DOL fiduciary rule sparks charges of reverse-churning

As more broker-dealers move clients from commission-based accounts to those that charge annual fees — in some cases as a way to insure they are complying with the Department of Labor’s fiduciary rule — they may be in danger of exposing themselves to reverse churning charges.

Commissions are seen as a more conflicted compensation method than fees. But if clients don’t execute many investment purchases, a firm is likely to generate higher revenue if it puts them in accounts that charge annual fees.

After a final DOL rule was released in 2016 and through its partial implementation last summer, there was a trend in the brokerage industry to move clients from commission to fee accounts.

And now, a class action suit has been filed against Edward Jones that highlights the dangers of reverse-churning, and may be a harbinger for similar cases.

In a complaint filed against Edward Jones and three other advisory firms, the plaintiffs alleged that they had been moved from commission-based accounts into fee-based accounts between 2013 and 2018 despite the fact that they did little trading.

The suit alleges that Edward Jones transitioned the plaintiffs into fee-based accounts under the cover of the DOL fiduciary rule, which requires brokers to act in the best interests of their clients in retirement accounts.

“Due to the disclosure requirements that would be imposed on Edward Jones if it continued to offer commission-based accounts after the DOL fiduciary rule was implemented, the company began to pivot its business strongly towards fee-based accounts by pushing its customers from commission-based accounts into Advisory Solutions accounts — regardless of whether the switch would be in the customer’s best interest,” the claim states.

In October letters to the DOL and other securities regulators, the Consumer Federation of America said that the DOL rule prohibits inappropriate shifting of clients from commission to fee accounts and that any effort to do so should be investigated.

Barbara Roper, CFA director of investor protection, said that she could not assess the validity of the claim against Edward Jones. But she said she has been told about situations similar to the one described in the case.

“We have heard persistent reports that this is happening at a number of firms, and I have heard that from sources I consider reliable,” Ms. Roper said.

“It’s not a universal practice, but you did see a shift from commission-based accounts to fee-based accounts in response to the rule,” said Joshua Lichtenstein, a partner at Ropes & Gray. “Whether there’s merit to the claims or not, I could imagine people trying to bring similar types of claims.”

Brokerage firms that have emphasized fee-based accounts are doing their best to comply with the DOL rule, according to Steven W. Rabitz, a partner at Stroock, Stroock & Lavan.

“It put institutions in a real bind,” Mr. Rabitz said. “I find it hard to believe that there would be an untoward push to one business model or another. Just because [there’s a transition] doesn’t mean there’s a per se problem.”

That’s what’s Edward Jones asserts.

“Edward Jones has consistently offered both fee-based and commission-based client accounts that adhere to all regulatory requirements,” spokesman John Boul wrote in an email. “We believe Edward Jones client accounts are among the best options in the industry, and we intend to vigorously defend this action.”

The fate of the DOL rule is in limbo after the 5th Circuit Court of Appeals recently stuck it down. It’s not clear whether the agency will continue to defend it or let it die in court. If it’s the latter, it could be a setback for potential litigation.

“It will be hard to see credible plaintiffs’ law firms bringing cases under a rule that has been vacated in its entirety,” Mr. Rabitz said.