Excessive trading occurs when a broker buys and sells investments to generate commissions; and not to benefit the the customer. This can only occur in commission-based, as opposed to fee-based accounts. Commission-based accounts generate fees on a per-trade basis. Fee-based accounts charge an annual flat-fee, regardless of the trade volume. Brokers who trade accounts solely to generate commissions, breach their fiduciary duty owed to the investor.
Main Street investors generally lack the experience to know what constitutes normal trading activity, and what’s excessive. Below are some guidelines.
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 designed to generate commissions for himself. FINRA 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.”
What Type of Investor is at Risk of Being a Victim of Churning?
While all investors can be victims of churning, those susceptible to financial abuse (elderly investors and investors with diminished capacities, for example) are particularly vulnerable. Such investors may not have the sophistication, or ability to monitor their accounts sufficient to identify churning. A nefarious broker might exploit this weakness, and make superfluous trades to generate commissions without the customer knowing.
Unauthorized Trading and Churning Often Go Hand-in-Hand
Generally, a broker may not make a trade in customer’s account without first receiving same-day, verbal approval from the customer. Without this same-day, verbal approval, the trade is considered unauthorized. A nefarious broker, however, 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 learn about the commissions the trades generate. A financial firm that properly supervises its brokers, should have measures in place to stop excessive trading before it starts.
How do you Identify Churning?
Churning is difficult to identify because the commissions are generally omitted from the customer’s monthly statements. Most customers have no idea that the commissions they pay their brokers are omitted from their monthly statements. Brokerage firms omit commissions from monthly statements precisely so customers remain ignorant about what they pay in commissions and fees.
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.
*The Law Offices of Patrick R. Mahoney is a full service law firm with extensive experience litigating cases involving a host of securities-related issues. This page is for information purposes only and does not constitute legal or investment advice; nor is it a comprehensive explanation of all churning of excessive trading issues. If you believe you have a claim, you should speak to competent counsel to better understand your options. Or, contact us.*