Unfortunately, there are some disreputable securities brokers and financial advisor out there. Some engage in churning, a type of broker misconduct, which can have serious financial consequences for their clients. All investors need to know what churning is, how to spot it, and what to do about it if they suspect their broker or financial advisor is engaging in this activity.
Churning occurs when broker or advisors “enrich themselves at the expense of their clients.” In plain English, churning takes place when a broker or financial advisor trades a customer’s account for the purpose of generating commissions, not because the trades are suitable for the client. It violates Federal law and regulation, runs afoul of industry regulations and standards, and may violate a myriad of other laws, such as laws requiring brokers to act as fiduciaries and always in the best interest of their clients. Churning an account also violates FINRA’s rule that brokers only recommend (or make) trades suitable for their clients.
Types of Churning
There are several types of churning investors should watch for. Churning is most typically found when a broker or advisor makes excessive trades in stocks or bonds. Excessive trading generates commissions for the broker but provides very little, if any, benefit to the investor.
While most people think of churning in the context of over-trading stocks, it isn’t limited to those types of securities alone. Brokers churn mutual funds, annuities, and life insurance policies (though the last is commonly called “twisting”). There are times when the decision to make such a trade is prudent, but in many cases, the broker is the only one who comes out ahead when this type of transaction that takes place soon after a previous trade.
Consequences of Churning: Sanctions, Fees and Penalties
Brokers and financial advisors who have been found liable for churning can be held liable to their clients not only for investment losses in the accounts, but the commissions and costs of the trades themselves. They may also be subject to enforcement action from regulators, who maintain the power to fine and suspend the broker for a distinct period of time, or in particularly bad situations, forever. Regulatory penalties are typically more serious when brokers have previous regulatory problems or customer complaints on their record.
Warning Signs Your Broker or Advisor Might Be Churning Your Account
All investors with an investment broker or advisor who works on commission must be diligent no matter how trustworthy they appear to be. Chances are, the broker is honest. But, unfortunately, there are those who take advantage. If you have given your broker express or implied control over your account, or your broker has simply taken control of your account, you may be a prime target for churning.
Pay attention to all the documents you receive from your broker and stay abreast of how your account is performing.
- Your broker is required by federal regulations to send you a written confirmation of every transaction. Unless you are an active trader, if you receive daily or weekly trading confirmations, your broker may be churning your account. This is particularly true if you did not sign a document giving the broker your explicit permission to trade in your account and your broker is not discussing each trade with you before the trade is made.
- Mutual funds and annuities generally should not frequently be switched for other mutual funds and annuities. Selling these types of investments shortly after they were purchased are often done to maximize the commission. The broker may send what seems to be a routine form for you to sign agreeing to the switch. Be cautious about such trades. Too many may be a warning sign that your account is being churned.
- If the market is moving upward, but your account is declining, it may be due to the commissions resulting from the excessive trading.
How to Prove You have a Churning Case
If you decide to file a claim against your broker, please know that a churning claim has three elements.
- The broker had control over your account. This means you gave the broker either express permission to trade without first clearing trades with you, or the broker simply took control over the account. Express control typically involves a signed agreement allowing the broker to trade within the account. Control can be implied if the evidence shows that, with rare exception, you always followed the broker’s advice, or if the broker simply traded your account without first gaining your approval for each trade.
- There was excessive trading on your account. Whether trading was excessive depends on the size of your account and what your financial goals are. Courts consider many factors in determining whether or not the trading was excessive and constituted churning.
- The broker’s intent in making the excessive trading was to earn commissions. Even if the broker did not have the specific intent to defraud, you may still prevail if the broker acted with a “reckless disregard” for your interest.
It is important to note, however, that if you bring your claim in arbitration (and you will probably be obligated to do just that, arbitrators sit in equity. That means they are not bound by legal technicalities and they maintain the power to fashion whatever remedy best fits the evidence presented to them.
If you win your case, you should be able to collect:
- The fees and commissions you paid the broker for the excessive trades;
- The losses you incurred due to the unnecessary trades; and,
- The gains you would have earned if the broker had not defrauded you.
If you believe your investment broker or financial advisor engaged in misconduct by churning your account, contact our broker misconduct attorneys at Stock Market Loss. We serve clients in all 50 states. You can also call us at (866) 932-1295.
Hugh Berkson is a Securities Attorney with McCarthy, Lebit, Crystal & Liffman, Co. LPA. Hugh is rated AV® Preeminent™ by Martindale-Hubbell®.
He obtained a business degree in Finance from the University of Texas at Austin in 1989, and is a 1994 graduate of Case Western Reserve University School of Law, where he was a member of the Order of the Barristers and received both the American Jurisprudence Award, (National Mock Trial) in 1993 and the Jonathan M. Ault Mock Trial Prize for 1993-1994.