“The brokerage might say to the fund, ‘If you transact those shares with our company, we might put extra muscle into advertising your fund,’” Nester said.

Nester said directed brokerage is intended to increase the mutual fund firm’s profit by attracting new customers—at investors’ expense.

Directed brokerage is legal if the customer is aware that it is taking place and understands and consents to the process, said Nester. The process becomes illegal if the customer is unaware of how the fund money is being spent.

“The fund holder has a right to know that his or her funds are being used for marketing purposes,” Nester said.

The SEC launched an industry-wide investigation of mutual fund sales in November 2003, and Morgan Stanley Dean Witter and Massachusetts Financial Services have been fined $50 million each for undisclosed directed brokerage.

Nester said the SEC aims to change its rules in the near future to make any directed brokerage arrangement illegal.

Capital Research engaged in directed brokerage—a practice American Funds said was “consistent” with SEC regulations—until recently, when it halted the practice to conform with the proposed SEC rule change, according to a statement on its website.

—Staff writer Alan J. Tabak can be reached at tabak@fas.harvard.edu.