Reverse Churning: When your Broker Collects a Fee for doing Nothing 

Investor alert: Fee-based Accounts may not be in your Best Interest 

Did your broker transition you from a commission-based to fee-based account? Reverse churning claims may stem from allegations that a broker or advisor moved an account with little trading activity from a commission-based account to a fee-based account for the sole purpose of generating revenue. Reverse churning has become more prevalent as many firms are looking for more ways to generate income from low activity accounts. 

What Is Reverse Churning?  

Churning, an illegal practice, occurs when a broker engages in excessive trading of securities in a customer’s account without considering the client’s investment goals and primarily to generate commissions that benefit the broker. 

Reverse churning, as the name implies, is the opposite — when a broker is paid a flat fee yet does nothing to earn the fee. 

When working with a broker, clients have a choice between an account that pays the broker a commission for each transaction made for the account, or an account that pays the broker a flat-fee commission, usually ranging from 1% to 3% per year of the total assets under management. 

Many firms made the switch to fee-based retirement accounts after the Department of Labor’s Fiduciary Rule came into effect requiring financial advisors to always act in the client’s best interest.  

Conflicts of interest are not allowed under the rule, and firms must fully disclose all fees. Reverse churning cases reportedly increased following the implementation of the Fiduciary Rule.  

Regulators Focus on Reverse Churning 

The Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) are both keeping an eye on account transitions, according to an article in Investment News. Some firms may be moving clients to fee-based accounts to comply with the DOL rule even though those clients would be better off in commission-based accounts.  

Just last week, the SEC hit Waddell & Reed with a $200,000 fine plus restitution for alleged failures to prevent reverse churning in a wrap fee investment advisory program.   

Waddell & Reed, whose wealth management business was recently acquired by LPL Financial, allegedly failed to ensure that the program, known as MAPLatitude, was appropriate for clients who were infrequent traders. See: Waddell & Reed to Pay $776K Over ‘Reverse Churning’ Charges   

In a wrap fee program, clients pay a fee covering all advisory services and trading costs, but clients who trade infrequently may be better off paying commissions in a non-wrap fee or brokerage account, according to the SEC.  

FINRA also increased scrutiny on fee-based accounts and double-charging investors. The regulator reportedly fined Robert W. Baird & Co. $500,000 and ordered it to return $434,510 in fees, plus interest, to 154 customers. Those customers either paid fees in fee-based accounts without generating activity or paid fees higher than those indicated on the Baird fee schedule. 

Geman v. S.E.C. 

At least one federal court has found that brokerage firms offering wrap-fee accounts owe customers a fiduciary duty. The Tenth Circuit, in Geman v. S.E.C., held that in moving client assets to a fee-based structure, a firm must act as a fiduciary and justify the annual fee. If a firm wants to move a client into a fee-based account, it must be able to justify the decision financially. 

Free Consultation with a Securities Fraud Attorney  

Fee-based accounts may not be the best idea for investors if annual fees end up costing more than the trading commissions for accounts that have very little activity. If your advisor leaves you withering away in a fee-based accounts despite a low level of trading, you may be a victim of reverse churning.  

If you are concerned about your investment accounts, the securities attorneys at the White Law Group may be able to help you.

For a free consultation with a securities attorney, please call The White Law Group at 888-647-5510.  For more information on the firm and its representation of investors please visit www.whitesecuritieslaw.com.    

 The White Law Group is a national securities arbitration, securities fraud, and investor protection law firm with offices in Chicago, Illinois and Seattle, Washington.