AFD Faces Fine For Directed Brokerage Violations

by Glen Shapiro, LawAndTax-News.com, New York

04 September 2006

A NASD (National Association of Securities Dealers) Hearing Panel ruled last week that American Funds Distributors, Inc. (AFD) violated NASD's Anti-Reciprocal Rule by directing brokerage commissions to securities firms that were the top sellers of American Funds mutual funds from 2001 through 2003.

The panel censured AFD and imposed a $5 million fine. The ruling resolves charges brought by NASD's Department of Enforcement in February 2005.

AFD is the principal underwriter and distributor of American Funds, the second largest mutual fund family in the United States. The directed brokerage commissions - amounting to more than $98 million during the relevant period - were paid by AFD's parent company, Capital Research and Management Company (CRMC), which is also the investment advisor to American Funds.

According to the panel's decision, the "evidence in this case shows…that AFD requested and arranged for CRMC to direct brokerage to its 50 leading retail firms" and that those recommendations were "conditioned upon their past sales of American Funds - indeed, that they were among the top 50 in the prior year's sales - and … the target amount AFD recommended was conditioned upon the specific amount of sales attained by the retailer."

However, the panel rejected NASD Enforcement's arguments that AFD engaged in a pattern of misconduct over a period of years that was intentional or reckless.

It noted that AFD's use of directed brokerage was consisted with practices that had arisen in the mutual fund industry over a number of years, that regulators did not express concern about those practices until 2001, and that, unlike its competitors, AFD acted voluntarily to change those practices when regulators began expressing those concerns.

"Under these circumstances, the Panel found that AFD's violations while serious, were not egregious," it stated.

The panel rejected NASD Enforcement's call for sanctions in the amount of the total directed brokerage payments, noting that the trades were placed and the commissions were actually paid by CRMC - which is not subject to NASD regulation.

Emphasizing that the sanctions can only address AFD's misconduct; the panel imposed what it termed "a very substantial fine" of $5 million.

Unless the matter is appealed to NASD's National Adjudicatory Council, or is called for review by the NAC, the hearing panel's decision becomes final after 45 days.

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