Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Wednesday, April 30, 2008

AFD $5 Million Fine for Directed Brokerage Upheld on Appeal

A $5 million fine imposed against American Fund Distributors (AFD) for directed brokerage in 2006 will stand, according to a ruling issued today by the National Adjudicatory Council (NAC), the appeals body of the Financial Industry Regulatory Authority (FINRA).  The NAC upheld a FINRA Hearing Panel decision finding that AFD violated FINRA's Anti-Reciprocal Rule when it directed more than $98 million in brokerage commissions between 2001 and 2003 to the 46 retail securities firms that were the top sellers of its mutual funds.

AFD is the principal underwriter and distributor of American Funds, a family of 29 mutual funds. In ruling on AFD's appeal of the Hearing Panel decision, the NAC concluded that AFD arranged for the direction of a specific amount or percentage of brokerage commissions to other securities firms conditioned upon those firms' sales of American Funds shares, an "outright" violation of FINRA's Anti-Reciprocal Rule.  The NAC also concluded that AFD's requests and arrangements for the direction of brokerage, conditioned upon sales, was directly at odds with the goal of the Anti-Reciprocal Rule, which is "to curb conflicts of interest that might cause retail firms to recommend investment company shares based upon the receipt of commissions from that investment company."

In the decision released today, the NAC emphasized that AFD tracked, monitored, and facilitated the directed brokerage payments by identifying the top-selling retail firms of American Funds, providing its investment adviser with the amount of commissions to be sent, and monitoring its investment adviser's trading with, and the payment of commissions to, the selected retail firms throughout the year. The NAC also highlighted the fact that AFD directed commissions to "step-out firms" - retail firms that had no capability to execute portfolio trades for American Funds, but nevertheless obtained commissions indirectly from clearing firms that did execute the trades.  The NAC also found that AFD's conduct was intentional.  The NAC concluded that AFD's violations, while "not egregious, were quite serious" and that a "substantial" fine of $5 million was appropriate based on the facts and circumstances of the case.

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