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FINRA Proposing a Wider Net to Capture Churning Brokers

Meyer Wilson

On April 20, the Financial Industry Regulatory Authority (FINRA) proposed a new rule that expands the liability of churning practices. The new rule states that a broker does not have to be in control of a client's account to be found liable for losses caused from churning. Under current FINRA rules, a broker can only be found liable for churning if he/she has discretion. The current law requires brokers who control client’s accounts to have a reasonable belief that the transactions they recommend are not unsuitable or excessive for their client.

FINRA's new proposed rule is intended to protect investors from unscrupulous brokers who use excessive trading as a way to increase their own profits. FINRA is concerned that a client has little protection against unethical churning tactics since the client relies on the broker's guidance for buying and selling investments. In such cases, clients routinely accept their broker's advice when making investment decisions, and they do not recognize that churning is going on. FINRA states that broker control of a client's account places an unnecessary burden on clients when trying to prove broker churning. Although the new FINRA rule will provide more protection for investors, FINRA will still have to prove that transactions were excessive and unsuitable for the investor.

The Securities and Exchange Commission (SEC) and FINRA have been investigating and targeting churning practices used by brokers for years. Both traditional churning, excessive trading, and reverse-churning, where brokers put buy-and-hold clients into advisory accounts that charge asset-based fees, cost unsuspecting investors millions of dollars in losses each year. Although no single test defines excessive trading activity, there are red flags that include:

  • Annual turnover rates greater than six
  • Cost-to-equity ratio greater than 20 percent
  • In-and-out trading patterns in a short period of time
  • Excessive account fees
  • Significant tax liabilities associated with investments

If the SEC approves FINRA's new rule, it could expand liabilities and violations for churning beyond brokers who control a client's account. If churning tactics are proven, even brokers who don't have account control can receive violations and penalties. If you have been a victim of broker misconduct, contact the investment fraud attorneys at Meyer Wilson at 888-390-6491 for a free consultation today.

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