• California Attorney General and American Funds Settle Revenue Sharing Litigation
  • March 31, 2008 | Author: David W. Freese
  • Law Firm: Pepper Hamilton LLP - Philadelphia Office
  • On February 14, 2008, California Attorney General Jerry Brown announced that the state had agreed to end the three-year litigation with Capital Research and Management Company and American Funds Distributors, Inc. The litigation stemmed from the companies’ alleged misuse of revenue sharing and directed brokerage arrangements with broker-dealers. Capital Research and Management Company and American Funds Distributors, Inc., respectively, are the investment adviser to and distributor of the American Funds mutual fund family.

    Revenue sharing occurs when an adviser or distributor pays a broker dealer for fund promotion. Directed brokerage occurs when an adviser directs portfolio transactions to a particular broker-dealer in exchange for extra promotion, or “shelf space,” of the fund shares. The suit alleged that the companies failed to disclose in the American Funds’ prospectuses such arrangements and that such non-disclosures amounted to a violation of the California Corporate Securities Law.

    As part of the settlement agreement, the companies agreed to alter certain business practices, including:

    • Improving disclosure in American Funds’ prospectuses with regard to revenue sharing arrangements;
    • Improving disclosure of expenses to retirement plan participants;
    • Establishing a committee of independent directors of American Funds to discuss distribution-related issues involving American Funds and the fund industry in general; and
    • Developing and implementing a policy to enhance the oversight over revenue-sharing activities of dealership relationship managers.

    Pepper Points - American Funds’ decision to forgo settlement until now is unique. In 2004, the distributors of the PIMCO and Franklin Templeton mutual fund families settled with California’s then-Attorney General Bill Lockyer for $9 million and $18 million, respectively. American Funds agreed to cover merely $2.5 million in California’s legal fees. American Funds still has a similar ongoing fight with the Financial Industry Regulatory Authority. American Funds has appealed a $5 million FINRA fine levied in 2006 based on allegations of similar brokerage arrangements. It remains to be seen whether California’s decision to settle will affect the appeal.