Churning, also known as excessive trading, occurs when a broker or advisor effects transactions in your account for the purpose of generating a commission. Many investors may not know that some investments pay higher commissions to brokers than others. Mutual funds and annuities are examples of investments with higher commissions. While churning may or may not benefit you, the investor, it always results in a benefit to the broker. Churning is not only unethical; it is illegal and a violation of securities laws.
FINRA Rule 2111 refers to churning as quantitative suitability. Per Rule 2111, quantitative suitability requires a broker with discretionary authority over a customer’s account to have a “reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, are not excessive and unsuitable for the customer when taken together in light of the customer's investment profile.” While there is no single test to define excessive activity, turnover ratios, cost-equity ratios, and in-and-out trading may indicate a broker engaged in churning of the customer’s account.
Churning typically occurs when the broker has a written agreement with you giving the broker the discretion to buy and sell securities on your behalf. However, simply because you consented to the transactions, or because you gave your broker written discretion to trade on your behalf, that permission does not give a broker the green light to churn or excessively trade your account. Churning and excessive trading may be indicated by a high volume of transactions (also known as excessive activity), but not necessarily. Churning may occur without excessive activity.
How do you know if you are a victim of churning? Churning is determined in light of your investment objectives and suitability. For example, as a conservative investor, your investment objective may be to buy and hold securities. In this case, there should be little activity on your account. If your statements show weekly or biweekly trades, you may be a victim of churning. Even if you are not necessarily a conservative investor, frequent sales and purchases of securities that do not fit your investment objections could indicate churning. An account balance that remains relatively steady despite the frequent buying and selling of securities or mutual funds is also a red flag indicative of churning. Has the value of your account declined despite current upward trends in the market? Churning may be the culprit. Additionally, if you notice that your mutual funds and annuities are traded for other mutual funds or annuities, your broker may be churning your account. The best way to ensure protection of your investments against churning is to closely monitor your statements for sales and purchases that do not align with your investment objectives.
Churning and engaging in excessive activity are each forms of broker misconduct equivalent to fraud. Brokers guilty of churning may face serious consequences, including fines, suspensions, and even revocation of their license. Brokerage firms may also be held accountable, depending on the circumstances. You may qualify for damages based on the broker’s receipt of excessive commissions, your expenses, and/or any actual losses to your portfolio. Claims for churning are typically heard through FINRA’s arbitration process. FINRA requires the filing of claims within six years of the “event or occurrence giving rise to the claim.”
If you believe there has been excessive activity or trade volume in your account, or if you believe your broker is recommending transactions for the purpose of generating commissions at the expense of your investment strategy, you should consult a securities fraud attorney to investigate this activity.
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