Edward Jones Prevails in Reverse Churning Class-Action Suit
(Updates with comment from plaintiffs’ lawyer in last paragraph.)
A federal judge in California has dismissed a lawsuit filed against Edward D. Jones & Co. that alleged the broker-dealer moved customers to fee-based advisory accounts from less expensive commission accounts in a “reverse churning scheme” that generated hundreds of millions of dollars annually for the firm.The lawsuit in the generally investor-friendly federal U.S. Eastern District Court of California has been closely watched because brokerage firms have been promoting advisory over traditional transaction accounts that yield annual fees regardless of clients’ trading patterns. Fee-based accounts also deter brokers from churning trades in order to generate commissions, firm executives said.
The lawsuit, which was filed in March 2018, alleged that Jones pressured its brokers to switch their largely middle-income customers into advisory accounts that charge as much as 2% of assets annually, even though the clients “generally engaged in very little trading.” It referred to the strategy as a “reverse churning” scheme and said clients were switched without regard to suitability and without receiving “full information.”
In dismissing the putative class-action suit, District Judge John A. Mendez on Tuesday upheld the St. Louis-based brokerage firm’s arguments that it gave customers “extensive disclosures” about the costs and benefits of fee-based accounts in a brochure they received titled “Making Good Choices.”
The brochure “explicitly charts and discusses the material differences between the account types” and includes information that an advisory program “can be more expensive than other investment choices over the long term,” the judge wrote.
“We’re pleased the federal court in California dismissed the ‘reverse churning’ case,” a Jones spokesman said. “Significant is that the court’s decision recognizes ‘Edward Jones provided substantial disclosures’ to clients.’”
Jones, the largest U.S. brokerage firm as measured by its more than 18,000 advisors, generally advocated buy-and-hold investing strategies appropriate to commission-based accounts, the lawsuit said. But it updated its computer systems in the summer of 2016 to make fee-based accounts a default recommendation, according to the lawsuit.
“[T]he conduct Plaintiffs allege as violations—including sales training for financial advisors, changed incentive structures and a new computer system—is not an actionable deceptive scheme,” the judge wrote.
The brokerage firm, which books more than 75% of its revenue from mutual fund sales, began marketing fee-based accounts in 2008 but accelerated its push “aggressively” in 2016, according to the complaint.
Jones also advanced its strategy out of fear that the now-defunct Department of Labor fiduciary rule would have made it more difficult to collect hundreds of millions of dollars annually from fund companies and insurers for sales into retirement accounts, the lawsuit said.
Jones generated $17.2 billion from asset-based fees in the approximately three-year period cited by the defendants, and executives named as defendants in the case received over $277 million in compensation, the lawsuit alleged.
“The mere fact that Edward Jones financially benefited from certain clients choosing to move into fee-based accounts does not foreclose that the clients may also benefit in the long-run from this new offering and that the company fully believes in the value of its product,” Judge Mendez wrote.
He denied the plaintiffs’ claims for breaches of fiduciary duty under state law (California as well as Missouri), saying that the federal Securities Litigation Uniform Standards Act creates a high bar against bringing class-action suits in state court.
The judge granted plaintiffs the right to refile a complaint conforming to his legal reasoning, but opined that “a further attempt to amend the complaint might prove futile.”
John Garner, a Willows, California-based lawyer who is co-counsel for the plaintiffs, said his team just received the ruling and is “considering our options.”