Brokers can engage in a variety of activity relating to mutual funds so as to generate excessive fees at the expense of the customer. Because mutual funds are generally long-term products, they should not be traded on a short-term basis. When they are, the broker engages in a fraudulent practice known as mutual fund switching which is strictly prohibited. In addition to the mutual fund switching, brokers can engage in other types of misconduct relating to mutual funds. A common abuse, which is difficult for the investor to detect, is the use of Class B shares of the mutual funds. Often the broker’s use of Class B shares (instead of Class A shares), especially when the investment amount is large, enables the brokerage firm and broker to generate a much higher commission at the expense of the investor.
The majority of Mutual funds are purchased as either a Class A share or a Class B share. The commission for Class A shares is paid when the purchase is made. The brokerage firm also receives its commission up front with Class B mutual funds, however the client pays a back ended surrender fee if the client sells the mutual fund within five or six years instead of a front ended commission. Class B funds charge a higher yearly administrative fee. If a client is making a large dollar mutual fund purchase in the same family of funds, then a Class A is more appropriate and if the brokerage firm has solicited a Class B purchase, this could be defined as mutual fund fraud.