WASHINGTON, Feb. 16 2005 – LAWFUEL – The Law News Network — NASD has charged American Funds Distributors, Inc. (AFD) with violating NASD’s Anti-Reciprocal Rule by directing approximately $100 million in brokerage commissions over a three-
year period to about 50 brokerage firms that were the top sellers of American
Funds. The payments were made to reward the firms for past sales and to
encourage future sales of American Funds’ 29 mutual funds.
AFD is the principal underwriter and distributor of American Funds, the
third largest mutual fund family in the U.S. with more than $450 billion in
assets and approximately 25 million shareholder accounts. The commissions
were payments for executing trades for the American Funds’ portfolio that were
directed to the brokerage firms as additional compensation for past sales of
American Funds, and to ensure that American Funds would continue to receive
preferential treatment at those firms.
NASD’s “Anti-Reciprocal Rule,” which first became effective in July 1973,
is designed to prevent quid pro quo arrangements in which brokerage
commissions, which are assets of the shareholders of the mutual funds, are
used to compensate brokerage firms for selling the funds’ shares. The rule
also is designed to ensure that the execution of portfolio transactions by
brokerage firms is guided by the principle of “best execution” and not by
other considerations. In addition, the rule is meant to eliminate the danger
that a brokerage firm, when recommending mutual funds to customers, will base
its recommendations on the additional rewards the firm may receive in
portfolio commissions from the funds rather than on the investment needs of
the customer.
“Prior cases in this area have focused on retail firms that received
directed brokerage payments from mutual fund companies in exchange for giving
preferential treatment to their funds,” said NASD Vice Chairman Mary L.
Schapiro. “Today’s action makes clear that it is just as impermissible to
offer and make such payments as it is to receive them.”
NASD’s complaint alleges that, between 2001 and 2003, AFD calculated
“target commissions” that it intended to direct to each of the top-selling
retailers of American Funds according to a formula that was based upon each of
the firms’ prior year’s sales of American Funds. AFD communicated to each of
these retail firms the specific amount of that firm’s “target commissions” for
the upcoming year and the fact that the amount was a function of the firm’s
prior year’s sales of American Funds, typically 10 or 15 basis points of those
sales. At the same time, AFD also discussed with the top-selling retail firms
the benefits that AFD expected to receive pursuant to the sponsorship
arrangements, such as the inclusion of American Funds on the firms’ “preferred
fund” or “recommended fund” lists, and enhanced access to the firms’ sales
forces.
According to NASD’s complaint, at the beginning of each year between 2001
and 2003, AFD provided a chart to the trading desk at AFD’s parent company,
Capital Research and Management Company (CRMC). CRMC is the investment
advisor to American Funds. The chart listed each of the top-selling retailers
with which AFD had a sponsorship arrangement and the amount of “target
commissions” for each firm. The Fund’s trading desk directed brokerage
commissions on American Funds portfolio transactions to the top-selling
retailers on the chart based on the “target commissions” set by AFD for each
firm. Throughout the year, the trading desk provided monthly updates to AFD
about the amount of brokerage commissions directed to each of the top-selling
retail firms. In turn, AFD occasionally provided updates to the top-selling
retailers about how much of the target commissions had been directed to them
throughout the year.
The trading desk not only directed brokerage commissions to firms that
executed American Funds portfolio transactions, but also to retail firms that
did not have the capacity to execute securities transactions. Those firms
(approximately 30 of the 50 or so) entered into “step out” arrangements with
clearing firms in order to receive the directed brokerage commissions.
NASD’s investigation found that the clearing firms, which executed the
trades, shared the brokerage commission with the retailers even though the
retail firms provided no services in connection with the trade. The amount of
commission that the retail firms received-typically seventy to ninety percent
of the commission-depended upon the agreement between their firm and the
clearing firm executing the trades. Twenty-nine million of the $100 million
in directed brokerage was paid in this fashion and ranged from a high of
approximately $5.4 million to one retailer to a low of approximately $112,855
to another retailer.
Under NASD rules, AFD can file a response and request a hearing before an
NASD disciplinary panel. Possible sanctions include a fine, suspension, bar,
or expulsion from the NASD.
NASD wishes to acknowledge the substantial assistance of the Pacific
Regional Office of the Securities and Exchange Commission in this matter.
Investors can obtain more information about, and the disciplinary record of,
any NASD-registered broker or brokerage firm by using NASD’s BrokerCheck.
NASD makes BrokerCheck available at no charge to the public. In 2004, members
of the public used this service to conduct more than 3.8 million searches for
existing brokers or firms and requested more than 190,000 reports in cases
where disclosable information existed on a broker or firm. Investors can link
directly to BrokerCheck at http://www.nasdbrokercheck.com. Investors can also
access this service by calling 1-800-289-9999.
NASD is the leading private-sector provider of financial regulatory
services, dedicated to investor protection and market integrity through
effective and efficient regulation and complementary compliance and
technology-based services. NASD touches virtually every aspect of the
securities business — from registering and educating all industry
participants, to examining securities firms, enforcing both NASD rules and the
federal securities laws, and administering the largest dispute resolution
forum for investors and member firms. For more information, please visit our
Web Site at http://www.nasd.com.
