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Reverse churning-the practice of putting clients who trade infrequently into a fee-based brokerage account-grabbed headlines two years ago when regulators went after brokerage firms for promoting the accounts with what they saw as too-little regard for the customers' interests. Regulators were concerned that clients would end up paying more in fee-based accounts than in traditional commission-based accounts, with little extra advice or service to show for the higher price tag.
Only two firms have been fined so far, but regulators and industry observers say that reverse churning is a key item on regulators' watch-list in audits. "It's here, and you have to deal with it," says Pete Michaels, a Boston-based securities attorney.
In the past year, Michaels has had many broker-clients who have received deficiency letters from regulators following audits. Among other things, the regulators wanted explanations for why certain clients were placed in fee-based brokerage accounts.
Michaels has had to write response letters on behalf of those clients, giving the rationale for putting those investors into fee- in-lieu-of-commission brokerage accounts. "It will be addressed in every single audit in every single branch in every single firm," he says.
As of this writing, Michaels is still waiting for responses from regulators. "We may be ahead of the curve on this," he says. "There could be a lot of fallout in the coming months."
Other industry observers and participants agree, noting that once a regulator has taken action to fine or censure a broker, a wave of client arbitrations often follows. "As soon as they hear of something they can sue on, they do it," says LaRae Bakerink, chairwoman of the National Association of Independent Broker/ Dealers (NAIBD) and chief executive officer of her own brokerage firm, San Diego-based WBB Securities.
That means financial advisers must understand the sometimes confusing rules and various categories of accounts, and adopt best practices to avoid raising regulators' ire-and maybe even customer- initiated arbitrations down the road.
HOW DID WE GET HERE?
The industry has come a long way in the past decade, ever since the time fee-based accounts first came to be regarded as a panacea to regulatory woes. In the early and mid-1990s, regulators had been on the warpath against churning-the practice of trading a client's account...