The New York City Department of Consumer Affairs has filed charges against a discount broker and two mutual fund companies, alleging that they violated the city's consumer protection law by misrepresenting investment risks or fund fees in advertisements.
The three companies are Dreyfus Corp. in New York, discount broker Charles Schwab in San Francisco, and Franklin Resources Inc. in San Mateo, Calif.
The charges involve advertising claims for Dreyfus' Growth and Income equity fund, Franklin's Valuemark II retirement annuity fund. and mutual funds offered by Charles Schwab. None of the charges against the mutual fund companies are related to any of their tax-exempt mutual fund offerings. Schwab officials could not be reached for comment.
In a separate action, the consumer affairs department referred ads for four other mutual funds, including T. Rowe Price's New Jersey Tax-Free Bond Fund, to the Securities and Exchange Commission for allegedly violating federal regulations.
"These companies' claims are misleading and deceptive and can trick investors into taking risks or paying fees they're unaware of," acting commissioner Richard Schrader said in a press release, referring to the companies against which the department filed claims. "A broker on Wall Street knows to read mutual fund ads with a grain of salt, but someone living on Main Street might not."
The agency alleges that a promotional brochure for the Dreyfus fund claims that the fund does not invest in junk bonds. However, the fund's prospectus states that up to 35% of the fund's net assets can be invested in "convertible debt securities deemed to be junk bonds."
Charles Schwab claimed in an ad that the funds it offers have "no loads," or sales charges; "no fees;" and "the same phone number." But at the time the ad appeared, about 15% of the funds from companies named in the ad and 85% of all funds handled by Schwab had transaction fees, the New York City agency said in its complaint. All had management and other types of charges, the agency said.
Franklin claimed in an ad that its fund offers "retirement income for life." Such a statement implies that the fund is risk-free, the consumer affairs department said. However, "while this fund pays an annuity issued by an insurance company, the investment is only as secure as the company and is by no means guaranteed," the department said.
The department also said that the T. Rowe Price New Jersey fund and three other mutual funds sometimes absorb some of their fees to boost advertised yields. However, the ads fail to disclose, as required by federal law, what the yield would have been if the fees been passed along to investors, the department said.
"We feel very confident that our ads are in absolute compliance with existing SEC regulations," said Henry H. Hopkins, legal counsel for T. Rowe Price.
"Their referral of our ad was erroneous," said Hopkins. He said that before ads for the $38 million New Jersey fund and others with expense limitations were used, their contents were reviewed by the SEC and the National Association of Securities Dealers.
Since the company specifies a definite period of time that it will absorb the fund's fees -- until Feb. 28, 1995 on the New Jersey fund -- it does not have to state exactly what the lower yield or total return would have been. Fund ads point out that present and past expense limitations boost total return and yields, but do not state the date on which the limitations will be terminated, Hopkins said.
In a statement, Franklin said, "all Franklin advertising materials are carefully reviewed." However, the company has contacted the consumer affairs department and expects "to resolve the matter quickly."
Joseph S. DiMartino, president and chief operating officer at Dreyfus, said the equity fund cannot invest in corporate junk bonds, which are debt securities. The fund does invest in convertible bonds with below investment-grade credit ratings, but these are equity securities whose purchase is in line with the goals of the fund, he said.
"I find it a stretch to say [the ad is misleading]," DiMartino added.
The three charged companies face fines of up to 500 per violation and will be expected to sign agreements to cease the deceptive claims, according to the consumer affairs department.
At a press conference at which the charges were announced, Schrader released a 40-page report called "Making Sense of Mutual Funds: Tricks of the Trade and Lessons for Investors."
The report, which details an investigation by the Consumer Affairs department into mutual fund market practices, says fund sales agents frequently give investors vague or misleading information on fees and risk. In addition, some banks use a hard sell to push risky stock funds, in some cases without disclosing that the investment is not insured by the Federal Deposit Insurance Corp.