The Eight-Month Switch
Mr. Rahman, 72, retired, has PKR 12,000,000 invested in an income fund. His distributor, Sana, earns a 2% upfront commission and a 0.25% annual trail. Over 30 months Sana has moved him through six different income funds. Each switch involved a 1.5% to 2% front-end load. Mr. Rahman's portfolio earned 4.1% annualised after loads, while the original fund would have earned 6.3% annualised after its own expenses. Sana earned about PKR 480,000 in upfront commissions from the switches. Mr. Rahman's risk profile says 'conservative, capital preservation, no equity.' He says he trusts Sana and does not read the switch forms. The latest switch moved him into a fund with a three-year lock-in and a higher commission. Sana's notes say only 'client agreed by phone.'
1. Is this churning? Explain using the facts and the client's suitability profile.
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The pattern strongly suggests churning: excessive switching to generate commission rather than to benefit the client. Six switches in 30 months is frequent for a conservative income investor. Each switch imposed a 1.5% to 2% front-end load, and the client's annualised return after loads was 4.1% versus 6.3% for the original fund. That 2.2 percentage point gap is consistent with costs and repeated re-entry rather than improved performance. The client is 72, conservative and focused on capital preservation; the latest switch into a three-year lock-in reduces liquidity and may be unsuitable. Sana's 2% upfront commission gives her a direct incentive to switch, and she earned PKR 480,000 from the switches. The notes say only 'client agreed by phone,' which does not show that the client understood the costs, the lock-in, or why the switch was better than staying put. Trust and a signature are not evidence of suitability.
2. What disclosure, documentation and conflict-of-interest failures are present?
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Sana did not disclose, in a way Mr. Rahman could understand, that she earns a 2% upfront commission on each switch and that the switch itself creates a cost. She did not compare the net outcome of staying in the existing fund with the net outcome of switching. She did not document the reason for each switch, the alternatives considered, or the client's agreement beyond 'agreed by phone.' She did not assess the three-year lock-in against his age and liquidity needs. She did not provide a written suitability statement showing that the new fund matched his conservative profile. The conflict of interest is structural: a 2% upfront commission and a 0.25% trail make a new sale far more profitable than retaining the existing investment. The firm also failed to supervise the pattern: six switches by one distributor for one elderly client should have triggered a review. The client's statement that he does not read the forms should have prompted a documented oral explanation and a comprehension check.
3. What should the AMC and distributor do to remediate and prevent recurrence?
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The immediate step is to stop further switches for Mr. Rahman and conduct an independent review of all six transactions. The firm should calculate the cost and return impact, explain it to him plainly, and determine whether compensation is appropriate where switches were unsuitable. He should be offered the option of returning to a suitable fund without a fresh load if the firm's policy permits, and the lock-in implications must be explained. The AMC should review Sana's other elderly clients for similar patterns and place her under enhanced supervision. Remediation should include a written switch policy: a documented client objective, a comparison of net costs and benefits, disclosure of commission, a suitability sign-off, and a second-person review for frequent switches or vulnerable clients. Training should cover churning, senior investors, and the difference between advice and a sales script. The firm should also monitor switch ratios, upfront commission concentration and complaint trends.