Churning, Excessive Trading and FINRA

Churning is what happens when a broker excessively trades in a customer’s account to earn more commissions. It is unethical, illegal, and a violation of Securities and Exchange Commission rules.

A financial advisor who engages in excessive trading while disregarding the best interests of a customer could end up fired by their firm, barred from the industry, and ordered to pay regulatory fees for the offense. They also may find themselves named in Financial Industry Regulatory Authority (FINRA) arbitration claims brought by customers seeking damages for the financial harm they suffered.

Unfortunately, stockbrokers who are churning in an account will often come up with very plausible and professional-sounding reasons for why this “trading strategy” is in a customer’s best interests. This can make it hard for an investor to identify that they’ve become the victim of churning until they’ve lost a lot of money or their account collapses.

Shepherd Smith Edwards and Kantas (SSEK Law Firm at investorlawyers.com) represent investors who have suffered investment losses because their financial advisor churned in their account. If you suspect that your broker may have excessively traded to earn more commissions, we can help you determine whether you have grounds for a claim. Contact our investment attorneys at (800) 259-9010 today.

Churning can dramatically increase a client’s risk of loss. For most high-frequency trading strategies to be profitable, it requires repeatedly timing the market successfully which has proven unlikely to be successful over any prolonged period.

Excessive trading also dramatically increases the cost of maintaining a commission-based account. This means the investments have to generate even higher rates of return just to break even after paying off the commissions, margin interest, and other fees.

At SSEK Law Firm, we have handled hundreds of churning cases over the years. As we noted earlier, churning may be hard to detect. One reason for this is that it can happen in a variety of ways.

In one churning case, the broker wholesale liquidated all his clients, including ours, out of one stock and then invested them in a different one on the same day. According to his Trade Blotter, which we procured in discovery, this financial advisor executed this particular procedure several times a month. He also appeared to only work a few days a month. Meanwhile, his clients did not make money. They lost money. All the while, the broker garnered quite a bit in commissions.

In another excessive trading case, the broker and their firm were making twice as much in commissions than the client was making in profits. To make matters worse, the broker recommended the client hold the losing positions while asserting that they would bounce back. In one particular year, that client ended up paying large short-term capital gains while holding a couple hundred thousand dollars in unrealized losses. Eventually, the broker’s antics caught up with him and the client realized he was being wronged.

Churning can also happen with mutual fund switching. Mutual funds are usually long-term investments. Switching prematurely from one mutual fund (especially those with upfront A-share loads) to another continuously with no clear purpose can be unsuitable for an investor and subject them to more commissions and fees. Excessive mutual fund switching has been a cause of many retail investors’ losses in recent years.

Examples of a few other long-term investments that should be held until maturity but that brokers have been known to churn include exchange-traded funds (ETFs), annuities, bonds, and life insurance policies.

According to the SEC, possible red flags of excessive trading may include when:

• Unauthorized trading is conducted in your account without your permission.
• Excessive fees, whether in frequency or amount, are billed to you.
• Frequent buying and selling of securities occur in your account even though the trades do not support your investment goals and/or are too risky.

If you suspect that you and your account have been the victim of excessive trading, you should speak with our seasoned investment attorneys right away.

At SSEK Law Firm we look at several different mathematical metrics when assessing the frequency of trading including:

• Turnover ratio: This calculates how often the total portfolio of an account is “turned over” or replaced with new securities. While some turnover in any portfolio is normal, there is also excessive turnover, which can be a sign of churning.
• Cost to equity ratio: When looking at churning, we are looking at how high the costs are relative to the size of the account and when those costs will start making it mathematically improbable, if not impossible, for the account to be profitable.
• Commission-to-equity ratio: We use this calculation to divide the total commissions charged to the customer in their account by the average account equity over a specific period.

Over the years, SSEK Law Firm has gone up against the biggest brokerage firms on Wall Street to recover investment losses sustained by investors because of churning. We’ve recovered many millions of dollars on behalf of our clients. Call our experienced securities lawyers at (800) 259-9010 today or contact us online.