State drops broker fee case
California and federal securities regulators have abandoned a 3-year-old fight to show that the giant American Funds mutual fund group cheated or misled its investors.
The separate moves by state Atty. Gen. Jerry Brown and by the Securities and Exchange Commission amount to big victories for the Los Angeles-based fund firm, which, with $1.1 trillion in assets, is the nation’s largest manager of stock and bond funds.
The 77-year-old company, insisting it had done nothing wrong, had balked at following other fund firms and reaching costly settlements with regulators over similar allegations in recent years.
Brown on Thursday said his office had agreed to drop its case accusing American Funds of failing to properly tell fund shareholders about special marketing-related payments made to brokerages that sold the firm’s funds from 2000 to 2004.
Former Atty. Gen. Bill Lockyer, who launched the case in March 2005, had called the payments “kickbacks” designed to induce brokers to sell shares in the company’s mutual funds to their clients. He said the company had an obligation to clearly spell out the arrangements to investors so they understood the potential for conflict of interest, and he vowed to seek tens of millions of dollars in restitution.
Brown, in dropping the case, said voluntary measures that American Funds had taken to improve its disclosures to investors had “resolved the state’s concerns.” Under its accord with the attorney general, the fund firm agreed to include additional language about its brokerage relationships in fund documents beginning March 1.
The agreement also calls for American Funds’ parent, Capital Group Cos., to pay $2.5 million to cover the state’s legal costs. By contrast, in 2004 two other fund firms -- PA Fund Management, which managed the Pimco-brand stock funds, and Franklin Resources Inc. -- paid the state $9 million and $18 million, respectively, in fines and restitution to settle similar cases by Lockyer.
Capital Group also agreed to drop a lawsuit it filed against the state that accused the attorney general of encroaching on federal regulation of fund companies.
Brown said he was swayed in part by the SEC’s decision to drop its probe of American Funds -- a decision that had been rumored last year but had not been publicly disclosed before Thursday. Brown said the SEC’s probe ended in October.
An SEC official in Los Angeles declined to comment.
A spokesman for American Funds confirmed that the SEC told the firm it had ended its investigation. He said the company was “pleased” with the agreement with Brown but declined to comment further.
The SEC since 2004 had been attempting to prove that American Funds had for years paid brokerages inflated trading commissions as a reward for pushing their brokers to sell the company’s funds.
Because trading commissions are paid directly out of fund assets, they are borne by fund shareholders.
American Funds still is battling one regulator on the issue of payments to brokerages: A hearing panel of the Financial Industry Regulatory Authority, the securities industry’s self-policing group known as FINRA, in August 2006 fined the company $5 million for what the group said were improper incentive arrangements between the company and about 50 brokerages from 2001 to 2003.
American Funds has appealed the ruling and fine to a higher panel at FINRA.
The probes by California, the SEC and FINRA all focused on the same basic issue: Did American Funds, in seeking to reward brokerages that hawked its funds, go too far -- at the expense of investors?
The SEC and FINRA’s predecessor organization, the National Assn. of Securities Dealers, in 2003 began to bring dozens of such cases against fund firms and brokerages, as regulators zeroed in on the industries’ long-standing practice of so-called revenue sharing.
The SEC had for decades permitted fund companies to offer certain forms of compensation to brokerages as a way of getting them to highlight fund products to their sales forces. Those payments -- which the fund companies typically said covered “educational” costs -- were in addition to standard brokerage commission charges on fund sales.
But fund companies were forbidden from having quid pro quo arrangements with brokerages that guaranteed a specific amount of extra compensation in return for a specific level of fund sales. That kind of arrangement could encourage brokers to sell certain funds to clients because it was in the brokers’ interest, but not necessarily in clients’ interest.
Nearly every brokerage or fund company accused of improper revenue-sharing practices settled with regulators, often paying large fines, without admitting or denying guilt.
American Funds refused to settle, insisting all along that its brokerage sales pacts were within regulatory guidelines and that its shareholders had suffered no harm.
Typically, financial companies settle regulators’ cases against them because “it’s cheaper to pay the price and go on with your life,” said Jay Baris, a partner at law firm Kramer Levin Naftalis & Frankel in New York.
But privately held American Funds has prided itself on its blemish-free record with regulators since its founding in 1931, and company officials were adamant that they would not accede to charges of wrongdoing simply to put the cases to rest.
The company’s sparring with regulators appeared to do no damage to its business: Thanks in large part to the strong performances of many of its mutual funds, American Funds took in more new cash from investors than any other fund company from 2002 to 2006, according to Financial Research Corp.
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