The Securities and Exchange Commission (SEC) and National Association of Securities Dealers (NASD) are generally good at regulating brokers. However, there are still brokers who commit dishonest activities, regulated or not. The best way to avoid them is to first know what they are. Here are some tactics you should be wary of.
Churning refers to the act of excessively trading a client’s account. Some brokers with discretionary authority over an account use this unethical practice in order to increase their commissions. Churning is done to benefit the broker rather than the investor, as the only purpose of the trade is to raise commissions and not actually the client’s chances of success and wealth.
As a matter of fact, you can already consider a trade that has no legitimate purpose churning. One key sign of churning would be an unusual increase in the number of transactions without any substantial gains in the portfolio.
If you are really worried that your account might be subject to churning, you ought to consider a wrap account, which is a kind of account that is managed by a portfolio manager in exchange for flat fee.
The advantage of a wrap is that it protects you from overtrading. Because the broker gets a flat annual fee, he or she only trades when it is beneficial to your portfolio.
Dividend selling is the activity in which brokers convince the client to buy a particular investment stock or mutual fund because of an upcoming dividend. In reality, the broker is merely trying to make some quick buck.
This kind of practice is also done with mutual funds. An advisor will tell a client to buy a fund because dividends are being paid out by companies in the fund. Just like the stock price above, the mutual fund’s net asset value is discounted by the value of the dividend, resulting in a gain only for the broker –in the form of commissions.
As a matter of fact, the investor is better off waiting until after the dividend offer: there will a lower price for the stock and the investor can avoid relatively higher taxes on the income from the dividend.
Many brokerages and mutual fund companies have a sales charge on specific investments. It isn’t that these sales charges are not legal. However, such charges cause you to pay more than you should.
Advisors may keep you from reaping the benefits of breakpoints by splitting your money up among different investment companies, even though each company offers similar services. This results to more commissions for the advisor and less cost savings to you as you are not able to take advantage of the lower commission rates when you reach the higher breakpoints.
Questionable or “unsuitable transactions” are investments made in a manner that is not consistent with the client’s circumstances or investment objectives. You should know that your broker is required by his or her duty to know your financial needs as well as limitations and to make investment recommendations accordingly.