Dick and Jane Investor have an investment account with ABC Brokerage. They have been saving for a number of years to fund their retirement. They feel comfortable with the brokerage firm and like their broker, Don, however, Dick has some concerns about the account. Opening a letter from ABC, he sees it’s a confirmation of a transaction of a trade on their account. Puzzled, he goes to his desk, pulling out their investment file.
“Look,” he says to Jane who has entered the room. “This is the second confirmation letter of a trade in our investment account this week. And, this is the 7th confirmation letter this month. What is Don doing? What is this?”
Jane shrugs, looking puzzled.
What “this” could be is churning of their account.
Churning in finance is the practicing of executing trades for an investment account by a broker in order to generate commissions from the account. Frequent trading in fee-based accounts is not an example of churning since no commissions are made on those transactions. However, there are concerns about “reverse churning” in those accounts.
How do you know if your investment account is being churned?
Unless you are sophisticated trader who likes to take risk, there shouldn’t be much trading in your account. If you’re like Dick and Jane Investor, long-term, conservative investors planning for their retirement, you probably follow the general wisdom that buy and hold strategies are the best way to go. So, if, like Dick, you receive confirmations 2 times a week or 10 times a month, it’s probably a warning sign that your broker is churning your account.
Another sign of churning is receiving a letter confirming that you want to sell an annuity or an insurance product shortly after buying it; this could be the firm wanting to maximize commissions and want to be sure you go along with the plan. If you have received a number of these forms, this could be a warning sign. Anything that generates an upfront commission creates some incentive to create churning activity for the commission based broker.
If your account is declining despite an upward moving market or is declining faster than a downward moving market, it might be churning. Unnecessary commissions will erode an account and cause the account to underperform relative to the market.
What is Reverse Churning?
Reverse churning, a new concern, is the practice of a broker placing an investor’s funds in a fee-based account for no reason other than to collect the fee. These accounts require the investor to pay a regular, fixed fee to the advisor, but it is often in exchange for very little actual advice, trading, or account activity. Therefore, the advisory firm generates more revenue while the customer does not receive any recognizable benefit.
Sanctions for Churning
Churning, is a serious offense and if proven, can lead to an immediate termination of the broker and potential barring from the industry. In the event a broker is caught churning, FINRA may place a monetary fine of $5,000 to $110,000 per instance. FINRA also has the right to suspend the broker from 10 business days to one year. In more egregious cases, FINRA can suspend for up to two years or even bar the broker indefinitely.
If you would like more information about churning or reverse churning, or if you feel that you have been a victim of securities fraud please contact me at: 313-962-7777 for a case evaluation