing a liability release in 2002 when he left the company. Murphy not only said the release did not bar fiduciary breach claims like Boeckman’s,he also agreed with Boeckman that claims that arose after the effective date of the release were not within the scope of the release.

Murphy wrote: “In light of the continuing duty of prudence imposed on plan fiduciaries by ERISA, each failure to exercise prudence constitutes a new breach of the duty, that is to say, a new claim. Thus, allegations that, following the execution of the release, A.G. Edwards continued to breach its fiduciary duty by continuing to pay excessive fees to mutual funds represent new, prospective claims not in existence when the release was executed.”

In the lawsuit, which Boeckman filed on behalf of himself and a proposed class of 401(k) plan participants, Boeckman claimed that A.G. Edwards should have used the plan’s large size, with more than $2 billion in assets, to generally get a better deal on fees.

Specifically, Boeckman alleged that the company could have hired its own money management staff, “thereby avoiding a host of fees associated with mutual fund transactions, including shareholder service fees, transfer agent fees, Rule 12b-1 fees, administrative fees, registration and reporting fees, expenses for reports to shareholders, postage and stationery fees, audit and legal fees, custodian fees, and state and local taxes.”

Otherwise, A.G. Edwards could have purchased institutional shares in the funds, which are typically available only to large or institutional shareholders such as endowments and private retirement plans, instead of retail shares commonly sold to individual or small investors, which entail higher fees than institutional shares.

The case is Boeckman v. A.G. Edwards Inc., S.D. Ill., No. 05-658-GPM, 9/26/06.

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