Complaint Against American Funds Puts Financial Advisors in a Bind

Allegations that American Funds had improper marketing deals with brokerages are posing a quandary for independent financial advisors, many of whom have helped make the Los Angeles firm the bestselling mutual fund company in recent years.

After 17 months of scandal revelations that have rocked the fund industry, some advisors say it’s difficult to find high-quality companies that haven’t had their reputations sullied.

“Quite honestly, where else do you go?” asked Emerson Fersch, a principal at Capital Investment Advisers in Long Beach. He said he had sold American Funds to many of his clients over the years and had his own retirement savings in the portfolios.

For now, Fersch said, he is inclined “to give them the benefit of the doubt.”

The NASD, the securities industry’s self-regulatory agency, alleged Wednesday that American Funds violated industry rules from 2001 through 2003 by steering stock trading business to brokerages as a reward for their sales efforts with the company’s funds.

The NASD, formerly the National Assn. of Securities Dealers, said American Funds had quid pro quo agreements with brokerages, funneling commission-generating stock trades to them based on their fund sales.

A 32-year-old securities industry rule forbids such arrangements because of the potential for conflicts of interest -- essentially, brokers touting funds to clients to reap financial rewards for their firms, instead of doing what’s best for the client.

American Funds said it didn’t have quid pro quo agreements, and that fund sales were just one consideration in sending trades to brokerages. Industry rules allowed that consideration, the firm said. It said it would fight the NASD’s complaint.

Some financial advisors said clients had begun asking about the allegations and whether they should stay in American Funds.

Reece Lewis, an accountant in West Los Angeles, said he fielded those questions from one of his clients Thursday.

“I said that this has been a good [fund] house for years, with above-average returns, and I saw no reason to get out because of a hiccup,” Lewis said.

American Funds’ history of strong, steady returns, and its focus on limiting portfolio losses in bear markets, has made its funds favorites among investment advisors in recent years. The firm’s stock and bond funds, which hold assets of more than $650 billion, took in $148 billion in net new cash in 2003-04, the biggest inflow of any fund company.

American Funds sells its funds primarily via brokers and other advisors. Many investors choose to buy the funds with an upfront fee, or load, of as much as 5.75% of the purchase sum.

That load complicates the question of whether investors who are upset by the allegations against the company should vote with their feet and take their money somewhere else, Lewis and other advisors said.

For an investor who just bought an American Funds portfolio in the last few years, “it’s expensive to get out,” Lewis said. The sales load is supposed to compensate the advisor who oversees the client’s money, but it’s also intended to encourage investors to stay in the funds for the long term. Selling out after a few years means the sales fee can take a big chunk out of an investor’s return.

Some analysts said “scandal fatigue” might help American Funds and its parent, Capital Group Cos., avoid a sudden outflow of money from the funds.

“The fund firms that were hurt the most were those named first in the scandal,” said Benjamin Poor, an analyst at fund research company Cerulli Associates in Boston. Putnam Investments, Janus Capital Group and Alliance Funds were among the firms that saw heavy cash outflows in 2003 after they were hit by allegations that they allowed “market timing” or other abusive trading in their funds, to the detriment of average investors.

“But after a while your senses dull to it,” Poor said of continuing charges of industry wrongdoing. For many investors, he said, it may come down to the idea that “if everyone is bad, I have to pick the less flagrant among them.”