Churning is a manipulative and deceptive practice in violation that violates Section 10(b), Rule 10b-5 thereunder, and FINRA Rules 2020 and 2010. It is fraudulent conduct that occurs when: (i) a registered representative controls trading activity in an account, (ii) the level of activity in the account is inconsistent with the customer’s objectives and financial situation, and (iii) the registered representative acts with intent to defraud or a reckless disregard for the customer’s interests.

FINRA Rule 2111 governs suitability, and provides, in part, that a broker-dealer or associated person must “have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the [firm] or associated person to ascertain the customer’s investment profile.” Pursuant to FINRA Rule 2111, a broker must have reasonable grounds to believe that the number of recommended transactions within a particular period is not excessive and unsuitable for the customer.

Excessive trading occurs, and is unsuitable, when a registered representative has actual or de facto control over trading in an account and the level of activity in that account is inconsistent with the customer’s investment objectives and financial situation. A violation of FINRA Rule 2111 is also considered to be a violation of FINRA Rule 2010 which requires an associated person to “observe high standards of commercial honor and just and equitable principles of trade.”

Possible Signs of Churning:

  • Lots of trading activity – Frequent in-and-out purchases and sales of securities that are inconsistent with the customer’s investment goals or otherwise questionable may be evidence of churning. Excessive trading usually stems from a broker’s desire to make money.  To make money, the broker must place trades.  To the broker, it makes no difference whether the trade benefits your bottom line, because the broker makes his money via the commission generated by the trade.  The more the costs of your trading activity rises, however, the higher your returns must be to outpace those costs.  Further, there is a point at which the cost of the trading activity is so excessive that it is improbable – if not impossible – for you to break even or make money.  That is, at some level your costs are so high that even the most successful of trades cannot keep pace.

Continue Reading Have you been a victim of churning?

Excessive buying and selling of securities in an investor’s account, also known as churning, is not only unethical, but also violates securities laws.  Most, if not all, churning stems from the broker’s desire to generate commissions that benefit the broker.  For churning to occur, the broker must exercise control over the investment decisions in the account.  Such control can be through a formal written agreement or de facto, aka the circumstances show that the broker controlled the account despite a lack of formal written agreement.

A recent FINRA disciplinary action illustrates churning.  In FINRA Case #2017054755206, Daniel Gordon Maughan (CRD #2561363, Los Angeles, California) accepted an Offer of Settlement in which he was barred from association with any FINRA member in all capacities.  Maughan was associated with Financial West Group from May 2010 until October 2019.  FINRA found that Maughan exercised de facto control over two customers’ trust account by making all investment decisions in the account, including what securities to buy and sell, the quantities of the securities to buy and sell, and when each transaction would occur.  Incredibly, FINRA found that Maughan executed trades in the trust account with a principal value of all purchases and sales in excess of $70 million.  Maughan’s excessive trading generated commissions and costs totaling approximately $841,000 while causing the trust account to incur realized and unrealized losses of approximately $812,000!

Similarly, brokers recently have entered into a Letter of Acceptance Waiver and Consent (“AWC”) by which they agree to a permanent bar from association with any FINRA member in all capacities, because the brokers refused to cooperate with FINRA’s investigation regarding possible excessive trading in customer accounts.  These brokers include, for example:

  • Stuart Blake Nichols (CRD #4932310, Birmingham, AL) – Nichols most recently was associated with Raymond James & Associates, Inc., from February 2013 through October 2019. See FINRA Case #2018060875701.
  • Philip Joseph Sparacino (CRD #3243960, Staten Island, NY) – Sparacino most recently was associated with First Standard Financial Company, LLC, from July 2014 through October 2019.  See FINRA Case #2019063631801.

While FINRA has barred these brokers from association with FINRA member firms, that does not mean FINRA or the member firms who previously employed these brokers will investigate your account or seek to pay you restitution for any misconduct that may have occurred in your account.  If you were a customer of Maughan, Nichols, or Sparacino, and suspect you may have been a victim of excessive trading or other misconduct, contact Farrar Law PLLC for a free consultation.  Farrar Law PLLC represents investors (including individuals, trusts, corporations, and institutions) on a contingency basis in claims against brokerage firms, investment advisors, clearing firms, banks, and insurance companies.

