BROKER MISCONDUCT: CHURNING
It may sound a little funny, but there’s nothing amusing about churning in the context of money. “Churning” is a term used to describe an illegal and unethical practice by a financial adviser who engages in excessive buying and trading on behalf of a customer in order to generate commissions.
Since brokerage agreements typically call for brokers to get commissions every time they execute a trade, there’s a built-in incentive for brokers to trade as much as possible. At the same time, brokers have a fiduciary duty to do what’s in the best interest of their customers.
Hence, we find ourselves in a zone where the best interest of the broker does not necessarily align with the best interest of his or her client.
Add to the mix the fact that brokers often enjoy carte blanche to invest on behalf of customers thanks to a written discretionary agreement, and you’ve got a recipe for all kinds of abuse, misconduct, and deception.
How Do You Know Your Investment Account Has Been Churned?
It can often be difficult to detect churning. Indeed, there is no quantitative measure of just what “excessive” trading is. But in most cases you “know it when you see it.” Most importantly, perhaps, churning often results in substantial losses in the customer’s investment account due not just to the purchase of poorly-performing financial products, but due to the excessive fees charged to the account as result of frequent trading.
As you can imagine, most brokers who perpetrate churning rely on not being detected at all, because many investors never closely examine their monthly statements. In many cases, a mere cursory look over monthly statements just isn’t enough to identify churning, because as mentioned above excessive trading is often disguised by actual losses of investment value.
Deceptive brokers will often point to the losses the financial products they purchased have suffered as the reason for the deterioration of a customer’s portfolio, when in fact the reason is a little of that and a lot of excessive trading fees.
What Can You Do If Your Broker Has Traded Excessively in Your Account?
Churning falls under FINRA (Financial Industry Regulatory Authority) Rule 2111 which relates to something called “quantitative suitability.” You may have heard of the term “suitability” before with regard to investing through a broker.
Typically, suitability refers to a situation of harmony between a client’s stated investment objectives and risk tolerance and the financial products that compose his or her portfolio (as purchased by a financial adviser). Gross mismatches in this regard are deemed illegal and unethical.
Quantitative suitability similarly requires that not only are financial products suitable for a customer, but that the number of transactions carried out on behalf of the customer by his or her broker be suitable as well. For this reason, abuses of quantitative suitability constitute securities fraud under the Securities Exchange Act of 1934 as well as SEC Rule 15c1-7, among other securities legislation.
How to Prevent Churning in Your Investment Accounts
The best way to prevent churning in your investment account is to stay involved with your own portfolio. Remain in regular contact with your broker, and don’t be afraid to ask questions.
In the vast majority of cases where churning occurred, brokers operated under the assumption that they were not being watched at all by their customers, encouraging brazen and illegal behavior. Monitoring your investments is the most effective way to prevent many types of abuse, especially churning.
PA & NJ Broker Misconduct Attorneys
Our securities attorneys have over a decade of experience helping retail investors recover losses from stock brokers and national brokerage firms. We understand complex financial products and appreciate how stressful losing your wealth to an unscrupulous or negligent advisor can be.
If you or anyone you know has been the victim of investment fraud or broker misconduct, please contact us immediately for a free consultation at 1-855-462-3330 or by using our online contact form.