(Bloomberg) — For three decades, Ken Leech was the other Bond king, the quiet one.

While investors hung on the every word of other California bond magnates like Bill Gross, Leech shied away from the spotlight to help build Western Asset Management Co. into one of the world's most formidable fixed-income shops, rivaling the likes of Pacific Investment Management Co. and BlackRock Inc.

On Wednesday, the foundations of the $381 billion firm were shaking.

Wamco, a unit of Franklin Resources Inc., said it is cooperating with investigations by the U.S. Department of Justice and the Securities and Exchange Commission. Those investigations center on whether he favored some clients over others — cherry-picking the most profitable trades, according to people with knowledge of the matter.

The firm said in a statement that Leech is taking a leave of absence as co-chief investment officer to focus on investigations after receiving a so-called Wells notice from the SEC, a warning that regulators may recommend enforcement.

Wamco, which is conducting its own investigation, is also winding down its $2 billion macro opportunities strategy and has elevated company veteran Michael Buchanan to sole CIO, according to the statement. The trades involved treasury derivatives in accounts managed by Wamco.

“Leech was an incredibly well-known name in the industry and credited with building and scaling what had been a really successful fixed-income platform with really diversified operations,” the Morningstar Inc. analyst said in an interview. Max Curtin.

Wamco accounts for almost a quarter of the parent's assets. Franklin shares fell 13% on Wednesday, the biggest one-day drop since October 2020, extending their decline this year to 34%.

“We anticipate further pressure on buybacks across the Western franchise given Mr. Leech's high profile within the firm and disproportionate exposure to institutional assets under management,” Jefferies Financial Group Inc. analysts wrote. Daniel Fannon in a note to clients. “The advisory community will likely need to revise their recommendations for the firm – as opposed to any individual fund – given the high level at which these breaches have occurred.”

Franklin Resources and its chief executive, Jenny Johnson, part of the family that has run the firm for decades, had no comment beyond the statement. A representative for Leech, 70, declined to comment.

“I believe he is a person of impeccable character and utmost integrity,” legendary investor Bill Miller said in an email, noting that he worked with Leech for decades at former Wamco parent Legg Mason. “I cannot comment on SEC matters, as I know nothing about them.”

Previous Fees

Founded in 1971, Pasadena-based Wamco has long been known as a bond manager with hot and cold streaks, and has previously imposed fines to settle investigations. In 2014, the firm paid 21 million dollars primarily to settle SEC charges that it defrauded clients and concealed investor losses resulting from a coding error and engaged in trading in mortgage securities that favored certain clients.

Leech, a graduate of the Wharton School of the University of Pennsylvania, joined Wamco in 1990 after working as a portfolio manager at Greenwich Capital Markets, First Boston Corp. and Detroit National Bank. He was inducted into the Society of Fixed Income Analysts Hall of Fame in 2007, and he is also a master of life on the bridge.

In 1991, the year after he started at Wamco, the firm's assets under management were $5 billion. They grew to $408 billion over the next three decades.

The firm was known for smart trades that beat benchmarks and benefited for much of the period from extended bond market rallies. In 2020, it was still a crown jewel of Legg Mason, which Franklin won that year, along with Wamco's decades of experience with large institutional clients.

Investors' guarantee

But Wamco soon found itself struggling.

At the end of 2021, Leech ESTIMATED The Federal Reserve would take its time raising rates, suggesting there might not even be a hike in 2022. Instead, the central bank raised rates seven times that year. The Core Plus fund, which he helped run, lost about 18% that year.

Its poor performance prompted investors big and small to pile in.

The $19 billion mutual fund returned 2.4% this year through Tuesday, trailing more than 90% of peers over the most recent three- and five-year periods. Fund managers were convinced for much of the past two years that the economy and inflation were poised to slow, and Leech's team stuck to the view that long-term bonds would rise as the Fed moved closer to cutting rates. This took longer than expected, and only now is the central bank on the verge of doing so.

Read more: The Fed's minutes show some case for a rate cut in July

Soon, change occurred within Wamco. Buchanan was named co-CIO alongside Leech last August. John Bellows, who co-managed Core Plus since 2018, left unexpectedly in early May. Until Wednesday, however, there was little sign that the 70-year-old would do anything other than try to turn things around at Wamco.

“Over time now I think we're hoping to get a clear picture of these changes,” Morningstar's Curtin said.