An investment adviser representative (IAR) manages two accounts for the same client: a taxable brokerage account and a tax-deferred IRA account. The IAR frequently uses proceeds from stock sales in the taxable account to purchase new positions in the IRA account, and vice versa, often incurring short-term capital gains in the taxable account. The client's stated objective for both accounts is long-term growth with a focus on tax efficiency. This trading pattern is most likely a form of:
- AExcessive trading (churning).
- BTime stamping.
- CSwitching.
- DReverse churning.
Show answer & explanationAnswer & explanation
Correct answer: C. Switching.
This scenario describes 'switching,' or interpositioning, where an IAR moves assets between different accounts (often for the same client) without a legitimate investment purpose, primarily to generate transactions and potentially fees, often incurring unnecessary taxes or costs. While it generates transactions, the primary issue is the switching between accounts, not just excessive trades within one account (churning).
Why the other options are wrong
- A. While it involves excessive trading, the specific pattern of moving assets between distinct accounts, especially across taxable/tax-deferred, is more precisely defined as switching.
- B. Time stamping refers to recording the exact time of order receipt, not a trading pattern.
- D. Reverse churning is charging an advisory fee for an inactive account, which is not described here.
Switching (Interpositioning)
An unethical practice where an agent or IAR moves funds or securities between different accounts or investment products, often for the same client, without a legitimate investment purpose, primarily to generate transaction fees or commissions, frequently incurring unnecessary taxes or costs.
- Involves moving assets between different accounts/products.
- Often lacks genuine investment benefit for the client.
- Can incur unnecessary transaction costs and/or taxes.
- Differs from churning by focusing on the 'transfer' aspect rather than just high volume within one account.
- Violates suitability and fiduciary duties.
Memory trick: Switching accounts, not client's best interest.