Excessive Trading (Churning)

When it comes to investing, it is important to be aware of what can go right, and what can go wrong. When a stockbroker engages in excessive trading – trading that is in excess of the client’s goals – in order to generate commissions for himself and/or his firm, this is considered fraudulent behavior. It is also referred to as “churning.”

The Financial Industry Regulatory Authority (FINRA) protects investors by investigating excessive trading and churning claims made by investors who have suffered financial loss at the hands of unethical brokers. However, FINRA rarely seeks restitution for the customer. Through securities arbitration, victims may be able to recover some or all of their losses with the help of experienced securities arbitration attorneys who are well versed in FINRA proceedings.

How Does an Excessive Trading Claim Work?

When a claim is brought against a brokerage firm or stockbroker, the investor has a good chance of success if they can prove:

1. The stockbroker, not the investor, was in control of the activity in the account and/or
2. The level octivity in the account constituted excessive trading (churning) based on the risk tolerance and investment objectives of the investor; or
3. The fees, costs, commissions, or mark-ups were high.

When an investor feels that he or she has suffered financial loss due to excessive trading or churning, an arbitration claim can be brought against the stockbroker or brokerage firm. There are several factors that the arbitrator or securities arbitration panel may consider when determining whether the stockbroker exercised appropriate conduct with the account. These factors include, but are not limited to:

1. The client’s level of sophistication, including factors such as education and occupation;
2. The client’s level of trust and reliance upon the stockbroker;
3. How much time the client spent on his or her own, independent research;
4. How much previous securities investment experience the client has; and
5. How much the client actually understands the investment strategy.

How is Excessive Trading Determined?

Statistical formulas are commonly used to determine if excessive trading took place in a client account. Under FINRA rules, “factors such as the turnover rate, the cost-equity ratio, and the use of in-and-out trading in a customer’s account may provide a basis for a finding that a member or associated person has violated the quantitative suitability obligation.”

The turnover rate measures how much activity occurs in the account during a year. It is calculated by dividing the total annual purchases by the average balance of the account during the period. Every time holdings are replaced with other holdings, or turned over, brokerage and transaction fees are generated. The higher the turnover rate, the higher the generated fees, along with the possibility of broker fraud.

To evaluate a trading strategy, the cost-equity ratio is also used. This measures the total annual costs that result from an investment strategy. It is calculated by dividing the total annual costs (including commissions and margin interests) by the average balance in the brokerage account.

While these examples are helpful in understanding how excessive trading (churning) is determined, investors simply need to know that there are professionals available to help them should they suspect they are victims of this type of unethical behavior.

FINRA Arbitration

An experienced securities law attorney at the Silver Law Group can provided you with more information about the arbitration process through FINRA. Our experienced and knowledgeable securities arbitration attorneys represent investors harmed by stockbroker and brokerage firm misconduct. Contact our team at 1-800-975-4345 today and tell us your story. 345 today and tell us your story.

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