Excessive Trading and Churning

High volume trading refers to a large number of transactions in an investor’s account over a particular period. Some investors seek high volume trading to capture profits from the quick movement in asset prices. For many others, high volume trading may be a sign of excessive trading. FINRA’s quantitative suitability standard requires that a broker has a reasonable basis belief that a series of recommended transactions to a customer, when viewed together, are not excessive or unsuitable for the investor.

Excessive trading occurs when a stockbroker ignores his obligations and makes a large number of trades in a customer’s account, not to benefit the customer but to generate commissions for the broker.

Churning is a more egregious variation of excessive trading. Churning refers to a situation where the broker executed an excessive amount of trades and did so with the intent to defraud or reckless disregard for the customer’s interest.

Excessive trading and churning are unethical and illegal. Both are violations of securities rules and regulations and can cause enormous harm to customers.

A recent example involves a broker churning the account of a 93-year-old Holocaust survivor resulting in over $700,000 in losses, while at the same time, the broker made nearly $700,000 in commissions.

Excessive trading is one of the most common types of investor complaints because brokers have a financial incentive to engage in such trading. Brokerage firms compensate most financial advisors on a commission basis; consequently, the more trades a broker executes, the more commissions the broker generates.

Excessive trading can be difficult to detect as commissions on individual trades may be small, but over time, they add up and can become excessive. Even for the most vigilant customers, it can be challenging to assess the exact amount of fees and commissions charged by the brokerage firm and their cumulative value over time.

If you have noticed any of the following trading activity in your investment accounts, contact our experienced securities arbitration lawyers for a free case evaluation:

• Frequent buying and selling of equities;
• Rapid buying and selling of higher commission products such as mutual funds, variable annuities, unit investment trusts, and closed-end funds; or
• The sale of a security that was intended to be a long-term investment after holding the investment for a short period, then using the proceeds to buy another nearly identical longer-term security. Longer-term securities could include mutual funds, variable annuities, unit investment trusts, and closed-end funds).

Excessive trading is not limited to high volume trading. Excessive trading can be any trade that is executed not to benefit the customer but to generate commissions for the broker.

How is excessive trading determined? Generally, there are two primary indicators of excessive trading: (1) turnover rate; and (2) cost-equity ratio.

A turnover rate is the number of times during a one-year period that investments in a securities portfolio are replaced by new investments. An investor’s risk tolerance and investment objectives are important factors in determining what turnover rate is excessive for a particular investor. Generally, a turnover rate of six suggests excessive trading, but a turnover rate below four can be excessive in some cases. For example, a turnover rate of four may be deemed excessive for a conservative investor with a need to preserve capital. The same turnover rate may be considered suitable for an aggressive investor with a high appetite for risk.

The cost-equity ratio is the amount the account would need to grow for the customer to break-even. For example, if the cost equity ratio in an account is 20 percent, the account would have to appreciate 20 percent just for the investor to cover the fees and expenses in the account. Commonly, a cost equity ratio of 20 percent or more is suggestive of excessive trading. Again, an investor’s risk tolerance and investment objectives are key considerations when determining whether a particular cost-equity ratio was in the investor’s best interest.

If you believe that you have been the victim of excessive trading or churning, please contact Iorio Altamirano LLP for a free and confidential case consultation. Our attorneys have reviewed thousands of account statements and have the experience to evaluate and detect wrongful activity in your investment accounts.