Two units of mutual fund company Franklin Resources Inc. agreed to pay $20 million in civil penalties to settle charges that they used fund assets to pay for marketing and failed to adequately tell investors, the U.S. Securities and Exchange Commission said today.

The SEC settled charges against Franklin Advisers Inc. (FA) and Franklin Templeton Distributors Inc. (FTDI), the investment adviser and principal underwriter and distributor affiliated with the Franklin Templeton mutual funds, alleging that Franklin, without proper disclosure, used fund assets to compensate brokerage firms for recommending the Franklin Templeton mutual funds over others to their clients.

This practice is known as compensating brokerage firms for “shelf space.” As part of the settlement, Franklin agreed to pay a US$20 million penalty as well as undergo certain compliance reforms.

Franklin also agreed to pay US$1 in disgorgement in recognition that shareholders had been harmed, Franklin neither admitted nor denied any wrongdoing.

The SEC order said that between 2001 and 2003, FTDI had shelf space agreements with 39 broker-dealers under which FTDI allocated US$52 million from brokerage commissions related to trades of fund shares (which were fund assets) to the broker-dealers in exchange for shelf space. Franklin did not adequately disclose these agreements to the fund boards or the fund shareholders.

The SEC said the use of brokerage commissions to compensate brokerage firms for marketing created a conflict of interest between FA and the funds because FA benefited from the increased management fees resulting from increased fund sales. Mutual funds that follow this practice of using brokerage commissions for marketing have an incentive to do their fund portfolio trading through brokerage firms that might not be the best choice for fund shareholders. FA was required, but failed, to disclose adequately the arrangements to the boards so they could approve this use of fund assets, and to shareholders so they could be informed when making investment decisions.