When advisors churn, clients burn
By Steven McCarty
The National Ethics Association
Have you ever replaced your smartphone before you really needed to? Then you have fallen victim to the high-tech equivalent of churning.
Churning, in this context, is perfectly legal, and brand marketers like Apple and Samsung depend on it. But churning exists in our industry, too. It occurs when an advisor sells consumers a product and then gets them to replace it with another one in order to generate an additional commission.
As you well know, each churn generates not only commissions, but it might also trigger surrender fees and other penalties. So if there’s no material gain to the client after the transaction, trouble can and often does ensue.
Churning has been with us forever. Yet despite compliance departments’ diligent efforts, advisors continue to succumb to its allure. Why?
For one thing, it’s easier to churn an existing account than it is to create a new client. And when an existing client trusts you, replacing multiple contracts without cause (other than making more money) can be child’s play. But just because churning is simple, doesn’t make it right. Here’s why:
Churning is illegal. One of the quickest ways to lose your license is to churn your clients’ holdings. (Example in a second.)
Churning is unethical. It dramatically violates the spirit of the fiduciary standard of care. Even though non-Series 65 agents aren’t true fiduciaries, I believe they should still uphold the spirit of that license.
Churning is a reputation killer. Once it gets out that you’ve been sanctioned (or worse) for churning, clients and potential clients will realize you aren’t worthy of their trust. And you can be sure they won't be shy about sharing that knowledge via the Internet.
Despite claiming not to sell investments on commission and claiming he operated under a fiduciary standard, he nonetheless replaced prior contracts he sold with 31 new EIAs. As a result, the advisor received roughly $160,000 in commissions, but his clients lost nearly $265,000 in surrender penalties and other fees.
For his efforts, the advisor is now looking at potentially losing his securities and investment-advisory licenses, as well as paying substantial fines. Plus, his state’s attorney general has brought fraud charges against him. Who needs this kind of trouble, not to mention a ruined reputation?
Don’t let this happen to you. Protect yourself by following these pointers:
- Never initiate a replacement unless there are tangible clients benefits for doing so.
- “Taking the money because you can” is not a sustainable business strategy. Instead, strive to build life-long, mutually beneficial relationships.
- Don’t just give lip service to words “client’s best interests.” Live that principle every day!