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Don't Let Your Broker Switch You From Fund To Fund Without A Very Good Reason
utual funds are not supposed to be traded, or bought and sold regularly. They are meant to be held as long term investments. Indeed, securities regulators presume that a switch between mutual funds is unsuitable. Brokers have the burden of rebutting that presumption, and it is difficult to do.
For example, recently the Securities and Exchange Commission (SEC) upheld a decision by the National Association of Securities Dealers (NASD) to censure, fine and suspend a broker who, on average, held his clients' mutual funds only for 11 months. Investors should consider the defenses that the broker raised, which both the SEC and the NASD rejected.
First, the broker claimed that he needed to switch from one growth fund to another because it offered better potential. However, the SEC and the NASD determined that better potential was not a sufficient reason for the switch.
Second, the broker claimed that he sold a mutual fund because the fund manager had announced that he would consider adding potentially risky investments - derivatives and options - to the portfolio. Nonetheless, that was not a sufficient reason for the switch, the regulators found, until there was evidence of a negative effect upon the fund's performance.
Third, the broker claimed that he sold a mutual fund because Morningstar (a rating service) dropped its coverage on the fund. But the SEC and the NASD concluded that that was not a sufficient reason for the switch.
Fourth, the broker claimed that he sold a mutual fund because another fund had received top ratings and would provide better downside protection in a "kind of shaky economy". Not good enough, the regulators found.
Fifth, the broker claimed that the fund he had sold would not do well because it concentrated in a particular industry, which he believed would do poorly. However, that was not a sufficient reason for the switch.
Sixth, the broker claimed that he sold a mutual fund because there was a new manager of the fund. The regulators determined that that was not a sufficient reason for the switch as the broker did not, in fact, present evidence of any detrimental effects due to the change in fund managers.
Furthermore, investors should remember that when a broker has a burning desire to switch mutual funds, he must attempt to obtain reduced sales charges. It is not a sufficient effort for the broker simply to sell a front end sales load fund and buy a deferred contingent sales load fund. Instead, the broker must attempt to have the investor's purchase qualify for "breakpoints", which are sales charge reductions for larger purchases.
Brokers also must consider Letters of Intent (LOIs). These are agreements to reduce sales charges in return for the investor's commitment to buy additional fund shares over a 13-month period. Additionally, when a broker sells a mutual fund from a family of mutual funds (for example, Fidelity), and buys another fund later from the same fund family, the broker has an obligation to inquire as to whether the investor can receive a reduced sales charge by way of a "reinstatement privilege".
Finally, if a broker has a burning desire to switch mutual funds, she has an obligation to consider remaining in one mutual fund family where there may be no sales charges whatsoever for switching.
As one can see, mutual fund switching rarely is justified. Even when it is justified, brokers must attempt to minimize sales charges as much as possible. Make sure that your broker understands these facts.
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Sponsored by James J. Eccleston. This Web site contains material of general interest. It is neither intended to, nor constitutes, either legal advice or investment advice.
Always consult an attorney and/or investment adviser when building and protecting your wealth.
All content Copyright © 2010 Advocate Compliance Partners, Inc. except where noted. All rights reserved.
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