What Is Churning?
Churning is when a broker engages in excessive buying and selling securities
in a customer’s account with one goal in mind – generating
commissions for the benefit of the broker. It is illegal, as brokers have
a fundamental duty to put the interests of their clients before themselves.
One of the ways brokers and firms try to mask churning is by making sure
that the investment objective for the brokerage account has been marked
“speculation” with a “high” or “aggressive”
risk tolerance. Then, when the account is excessively traded, the broker
and firm often argue that the customer was willing to take those risks
and that active trading is what the customer asked for.
However, under the rules governing the securities industry, brokers and
brokerage firms must be able to demonstrate that the recommended trading
strategies are suitable for a particular customer. And in cases where
an account has clearly been churned, the activity is
not suitable for anyone, regardless of their investment objectives. And this makes sense, because
even if you have an aggressive risk tolerance, no customer ever agrees
or asks for their account to be manipulated solely for the purpose of
deriving profits for the broker or brokerage firm.
So, how do you know if your investment account is being churned by your
broker? The evidence that proves churning is hidden in your account statements.
It is considered fraud and is both illegal and unethical. In order to mask
churning, unscrupulous brokers will hold on to the investments in your
account that perform poorly, while selling off those that are profitable.
In this way, your portfolio can appear to be performing well—thanks
to the gains you see each time a profitable investment is sold. Unfortunately,
your portfolio is actually losing money on frequent commissions and becoming
filled with poorly performing investments.
Investment Fraud Lawyer for Churning Cases
Brokers have a duty to place their clients' interests ahead of their
own. When a broker engages in excessive trading, typically for generating
additional commissions, the broker violates that duty through an activity
called "churning." This violation means the broker and brokerage
firm may be held liable for any losses that arise out of the churning
of the account.
Excessiveness is typically determined by evaluating your account's
annual turnover rate and the "break even" or "cost-equity"
ratio. Per both the SEC and the courts, a turnover rate of over 6% is
excessive. However, with a vast majority of standard turnover rates being
below 1%, churning may be proven at a significantly lower rate. Standards
also exist that determine that most accounts requiring at least a 15%
annual return to "break even" meet the definition of "excessively
According to the U.S. Securities and Exchange Commission, churning is an
illegal and unethical activity that violates numerous laws, including the
SEC Rule 15c 1-7. The Financial Industry Regulatory Authority (FINRA) also has rules to
prevent excessive trading for broker gain. These rules are found under
the "suitability" section of FINRA rules.
Specifically, churning violates the FINRA principle of "quantitative
suitability" detailed in § 2111.05(c).
Quantitative suitability requires a member or associated person who has
actual or de facto
control over a customer 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, as delineated in Rule 2111(a).
Establishing Excessive Activity & Proof of Control
According to this rule,
excessive activity as well as proof of control must be established. Even if it can be established
that an account has been churned, for liability to exist, it must be proven
that the broker had effective control of your account. Proof of control
may be established through a written document granting the broker control
of your account or by showing that you relied so completely on the advice
and recommendations of your broker that the broker was effectively responsible
for the number of transactions in your account and their frequency.
To establish excessive activity, there are certain evidences to look for.
Your investment fraud attorney may evaluate the following when testing
- Turnover rate
- Cost-equity ratio
- Use of in-and-out trading in a customer's account
Bringing a Churning Claim to Arbitration
When you bring a churning claim to arbitration, the following will be examined:
Turnover: The dollar amount of opening buy transactions as compared to the average
net worth or equity of the portfolio. The general rule of thumb is that
if your portfolio has a turnover of 600 percent or six times the average
net worth of the account, then churning most likely took place. This calculation
is one of the most important factors in these claims.
Control: Another key element is who was in control, meaning the person who decided
what to buy and sell, how much and when to do it. To have a successful
claim, you have to show that your broker or advisor controlled and directed
the trading activity in your account.
You Need Meyer Wilson for Your Investor Claim
Meyer Wilson has decades of collective experience doing one thing: recovering client
losses against the largest, strongest investment firms in the nation.
Our practice, comprised of investment fraud attorneys and securities fraud
lawyers, has devoted itself to serving the victims of stockbroker fraud,
meaning that we have the skill, experience, and resources necessary to
do so aggressively and excellently. We have helped hundreds of clients
recover hundreds of millions of dollars in lost assets from the firms
that handled them with negligent practices, such as churning.
We have helped clients recover over $350 million. Call us or complete our
online form for a
free case consultation. Let us help you determine your next move.