Anti-Reciprocal Rule (FINRA) - Explained
What is the AntiReciprocal Rule?
Written by Jason Gordon
Updated at September 23rd, 2021
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Table of Contents
What is the Anti-Reciprocal Rule?How Does the Anti-Reciprocal Rule Work?Examples of Anti-Reciprocal Rule EnforcementAcademic Research on Anti-Reciprocal RuleWhat is the Anti-Reciprocal Rule?
The Anti-Reciprocal Rule is a regulation by the Financial Industry Regulatory Authority (FINRA) that prohibits a mutual fund manager and a brokerage firm from colluding to engage in business transactions that will affect a client negatively. The anti-reciprocal rule was designed to protect investors and clients of brokerage firms from being victims of conflict of interest that might occur when a mutual fund and brokerage frim collaborate. When collaborations occur between two market makers such as a brokerage firm and a mutual fund, an investor might be a victim of bad advice emanating from conflict of interest. The anti-reciprocal rule protects investors from such.
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How Does the Anti-Reciprocal Rule Work?
The anti-reciprocal rule was first used by FINRA in 1973 after its adoption, this rule prevents the occurrence of a collaboration between two market makers that are only for their own benefits and not for the best interest of their clients. When brokerage firms and mutual firms go against the anti-reciprocal rule, they face a penalty or pay a fine to FINRA. There are diverse arrangements or collaborations between a brokerage firm and a mutual fund that could cause harm to an investor. For instance, if a brokerage firm recommends a mutual fund company to an investor only for them to generate commissions on the investors they send in, such collaboration is against the interest of the client or investor. When the anti-reciprocal rule was amended in 1981, it included some definitions that offer more protection to clients of brokerage firms and investors.
Examples of Anti-Reciprocal Rule Enforcement
There are many scenarios when FINRA has enforced the anti-reciprocal rule and punish brokerage firms and mutual fund companies that violate the rule. Usually, when this rule is violated, the offender is required to pay a fine to FINRA. The National Adjudicatory Council (NAC) is the appeal body of FINRA, this is the council that conducts hearings for cases related to the violation of the anti-reciprocal rule brought before it.
Academic Research on Anti-Reciprocal Rule
- Compensation practices for retail sales of mutual funds, Krawczyk, S. S. (2003). Compensation practices for retail sales of mutual funds.Journal of Investment Compliance,4(4), 27-45. During 2003, compensation practices for the retail sale of mutual funds came under fire. Recent revelations about failures in the processing of mutual fund breakpoints had triggered a more indepth investigation into mutual fund marketing and compensation practice by securities regulators, Congress, and the states. This article focuses on the regulation of sales compensation practices primarily as it affects a brokerdealer selling mutual funds in the retail market. It addresses the regulatory framework for three key compensation practices: (1) the use of noncash compensation in connection with mutual fund sales; (2) marketing and compensation arrangements providing enhanced compensation to a selling firm as well as to its sales representatives for the promotion of certain fund securities over others, such as proprietary funds over nonproprietary funds, preferred funds over nonpreferred funds, and Class B shares over Class A shares; and (3) the use of commissions for mutual fund portfolio trades as an additional source of selling compensation for selling firms, a practice sometimes referred to as directed brokerage. [PDF]
- Do Funds Mask Distribution Fees as Brokerage Commissions?, Jaiswal, S. Do Funds Mask Distribution Fees as Brokerage Commissions?.
- EO doeCE, ACT, S. EO doeCE.Litigation,6398, 405.
- When a Fund is Sued: An Independent Director's Guide to Fund Litigation-Part 1, Helm, R. W., Dodds, W. K., Wingler, J., & Geffen, D. M. (2010). When a Fund is Sued: An Independent Directors Guide to Fund Litigation-Part 1. This article explains what independent fund directors should know about fund litigation. While independent directors were named defendants in prior lawsuits - for example, 36(b) excessive fee lawsuits - the scope of litigation that followed 2003 was without precedent both in terms of the number of lawsuits and the number of those suits naming directors as defendants. The number of lawsuits and the scope of litigation reflect the increased scrutiny to which the conduct of fund directors is subject. This article first describes the most common types of claims against funds and the roles that independent directors typically play when these claims are brought by a plaintiff. It then describes the differences between direct actions against a fund and derivative lawsuits brought on behalf of a fund, including the critical role independent directors have to play with respect to derivative lawsuits by investors on behalf of the fund. Part 2 of this article, which will appear in an upcoming issue of The Investment Lawyer, will focus first on the attorney-client privilege, which is critical in fund litigation. Part 2 will then cover the related topics of insurance and indemnification in the context of directors and fund litigation. It also will discuss payment of the settlement costs in fund litigation.
- Finders Fee Compensation to Brokers and Others, Casey, J. L. (1975). Finders Fee Compensation to Brokers and Others.Bus. Law.,31, 707.