Former Western Asset Bond Manager Ken Leech Hit with Criminal Charges

Western Asset Management Company’s former Chief Investment Officer Ken Leech was charged by the US Department of Justice with fraud and lying to the SEC, which leveled related civil charges, as well. In theory, if Leech is convicted, he could face years of prison time.

The charges have been months in the making. The first sign of trouble was a July 26, 2024, regulatory disclosure by Western’s corporate owner, Franklin Resources BEN, of an initial, internal Western investigation followed by parallel investigations from the SEC and DOJ into certain past trade allocations of Treasury derivatives in select managed Western accounts. On Aug. 21, 2024, Western announced that Leech was on leave and that he had been served a Wells Notice, signaling that the SEC intended to bring enforcement actions against him and giving Leech a limited amount of time to convince them otherwise.

In reaction to the allegations and uncertainty about the leadership changes, we adjusted the Morningstar Medalist Rating scores of strategies under analyst coverage on Sept. 10, 2024. We lowered some People ratings to Average while maintaining Above Average Process scores on some of the same funds.

The regulators had otherwise been silent until yesterday’s filings. They are detailed and their allegations searing, but the case remains extremely complicated. Leech is accused of making Treasury market derivatives trades for multiple accounts, observing their success or failure, and then allocating them to favor one of his strategies over the others. The 34-page SEC complaint, which is more detailed than the 22-page DOJ indictment, implies that all the strategies invested in the same or similar sectors and that the trades could have reasonably been allocated to one or the other as a result. It includes numerous examples of trades and their profits and losses, and says that “Favored Portfolios primarily included portfolios in the Macro Opps strategy, whereas Disfavored Portfolios primarily included portfolios in the Core and Core Plus strategies.”

The charges do not shed much additional light on the situation, so we are not changing our ratings.

The trades occurred over more than two years, numbered in the thousands, and were in very different strategies, of very different sizes. As a result, many of the assertions are difficult to reconcile with the strategies’ mandates, flexibility, and asset levels. In fact, those features were so different that it would be surprising to see the same trades being applied equally across them.

Assets in the Core and Core Plus strategies, for example, were orders of magnitude greater than the assets in Macro Opps. The complaint notes that “as of June 30, 2021, Macro Opps had approximately $13 billion in AUM, compared to approximately $166 billion in combined AUM for Core and Core Plus.” The latter figure is nearly 13 times the former. And while Core and Core Plus have benchmarks and constraints on their interest-rate sensitivity, Macro Opps had no benchmark, and a vast range across which to manage its interest-rate exposures. In other words, you would expect to see differently sized trades based on the nature of the strategies, regardless of their asset levels.

A key plank in the allegations is that Leech had a financial motivation to favor Macro Opps. The complaint estimates that because of differing fee structures, each dollar of assets under management in Macro Opps portfolios “could generate approximately four times as much revenue for Western Asset as each dollar in Core and Core Plus portfolios.”

Even so, the case for financial motivation is questionable based on other numbers included in the complaint. Albeit on a much smaller asset base, the Macro Opps portfolios they accused Leech of favoring earned more than USD 56 million in net revenue in 2020, whereas the supposedly disfavored Core and Core Plus strategies together earned USD 91 million, or 62% more. In other words, on the whole, economic incentives would have still run in the opposite direction of what the complaint alleges. Judging from assets under management data available to Morningstar, that remained true throughout the period of alleged favoritism.

Leech will have his day in court. Meanwhile, Western leadership has taken steps to strengthen processes moving forward, and it still has appeal as an asset manager, the charges against Leech notwithstanding. And while Leech’s departure is a significant loss in terms of investment talent, the firm still has a lot of experienced personnel as well.