Long names call for shorthand.  Here is a list (by no means exhaustive) of acronyms for investment and finance-related entities, which you might come across in this blog or elsewhere:

  • ACLI – American Council of Life Insurers. ACLI is an association of American life insurance carriers which promotes the life insurance industry to the public and deals with legislation on all levels of government as it relates to life insurance.  ACLI is based in Washington, D.C. and is an SRO.
  • AICPA – American Institute of Certified Public Accounts. AICPA is the national professional organization for Certified Public Accountants (CPAs) in the United States.  AICPA is an SRO.
  • CBOT – The Chicago Board of Trade. CBOT is an SRO.  A commodity exchange established in 1848 where both agricultural and financial contracts are traded. The CBOT originally traded only agricultural commodities such as wheat, corn, and soybeans. The CBOT currently offers options and futures contracts on a variety of products including gold, silver, US Treasury bonds, and energy.  The CBOT is part of the Chicago Mercantile Exchange (CME) Group.
  • CFTC – The U.S. Commodities Futures Trading Commission. Established as an independent agency of the US government in 1974, the CFTC regulates U.S. derivatives markets, which includes futures, swaps, and certain kinds of options.

Continue Reading Alphabet Soup – Who Are These People?

Investing has its own language, including beloved acronyms and shorthand.  Here’s a list (by no means exhaustive) of general terms you might hear thrown around in this blog or elsewhere:

  • AUM assets under management, which is the total market value of the investments that a person or entity manages on behalf of clients.
  • BD – an abbreviation for a broker-dealer. A BD is a buyer and seller of securities, as well as a distributor of other investment products.  A BD must be registered with the SEC.  BDs include large subsidiaries of huge commercial and investment banks, as well as independent boutiques.  A wirehouse is a BD that sells its own products to customers, while an independent BD sells products from outside sources.  As a dealer, the firm acts on its own behalf for transactions in the firm’s own account.  As a broker, the firm handles transactions behalf their clients. 
  • CFP – Certified Financial Planner. The CFP designation issued by the CFP Board of Standards, Inc., to professionals who have completed extensive training and experience requirements and are held to rigorous ethical standards for personal financial planning.
  • CRD – Central Registration Depository. This is a database maintained by FINRA and used by the U.S. securities industry and its regulators. Web CRD consists of the registration records of broker-dealer firms and their associated individuals including their qualification, employment and disclosure histories. The general public can review reports generated from Web CRD using BrokerCheck.  BrokerCheck will generate certain disclosable current and background information regarding your broker or investment advisor.

Continue Reading Alphabet Soup – Some General Terms that Might Get Thrown Around

Working under the supervision of the SEC, one of FINRA’s tasks is to write and enforce rules governing the ethical activities of brokerage firms and brokers.  With respect to discretion, FINRA Rule 3260(b) (aka NASD Rule 2510(b)) provides that for a broker to exercise discretionary power in a customer’s account, the customer must provide prior written authorization and that the broker’s firm must approve the discretionary arrangement.

FINRA’s Monthly Disciplinary Actions for December 2019 include several instances of brokers who ran afoul of FINRA Rule 3260:

