Excessive Trading/ Churning Attorney
Churning occurs when an investment professional excessively trades in a customer’s account without regard to the customer’s investment objectives for the purpose of generating commissions. Churning can involve almost any kind of security, such as stocks, bonds, options, mutual funds or variable annuities. Churning is both illegal and unethical – it violates the federal securities laws and the rules established by self-regulatory organizations, such as the Financial Industry Regulatory Authority, Inc. (“FINRA”).
Investment professionals often justify excessive trading by trying to convince their customers that the trading was necessary, saying such things as it was time to “get out” of the position to capture a small profit, or “I know this stock” and have “figured out the trading pattern” so that “you can make a profit.” While these and other similar reasons seem reasonable, they are simply excuses for the investment professional to charge excess commissions.
There are many warning signs that indicate a customer’s account is being churned. These include: a high turnover rate within the account; in and out trading of stocks; repeated trading in one stock; active trading of mutual funds, bonds, or other, non-equity securities; options trading; and trading on margin. When churning is suspected, it is important to consult with an experienced securities attorney, such as Jeffrey M. Haber.
To determine whether a customer has a viable churning claim, Mr. Haber will consider the following three factors: (1) whether the investment professional has control over the account, (2) the amount of trading in the account, and (3) whether the investment professional acted with intent to defraud or in reckless disregard of the customer’s interests.
The first element of a churning claim – control – refers to whether the investment professional was responsible for the trading; that is, whether the trading was done at the request of the customer. Proving this factor involves demonstrating that the investment professional had either express or implied control over the account. The most direct way to prove control is through a discretionary trading agreement in which the customer gives the investment professional discretionary authority to trade the account. More typically, however, control is established by demonstrating that the investment professional had “de facto” control over the account, like when a customer always follows the investment professional’s recommendations.
The second element of a churning claim requires proof that the account was excessively traded. While there are no bright line tests used to determine whether trading in a customer’s account was excessive, there are two indicators commonly used to determine whether excessive trading has occurred: the cost-to-equity ratio and the annualized turnover ratio. The cost-to-equity ratio measures the return on investment an investment professional will have to earn to “break even,” or cover firm expenses, broker fees, and any margin interest. This ratio is calculated by the total annual costs (commissions and margin interest) divided by the average balance in the account. The annualized turnover ratio examines the value of the securities purchased in the account over one year against the average equity of the account. Different levels of churning may represent presumed or conclusive evidence of an investment professional’s control over the account. For example, for conservative investors, an annualized turnover rate of 2 is suggestive of churning, a turnover rate of 4 is presumptive of churning, and a turnover rate of 6 or more is conclusive of excessive trading. The customer’s level of sophistication and their ability to understand the risks associated with the particular investment strategy help to determine whether the level of activity is excessive.
The third element of a churning claim requires proof that the investment professional excessively traded the account with the specific intent to defraud, or at least with reckless disregard of the client’s interests. Churning, in essence, involves a conflict of interest in which an investment professional seeks to maximize his or her compensation at the expense of the customer. If the level of trading is high enough, the motivation to create such high commissions, by its very nature, often is all that is necessary to satisfy this element of a churning claim.
The Law Office of Jeffrey M. Haber can help you determine whether an investment loss is the result of churning. Customers who suffer losses as a result of an investment professional’s excessive trading may be able recover their losses in a FINRA arbitration. If you believe there has been excessive trading in your account, or if you believe your investment professional may be recommending transactions for the purpose of generating commissions rather than pursuing your investment strategy, contact Jeffrey M. Haber to discuss your rights.