Brokerages Settle Fund-Sale Cases
Fifteen brokerage firms, including two units of San Francisco-based Wells Fargo & Co., settled charges Wednesday that they gave preferential treatment to mutual funds with which they had lucrative stock-trading arrangements.
The brokerages agreed to pay more than $34 million to settle investigations by the NASD, the securities industry’s self-regulatory body, into whether the firms recommended funds to investors based on the stock-trading work received from fund companies.
The brokerages violated rules that bar them from favoring certain fund companies based on the volume of brokerage commissions they paid, according to the NASD, formerly the National Assn. of Securities Dealers.
Fund companies viewed the so-called directed-brokerage deals as a key way to stand out in a crowded field. They often were named to “preferred lists” and given special access to pitch themselves to salespeople at brokerage firms. Brokerages might offer products from 200 or more fund families but would typically name only 10 or 12 to preferred lists.
“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,” Mary L. Schapiro, NASD vice chairwoman, said in a statement.
Regulators began focusing on directed brokerage almost two years ago amid a scandal over trading practices in the $7.9-trillion mutual fund industry. They worried that brokers were suggesting funds to individual investors based on hidden financial incentives rather than investors’ best interests.
The Securities and Exchange Commission barred the use of directed brokerage last year.
Two Wells Fargo units -- San Francisco-based Wells Fargo Investments and Irving, Texas-based H.D. Vest Investment Services -- paid a total of almost $7 million to the NASD.
The NASD alleged that six fund companies directed trades to Wells Fargo Investments to be in its Preferred Partner program. They received “enhanced exposure,” such as access to Wells Fargo salespeople and the right to send prospecting letters to Wells’ customers.
The company said that it ceased directed brokerage in December 2003, before the SEC’s prohibition of the practice. “We cooperated fully with the NASD during the course of the investigation,” the company said, declining to comment further.
As is customary in such settlements, the 15 firms neither admitted nor denied the charges.
The NASD brought a high-profile directed-brokerage case in February against Los Angeles-based American Funds, alleging that it paid $100 million in commissions to about 50 brokerages from 2001 through 2003. American Funds, the third-largest U.S. mutual-fund manager, has denied that it did anything wrong.
Some industry experts say that directed brokerage, though unsavory, was well-known to regulators for years and that it is unfair to now charge brokerages or funds with improper activity.
In an interview, Barry Goldsmith, head of the NASD’s enforcement unit, said fund managers can consider a brokerage’s sales of its products when steering its trades. But many directed-brokerage arrangements have evolved into “institutionalized or standardized” agreements that clearly break the rules, he said.
“The cases we’ve brought are not cases that are close to the line,” Goldsmith said. “This is a practice that has evolved -- and not in the right direction -- over time.”
