When Johnston, Lemon & Co. Inc. decided to switch its "house" money market fund from the local Fund for Government Investors to Alliance Capital Management of New York, the Washington brokerage firm viewed it as a normal business decision that would benefit both it and its customers.
Instead, the action stirred a hornet's nest.
In a Nov. 22 letter to clients, James H. Lemon Jr., president of the brokerage firm, said that money market accounts invested in the Fund for Government Investors would automatically be switched to Alliance Dec. 6 unless Johnston, Lemon was otherwise instructed.
The $1.3 billion Fund for Government Investors launched a defensive action to keep the 10,000 accounts generated by Johnston, Lemon. One Johnston, Lemon client, former Federal Aviation Administration chief Langhorne Bond, was so angered by Lemon's letter that he wrote a stinging protest to the brokerage firm on Nov. 27.
FFGI urging its Johnston, Lemon customers to instruct the brokerage firm to keep their accounts with FFGI. The letter said its yield is higher than the equivalent Alliance fund.
FFGI accused Johnston, Lemon of making the switch to earn a higher fee from Alliance than it could get from FFGI. Both funds pay a "distribution" allowance to brokers that maintain a special relationship like the one Johnston Lemon had with FFGI and, as of Monday, has with Alliance.
According to Terry Apple, vice president for marketing at FFGI, the fund retained $50 million of the $100 million that Johnston, Lemon customers had invested in FFGI. However, FFGI investors at Johnston, Lemon no longer have the ability to move their money market deposits through their Johnston, Lemon broker.
Lemon said Alliance offered three money market funds -- a regular money fund, one that invests in Treasury and government agency securities (as FFGI does), and one that invests only in Treasury securities. Alliance plans to introduce a tax-free fund soon.
Bond decried what he called the "negative option" offered by Johnston, Lemon, referring to the shift of a customer's account unless the firm was otherwise instructed.
Bond also said that if FFGI's rating and yields are superior, Johnston, Lemon should have spelled that out. Furthermore, Bond said, he objected to Lemon's decision to "sell a fund holding U.S. government securities which are not subject to state and local taxation and invest in a fund, much of which is subject to state and local taxation."
(FFGI's Apple said that the fund's lawyers believe its dividends are subject to local taxes. Bond said that while many states and the District of Columbia take the position that income from funds that invest in Treasury securities are taxable, he said he disagrees and added that the states' position has not yet been tested in court.)
Lemon said he would not comment on Bond's letter, nor would he confirm or deny the report that $50 million in his customers' money market deposits were not automatically shifted to Alliance.
Lemon said that the firm decided to change money market funds because it felt the products offered by Alliance were better and gave his customers more investment opportunities. He said his firm interviewed many other money market funds before settling on Alliance, which has more than $13 billion in its three funds. He acknowledged that Alliance will pay a higher fee to Johnston, Lemon.
In his letter to customers, Lemon said that the firm would receive "distribution assistance" from Alliance, as well as fees for servicing accounts, that enable Johnston, Lemon to provide "money fund service to you without additional charges."
In an interview, Bond said that despite his anger at Johnston, Lemon he intends to continue to do business there. He said he just wanted the old-line Washington brokerage firm to "pause" before it made such changes.