American Funds Distributors has won a partial victory in a hearing in front of a NASD panel over whether it improperly used directed-brokerage payments to securities firms. The sales arm of the American Funds family was censured by the panel and ordered to pay a $5 million fine. However, the panel also found that American Funds' payments were "serious" but not "egregious" violations of the NASD rules.

That distinction seems to allow the fund industry to draw a line between past a future practice while not opening the industry to another wave of scandals surrounding how fund firms paid for shelf space at broker-dealers.

The panel found that American Fund's used directed brokerage in a way that was consistent with other fund firms' practices and that regulators had not questioned those regular practices until 2001. It also found that American Funds voluntarily changed its practices regarding the use of directed brokerage when regulators expressed their concerns. The NASD Enforcement had contended that American Funds Distributors had been reckless and intentionally violated the rules.

The specifics of the case involved $98 million of payments to fifty leading retail broker-dealers that were the top sellers of American Funds. The panel did not reveal the identity of the brokers. The payments were made by Capital Research and Management Company , the investment advisor to American Funds.

Capital Research paid the brokers based on their past sales of American Funds products and whether they met sales hurdles.

Those payments violated the NASD's Anti-Reciprocal Rule, the panel found. The rule was intended to abolish "reciprocal business practices in connection with the distribution of mutual fund shares, i.e., the use of portfolio brokerage of mutual funds to reward broker-dealers for sales of mutual fund shares."

"This sort of reciprocal use of mutual fund brokerage is precisely what the rule was intended to proscribe ... A clearer use of directed brokerage to further reciprocal arrangements, contrary to the purpose of (the Anti-Reciprocal Rule), is difficult to imagine," panel members wrote.

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 Capital Research -- which is not subject to NASD regulation.

The hearing panel's decision becomes final after 45 days unless it is appealed to NASD's National Adjudicatory Council (NAC), or is called for review by the NAC. 

Stay ahead of the news ... Sign up for our email alerts now
CLICK HERE