Spotting Broker Churning: Protecting Your Investment Account from Excessive Broker Trading
In discretionary accounts, brokers have the power to transact with their client’s assets freely. Although brokers typically act responsibly, sometimes brokers abuse client confidence for personal gain. Churning occurs when a broker buys or sells investments, such as stocks, in a customer’s account to generate excessive commission. It is a breach of the broker’s duty to recommend suitable investments and can be determined to be a negligent or fraudulent practice. As detecting churning can be difficult, investors should contact a broker fraud specialist to assist in a thorough account review.
What is Churning?
Churning occurs in a discretionary trading account when a broker enters into transactions to generate commissions, and the broker unjustifiably gains from the transactions. Suitability claims often accompany churning claims.
Churning can also occur in a non-discretionary account when the broker is in a position to determine the volume and frequency of the transactions where the customer is willing to follow the broker’s suggestions.
How do I Detect Churning?
To establish churning, the investor must prove a substantial disparity between the turnover in the account in question and the normal trading activity for similar accounts. This occurs where: 1. Excessive trading occurred in light of the investor’s investment objectives; 2. The broker exercised control over trading in the account; and, 3. The broker acted with the intent to defraud or with willful and reckless disregard for the investor’s interest.
Each case is unique, and establishing churning is a factually intensive process. The trier of the facts will review the account trading patterns, turnover ratio, as well as the broker’s commissions and profits.
Although churning is often difficult to prove, an experienced broker fraud specialist can assist you in performing a thorough account review.
What is a Turnover Ratio?
Turnover ratio, a vital aspect of every churning claim, is the measure of the number of times investments are replaced in an account during a given time. Churning requires the broker to trade in and out of securities, possibly even the same stock, numerous times over a short period. Consequently, a high turnover ratio usually indicates that the broker has engaged in churning. Churning occurs when this type of investment activity serves no purpose for the investor and occurred to generate excessive commissions.
Although a high turnover ratio often supports an investor’s churning claim, the investment type affects the amount of permissible turnover. Less turnover is tolerated for debt investments, such as bonds and mortgages, as opposed to equity holdings. However, option investments allow for the highest turnover ratio.
If you believe that your account has a high turnover ratio, contact an attorney today to discuss your rights.
When Does a Broker Have Control Over a Non-Discretionary Account?
An investor may still pursue a churning claim despite maintaining a non-discretionary investment account. To prove churning, the investor must show that his or her broker has control over the account. Although a broker must get authority from the client to execute a transaction, de facto control is established where an investor relies on a broker’s advice to such a degree that the investor did not independently evaluate the broker’s recommendations and did not exercise independent judgment. The trier of the fact is more likely to find that investors with little to no investment experience have ceded de facto control to their broker.
What Can I Do If I Have Been the Victim of Churning?
An investor who is the victim of churning can sue his or her broker and brokerage firm for damages.
The firm is liable for its failure to detect churning. Firms must institute compliance systems to defect churning. When churning is detected, the firm must generate an exception report indicating the detection. The presence of a red flag imposes a duty to investigate the matter. Firms often fail to investigate and detect churning.
What Am I Entitled to Recover in A Churning Suit?
Typically, brokers who engaged in churning are liable for the loss in account value due to the excessive commissions, the commissions generated, and accrued interest. An increase in total portfolio value does not prevent an investor from bringing a churning claim.
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