For years, firms have been using wrap products to charge an annual fee based upon the value of assets under management regardless of the number of trades, as opposed to fees per trade. In other words, wrap accounts were an effective tool to avoid churning claims because the customer theoretically could trade daily and only be charged an annual fee. These accounts are, however, giving way to a new type of customer complaint and regulatory oversight.

The new claim is known as reverse churning. In that situation, the client is placed into a wrap account, but trades very infrequently. As a result, the client winds up paying more in wrap fees than she would have with a straight brokerage, pay per trade account. idea.jpg

You can avoid these types of claims and potential regulatory headache by doing some simple due diligence when the account is opened and over the life of the account. As part of the “know your customer” intake process, you need to make proper inquiry to get a sense from your new client how frequently that client may want to execute trades in the account.

If your prospective client is looking for an active trading strategy, then the wrap account is probably the right way to go, and vice versa. It is equally important to review your accounts on a regular basis, at least annually, to see if the account activity justifies the fee structure. If the fees are out of whack when judged against the trading volume, then recommend a change in a formal written communication.

Unfortunately, reverse churning does not change butter into cream. To avoid what it can create, do your due diligence during your initial and subsequent know your customer analysis. Make sure your client is in the right type of account and avoid the stomach upset associated with a churn.

* photo from freedigitalphotos.net