Churning occurs when a broker or financial advisor makes transactions in a client’s investment account where the broker’s interest in making commissions overrides the investor’s interests in the account. When a broker makes a buy or sell recommendation for an account, that broker should have the investor’s best interests based on their investment objectives in mind. If the broker makes excessive buy and sell recommendations for the purpose of generating commissions for the broker from each buy and sell transaction, that broker is engaged in “churning” the account. Excessive turnover in the assets of the account, and/or a high cost to equity percentage are often a sign of churning. Churning is sometimes referred to as quantitative suitability.
If you believe you may have been a victim of churning, you should contact one of our lawyers as soon as possible.
Churning is also a subset of federal securities fraud and is defined as follows by the U.S. Court of Appeals for the Fourth Circuit:
Churning occurs when a broker exercising control over the volume and frequency of trading, abuses his customer’s confidence for personal gain by initiating transactions that are excessive in view of the character of the account. Its hallmarks are disproportionate turnover, frequent in and out trading, and large brokerage commissions. It is a deceptive device made actionable by Ǡ10(b) of the Securities Exchange Act and S.E.C. Rule 10b-5. Carras v. Burns, 516 F.2d 251, 258 (4th Cir. 1973).
The factors to be considered in a churning case are alternatively defined in the case of Bergen v. Rothschild, 648 F.Supp. 582, 585 (D.D.C. 1986):
(1) the number and frequency of the trades; (2) the amount of in and out trading; (3) the amount of commissions generated by the trading both in dollar terms and as a percentage of the brokers salary; (4) the investor’s objectives in the market and his level of business sophistication; and (5) the degree of control exercised by the securities dealers over the investment account. Horne v. Francis I. du Pont & Co.,428 F.Supp. 1271, 1274 (D.D.C. 1977)).
To establish control, [t]he account need not be a discretionary account whereby the broker executes each trade without the consent of the client. [T]he requisite degree of control is met when the client routinely follows the recommendations of the broker. Mihara v. Dean Witter & Co., Inc.,619 F.2d 814, 821 (9th Cir. 1980).
One common method of measuring the trading in an account to determine if churning has occurred is to calculate the turnover ratio, that is — how often on an annual basis the value of the account is bought and sold. As stated by the NASD [now FINRA] National Adjudicatory Council: “[t]urnover rates between three and four … have triggered liability for excessive trading, and the courts and the SEC have held that there is little question about the excessiveness of trading when an annual turnover ratio in an account is greater than six. ” Department of Enforcement v. Howard, 2000 NASD Discip. LEXIS 16 (NAC, Nov. 16, 2000).
The Howard decision also relied upon an additional method of addressing excessive trading, cost-equity ratios: “Excessive trading has also been found in cases in which the cost-equity ratio was between 15 and 30 percent, or more.” Dept. of Enforcement v. Howard, supra.
Churning typically occurs in regard to buying and selling stocks / equities, but can also occur with bonds, mutual funds, and variable annuities.
The attorneys at Greco & Greco have filed many FINRA arbitrations over the past 25 years involving a financial advisor’s churning of their customer accounts to generate commissions and fees for themselves, resulting in massive losses for the customer. If you believe that your broker / financial advisor or brokerage firm has been churning your securities / investment account, please contact Scott Greco for a free attorney consultation. Our Virginia securities fraud lawyers represent individuals from all states across the country and have decades of experience protecting the rights of customers, and holding securities firms responsible for the acts of their brokers.