Churning of a Securities Account
Boca Raton, Florida Securities and Investment Attorney Russell L. Forkey, Esq.
When you read the following post, you will see that your chances of recovering on a churing claim are substantially increased by retaining a lawyer who has experience in this area of the law. As you can see from this post, churning is primarily a violation of federal law. Whether or not you can make a claim for churning, under state, law depends on the law of each state. Thus, this article is generic in nature and is being provided for educational purposes only. If you have any questions concerning whether or not you have been exposed to this illegal activity, you should contact an experienced attorney.
Churning refers to the excessive buying and selling of securities in your account by your broker, for the purpose of generating commissions and without regard to your investment objectives. For churning to occur, your broker must exercise control over the investment decisions in your account, either through a formal written discretionary agreement or otherwise. For example, if you relied on your broker's advice because you were unable to evaluate the broker's recommendations and exercise your own judgment, your broker may have exercised control over your account. Churning can be a violation of SEC Rule 15c1-7 and other securities laws.
The major securities industry self-regulatory organizations have rules prohibiting churning and excessive trading. Excessive trading is the same as churning, but without the requirement that the person engaging in the trading does so for the purpose of generating commissions.
There are numerous state and federal court cases that set forth the legal requirements that must be proven to establish a claim for churning. The case that I have enjoyed reading and re-reading on this issue is styled Miley v. Oppenheimer & Company, Inc., cited at 637 F.2d 318 (5th Cir. 1981) which was a case decided by the United States Court of Appeals for the Fifth Circuit in 1981. The reason that I have always enjoyed reading this case is because it is in prose. It equates a discussion of the securities laws with the "churning" of milk.
First, it discusses the ingredients of a "churing case" as "skimmed versus evaporated milk." As the court noted, "churing occurs when a securities broker enters into transactions and manages a client's account for the purpose of generating commissions and in disregard of his client's interests. Once an investor proves that: (1) the trading in his account was excessive in light of his investment objectives; (2) the broker in question exercised control over the trading in the account (which can be established in various ways - for example a hybrid-type account); and (3) the broker acted with intent to defraud or with willful and reckless disregarded for the investor's interests, the broker may be held liable for a violation of section 10(b) of the Securities Exchange Act of 1934 and S.E.C. Rule 10b-5." Additionally, upon proving the three elements of a federal securities law churning violation, the investor will, in most or perhaps all cases, be entitled to hold the broker liable for breach of fiduciary duty.
Second, compensatory damages, "crying over the spilt milk." In the Miley case, the judge allowed the plaintiff to recover for both the commission and interest paid as a result of the excessive trading and for the decline in the value of the portfolio in excess of the average decline in the stock market during the time in which the defendant handled the account.
In discussing this method of damage calculation, the court held that "First, and perhaps foremost, the investor is harmed by having had to pay the excessive commissions to the broker the "skimmed milk" of the churning violation. Second, the investor is harmed by the decline in the value of his portfolio the "split milk" of the churning violation as a result of the broker's having intentionally and deceptively concluded transaction, aimed at generating fees, which were unsuitable for the investor."
Where there is churing the customer can be damaged in many ways. He must pay the brokerage commissions on both purchases and sales, he may miss dividends, incur unnecessary capital gain or ordinary income taxes depending on the holding period and, most difficult to measure, he may lose the benefits that a well-managed portfolio in long-term holdings might have brought him.
Another interesting finding by the court was that "Churning is a unified offense: there is not single transaction, or limited, identifiable group of trades, which can be said to constitute churning. Rather, a finding of churning, by the very nature of the offense, can only be based on a hindsight analysis of the entire history of a broker's management of an account and of his pattern of trading that portfolio, in comparison to the needs and desires of an investor."
Based on the above discussion, the court approved the following jury instruction: relative to the issue of damages:
"by a preponderance of the evidence the difference between the amount of plaintiff's original investment and the dividends therefrom less any withdrawals received by the plaintiff and less the ending value of the account with the defendants. This amount is to then be reduced (or increased) by the average percentage decline (or increase) in the value of the Dow Jones Industrials or the Standard and Poor's Index during the relevant period of time."
There are other types of damage calculations that can be used depending upon the particular facts and circumstances of the case. This is one reason to make sure that you retain experienced counsel.
With extensive courtroom, arbitration and mediation experience and an in-depth understanding of securities law, our firm provides all of our clients with the personal service they deserve. Handling cases worth $25,000 or more, we represent clients throughout Florida and across the United States, as well as for foreign individuals that invested in U.S. banks or brokerage firms. Contact us to arrange your free initial consultation.