  • Charles Harper Bridgers (CRD #1226108, Wilson, North Carolina) October 16, 2019 – Bridgers entered into an AWC with FINRA in which he was assessed a deferred fine of $10,000 and suspended from association with any FINRA member in all capacities for three months. Without admitting or denying the findings, Bridgers consented to FINRA’s findings that he entered municipal-bond orders in a customer’s brokerage account without the customer’s specific authorization and without authorization to exercise discretion over the account. FINRA further found that before learning the customer had died, Bridgers entered the orders in the customer’s account, and entered notes in the firm’s system that falsely stated that he had conferred with the customer before executing these transactions. FINRA found that both the trades and the system notes post-dated the customer’s death, and therefore, the trades were unauthorized.  The suspension is in effect from October 21, 2019, through January 20, 2020. See FINRA Case #2018057553801.  Bridgers previously was registered with Wells Fargo Clearing Firm LLC (1999-2018).
  • Steven Tarasius Yellen (CRD #1281663, El Paso, Texas) October 22, 2019 – Yellen entered into an AWC with FINRA in which he was assessed a deferred fine of $25,000 and suspended from association with any FINRA member in all capacities for one year. Without admitting or denying the findings, Yellen consented to FINRA’s findings that he engaged in unauthorized trading, amongst other things. In particular, FINRA found that Yellen exercised discretion in a customer’s account without written authorization or acceptance of the account as a discretionary account while registered with Morgan Stanley.  Yellen also completed false annual compliance questionnaires wherein he denied having any accounts in which business was transacted on a discretionary basis. Yellen further opened a second account for the customer without her knowledge or authorization and subsequently made an unauthorized transfer of $30,000 from her original account to the second account and used the funds to execute two unauthorized transactions. After Yellen left Morgan Stanley and became associated with Ameriprise Financial Services, he continued to engage in unauthorized trading by entering trades for customers that were beyond the option trading risk levels authorized by the customers. FINRA found that in so doing Yellen mismarked options order tickets as unsolicited when they were solicited, which was intended to circumvent the firm’s systems.   The suspension is in effect from November 4, 2019, through November 3, 2020. See FINRA Case #2018057175001.  Yellen previously was registered with Morgan Stanley entities (1984-2016), then Ameriprise Financial Services (2016-2018).

Continue Reading FINRA Publicizes Recent Cases of Unauthorized Trading

Merriam-Webster defines discretion as “individual choice or judgment.”  In the investment arena, discretion similarly refers to the exercise of judgment.  When the customer makes all the trading decisions in the account, then the account is non-discretionary.  In contrast, a discretionary account is one where the customer has given the broker written authority to buy and sell securities without the customer’s consent; that is, the broker can place trades without conferring with the customer.  Even in discretionary account, however, the broker must make decisions in keeping with the customer’s risk tolerance and investment objectives.

  • What if I never initiate trades in my account and always follow my broker’s recommendations – is my account discretionary?  NO.
  • What if I told my broker he can do whatever he wants in my account and doesn’t need to consult me regarding trades – is my account discretionary?  NO.

Following your broker’s lead by uniformly accepting her recommendations does not equate to discretionary authority, nor does giving your broker verbal carte blanche to do as she pleases with your account.  Your account is discretionary only if you have provided formal written permission for your broker to place trades without your consent.  This should involve completing the brokerage firm’s form, which is then approved by firm management.  In this regard, FINRA Rule 3260(b) (aka NASD Rule 2510(b)) states:

No member or registered representative shall exercise any discretionary power in a customer’s account unless such customer has given prior written authorization to a stated individual or individuals and the account has been accepted by the member, as evidenced in writing by the member or the partner, officer or manager, duly designated by the member, in accordance with Rule 3110.

(FINRA Rule 3260(d) describes the limited exceptions to the Rule.)

One recent FINRA broker discipline aptly illustrates the application of Rule 3260(b).  In October 2019, Simon Michel Joseph (CRD #5602157, Alexandria, Virginia) entered into a Letter of Acceptance, Waiver and Consent (“AWC”) in which he was fined $10,000 and suspended from association with any FINRA member in all capacities for 30 business days as a result of unauthorized trading.  Without admitting or denying the findings, Joseph consented to FINRA’s findings that he exercised discretion in accounts maintained by customers without having written authorization from the customers and without having requested or obtained approval from his member firm. Continue Reading Discretion – Who Has the Power to Choose?

