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Switching
Switching of mutual funds or variable annuities for the benefit
and profit of the broker/dealer and its representative contrary
to the best interest of the customer is conceptually the same
as churning. Switching occurs when the salesperson recommends
or effects the sale of one mutual fund or annuity to provide
funds for the purchase of another mutual fund or annuity in
order to create commissions, not for the best interest of the
customer.
Switching of mutual funds and variable annuities is characterized
by a recommendation to redeem a loaded mutual fund or annuity
four years or less after its purchase and/or when the customer
experiences a surrender charge to generate funds to purchase
a new mutual fund or annuity with a new front load or rear
end surrender charge. Unless there is a clear and demonstrated
need for the switch based upon changed investment objectives
and/or needs of the client and/or problems with the original
mutual fund or annuity, the transaction should be examined.
Because most mutual fund families have a wide range of funds
with different investment objectives and policies and allow
interfamily switches at no or low commissions, any switches
between fund families, even due to a change of the customer’s
investment objective, should be questioned if the customer
experiences additional or new commissions or charges.
The NASD and SEC are looking very closely at the marketing
of variable annuities. Because a characteristic of variable
annuities is the ease of the exchange of investment portfolios
within the annuities at little or no cost, a switch between
variable annuities is hard to justify on the basis of a changed
investment objective. In light of the fact that the separate
accounts of the various portfolios are kept separate from the
general assets of an insurance company and that the underlying
investments are held at the mutual fund companies, it is difficult
to justify a switch of a variable annuity based upon the financial
status of the insurance company. Switches between variable
annuities are often subject to question.
For more information see purchasing variable annuities in
tax deferred accounts and trading mutual funds under suitability
below.
Next topic: Fraud
by Conduct: Twisting
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