Investing in your future is one of the most important actions you can take to help you find financial security and provide for your loved ones after you pass. While there are countless trustworthy brokers to work with, there are exceptions that can put your financial future at risk. One of the common improper and unethical violations of law is “churning,” also known as excessive trading. This practice is incredibly dangerous for investors, and can destroy your investments quickly.
Understanding The Misconduct
Churning is the practice of trading in excess of your goals as a way to increase commissions for the broker and their firms. Your financial goal may be capital preservation and long-term growth, but a broker may suggest a more aggressive strategy that involves regularly buying and selling, attempting to time the market or otherwise chasing supposedly good investments. More transactions necessarily lead to higher commissions, fees, and costs. You may also suffer unfavorable tax consequences, since any gains from short-term trading are usually taxed as ordinary income, rather than being taxed at more favorable capital gain rates. This behavior, particularly when done without your consent, is considered fraudulent activity by the Financial Industry Regulatory Authority (FINRA) and can provide the basis for an investor to bring an arbitration case against the broker and their brokerage firm, as well as possible regulatory sanctions.
Typically, an arbitration claim against a firm or a broker needs to prove two things to have the greatest chance of success:
- That the stockbroker or firm, not the investor, controlled the account’s activity;
- The account activity was unsuitable because the amount of trading was unreasonable and excessive based on the investor’s risk tolerance and investment objectives.
Understanding The Process
The arbitrator or arbitration panel will consider the evidence presented by the investor to determine whether the broker exercised the necessary control over the account, including:
- The level of client sophistication, including education and occupation;
- The client’s trust and reliance on the broker;
- Whether the client gave the broker discretion to trade, or agreed to every recommendationmade by the broker;
- The client’s previous securities investment experience;
- The extent to which the client understands the overall investment strategy.
The most common factor used to determine whether a trade was excessive is the use of statistical formulas. Annual Turnover rate, cost-equity ratio, and the extent of in-and-out trading in an investor’s account can all help prove that a broker violated the quantitative suitability obligation. Fro example, by adding up all purchases in a year, and dividing the total annual purchases by the average balance of the account throughout the year, an arbitrator can determine whether the annual turnover ratio is suspiciously high.
Churning isn’t restricted to Wall Street and major investment firms. It can happen at even the smallest firm. In fact, some of the worst churning occurs at smaller brokerage firms, which do not have the supervision, oversight and control often found at the major Wall Street firms. It’s vital to keep an eye on your investments.
Gaslowitz Frankel LLC is Georgia’s premier fiduciary litigation law firm. The firm provides representation to individuals, executors, trustees, investors, shareholders, and financial institutions in complex fiduciary disputes involving wills, estates, trusts, guardianships, businesses, and securities and investment disputes.
If you or a loved one feels they may be the victim of excessive trading, we can help. Call the firm at 404-892-9797 for a free consultation.
