February 18, 2005 - from WSJ NEW HAMPSHIRE regulators accused American Express Co.'s financial-advisory unit of defrauding customers by giving its sales force secret incentives to sell poorly performing in-house mutual funds, rather than investments from competitors. American Express Financial Advisors awarded bigger bonuses for selling the proprietary funds, investigators said. E-mails collected by the state show supervisors praising advisers who sold American Express funds and chiding those who didn't. In one sales contest, American Express offered advisers free one-year leases on Mercedes-Benzes as prizes for promoting a new in-house fund. The New Hampshire Bureau of Securities Regulation said in an administrative complaint that the American Express unit violated state and federal securities laws requiring advisers to act in clients' best interests and to disclose conflicts of interest that could taint their recommendations. The agency, which investigated practices from 1999 to 2003, asked a hearing officer to impose penalties of up to $17.5 million, including restitution. "We have been cooperating with the state of New Hampshire on this matter and we will continue to work with the state to help bring this matter to a resolution," said David Kanihan, a spokesman for American Express's financial-advisory business. He declined further comment. The complaint, which provides an unusually detailed look at incentives offered to sell in-house funds, comes at an inopportune time for the company. Earlier this month, American Express said it planned to spin off Minneapolis-based American Express Financial Advisors, which analysts value at about $10 billion. New Hampshire regulators are attacking the integrity of the unit's signature product: financial plans that the company promotes as tailored to customers' needs but that regulators say were used primarily to push American Express mutual funds. "American Express had a pervasive sales culture that was established and managed with one thing in mind -- to push American Express products and other products that in many cases benefited American Express at the expense of its clients," Mark Connolly, the bureau's director, said in an interview. Other regulators also are scrutinizing the company's sales practices. Last year American Express said the staff of the National Association of Securities Dealers recommended an enforcement action against it concerning payments it receives from outside mutual-fund companies to sell their funds -- money that regulators also believe can taint advice. American Express also has said that the Securities and Exchange Commission is investigating its fund sales practices. Securities firms get commissions for selling both in-house and outside mutual funds, but they can profit more from selling in-house offerings because they receive continuing money-management fees as long as the customer stays in the fund. At American Express, which has 12,000 advisers, proprietary funds make up less than half of mutual-fund sales, the company's Mr. Kanihan said. New Hampshire regulators said investors were harmed because American Express funds had lackluster returns. Over the five years ended Jan. 31, fewer than a quarter of the company's funds beat the average investment performance of comparable funds, according to Chicago researcher Morningstar Inc. Disclosure materials given to American Express customers note that bonus programs are based in part on sales of proprietary products and "present a potential conflict of interest in choosing your products." But New Hampshire's Mr. Connolly said earlier disclosures were less detailed and generally have "evolved from nonexistent to vague legalese." Jeffrey Spill, the agency's deputy director, said that because American Express acts as a registered investment adviser -- not merely a broker -- securities law requires it to act in a client's best interest, in addition to disclosing conflicts. American Express Financial Advisors had $7 billion in sales and $700 million in net income last year. In an interview earlier this month, James Cracchiolo, who runs the advisors unit, said: "We do not pressure advisors to sell proprietary products at all." But New Hampshire regulators say the firm gave more emphasis to sales of proprietary funds in calculating bonuses to senior executives. In 2003, Larry Post, American Express Financial Advisors group vice president for New England, received more than $1 million in compensation, including roughly $900,000 in bonuses, some of which were tied to sales of proprietary products, the state said in its complaint. Mr. Post didn't return a call seeking comment. Five years ago, the company held a contest to encourage sales of its new AXP European Equities Fund. Advisers could get points for sending clients to seminars that pitched the fund, and the 10 who got the most could win a luxury-car lease. "You have the opportunity to drive a Mercedes-Benz for one year FREE . . . that's right, your own 2001 Mercedes-Benz C230 sedan," read a memo e-mailed to American Express financial advisers in 2000. "Drive your client portfolio with AXP European Equities Fund." In an August 2003 e-mail, a supervisor sent around a list of names and the following message: "Congrats to the following advisors for achieving 90%+ Proprietary Investment Mix (And thanks from the company -- its [sic] how we make money . . . " In a July 2003 e-mail cited by regulators, Robert A. Bonfiglio, a supervisor in American Express's Bedford, N.H., office, asked an unnamed financial adviser to explain why he had put his clients in non-American Express funds. "I noticed about half of it [sales] went to non-proprietary business," he wrote. "Can you share with me what the case(s) were? We're working hard to see if we can use American Express products to help you[r] clients." Mr. Bonfiglio didn't return a call to his office for comment.