Stockbroker Misconduct: Is Your Broker Churning Your Account?

churning
17
Jul
churning

When you hire a stockbroker, you’re trusting them with your investment future. So when you suspect that your broker is scamming your account, you want to deal with the problem as soon as possible.

There are a number of ways to help recover your losses after securities fraud, but first, you need to know what your broker is doing to your account.

Here, we’re covering churning, the various types, anti-churning rules, and signs that your broker is churning your account.

What is Churning?

First, the basics: what is account churning?

Churning is a practice in which a broker conducts excessive trading on a stock investment in order to rack up commissions against the best interests of the customer.

Since the income of many brokers is tied to the volume of trading done for a customer, you can understand why the practice can be tempting for many brokers.

And while, in theory, a broker doing more trading on your stocks could help your stock portfolio, the SEC rules and securities laws view churning as illegal and unethical.

Types of Churning

There are a couple of different ways that a broker might churn your account.

The most common way, as we just discussed, is when a broker does excessive trading on an account to generate commissions. As a rule, a broker must justify all commissionable trades and how they benefit you. If there doesn’t appear to be any benefit to you, this may be an example of churning.

However, churning doesn’t just apply to stocks. Brokers can also churn annuities and mutual funds, particularly mutual funds with up-front loads called A-shares.

This type of mutual fund is a long-term investment. If a broker sells your A-share within five years, it must be substantiated with prudent investment decisions.

Then, there are annuities. Unlike mutual funds, a deferred annuity is a retirement saving account without an upfront fee. Instead, they have deferred surrender charges which can range from 1-10 years.

Laws Covering Churning

As you can guess based on the types of examples above, churning has a huge impact on your financial future, both because your broker is making investments that aren’t in your best interest and because you’re paying more in commissions than you actually should.

This is why the SEC has certain rules against churning. Here are three key rules that apply to churning which together make up the legal basis against it.

SEC Rule 15c1-7

SEC rule 15c1-7 cover discretionary accounts and address the practice of churning in pretty explicit terms.

Under this rule, the SEC says that a broker acts in a fraudulent, manipulative, or deceptive way if:

  1. they have discretionary power over the customer’s accounts, and
  2. they use that power to complete transactions that are excessive

Note that what the SEC qualifies as excessive varies between accounts, which is why the rule states that the transactions should be excessive in view of the financial resources and character of the account in question.

FINRA Rule 2111

The second rule is FINRA rule 2111.

This rule covers reasonable belief and states that a broker must have a reasonable basis to believe that a financial transaction will be in the customer’s best interest based on information obtained through reasonable diligence.

They should also have a reasonable basis for believing the transaction is beneficial based on the customer’s investment profile, which includes factors like age, financial situation, financial needs, investment objectives, tax status, investment experience, liquidity needs, and risk tolerance.

In other words, the broker must be able to justify a transaction as beneficial to a customer’s best interest based on the relevant information.

NYSE Rule 408(c)

Finally, there’s NYSE rule 408(c).

Rule 408 in general covers discretionary power in customers’ accounts, rather like SEC rule 15c1-7. Also like SEC rule 15c1-7, it directly addresses the practice of churning.

Part C of the rule states that no one exercising discretionary power over a customer’s account, including members, allied members, or employees of a member organization, can effect purchases or sales of securities that are excessive in view of the financial resources of the customer in question.

It also states that such member organizations (like investment firms) cannot allow their brokers or other individuals with discretionary power over their customers’ accounts to complete such transactions.

In other words, if a broker is churning your account, they cannot argue that their firm allowed them to do so, nor can a firm legally allow their brokers to churn accounts.

Warning Signs of Churning Stocks

With this in mind, it helps to know how to detect account churning so that you can stop your broker from scamming you as quickly as possible.

Unfortunately, detecting churning is rather difficult, in part because brokers buy and sell securities every day and a few extra here and there is easy to pass off as normal.

That said, your broker has certain responsibilities related to your account, and these can help you keep an eye out for churning.

Remember that your broker is supposed to be trading in the best interests of your investment portfolio, so the best place to start is your own account. Look at the resources and goals of your account and see if the transactions your broker is making align with your financial situation and goals.

Churning, after all, involves transactions that are excessive or unnecessary when your investment goals and resources are taken into account.

If You’re a Victim of Securities Fraud

If you do believe that you’re a victim of account churning or other forms of securities fraud, don’t wait to get help.

Many investors believe that they have no redress if they suffer financial loss due to poor or fraudulent investments, but that’s not actually true. Our law firm helps you figure out how to make your case to recover some of your financial losses in the event of securities fraud.

If you need somewhere to get started, check out our blog for tips and explanations, like this post explaining stock fraud.

If you need to get in touch with an attorney regarding your case, use our contact page to get started.