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.
- A flurry of trade confirmations – A trade confirmation is the brokerage firm’s official communication regarding a trade. Confirmations may be paper or electronic, just like the receipt you receive from the cash register when you purchase groceries. The confirmation records information about the trade, such as the date, price, commission, fees, and settlement terms. The confirmation will note whether the trade is “solicited” or “unsolicited.” Read the confirmation carefully so you are not confused. First, there are other account activities, such as reinvestment of dividends or payment of proceeds, which may generate a confirmation (i.e., the brokerage firm’s receipt), but have nothing to do with a trade, aka buy or sell of a security. Second, some firms may mark a trade “unsolicited,” but in the absence of such designation the trade is assumed to be “solicited.”
- “Unsolicited” Trades – A trade is marked solicited or unsolicited based upon the circumstances. Generally, a solicited trade is one recommended or suggested by the broker. In contrast, an unsolicited trade is one that you requested or which was your idea. A brokerage firm’s system of supervision typically provides for closer scrutiny of trades recommended by the broker. Therefore, if a broker is engaging in excessive trading, she may mark trades as “unsolicited” to avoid scrutiny.
What should you do if you have questions or concerns about your account?
- If you see a mistake or have a question, raise your concern as soon as possible with your broker. Do not be intimidated or misled. Similarly, do not feel embarrassed. It is better to feel silly for having asked a question, than to feel like a fool because you sat silently and were scammed.
- If you continue to have any questions or concerns, then contact your broker’s supervisor or compliance department to discuss it further.
- If you make a complaint about trades in your account, do it in writing and keep copies of everything.
- Take notes of conversations regarding concerns about your account, including the names and dates of people with whom you spoke and what they told you.
- If you feel like you are getting the runaround from the brokerage firm, then you can contact FINRA, the SEC, or your local securities regulator. Remember, however, that the resources of these agencies are limited, and they often act slowly. Thus, you would be wise to speak with a securities attorney. You can contact Farrar Law, PLLC, and receive a free consultation. Farrar Law, PLLC, accepts cases, both small and large, on a contingency basis.