What are the possible signs of fraud or other misconduct in your account?  Here are some potential red flags:

  • Big drops in the value of your portfolio, particularly when these dips don’t follow the market or seem exaggerated in comparison to what the market is doing.
  • Under-performance of the portfolio compared to the market. While there may be a perfectly benign explanation for this, it can also be a telltale sign of misconduct, including unsuitable investments, high commission investments, and other misconduct which benefits the broker at the investor’s expense.
  • Up the ante – the original.  Your broker recommends an investment strategy that makes you uncomfortable, particularly if the risk is more than you desire or inconsistent with what you have told the broker.  We’ve all acted against our better judgment in getting a bad haircut, unflattering sweater, or unsavory dinner special.  Do not make the mistake of accepting an investment recommendation that runs counter to your gut.
  • Up the ante – the remix.  Your broker recommends the purchase of a security that requires you to sign new account paperwork changing your risk tolerance to a higher level. In a nutshell, if your risk tolerance is moderate, then you must really question a recommendation which requires you to change that tolerance on paper to “aggressive” or “speculative.” That is, if the firm has earmarked an investment as “aggressive” or “speculative,” then there is a reason why it was not meant for a moderate risk investor.  Don’t let you broker persuade you otherwise.
  • Lots of trading.  Even a modest mathematics student understands that at some point the cost of making transactions outweighs the possible reward of those transactions, even under the best circumstances. When a broker engages in excessive trading in an customer’s account without regard to the customer’s investment goals and primarily to generate commissions for the broker, then the broker may be engaged in an illegal practice known as churning.

Continue Reading Possible Signs of Mischief

Investing is complicated – that’s probably the primary reason you chose to work with a broker.  Unfortunately, despite one’s best efforts, things may have gone disastrously awry.  Now, you are sitting down to a late night Google session and attempting to figure out your options.  Obviously, when you embarked upon your investment journey you expected some market hiccups, but nothing which would require litigation.  Sadly, your eyes have been opened to this possibility, but even that may be other than you expected, because if you want to pursue a claim related to investment losses or misconduct, then you must step into the world of arbitration.  Here’s some basic information to get your feet wet:

Why do I have to arbitrate?

Remember when you opened your securities account or first invested through the brokerage firm?  Lots of paperwork, right?  Sign, sign, sign.  Well, amongst those papers you signed, the brokerage firm likely required you to agree in writing to arbitrate disputes concerning the account.

If the brokerage firm is a member of FINRA (such as UBS, Merrill Lynch, Raymond James, etc.), then the chosen arbitration forum with be FINRA. FINRA Rule 2268(a) requires firms to highlight predispute arbitration agreements and disclose that by signing the arbitration agreement the parties agree that:

  1. All parties to this agreement are giving up the right to sue each other in court, including the right to a trial by jury, except as provided by the rules of the arbitration forum in which a claim is filed.
  2. Arbitration awards are generally final and binding; a party’s ability to have a court reverse or modify an arbitration award is very limited.
  3. The ability of the parties to obtain documents, witness statements and other discovery is generally more limited in arbitration than in court proceedings.
  4. The arbitrators do not have to explain the reason(s) for their award unless, in an eligible case, a joint request for an explained decision has been submitted by all parties to the panel at least 20 days prior to the first scheduled hearing date.
  5. The panel of arbitrators may include a minority of arbitrators who were or are affiliated with the securities industry.
  6. The rules of some arbitration forums may impose time limits for bringing a claim in arbitration. In some cases, a claim that is ineligible for arbitration may be brought in court.
  7. The rules of the arbitration forum in which the claim is filed, and any amendments thereto, shall be incorporated into this agreement.

This provision of FINRA Rule 2268 became effective on May 1, 2005, so if you are a customer whose relationship pre-dates May 1, 2005, then the account agreement you signed will be subject to the provisions of FINRA Rule 2268 in effect at the time you opened your account.  In other words, if you do not recall this detailed disclosure it might be that your agreement did not have it.  (It is also equally possibly you were flush with enthusiasm for your new investment adventure and inundated with papers to sign — such that you saw this disclosure language but it simply failed to register.)

Arbitration is the subject of contract between the parties.  Thus, the parties can determine their own rules, or choose to adopt the rules of an arbitral forum.  Investment advisors who are not FINRA members may include predispute arbitration clauses in their account agreements, which require submission of disputes to the American Arbitration Association (“AAA”) or Judicial Arbitration and Mediation Services (“JAMS”). Continue Reading Remind Me Again Why I’m Arbitrating — And Who the Heck is FINRA?