The Wall Street Journal has picked up on the SEC's look into how American Funds compensated brokerage firms to which it sent portfolio trades. The report follows the lead of the Los Angeles Times, which reported on the investigation in its Thursday edition. In February, the NASD announced that it was also probing the use of directed-brokerage by American Funds.

The WSJ article reports that unnamed sources told it that the SEC staff has not decided whether to recommend an enforcement action. At issue, according to the paper, is whether the fund firm achieved "best execution" on step-out trades that were sent to various broker-dealers.

The paper also said it contacted "an official in the SEC's Los Angeles office" who declined to comment.

The crux of the SEC questioning is how American Funds shareholders could have received best execution if two broker-dealers -- the one being compensated for hitting sales targets and the one executing the trade -- were compensated for the trades. Theoretically, American Funds could have achieved a better price by going directly to the broker-dealer executing the trade.

However, best execution does not necessarily mean best price, but the case of step-out does raise the interesting question broached by the SEC since the trade execution would likely be identical whether or not the distributing broker-dealer were included in the deal.

The WSJ also notes that the SEC seemed to approve of step-outs in 1998 when it wrote that "By telling a broker executing a trade to step-out a portion of the commission to another broker, an adviser can use the broker that provides best execution to execute the trade, and can pay commissions ... to other brokers from which it receives research or other services, even if those brokers have inferior execution capability."  

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