An SEC case ordering a wealth manager to pay a relatively small fine for so-called reverse churning is attracting a lot of attention among some industry compliance experts.
In a Sept. 19
Potential reverse churning cases have
Waddell & Reed's settlement follows
"It was an open question about how far the SEC and FINRA could take questions about account type when it came to broker-dealers," Schroeder said in an interview. "The duty of care applies to that account-type recommendation, and that's what reverse churning is all about. If I were a broker-dealer, I would read from this that my account type recommendation is likely to be under scrutiny."
She and Eversheds Sutherland Washington office leader Brian Rubin also agree that the regulator faulted Waddell & Reed at a basic level for not following its own guidelines on the question of what type of account best fit the clients. Like a different case
"In both of the cases, the firms had procedures in place to deal with inactive accounts, but they failed to supervise and enforce those procedures," Rubin said in an interview. "If you have procedures in place, then you should make sure that you are properly supervising them."
For Northeastern University finance professor Nicole Boyson, the procedure itself at Waddell & Reed poses the biggest concerns. Between January 2015 and July 2021, Waddell & Reed's policy called for converting wrap accounts into brokerage ones when there were fewer than four trades in the account over the past two years, according to the settlement. Boyson, who has
The duty of care requires wealth managers to "provide investment advice in the best interest of its client based on the client's objectives" and ongoing "advice and monitoring over the entire course of the relationship," according to Waddell & Reed's settlement. Boyson argued that the number of trades in a wrap account is a flawed way of evaluating whether the firm is living up to its obligations, let alone assigning a number like four trades over two years.
"This is a common and tiresome theme in the business," Boyson said in the tweet thread. "Lip service is paid to 'fiduciary responsibility,' but for retail clients in RIA wrap accounts, this is complete and utter nonsense and an excuse to charge much higher fees than would have been charged in a brokerage account."
She called on the SEC "to focus far more time and attention on these cases" and said that firms offering wrap accounts "need to take a very hard look at the fiduciary standard and stop screwing their retail clients by pretending to be fiduciaries. Just be brokers."
For its part, Waddell & Reed promised to pay clients back the $484,645 plus $90,944 in interest that the SEC said it improperly charged the wrap fee customers in 737 accounts, as well as a $200,000 fine. The firm didn't admit or deny the SEC's allegations in settling the case. And no one is using the wrap fee program — which Waddell & Reed called by the name "MAPLatitude" — any longer. LPL
"LPL fully cooperated with this investigation, which was a legacy Waddell & Reed matter," spokeswoman Linda Morgan said in a statement. "The investment program at issue was discontinued in July 2021, after LPL acquired Waddell & Reed."
While the MAPLatitude program was up and running the prior half dozen years, Waddell & Reed displayed spotty compliance with its own policies, according to the SEC. Ironically, the company correctly followed the first step in flagging the accounts with less than four trades over the previous eight quarters in lists it called its "reverse churning reports." Unfortunately for the firm and its clients, though, Waddell & Reed largely didn't follow up with the necessary next stage of converting the accounts to brokerage holdings, the SEC said.
In some instances, the company didn't contact the relevant advisors to find out whether the clients wanted to boost their activities and remain in the MAPLatitude program. Other times, the company didn't do anything with the inactive accounts even after compliance staffers spoke with the advisors. On some occasions, the compliance team failed to instruct the operations staff to convert the accounts to brokerage holdings. And, in still other examples, the compliance team told the operations employees to do so and the operations staff never actually switched them.
"Application of Waddell [& Reed's] compliance policy for its MAPLatitude program lacked reasonable coordination, oversight and a method of confirming that inactive accounts had been addressed appropriately," according to the SEC's settlement.
Despite Waddell & Reed's case getting resolved, the threat of reverse churning allegations continues to loom over advisors and the industry at large. In addition to a risk
Firms must disclose incentives for recommending wrap accounts, compensation from sponsors or company affiliates that are tied to the products and "the possibility that the investor will bear higher costs by participating in the wrap fee program than in other types of accounts," the staff bulletin stated.
"Firms also should consider the scope of the relationship with respect to the account and whether there is an obligation or agreement to monitor the account and, as applicable, disclose any incentive to not migrate infrequently traded wrap fee accounts to brokerage or non-wrap advised accounts (sometimes referred to as 'reverse churning')," it continued.
