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What Is Illegal Churning or Excessive Trading?

Many of us have a basic understanding of how buying and selling securities works. Sometimes, investors entrust decisions about their investment strategy to a brokerage firm.

Financial advisors must execute a trading strategy for clients' investment accounts that aligns with their goals. But, some investment professionals engage in unethical practices. Professionals can make investment decisions to benefit themselves rather than clients.

"Churning" is one such unethical practice. It's an illegal practice where a broker engages in excessive buying and selling activities. The broker seeks to generate commissions for the stockbroker. This article describes churning in more detail. It also discusses related securities laws and industry rules and how to spot a churning case committed by your broker.

What Is Churning?

When brokers buy and sell securities, they usually make a commission from that transaction. Churning happens when a broker conducts excessive or frequent buying and selling of securities. If a broker does this to increase total commissions instead of acting in the client's best interests, it's illegal.

When a broker has actual or effective control over the investment decisions of a client's account and engages in a turnover rate for the broker's benefit, it's churning. Churning is unethical. In some cases, it's illegal. Such trading activity can affect the brokerage accounts of novice and experienced investors.

Red flags that may signal churning include the following:

  • Unauthorized trading
  • An excessive number of trades
  • Excessive transaction fees

You can take action if you see any of these red flags and believe your broker is churning. The Securities and Exchange Commission (SEC) protects investors and the markets. It oversees broker-dealers and self-regulatory organizations such as the Financial Industry Regulatory Authority (FINRA).

FINRA is a non-profit organization overseen by the SEC and authorized by Congress to protect investors and promote market integrity. As explained below, you can submit a complaint to the brokerage firm and the Securities and Exchange Commission (SEC) or FINRA.

Laws and Regulations Prohibit Churning

Applicable federal securities law and industry rules related to churning include the following:

  • SEC Rule 15c1-7 states that a broker acts in a manipulative, deceptive, or fraudulent way when they have discretionary power over a customer's account and makes excessive transactions "in view of the financial resources and character" of the customer's account.
  • FINRA Rule 2111 requires brokers and agents covered by FINRA to have a "reasonable basis" to believe that a transaction or recommendation is suitable for the customer. The broker and agent can consider the customer's investment profile (which includes factors like age, other investments, financial needs, investment objectives, and risk tolerance).
  • NYSE Rule 408(c) prohibits members of the New York Stock Exchange and their employees from exercising discretionary power to make excessive securities transactions in size or frequency in light of the customer's financial resources.

Churning can violate an investment advisor's general fiduciary duty to always act in the client's best interests and may constitute securities fraud.

How To Detect Illegal Churning

Detecting illegal churning can be difficult. Brokers are in the business of buying and selling securities every day. But they still have specific responsibilities in executing those duties.

To detect churning, it helps to look at the long-term investment goals and resources to fund your account. Churning involves transactions that are too large or frequent for the account. Frequent in-and-out purchases and sales of securities that don't appear necessary to fulfill the customer's investment goals may be evidence of churning.

If you suspect that your broker is participating in churning at your expense, you can file a complaint with the SEC or with FINRA's Investor Complaint Center.

Get Legal Help With Your Churning Claim

Securities law is a complex legal field that requires specific knowledge of industry laws, rules, and regulations. If you've been a victim of churning, you may be able to get damages for your investment losses. It may also be possible to recover commissions your broker got by excessively trading on your account.

If you need help with a securities claim, it's wise to consult an attorney. An experienced local securities attorney can explain your legal options.

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