Thursday, August 31, 2006

Directed Brokerage

"Directed brokerage" is a malpractice often found in the US, where mutual fund managers direct brokerage commissions of portfolio transactions as a reward to those securities firms which are top sellers of fund managers' funds to retail clients.

Such practice violates the so-called "Anti-Reciprocal Rule" by posing a potential conflict of interest in both buy and sell sides. Securities firms which are good sellers of funds may not be the best executors of portfolio transactions. Fund managers using these securities firms may have put their own interests (fund sales results) ahead of the fund investors' interests.

On the other hand, securities firms which advise their clients to purchase the funds managed by fund managers offering directed brokerages may not act in the clients' best interests. They may recommend unsuitable funds to their clients for the purpose of earning more commissions from fund managers.

There have been numerous cases of directed brokerage violations in the US, from the case of Morgan Stanley to the recent cases of ING and American Fund Distributors.

In HK, so far no similar enforcement case has come out. Retail funds are mainly sold by banks and IFAs instead of securities brokers which execute trades for fund houses. Mis-selling of funds is directly driven by commission rebates for funds sales, not indirectly by brokerages of securities dealing.

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