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Excessive Trading or “Churning”

Investor disputes with brokerage firms and their representatives that allege a stockbroker excessively traded or “churned” a brokerage account may be a cause of action in a FINRA arbitration claim for damages. A FINRA arbitration claim for excessive trading or “churning” can be attributed to a breach of fiduciary duty and
a conflict of interest for a recommended investment strategy whose sole purpose is to enrich a brokerage firm and/or the stockbroker to generate excessive commissions, fees or costs. A FINRA arbitration will generally be successful for excessive trading or “churning” claim if a customer can prove two case facts. First, the panel must conclude the stockbroker controlled or solicited the activity in the account and second, the activity in the account was excessive based on the claimant’s risk tolerance and investment objectives.

There are many factors an arbitration panel will consider to determine whether a stockbroker had control over the activity in a brokerage account. The important factors that may be considered include:

  • Client Sophistication;
  • Prior Transactions of a Similar Nature and Frequency;
  • Client Trust and Reliance Upon a Broker;
  • Time Client Devoted to Independent Research;
  • Percentage of Transactions Solicited vs. Unsolicited;
  • Simultaneous Positions with Multiple Brokerage Firms; and
  • Extent to Which Client Fully Understands Investment Strategy.

With these factors in mind, an arbitration panel will determine the likelihood that a stockbroker was in control of the account transactions which include the specific strategies that were employed.

A FINRA arbitration panel will frequently consider statistical measures of account activity to determine whether the transaction history for a brokerage account was excessive. The statistical measurements used are the turnover ratio and the cost-equity ratio of a trading strategy in a brokerage account. The turnover ratio measures level of activity and is calculated based on total annual purchases divided by the average balance in the brokerage account during a year. The cost-equity ratio measures the total annual costs incurred from an investment strategy calculated based on total annual costs (commissions and margin interest) divided by the average balance in the brokerage account. This is frequently referred to as the “breakeven” rate of return. An investor’s level of sophistication and their ability to understand the risks associated with the particular investment strategy will help determine whether the level of activity is considered excessive.

The following statistical measures of the annualized account costs and turnover are thresholds which many considered to represent different levels of evidence for an excessive trading or “churning” claim.

Cost Ratio Turnover Rate Level of Evidence
4% 2 times Inference
8% 4 times Presumption
11% 6 times Conclusive

 

These different levels of evidence for the “churning” of a brokerage account are presumed as evidence of a stockbroker’s control over the account. Arbitration panels will consider whether it is reasonable to expect investment returns to cover the costs associated with the investment strategy and still provide the required investment return for the amount of risk assumed.

The Silver Law Group can help you determine whether an investment loss is the result of a brokerage firm and their financial advisor’s excessive trading or “churning of an investment account. If an investor suffers losses as a result of excessive trading or “churning they may be able recover their losses in a FINRA arbitration claim.

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