15 Firms Charged With Directed Brokerage Violations, Fined $34 Million

The National Association of Securities Dealers confirmed that it has imposed fines totaling more than $34 million on 15 broker-dealers in connection with the receipt of directed brokerage in exchange for preferential treatment for certain mutual fund companies.

The cases, part of NASD’s efforts to eliminate conflicts of interest in the sale of mutual funds, focus on brokerage firms involved in selling mutual funds to retail investors, as well as one mutual fund distributor. All of the cases involve violations of NASD’s Anti-Reciprocal Rule, which prohibits firms from favoring the sale of shares of particular mutual funds on the basis of brokerage commissions received by the firm. Among other things, a firm may not recommend specific funds to sales personnel or establish preferred lists of funds in exchange for directed brokerage.

NASD found that the 14 retail firms, most of which sold funds offered by hundreds of different mutual fund complexes, operated “preferred partner” or “shelf space” programs that provided certain benefits to a relatively small number of mutual fund complexes in return for directed brokerage. The benefits to mutual fund complexes of these quid pro quo arrangements included, in various cases, higher visibility on the firms’ internal Web sites, increased access to the firms’ sales forces, participation in “top producer” or training meetings, and promotion of their funds on a broader basis than was available for other funds.

“When recommending mutual fund investments, firms must act on the basis of the merits of the funds and the investment objectives of the customers and not because of other benefits the brokerage firm will receive,” said NASD Vice Chairman Mary L. Schapiro. “NASD’s prohibition on the receipt of directed brokerage is designed to eliminate these conflicts of interest.”

The mutual fund complexes that participated in these programs paid extra fees for enhanced visibility. The additional fees were typically based on a combination of sales and/or assets under management by the brokerage firm. Some of the complexes participating in the preferred partner programs paid part or all of the revenue sharing fees by the use of directed brokerage – that is, by directing a portion of the trades in the portfolios they managed to the trading desks of the firms participating in the program.

For firms that did not have the capacity to provide trade execution, trades were sent to designated third parties, which then remitted a portion of the trading commissions to the retail firms – although they provided no services in connection with the trade. These commissions were sufficiently large to pay for the benefits received by the funds as well as the costs of trade execution.

The retail firms generally monitored the amount of directed brokerage received to ensure that the fund complexes were satisfying their revenue sharing obligations. The use of directed brokerage allowed the fund complexes to use assets of the mutual funds instead of their own money to meet their revenue sharing obligations.

NASD also censured and fined one mutual fund distributor, AllianceBernstein Investment Research and Management, Inc. AllianceBernstein paid for some of its shelf space obligations by having its affiliated investment adviser direct portfolio transactions to or for the benefit of firms to which the distributor owed revenue sharing fees.

The 15 firms and their respective fines are as follows (firms noted with asterisks are wholly owned subsidiaries of AIG Advisor Group Inc.)

Royal Alliance Associates, Inc.*
$6,600,000 New York, NY
H.D. Vest Investment Services
$4,015,000 Irving, TX
AllianceBernstein Investment
Research and Management, Inc.
$3,984,087 New York, NY
Linsco/Private Ledger Corp.
$3,602,398 Boston, MA
Wells Fargo Investments, LLC
$2,970,000 San Francisco, CA
SunAmerica Securities, Inc.*
$2,500,000 Phoenix, AZ
FSC Securities Corp.*
$2,400,000 Atlanta, GA
Securities America, Inc.
$2,400,000 Omaha, NE
RBC Dain Rauscher, Inc.
$1,700,000 Minneapolis, MN
McDonald Investments Inc.
$1,500,000 Cleveland, OH
AXA Advisors, LLC
$900,000 New York, NY
Sentra Securities Corporation* and
Spelman & Co., Inc.*
(joint fine) $780,000 Phoenix, AZ
Advantage Capital Corp.*
$450,000 Atlanta, GA
Advest, Inc.
$286,415 Hartford, CT

The fines imposed on eight of the firms – Royal Alliance Associates, SunAmerica Securities, FSC Securities Corp., Advantage Capital Corp., Sentra Securities Corp., Spelman & Co., RBC Dain Rauscher, and McDonald Investments – included charges relating to their failure to retain emails as required by the federal securities laws and NASD rules.

The fine imposed on H.D. Vest Investment Services included charges related to violations of NASD rules relating to non-cash compensation. H.D. Vest reimbursed brokers’ expenses incurred in connection with certain firm training and educational conferences based, in part, on the brokers’ sales of funds that participated in its preferred partner program – instead of giving equal weight to the sales of all mutual funds, as required by NASD rules.

H.D. Vest Investment Services, RBC Dain Rauscher, and McDonald Investments were also charged with violations of NASD’s supervisory systems and procedures rule.

In settling these matters, the firms involved neither admitted nor denied the charges, but consented to the entry of NASD’s findings.

NASD has brought five previous actions for similar violations, including a complaint that is still pending against American Fund Distributors and settlements with Quick & Reilly Inc., Piper Jaffray & Co., Edward D. Jones & Co. L.P. and Morgan Stanley DW Inc.

Investors can obtain more information about, and the disciplinary record of, any NASD-registered broker or brokerage firm by using NASD’s BrokerCheck at www.nasdbrokercheck.com. Investors can also access this service by calling 1-800-289-9999.

For more information, visit www.nasd.com.

Topics New York Agencies