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I work for a dual registered broker-dealer/investment advisor. Recently, we underwent an examination and during the exit interview the examiner mentioned that he had some concerns over what he called "reverse churning." I'm not sure I understand what he was getting at, since I have always thought of churning as excessive trading. How can an account be traded too little? It almost sounds as if the examiner wants the client to pay more. Can you help make sense of this for me?
I have seen "reverse churning" arise most often when a broker-dealer is acting in dual capacities as both a registered investment advisor and a broker-dealer in connection with wrap accounts.
Generally speaking, a wrap fee program will charge a higher advisory fee to cover, or offset, the transaction charges that would otherwise be paid on a frequently traded account. The higher advisory fee is justified by the fact that the more frequent trades would have cost the client more if he or she had to pay the commissions.
Conversely, a non-wrap account would normally be more appropriate for "buy and hold," or less frequently traded, accounts. Typically, the advisory fee charged in that case would be lower than in a wrap account because there would be fewer trades. The client benefits by paying the lower fee even though he or she has to pay the commissions.
The "reverse churning" comes in when the client is in a wrap program despite being a low-volume trader. In that case, being charged the higher advisory fee would be seen as inappropriate since the non-wrap program would have been a better deal for the client.
I'm thinking of leaving my broker-dealer, giving up my Series 7 license and becoming a registered investment...