InvestmentNews Editorials

Beware: Regulators won't take excuses for reverse-churning

Exam priorities and lawsuits are zeroing in on account switching

Apr 14, 2018 @ 6:00 am

With regulatorszeroing in on reverse-churning, and lawsuits popping up around the practice, advisers should be paying attention.

The concern stems from conflicts of interest that advisers face when deciding whether to move clients from commission-based accounts to often more expensive fee-based accounts (depending on how much trading occurs, which additional services are provided and how much the fee is). But some advisers have felt pushed in that direction regardless of the circumstances, especially in retirement accounts, because of the compliance demands of the Labor Department's fiduciary rule.

And there's the rub: If the transition to a fee-based account is not in a client's best interests, it shouldn't happen.

That leaves advisers and their firms with a few choices: Use the best-interest contract exemption to allow for the variable pay of commissions, change the commission structure to be level, or move a client into a fee-based account. The third choice is the easiest to execute.

But advisers had better be sure they can justify the higher fee if that's the route they go.

Why? Because regulators have rightly been focusing more on the movement between accounts and are eager to find instances of profiteering. Are clients being moved to fee accounts because it really is in their best interest or because it's an easier way for advisers to meet a regulatory requirement?

Red flag

Last October, the Consumer Federation of America sent letters to DOL Secretary Alexander Acosta, SEC Chairman Jay Clayton and Finra Chief Executive Robert Cook raising such concerns. The organization pointed to comment letters from industry groups and firms that some of them are moving clients to fee accounts to comply with the DOL rule even though those clients would be better off in commission accounts. There's a red flag.

In their exam priorities for this year, both the Securities and Exchange Commission and the Financial Industry Regulatory Authority Inc. included a focus on account transitions.

The SEC said practices that result in investors paying inadequately disclosed fees — such as "advisers that changed the manner in which fees are charged from a commission on executed trades to a percentage of client assets under management" — would be examined. And Finra included guidance in its priorities warning dually registered advisers against any switch that "clearly disadvantages the customer."

This isn't the first time regulators have faced potential blowback from or inappropriate reactions to the DOL rule. In 2014, the SEC included parking clients in wrap accounts as an area of scrutiny.

As Blaine Aikin pointed out a few years ago in a column in InvestmentNews, "The first occurrences of reverse-churning came to light around 2005, when the SEC adopted an exemption permitting brokers to accept fee-based compensation. In a subsequent sweep of fee-based brokerage accounts by Finra, it found not only widespread absence of trading activity, but also double-dipping, in which brokers charged commissions for investment products that were subsequently placed in the fee-based accounts."

So whatever the fate of the Labor Department's fiduciary rule, securities regulators' attention to account switching is here to stay — as is their focus on fees in general. In an SEC risk alert last Thursday, the agency pointed to frequent compliance issues it found during exams, and among them was charging clients additional fees, such as brokerage fees, when the client had been placed in a wrap account.

Given that reality, advisers better be prepared to answer these questions the next time an examiner comes knocking: Which services are performed to justify the fees? What was the decision-making process used to determine whether a fee account was a better model for the client than a commission account?

0
Comments

What do you think?

View comments

Recommended for you

Upcoming Event

Apr 17

Conference

Innovation Summit 2019

InvestmentNews will gather the biggest names and the brightest minds in the financial services industry in one room, for one day. This new event will include the icons and innovators alumni, along with those recognized on this year’s list to... Learn more

Featured video

INTV

Why millennial demand for ESG is falling on deaf ears

Editorial director Fred Gabriel and senior columnist Jeff Benjamin say there's a disconnect between the big appetite for environmental, social and governance funds in 401(k) plans and their offering.

Latest news & opinion

ESG options scarce in 401(k) plans

There's growing interest among plan participants, but reluctance to add funds that take into account environmental, social and governance factors persists.

Ameriprise getting ready to launch its bank

Firm's advisers will soon have access to lending products such as mortgages.

Envestnet acquires MoneyGuide for $500 million

Deal will allow Envestnet to deepen integrations between MoneyGuide and its other wealth management solutions.

Genworth move could signal big shift in distribution of long-term-care insurance

Insurers may turn to direct-to-consumer sales only, bypassing brokers and insurance agents.

Morgan Stanley threatens to pull out of Nevada over state's fiduciary rule

Wirehouse says it would not be able to work there under state's current proposal.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print