Investors rely on their brokers to make trades that are in their best interests and in line with their financial objectives. A broker, however, may buy and sell stock excessively in order to generate more commission fees, a practice also known as account churning. If you suspect that your broker has engaged in this unlawful conduct, you may have rights that you can assert. Securities lawyer Steve A. Buchwalter has helped many individuals in Orange County and elsewhere in California pursue claims against brokers who have not properly represented their interests.Brokers and Account Churning
Brokers must adhere to certain ethical standards of conduct. The Financial Industry Regulatory Authority, or FINRA (formerly the National Association of Security Dealers), sets out rules that brokers, dealers, and other members must follow when dealing with their clients. FINRA rule 2111 requires that a broker have a reasonable basis for recommending a transaction or investment strategy. The transaction or strategy must be suitable to the client based on a variety of factors, including the client’s age, investment experience, objectives, and financial situation. The frequency of transactions may be unsuitable given a particular client’s circumstances.
Brokers generally earn a commission on their trades, which can create a conflict of interest if the broker’s trading level amounts to churning. Account churning occurs when a broker seeks to maximize his or her compensation by trading excessively, without regard to the client’s interests. By churning an account, a broker can charge more fees to a client and consequently erode the gains or value of the client’s account.
If a broker’s compensation is fee-based, it is based on a percentage of the value of an account, not on each trade. This type of fee structure may encourage reverse churning, which is when an account is inactive or holds investments that are unlikely to be sold or purchased. The broker will simply sit on the account without taking any action to further the client’s goals. It can also result in the broker recommending margin trading (borrowing from the firm to make more purchases) which increases the value of the account because the loan proceeds (and the securities bought with those proceeds) are added to the value of the account.Elements of Churning
To prove churning, a client will have to establish three elements, the first of which is control. A broker must have either express or implied control over an account. For instance, a broker may have express control if the client gave him or her written discretionary authority, such as by power of attorney, to make trades on the account. A broker may have implied, or de facto control, of an account through his or her course of conduct with the client. For example, if the client had limited knowledge of the marketplace and habitually followed the broker’s recommendations, the broker may arguably have de facto control of the account.
The second element is excessive trading. Whether an account was excessively traded depends on a client’s risk tolerance, financial goals, and knowledge of investment strategies. Brokers will often argue that trades were legitimately made based on market fluctuations and opportunities. A quantitative analysis and review of an account’s trading history is crucial to establishing whether a broker’s conduct was reasonable, or rose to the level of churning. Some factors to consider include:
- Patterns of sales and purchases over the life of the account;
- The account’s turnover ratio;
- The commission to equity ratio;
- Market fluctuations at the time of the trades; and
- Erosion in an account’s value despite an upward trend in the overall market.
Experienced accountants and other financial experts may help determine whether the level of trading was reasonable or excessive given the circumstances.Consult a Ventura County Lawyer if You Are a Victim of Investment Fraud
Knowledgeable investment fraud attorney Steve A. Buchwalter represents individuals throughout Ventura County and the surrounding areas who have been burned by their brokers. He has counseled and advocated for clients in account churning and other investment fraud cases. Mr. Buchwalter is also a seasoned litigator who works closely with other professionals to build your case and advocate for your interests. He works with clients in Irvine, Santa Barbara, and other communities throughout Southern California and statewide. Call us at (818) 501-8987 or complete our online form to schedule a consultation.