Minneapolis-based American Express Financial Advisors will pay $7.4 million in penalties and reimbursements for shorting customers who were supposed to receive sales discounts on large mutual fund investments as part of an industry-wide disciplinary action unveiled by federal securities regulators Thursday.
In total, 15 mutual fund companies and securities brokerages agreed to pay $43 million in fines and reimbursements to settle up with the Securities and Exchange Commission and the National Association of Securities Dealers.
The settlement came out of a broader investigation into allegations that securities companies routinely overcharged mutual fund investors. The settlement is the latest blow to an industry that has been shaken by a series of scandals in recent months.
American Express was among the hardest hit its penalty is the third biggest â€” and was one of seven companies sanctioned by the SEC.
The NASD doled out smaller fines to eight smaller firms. All were accused of failing to pay so-called break-point discounts to investors who bought Class A mutual fund shares in 2001 and 2002. Break point discounts are supposed to be given to customers who buy large blocks of mutual funds that carry up-front sales charges or front-end loads.
“The firms that got penalized were firms where there was a higher-than-average failure rate and/or a very high dollar amount in discounts that weren’t provided,” said SEC spokesman Herb Perone.
The disciplinary action was based on the findings of a joint SEC, NASD and New York Stock Exchange sweep in late 2002 and early last year. “There were very few firms that got it right all the time and there was scant evidence that there was anything deliberate about this.”
Amex spokesman David Kanihan said the firm did not intentionally short customers and is taking steps to correct the problem.
“We’re taking a look at anything that we can that we think will help here,” he said. American Express agreed to pay a $3.7 million fine and repay $3.7 million to investors who should have received discounts during 2001 and 2002. However, the company intends to reimburse customers back to Jan. 1, 1999, as a goodwill gesture, Kanihan said.
American Express failed to pay appropriate discounts nearly 30 percent of the time, according to the SEC. Other big firms performed worse, however. Legg Mason Wood Walker Inc. and Linsco/Private Ledger Corp., for instance, failed to deliver break point discounts 35 percent of the time. Some smaller firms missed the mark nearly nine times out of 10.
“There’s no excuse for it being so high or really at all,” said Paul Herbert, an analyst at Chicago-based mutual fund research firm Morningstar Inc. “It really should be an automated process. There shouldn’t be any allowance for an individual to either grant or not grant anything that’s really promised.”
Instead, calculating break points largely has been left up to individual stockbrokers and financial advisers.
Calculating break point discounts can be a daunting task when customers may own shares of various funds or fund families at more than one brokerage and because each fund offers different discounts and those discounts vary by portfolio size.
Kanihan said tracking a customer’s holdings is difficult and depends on the customer’s cooperation. For instance, an Amex customer might well have accounts at other firms and may own shares of the same American Express fund or fund family in more than one account. Yet the American Express adviser who has one of those accounts is supposed to roll all those assets together to determine whether a discount is due, Kanihan said.
American Express is backtracking through its records to determine which customers deserved discounts but didn’t get them. American Express has approximately 2 million customers and a great majority of them have purchased Class A mutual fund shares, Kanihan said. “We have already sent just about all of our clients a letter,” he said. “Some of these people won’t be eligible for a refund.”
The discipline handed out Thursday is likely to shake further investor confidence in mutual funds, which are widely held and have approximately $7 trillion worth of capital.
The industry is reeling from allegations that several well-known fund companies allowed wealthy institutional investors to make illegal late trades and to engage in market-timing strategies that are taboo for smaller investors.
American Express has disclosed that regulators looking into market timing and late trading have requested documents from the firm. The Minnesota Department of Commerce also is investigating market timing and late trading at Amex and 15 other mutual fund companies based in the state.
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