What is a Churning or Excessive Trading?

Churning is a form of securities fraud that occurs when a broker engages in excessive trading in a client’s account that is unsuitable for the client in order to generate commissions for themselves. When a broker engages in churning, the high level of trading combined with the commission fees charged, make it virtually certain that the clients would lose money over time.

Most victims of churning are investors with limited investment experience who generally seek to invest in conservative investments with minimal risk to insure the safety of their principal. Sadly, many victimized investors are also seniors. The resulting financial harm caused by the broker’s misconduct is the payment of excessive commissions and may include the decline in the value of the investor’s portfolio. 

Did Your Broker Engage in Excessive Trading?

Brokers have a duty to make sure that they have a reasonable basis for any investment strategy they recommend to clients. A broker violates the antifraud provisions of the securities laws by recommending a security without an adequate and reasonable basis. Brokers are also bound to follow FINRA Rule 2111, which requires them to have a reasonable basis for client recommendations.

Excessive trading occurs when a broker who has control over the trading in a client’s account recommends a high number of trades that are not consistent with the client’s objectives and financial situation. According to FINRA’s guidance, turnover rate, cost-to-equity ratio and use of in-and-out trading may establish that a broker engaged in excessive trading.

Control is established when a broker has control over the trading in client’s account when the broker has discretionary authority over the account. The broker may also have control if the client routinely follows the broker-dealer’s recommendations. Proof of control can also be established if the investor defers to the broker with respect to establishing a trading strategy, and the broker decides what to buy or sell in the client’s account. 

The measures used to determine whether the broker’s frequency of trading is excessive include turnover ratio, the cost-to-equity ratio, and in-and-out trading.

• Turnover Ratio: The turnover rate represents the number of times in one year that a portfolio of securities is exchanged for another portfolio of securities. A turnover rate between three and six may be indicative of excessive trading.
• Cost-to-equity Ratio: The cost-to-equity ratio measures the amount an account has to increase in value annually just to cover commissions and other expenses, or break even. A cost-to-equity ratio above twelve is generally viewed as very strong evidence of excessive trading.
• In-and-out Trading: In-and-out trading occurs when a broker repeatedly buys and sells all or part of an investor’s portfolio, immediately reinvests the proceeds and sells the recently acquired securities soon thereafter; or your broker repeatedly buys and sells the same securities time and again. This practice is extremely difficult for a broker to justify. The practice of in-and-out trading often results in payment of excessive commissions to the broker in excess of any profits you would expect to receive, is not consistent with your investment objectives, and is not in your best interest.

How to Recover Your Losses 

Riera Law represents churning victims who were scammed through a trusted stockbroker or financial advisor who works for a securities brokerage firm. If you have been scammed, it is crucial to take legal action as soon as possible to recover your losses and to prevent others from being victimized. If you have been fraudulently victimized, we can assist you. Contact us today, and let us determine whether your brokerage account was excessively traded.