Firm pays over $470,000 to settle switching charges.
SEC Settles Fund Switching Case
On August 28, 2000 the SEC announced that it had settled an administrative proceeding against Dean Witter Reynolds for failure to supervise a registered representative who engaged in mutual fund switching violations. In re Dean Witter Reynolds, Inc., Release No. 34-43215 (Aug. 28, 2000).
The representative was not named, and it is believed that the case against her is proceeding.
Mutual fund switching is the practice of liquidating customer holdings of investment company shares and using the proceeds to purchase shares of other investment companies. Mutual fund switching violates the antifraud provisions of the securities laws when registered representatives, in order to increase their compensation, induce investors to incur the costs associated with redeeming shares of one mutual fund and purchasing the shares of another fund and the benefit to the customer does not justify those costs.
The representative engaged in at least 48 violative switch transactions, the majority between funds with identical or very similar investment objectives. Several of these switch transactions exhibit a circular switching pattern, where the representative’s customers engaged in a series of mutual fund switches and, after generating thousands of dollars in commissions for the representative and Dean Witter and incurring thousands of dollars of contingent deferred sales charges and front-end load fees for the customers, ended up buying back into the same mutual funds that they sold in the first instance.
The SEC stated in the consent order that, while Dean Witter had written supervisory procedures, it did not have a system in place to effectively implement these written procedures.
The order includes the following criticisms of Dean Witter’s systems:
- Although all switches purportedly required managerial pre- approval, there was no system in place to alert the branch manager prior to the execution of the transaction that a switch was involved. If the representative chose not to seek prior manager approval, the transaction would be processed without pre-approval.
- While Dean Witter’s written policies required that a switch letter be obtained from the client before the trade involving the switch be processed, they were not enforced.
- Moreover, the policies were flawed in that they relied upon the representative to prepare the letter with the requisite information (including the reason for the switch and the amount of sales charges incurred) and to mail it to the client. Dean Witter received such letters from clients, if at all, after switch transactions had been executed.
- There were few, if any, consequences for failing to obtain switch letters.
- What review and approval of mutual fund switches that did take place usually occurred after the switch transaction had been executed, typically by the branch manager or a delegate looking at the monthly switch report and/or at the mutual fund switch letters returned by customers. No one took any steps to verify the accuracy of the representations in the letters.
Dean Witter agreed to reimburse customers $276,702 in charges and interest, to pay a civil penalty in the amount of $200,000, and to retain an independent consultant to review its procedures. The order is available online at http://www.sec.gov/enforce/adminact/34-43215.htm
Copyright 2000, John M. Baker, Esq., Stradley, Ronon, Stevens & Young, LLP, 1220 19th Street, N.W., Suite 700, Washington, DC 20036 – (202) 822-9611- Fax (202) 822-0140 This article was originally posted to the FundLaw List, http://www.egroups.com/group/fundlaw. To subscribe to FundLaw, send a blank e-mail to email@example.com
Nothing herein is intended as legal or financial advice. The law is different in different jurisdictions, and the facts of a particular matter can change the application of the law. Please consult an attorney or your financial advisor before acting upon the information contained in this article.
Mark Astarita is a nationally recognized securities attorney, who represents investors, financial professionals and firms in securities litigation, arbitration and regulatory matters, including SEC and FINRA investigations and enforcement proceedings.
He is a partner in the national securities law firm Sallah Astarita & Cox, LLC, and the founder of The Securities Law Home Page - SECLaw.com, which was one of the first legal topic sites on the Internet. It went online in 1995 and is updated daily with news, commentary and securities law related links.