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Churning and Excessive Trading

Churning and Excessive Trading – Overview

Churning and excessive trading occur when a financial advisor buys and sells securities motivated primarily to generate commissions as opposed to buying and selling securities for the customer’s benefit.  Churning and excessive trading happen in commission-based as opposed to fee-based accounts. Commission-based accounts generate fees on a per-trade basis, whereas a fee-based account typically charges an annual flat-fee, regardless of the amount of trading that occurs in the account.

Churning and excessive trading can sometimes be difficult to spot because Main Street investors often don’t have the experience to know what constitutes normal trading activity, and what constitutes excessive trading. Below are more details about these types of activities.

What is Churning?

Churning occurs where a financial advisor trades securities in a customer’s account at an excessive rate not to benefit the customer’s financial interests, but to generate commissions for the broker. Churning occurs in accounts where fees are charged on a transactional/per trade basis, as opposed to accounts where the customer is charged a flat annual fee tied to the amount of assets they have invested.

What’s the difference between Churning and Excessive Trading?

Both churning and excessive trading refer to the situation where a broker makes numerous trades in a customer’s account for the broker’s benefit (through the commissions he generates) as opposed to making trades for the customer’s financial benefit. FINRA (the governing body that regulates most financial firms) considers churning a more egregious variation of excessive trading. FINRA’s deputy head of enforcement has described churning as follows, “[Churning refers to] the situation where not only did the broker execute an excessive number of trades in the customer’s accounts, but he or she did so with either an intent to defraud or with reckless disregard for the customer’s interests.”  – See Transcript of FINRA’s podcast entitled: Excessive trading: When a Lot Becomes Too Much;

What Type of Investor is at Risk of Being a Victim of Churning?

While all investors can be victims of churning, the senior, elderly, and investors with diminished capacities are particularly vulnerable. Such investors may not have the sophistication, or ability to monitor their accounts sufficient to identify churning. A nefarious broker might know this and seek to exploit such a customer by making trades without the customer’s authorization to generate commissions without the customer knowing.

Unauthorized Trading and Churning Often Go Hand-in-Hand

As a rule, a broker may not make a trade in customer’s account without first receiving same-day, verbal approval from the customer. Absent this same-day verbal approval from the customer, the trade is considered unauthorized. A nefarious broker, however, who wishes to churn an account, may not seek same day (or any) approval from the customer before placing the trade (or trades) because the broker does not want the customer to know about the trade; and more importantly, the commission the trades generate.

How do you Identify Churning?

Churning is difficult to identify because the excessive commissions the broker generates through excessive transactions are often not reflected on the customer’s monthly statements. These commissions appear instead on the customer’s individual trade confirmations. To properly calculate the total commissions, the customer must take the onerous step of gathering all their trade confirmations from every transaction, in every account, and add all the commissions from each transaction. Most customers have no idea that the commissions they pay their brokers are not reflected on their monthly statements, so they discard their trade confirmations. This problem is exacerbated for an elderly or diminished customer. The brokerage firms created this framework by design because brokerage firms do not want their customers to know what they are paying in commissions.

What to do if you Suspect Churning?

If you are an investor concerned that you may be the victim on churning or excessive trading, you should consider discussing the issue with competent legal counsel.  If you would like to discuss your situation and potential for recovery of any investment losses, please contact us for an evaluation of your potential case.