What is the Anti-Reciprocal Rule
The Anti-Reciprocal Rule is a regulation that was first created by the Financial Industry Regulatory Authority (FINRA). It was designed to protect individual investors from conflicts of interest that might arise when certain brokerage firms and mutual funds work in collaboration.
BREAKING DOWN Anti-Reciprocal Rule
The Anti-Reciprocal Rule specifically aims to prevent an arrangement between a brokerage firm and a mutual fund that might be mutually beneficial to them, but not to the investor. For instance, the brokerage firm might direct its clients to the mutual fund company, thereby generating sales; the mutual fund, in turn, might send its trades through the brokerage firm, generating commissions.
Brokerage firms and mutual funds can be fined by FINRA if there is proof that they have violated the anti-reciprocal rule.
As FINRA explains, when it was first adopted in 1973, the Anti-Reciprocal Rule "prohibited members from seeking orders for the execution of portfolio transactions on the basis of their sales of investment company shares. Principal underwriter members were similarly prohibited from participating or influencing the investment company to consider sales of investment company shares as a qualifying or disqualifying factor in the selection of a broker-dealer to execute portfolio transactions."
The rule was amended in 1981, "to specify that subject to certain restrictions it does not prohibit members from seeking or granting brokerage commissions in connections with the sale of investment company shares, and that it does not prohibit members from selling shares of investment companies which follow a disclosed policy of considering sales of their shares as a factor in the selection of broker-dealers to execute portfolio transactions, subject to best execution," according to FINRA.
In its definition of the anti-reciprocal rule, the group also offers a list of scenarios meant to clarify a "condensation of specific situations" that are inconsistent with the regulation, such as "a request by a dealer, or an offer or agreement by a principal underwriter, for a specified percentage of portfolio brokerage commissions relative to the dealer's sale of fund shares," or "a request by a dealer, or an offer or agreement by a principal underwriter, that portfolio business be placed to finance all or part of the dealer's sales contest."
Examples of Anti-Reciprocal Rule Enforcement
In 2008, for example, FINRA announced that a $5 million fine levied two years previously against American Fund Distributors (AFD) for directed brokerage would stand after being brought to FINRA's appeals body, the National Adjudicatory Council (NAC).
"The NAC upheld a FINRA Hearing Panel decision finding that AFD violated FINRA's Anti-Reciprocal Rule when it directed more than $98 million in brokerage commissions between 2001 and 2003 to the 46 retail securities firms that were the top sellers of its mutual funds," according to the press release.
"AFD is the principal underwriter and distributor of American Funds, a family of 29 mutual funds. In ruling on AFD's appeal of the Hearing Panel decision, the NAC concluded that AFD arranged for the direction of a specific amount or percentage of brokerage commissions to other securities firms conditioned upon those firms' sales of American Funds shares, an 'outright' violation of FINRA's Anti-Reciprocal Rule."
The NAC also ruled that AFD's "requests and arrangements for the direction of brokerage, conditioned upon sales, was directly at odds with the goal of the Anti-Reciprocal Rule, which is 'to curb conflicts of interest that might cause retail firms to recommend investment company shares based upon the receipt of commissions from that investment company,'" according to FINRA.