NASD Charges American Funds with Steering Broker Payments

February 17, 2005, 1:00 a.m. EST 1 Min Read

Regulators have charged American Funds Distributors, distributor of the American Funds, with violating securities rules by directing $100 million in commissions, over a three-year period, to roughly 50 brokerage firms that were top sellers of American Funds.

Citing violations of its "anti-reciprocal rule", NASD alleges that American made payments to brokers as a reward for past sales and to encourage future sales of American's lineup of 29 mutual funds. First passed in July 1973, the rule prohibits quid pro quo arrangements in which brokerage commissions are used as an incentive to sell certain fund shares.

The concept behind the anti-reciprocal rule is to ensure that investors are receiving best execution on their portfolio transactions. It is designed to eliminate the possibility of a brokerage recommending funds based on which fund company gave it the fattest payout as opposed to what is best suited for the investor.

"Today's action makes clear that it is just as impermissible to offer and make such payments as it is to receive them," said Mary Schapiro, NASD vice chairman, in a press release.

According to the complaint, between 2001 and 2003, AFD calculated "target commissions" that it planned to direct to each of the top sellers of American Funds based on each of the firms' prior year's sales. American's trading desk then directed brokerage commissions on American Funds portfolio transactions to the top-selling retailers based on those estimates.

In addition, the trading desk directed brokerage commissions to retail firms that did not have the capacity to execute trades. These firms entered into "step out" arrangements with clearing firms to receive the kickbacks. NASD found that the clearing firms shared the commissions with the retail firms even though they contributed nothing to the trading process.

American Funds is the nation's third-largest mutual fund complex. with more than $500 billion in assets, which are managed by sister company Capital Research and Management Co.