Judge: Edward Jones didn't breach fiduciary duty by moving client assets

A recently dismissed "reverse churning" case against Edward Jones is exposing a gaping hole in the duties hybrid firms owe to customers when they move their assets between brokerage and advisory accounts.

Judge Daniel Calabretta of the U.S. District Court for the Eastern District of California issued a summary judgment Monday dismissing the claims of four investors who had accused Edward Jones in 2018 of not looking out for their best interests when it urged them to move into its Advisory Solutions channel. Before making that transfer, the clients had had their assets in Edward Jones brokerage accounts.

The moves to advisory accounts meant the investors had to begin paying fees calculated as a percentage of the assets they had under management. Before that, they had been paying commissions for every trade they authorized in their brokerage accounts.

And since they were infrequent traders, according to the suit, they'd have been better off if their assets had simply stayed put.

"As previous 'buy and hold' investors who engaged in minimal trading, Plaintiffs allege that the advisory accounts were not suitable for their needs because switching Plaintiffs to those accounts led to them paying higher fees," Judge Calabretta noted in his decision ruling against the investors.

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Reverse churning

The plaintiff's initial suit had accused Edward Jones of a "reverse churning scheme." Normal churning is the practice of making frequent trades in a client's brokerage account to rack up commission income. In the "reverse" version, advisors allow assets to sit unattended in advisory accounts, where they produce annual fees while virtually no wealth management services are provided in return.

In dismissing the charges against Edward Jones, Calabretta laid heavy emphasis on the separate conduct standards governing investment advisors and brokers. Advisors, he noted, fall under the fiduciary duty to always put their clients' interests first.

But Judge Calabretta found that since the plaintiffs couldn't have had an advisory relationship with Edward Jones before they opened advisory accounts, the fiduciary duty didn't apply. Edward Jones was only acting as a "prospective" investment advisor when it recommended the transfers, he wrote.

The judge also found Edward Jones couldn't be held liable under the conduct standard applying to broker-dealers. He noted that a relatively new standard for broker-dealers — called Regulation Best Interest — was approved by the Securities and Exchange Commission in 2019.

But that rule, which calls on brokers to look out for clients' best interests, wasn't in effect when the Edward Jones investors in this case moved their assets over to advisory accounts in 2014 and 2015. Those transfers instead fell under the old "suitability" conduct standard, which merely called on brokers to first make sure any particular investment they were considering recommending was in fact a good fit for their clients.

Since Edward Jones was not advising the clients to buy or sell securities when they moved accounts, the judge ruled, the suitability standard also did not apply.

In dismissing the case, Calabretta wrote, "Because Plaintiffs have not established that [Edward Jones] owed a fiduciary duty to Plaintiffs, nor provided evidence that [Edward Jones] breached its fiduciary duty, no trier of fact would be able to find in favor of the Plaintiffs."

An Edward Jones spokesperson said in a statement, "This decision validates that the personalized approach our financial advisors take to understanding our clients' needs and objectives fully meets applicable regulatory requirements. Our top priority remains serving our clients and helping them achieve financially what is most important to them and their families."

Better off with a broker or an advisor?

Bill Singer, a securities lawyer and retired author of the Broke and Broker blog, said the case exposes the confusion that still reigns when clients deal with so-called hybrid firms that, like Edward Jones, have both brokerage and advisory arms. Regulators require hybrids to publish Customary Relationship Summaries laying out exactly what sort of relationships they can have with clients and disclosing how they make money from both their advisory and brokerage businesses.

Still, Singer said, too few investors understand the duties of care and loyalty they're owed in differing circumstances or exactly how they'll be charged for various services and types of advice.

"If a client is actively trading, then of course they would most likely be better off paying an advisory fee," Singer said. "If the fee on your advisory account turns out to be $22,000, but you are running up $48,000 in commissions, you'd be better off paying an advisory fee."

The question, Singer said, then becomes: How do you help clients understand which type of relationship — brokerage or advisory — would be most beneficial in varying situations?

"How do you tell someone at a broker-dealer they should be charged a commission for each trade and/or should charge a fee for assets under management?" Singer said. "How is that decision made? And if that decision is made, how is it explained to customers to say, 'Listen, maybe you'd be better off paying a fee'?"

A tangled tale and evolving standards of duty

The case against Edward Jones also accused the firm of violating its fiduciary duties after it had moved the four plaintiffs over to its advisory business. For instance, one of the plaintiffs — Jesse Worthington — saw his assets moved over into an advisory product known as Guided Solutions in 2016. The initial complaint said he paid $792 in fees on that account that year, and more than $3,350 for the entire time he was in Edward Jones' advisory business.

Meanwhile his wife, Colleen Worthington — also a plaintiff — saw at least $53,261 invested in Edward Jones' Bridge Builder mutual funds. She, according to the complaint, ultimately paid more than $2,130 in advisory fees. The other plaintiffs, Edward Anderson and Raymond Keith Corum, made similar allegations.

But Judge Calabretta found that all those decisions were made after Edward Jones advisors had made reasonable attempts at understanding the clients' investing needs and goals. He noted that all the plaintiffs had testified that they had had meetings with their advisor to discuss their financial circumstances and plans.

"The mere fact that defendant recommended customers to open advisory accounts and that defendant increased revenue by providing these additional services does not, standing alone, support an inference that defendant made those recommendations without a reasonable belief that the accounts were in the clients' best interests, especially in the face of contrary evidence," he wrote.

One of the lawyers bringing the suit, Franklin Azar, the founder of Franklin D. Azar & Associates, did not immediately return a request for comment. Earlier this week, he told the industry publication Ignites, which first reported the recent summary judgment, that he plans to file an appeal.

The suit against Edward Jones has a long and tangled history. After first being filed in 2018, it was resubmitted in amended forms three times. Edward Jones managed to have some of the earlier complaints dismissed by lower courts, only to be overruled in March 2021 by the Ninth Circuit Court of Appeals, which found that breaches of the fiduciary duty may have occurred.