Lawsuit alleges Edward Jones needlessly shifted clients to advisory accounts

A class action lawsuit filed in a California federal court against Edward Jones alleges the broker-dealer profited from a firm-wide scheme that moved investors of modest means from commission-based brokerage accounts to more expensive fee-based fiduciary accounts.

The firm began a concerted effort of moving brokerage clients to fee-based accounts, which charge an annual fee based on account assets, in 2008, says the complaint, which names Edward Jones’ holding company, two affiliates, and several executives as co-defendants.

That effort was increased in 2013, and peaked after implementation of the Labor Department’s fiduciary rule in 2017, which the plaintiffs allege was used as cover to transition existing clients to advisory accounts that generate more revenue for the firm.

“Due to the disclosure requirements that would be imposed on Edward Jones if it continued to offer commission-based accounts after the DOL Fiduciary Rule was implemented, the Company began to pivot its business strongly towards fee-based accounts by pushing its customers from commission-based accounts into Advisory Solutions accounts – regardless of whether the switch would be in the customer’s best interest,” according to court documents.

During the five-year class period proposed in the complaint, which began in March of 2013, before the fiduciary rule was finalized, and ends March 30, 2018, Edward Jones posted $17.2 billion in revenue from asset-based fees.

In 2017, the firm posted about $5 billion in revenue from asset-based fees, a 36 percent increase from the previous year. Commission revenue was around $1.3 billion.

In 2013, fee revenue was about $2.3 billion, while commission revenue was around $2.1 billion.

One of the three named plaintiffs in the complaint alleges they were moved to an advisory account after requesting to stay in a commission-based account.

Labor’s influence on migration to fees

Labor’s fiduciary rule “further motivated Edward Jones to shift clients’ commission-based accounts to Advisory Solutions,” the complaint says.

The allegation that that amounts to fraud will no doubt raise cynicism in industry opponents of the rule, who argued for years that its effect would be just that: a migration to fee-based accounts, which are more expensive for buy-and-hold investors of modest means.

While the fiduciary rule is referenced throughout the lawsuit, the complaint is being brought under the Securities Exchange Act of 1934, the Securities Act of 1933, and California and Missouri securities laws.

Labor’s rule, which has been vacated by an appellate court, expressly favors the fee-based compensation structure that most often accommodates fiduciary advice.

“The Department believes that, by itself, the ongoing receipt of compensation calculated as a fixed percentage of the value of a customer’s assets under management, typically would not raise prohibited transaction concerns for the adviser,” regulators wrote when the rule was finalized in 2016.

Under fee-based accounts, adviser and investor interests are aligned, the Labor Department reasoned in its rule: Increased account values result in higher adviser compensation, and more money for investors.

But the text of the rule also clarifies the fiduciary implications of moving clients from commission accounts to fee accounts.

“Prohibited transaction rules would be implicated by a recommendation to switch from a commission-based account to an account that charges a fixed percent of assets under management,” the rule says.

Despite the fiduciary rule’s new requirements on commission-based accounts, the practice of reverse churning, or placing clients into fee accounts simply to generate revenue, is “still prohibited,” attorneys for the plaintiffs argue.

All told, the lawsuit alleges six different fiduciary breaches under the securities laws.

Specific monetary relief is not requested, but the lawsuit notes that Edward Jones manages $1.1 trillion in assets for 5.2 million households. About 28 percent of the firm’s assets are in its Advisory Programs.