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July 30, 2019

Excessive Trading (Churning)

Excessive trading, also called “churning”, happens when a broker buys and sells a high volume of securities for the purpose of generating commissions in a customer’s account. In doing so, they are creating a roundtrip transaction to earn more money. Churning violates federal and state securities law and FINRA rules. Moreover, it is an unethical breach of the broker’s duty to his or her customer.

In this article, you will learn about excessive trading, how to spot it, and how to prevent it from happening in your account, and when you may have claim against a broker for churning.

What is Wrong with Excessive Trading?

Excessive trading or churning can be very harmful because it generates unnecessary fees and commissions that are paid out of the customer’s account. As a result, customer may have less money to invest, lose investment opportunities and face tax liabilities.

Excessive trading is a breach of a broker’s obligation to his or her customer. Brokers may only recommend transactions or trades that are suitable in light of the customer’s financial circumstances and investment objectives. A broker who engages in excessive trading for their own financial gain is not making recommendations based their customer’s investment objectives.

Excessive trading may also involve unauthorized trading. Buying and selling stock is not something that brokers can do at their own whim because brokers may only execute trades with their customer’s consent. Purchasing or selling a security without the client’s consent is unlawful. A broker who engaging in excessive trading may be unable or unlikely to obtain the required consent for the numerous transactions in the customer’s account.

This type of conduct is punishable by law, as it could make for a breach of contract or conflict of interest. More to the point, brokers who have engaged in excessive trading can face fines, suspensions, or even lose their license.

What Should You Look out For?

Don’t be fooled into thinking that this is something that only happens with big Wall Street companies. It can occur when you use the services of a small firm as well.

If your broker is executing a high number of trades in your account, you should look into whether he or she is churning the account. These are some of the hallmarks of churning:

  • High Turnover Ratio – A turnover ratio is the percentage of shares that have been replaced (turned over) with other ones during a year. The higher the number, the greater the level of activity in the account — which means a greater amount of commissions for the broker.
  • High Cost to Equity Ratio or Breakeven Percentage – The cost to equity ratio measures the costs associated with the trading activity in an account on an annual basis as a percentage of the equity in the account. An account will break even if it earns profit in an amount equal to its cost to equity ratio.
    In order for your stock to thrive, you should always be on the lookout for these behaviors. Good trading is usually attributed to “under trading,” rather than “shotgun trading,” or any other churning methods.

Final Thoughts

Detecting excessive trading may prove to be tricky because brokers have the power to use their discretion to some extent and are in the business of trading securities daily. To prevent churning from going unnoticed in your account, you should be familiar with the features of your account such your broker’s authority to make decisions in your account without obtaining your approval (a discretionary vs non-discretionary account) and the fees and commissions associated with your account. If your broker recommends a transaction, make sure you understand how the transaction will further your investment objectives and the costs associated with the transaction. In addition, you should review your account statements and confirmations to spot any unauthorized activity or unexpected fees.

Do your research before hiring a broker. You should review your broker’s registration, licensing, employment information, and disciplinary history using FINRA’s BrokerCheck website.

If you believe your broker is excessively trading or taking advantage of you in any other way, you should speak with an attorney immediately. If you pursue legal action, you may be able to get your money back. You could be repaid the commissions your trader has charged and damages for the losses you have faced because of their trading choices.