Wednesday, February 16, 2005

American "Pie"

NASD announced today it is filing charges against American Funds Distributors (AFD) for directing brokerage commissions to firms that were the top peddlars of American funds products. NASD is charging AFD with violating it "anti-reciprocal rule" which was implemented in 1973 to eliminate arrangements whereby investment managers reward brokers for selling their products by directing trades and commission revenue to them. The NASD press release indicated there were trading allocations developed for each broker based on their prior year sales of American Funds. Though this is the first regulatory pie on their face, AFD's perspective on the issue seems to be that as long as they receive "best execution" on the trades then they have fulfilled their responsibility to the fund shareholders. From a fiduciary perspective, provided they have done so, they may have. In the pension world, trading commissions are plan assets and fiduciaries have a responsibility to ensure these assets are spent solely for the benefit of plan beneficiaries, should there be some collateral benefit elsewhere, sobeit. Pension fiduciaries invested with American Funds should at least keep an eye on this and secure documentation on Americans trading, directed brokerage and soft dollar policies.

This kind of arrangement should not be a surprise to anyone since AFD has chosen to use brokers as their primary sorce of product distribution. By gosh by golly how would you think they incent brokers to sell... a good informatio ratio?. Like it or not "quid pro quo" happens in many ways in the investment business. This particular way, though an industry norm, is probably just making the NASD sweat a little too hard. For once they want to beat the SEC and every state's Attorney General to the punch.

What has always surprised me about Amerian Funds is that they have a very fundholder driven culture and their institutional value system, at least from what I have been able to observe, is impeccable. Yet their products have always been sold by brokers and not bought by investors. The fact that retail investors must pay sales loads and the distribution system must be rewarded in this way combines the very worst in distribution practices with a high quality investment maufacturing organization.

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