Churning and Excessive Trading

When reviewing your account statements, trade confirmations, or online account, look out for these red flags that may indicate excessive trading:

• Unauthorized trading: Be alarmed if you become aware of trades in your account that you did not authorize your broker to make. As we have indicated in other posts, there are basically three type of accounts: nondiscretionary, discretionary and hybrid. Please follow the highlighted links so you can appreciate the nature of each type of account and the brokers responsibilities associated therewith.
• Frequent trading: Be wary of frequent in-and-out purchases and sales of securities that don’t seem consistent with your investment goals and risk tolerance. Also, note that investments that might be considered suitable for you can still be churned.
• Excessive fees: Be suspicious if the total amount of fees seems high or if one segment of your portfolio consistently generates high fees.

It is important to note that excessive trading (churning) can occur if the overall account value increases. This is especially true in an overall rising market.

The benefit to the account executive is self-evident. A broker typically earns a portion of the commissions or other fees on each purchase or sale of securities that the brokerage firm makes for an investor. When a broker engages in excessive buying and selling (i.e., trading) of securities in a customer’s account without considering the customer’s investment goals and primarily to generate commissions that benefit the broker, the broker may be engaged in an illegal practice known as churning.

When you open a brokerage account, your broker should ask you to specify your overall investment goals (or “investment objectives”) and how much risk you are willing to tolerate. Different firms use different terms to describe investment objectives or risk-tolerance levels. Some common terms are: “capital preservation,” “income,” “growth,” “moderately aggressive,” “aggressive growth,” and “speculation.” Make sure that you understand what these terms mean and that you know what you communicated to your broker.

Communicating your investment goals to your broker, should provide you with some degree of protection, especially in today’s computer age. Most firms monitor customer accounts, including trading activity, with computer software that is designed to alert management to account executive abuse. If you receive an unsolicited letter or a call from firm management, this is a red flag that requires your immediate attention.

If you receive such notification, you should ask your broker to explain:

• The rationale for the broker’s recommended trading activity and investment strategy given your investment objectives
• The total commissions or other transaction fees you have paid over the past month, quarter, or year
• What percentage return on your investment you would need to break even on the fees you are paying

Either before or after you have this information, you may want to speak with the broker’s manager or the firm’s compliance department to understand and question the nature of the trading in your account in light of your investment goals and risk tolerance.

If you believe a broker has engaged in excessive trading including churning, you should contact a qualified professional.

With extensive courtroom, arbitration and mediation experience and an in-depth understanding of elder abuse, exploitation and 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.