Excessive Trading / Churning

Excessive trading or “churning” occurs when a stockbroker buys and sells securities in a customer’s account solely for the purpose of generating commissions. Churning violates both securities laws and FINRA rules.

Under FINRA Suitability Rule 2111 stockbrokers have the obligation to have a reasonable basis for recommending a series of transactions in a customer’s account that while they may appear suitable when viewed in isolation they may be excessive or unsuitable when view in aggregate given the customer’s investment profile (this is also referred to as , “quantitative suitability”).

Per FINRA Dispute Resolution statistics churning is one the 15 top types of controversies in customer arbitration claims.

A FINRA arbitration claim for excessive trading or “churning” will be successful if: the stockbroker controlled or solicited the activity in the account AND the activity in the account was excessive based on the claimant’s risk tolerance and investment objectives.

There are many factors considered when determining if a stockbroker had control over the activity in a brokerage account. Some 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.

Statistical measures are usually used to determine whether the activity in the account was excessive. Some statistical measures used to evaluate a trading strategy in a brokerage account include the turnover ratio and the cost-equity ratio.

The turnover ratio measures the level of activity in the account and is calculated by dividing the total annual purchases by the average balance in the brokerage account during a year. The cost-equity ratio measures the total annual costs incurred in a customer’s account. The cost-equity ratio is calculated as all costs accrued in the account for the year (commissions, margin interest, and any other fees) divided by the average balance in the brokerage account. This is frequently referred to as the “breakeven” rate of return. An arbitration panel will determine the reasonableness of this rate and whether or not it can be expected that investment returns cover the costs incurred in a customer’s account.

Ultimately an investor’s level of sophistication and their ability to understand the risks associated with the particular investment strategy will determine whether the level of activity is considered excessive. For this reason it is important for investors to review and understand their brokerage statements and trade confirmations.

FINRA has issued guidance for investors wishing to evaluate investment performance and helpful tips on monitoring investments.

Silver Law Group and its attorneys have extensive experience seeking and recovering losses related to churning and excessive trading. Our attorneys and forensic accountants can help determine whether an investment loss is the result of a brokerage firm and its financial advisor’s excessive trading or churning of an investment account. If an investor suffers losses as a result of excessive trading or churning he or she may be able recover losses in a FINRA arbitration claim. Contact Silver Law Group to discuss if you have a claim for churning/excessive trading.