A California-based unit of Legg Mason Inc. agreed to pay more than $21 million to settle government charges that it defrauded clients by not properly informing them of losses caused by improper investments and by engineering trades between clients that shorted the sellers.
The Securities and Exchange Commission announced the settlement in conjunction with the Department of Labor on Monday, identifying actions that they allege occurred at Western Asset Management Co. between 2007 and 2010.
The news of the settlement by its largest investment unit comes during what analysts see as a turnaround at Legg Mason. The Baltimore-based money manager, which is structured as an umbrella company for affiliated investment firms, struggled in the aftermath of the economic crisis as clients withdrew funds.
But that momentum appeared to shift last year when the company formally installed a new CEO, Joseph A. Sullivan, and experienced its first quarter of positive inflows to its stock and bond funds since September 2007.
The SEC announcement could hurt that turnaround, but is not likely to have a significant effect, said David Chiaverini, a New York-based analyst with BMO Capital Markets.
"This takes a little bit of the wind out of its sails, but at the same time, this apparently occurred a few years ago," he said. "It's to be seen how much it impacts flows, but it doesn't help because it's getting people talking about Legg Mason in a negative way, and … they had some positive changes happening."
Legg Mason shares fell 88 cents, dropping 2 percent Monday, to close at $41.35 each.
According to the SEC and the Labor Department, Western Asset Management, which counts among its clients many employee benefit plans, allowed almost 100 accounts to hold $90 million worth of off-limits securities due to a coding error. The securities remained in the accounts until June 2009, although the fixed-income manager discovered the problem in October 2008, the agencies said. When the assets were sold, it resulted in "significant losses" that weren't explained immediately or reimbursed to the clients, the Labor Department said.
"Western Asset put its own interests above its clients and avoided telling investors what had caused losses in their accounts," said Michele W. Layne, director of the SEC's Los Angeles Regional Office. "By concealing the error, Western Asset avoided reimbursing clients for their losses."
Western Asset will pay $12 million to settle the claims related to lack of disclosure, including $10 million to compensate clients for their plan losses.
The settlement also includes money to address claims that between 2007 and 2010 the firm arranged more than 500 non-public so-called "cross trades" of assets such as mortgage-backed securities between clients, pricing the exchanges in a way that favored the buyers and denied sellers $6.2 million, according to the regulators.
For the cross trading violations, Western Asset must pay more than $7.4 million to clients who were harmed plus a $1 million penalty to the SEC and a $607,717 penalty to the Labor Department.
"Workers invest too much in retirement plans to have them diminished by the very people they trust to grow their savings," U.S. Secretary of Labor Thomas E. Perez said. "The department is committed to protecting retirement savings so that more of America's workers have the opportunity to build nest eggs and live securely when they retire."
Under the settlement, Western Asset neither admits nor denies the charges. The company's insurance will cover most of the cost of the sanctions, which do not have "a material impact" on the company's financial standing, according to a statement released by Legg Mason spokeswoman Mary Athridge.
"Western chose to settle the matters to avoid the uncertainty, expense and distraction of litigation," she said, adding that the fund has "redoubled its efforts over the past five years to address regulatory compliance and related matters including the strengthening of controls in the areas covered by the settlements."
The settlement is unlikely to affect the long-term fortunes of a firm like Western Asset, which had more than $400 billion in assets under management last year, said Larry Harris, a former SEC chief economist and now a University of Southern California finance professor.
"Most of the investors will never know about it," he said. "It will never make any difference to them."
The settlement's goal is to help make firms take compliance seriously, Harris said.
"The SEC can't watch everybody's accounts continuously. We trust the industry to police itself," Harris said. "When we find that they're not properly policing themselves, that requires a strong slap on the wrist — in this case, more than a slap on the wrist."