A lawsuit in Florida is seeking class-action status against Raymond James for what it claims is reverse-churning, a practice that the firm has been accused of since at least 2005.
In the latest case, Kimberly Nguygen of Garland, Texas, is claiming Florida-based Raymond James moved her from a commission-based to a fee-based account even though she is a “buy and hold” investor who would require few, if any, trades.
Nyguyen opened her commission-based account with Raymond James in June 2015, but in January 2016, her advisor advised her to transfer her assets to a fee-based Freedom Account, according to the complaint. She paid more than $7,432 in fees between 2016 and 2018, which the complaint said was “substantially” more than she would have spent in a commission-based account.
Although regulators and legislators regularly castigate the insurance and financial industries for exchanges primarily for commission, or “churning,” not as much attention has been focused on “reverse-churning,” or exchanging commission-based funds to fee-based accounts to increase broker revenue.
In fact, the claim accuses Raymond James of using federal regulation that was designed to control churning as an opportunity to reverse-churn.
“Raymond James has disclosed that a significant portion of that increase in assets came from existing clients,” according to the complaint. “For example, Raymond James provided in its 2017 Form 10-K that the increase in assets in Fee-Based Accounts was driven by ‘clients moving to fee-based alternatives versus traditional transaction-based accounts in response to the recently implemented DOL regulatory changes.’ Accordingly, plaintiff [Nyguyen] reasonably believes there are thousands, if not tens of thousands, of members in the proposed class.”
DOL Rule Meant To Curb Abuse
The U.S. Department of Labor’s fiduciary regulation was called the conflict of interest rule because the department argued that the existence of commissions and bonuses enticed agents and advisors to sell for their own benefit rather than the client’s. The Trump Administration shelved the rule in 2018.
One of the rule’s primary purposes was to prevent churning, such as when an annuity is exchanged for another one and incurs onerous expense for the client, or when a fee-based product is exchanged for a commission-based product.
“Ironically, the announcement of the Fiduciary Rule, a rule designed to protect investors, provided Raymond James with an external rationalization to accelerate that transition process based on compliance with the Fiduciary Rule even though the Company could have just as easily complied with the Fiduciary Rule without transitioning clients to Fee-Based Accounts,” according to the complaint. “However, Raymond James would have made less money if its clients stayed in commission-based accounts.”
Although the firm had announced that clients could keep their commission-based accounts under the fiduciary rule, the complaint alleges the firm encouraged representatives to move all clients to fee-based accounts regardless of suitability in violation of its own policy and FINRA regulations.
This lawsuit focuses on Raymond James but reverse-churning has been an issue with many large broker-dealers. This Money Magazine article from 2017 identified several firms that switch clients into fee-based accounts.
Not The First Time
The complaint lays out three questions that would make the lawsuit a class-action:
- Whether Raymond James breached its duties to the class by failing to employ appropriate supervisory measures to determine the suitability of fee-based accounts before transitioning its clients into those accounts.
- Whether Raymond James breached its duties to Class members by failing to conduct at least annual reviews to determine whether Fee-Based Accounts continued to be suitable for clients after the transition.
- To what extent the Class members have sustained damages and the proper measure of damages.
But Raymond James had been sanctioned earlier for similar practices.
In 2005, FINRA’s forerunner, the National Association of Securities Dealers fined the firm $750,000 for moving clients into fee-based accounts despite suitability, although the firm did not accept or deny the charges.
The NASD accused Raymond James of moving 2,913 existing customers between early 2001 and December 31, 2003, who had commission-based accounts for more than one year without executing a trade in the account.
“Based on the customers’ trading history, Raymond James should have known these customers were ‘buy and hold’ customers and that fee-based accounts may not have been appropriate for them,” NASD said at the time. “Of these 2,913 customers, 190 never executed a trade in their fee-based accounts, yet they paid Raymond James total fees of approximately $138,000.”
Raymond James and its advisors told the NASD that they were “terminating their fee-based brokerage programs and will completely discontinue their fee-based brokerage business by July 1, 2005,” the agency said. “As part of the sanctions imposed by NASD – in the event that either of the Raymond James firms involved in today’s action continues with any fee-based brokerage business after July 1, 2005 – the firm must retain an independent consultant to make recommendations regarding establishing, maintaining and enforcing a supervisory system and written procedures relating to its fee-based brokerage business that are designed to achieve compliance with applicable securities laws and NASD Rules.”
Mary Schapiro, then the NASD vice chairman, expressed caution about fee-based accounts.
“Fee-based accounts can be appropriate for many investors,” Schapiro said. “But they are not automatically appropriate for everyone. Firms should not recommend these accounts without first making a determination, by looking at traditional suitability factors as well as the customer’s trading history, that the account is appropriate in light of the services provided, the projected cost to the customer, alternative fee structures available and the customer’s preference. They also should periodically review these accounts after they are opened to see that they remain appropriate.”
Schapiro later became the SEC chairman and urged the DOL to adopt the fiduciary rule, which considered commissions a conflict of interest.
In 2019, Raymond James settled a similar case with the SEC, which said the firm’s advisors did not “consistently perform promised ongoing reviews of advisory accounts that had no trading activity for at least one year,” according to the SEC. “Because they did not conduct the reviews properly, they failed to determine whether the client’s fee-based advisory account was suitable. The order further finds that the entities also misapplied the wrong pricing data to certain UIT positions held by advisory clients, causing them to overpay fees.”
The firm agreed to pay $15 million in restitution and a penalty.
Raymond James did not respond to a request for comment on the current lawsuit or its policies to prevent abuse.
Steven A. Morelli is editor-in-chief for AdvisorNews. He has more than 25 years of experience as a reporter and editor for newspapers and magazines. He was also vice president of communications for an insurance agents’ association. Steve can be reached at email@example.com.
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