What Does it Mean for Your Broker to Receive Excessive Commissions (otherwise called Churning)?
As an investor, your priorities are to protect and grow your wealth. Like anyone using a money manager, you are probably happy to pay your broker a fair fee and any earned commissions. However, like any smart investor, you’ll need to be on the lookout for fraud in your account.
Investment fraud comes in all shapes and sizes. Sometimes, investors are surprised to learn that investment fraud includes situations where their stockbroker engages in excessive trading in their account. Investors can also be defrauded when a stockbroker recommends unnecessary and overly expensive products.
We’ll walk you through a few investment fraud situations for which you should always be on high alert. At Patil Law, we can also help if you think you have been a victim of excessive trading or investment churning and have suffered investment losses as a result.
Why Do Brokers Churn Accounts?
Excessive trading or “investment churning” is the practice of engaging in a number of trades well beyond the number of trades required to maintain the client’s account. Typically, brokers who engage in this type of behavior do it for the sole purpose of generating a higher number of commissions. Investment churning is an extremely risky practice that can result in significant losses for clients. However, churning can generate high commissions, fees, costs, and greatly benefit the individual stockbroker and their firm. Unfortunately, this form of investment fraud is
not uncommon. If you believe you have been a victim of churning in your investment accounts, talk to a securities fraud lawyer as soon as possible.
How a Claim for Commission Abuse Works
Excessive trading can be a cause of action in a Financial Industry Regulatory Authority (FINRA) arbitration claim for damages. Stating a claim for damages in FINRA arbitration can be a complex process. Having an experienced securities fraud lawyer by your side can greatly simplify the process. At Patil Law, we only represent investors like you, never banks or brokers.
To be successful in a claim against a brokerage firm or stockbroker, an investor needs to demonstrate the following:
- The stockbroker had full control over activity in the investment account; and
- The amount of activity in the account constituted excessive trading, otherwise known as investment churning, based on subjective and objective factors.
If both of these facts are true of your account, speak with a securities fraud lawyer immediately. Any investor who suspects that they have been harmed by excessive trading or investment churning should bring an arbitration claim against the brokerage firm or stockbroker (or both). It’s important to try to recoup any losses you may have suffered and prevent future churning losses for yourself and other clients who use your broker.
Understanding Whether Trading Is Excessive
When trying to determine whether excessive trading is occurring in your account, an attorney and an arbitrator will typically use both subject and objective tests. It’s common to use complex statistical formulas to test whether trades in the account line up with what an investor should expect. FINRA suitability rules provide the basis for creating those formulas. One such rule states as follows: “factors such as the turnover rate, the cost-equity ratio, and the use of in-and-out trading in a customer’s account may provide a basis for a finding that a member or associated person has violated the quantitative suitability obligation.” Your attorney will know how to use these rules and formulas to assist you in determining if you are a victim of excessive trading.
Turnover Rate
As an investor, it’s important to understand what’s coming into your account and what’s going out. The turnover rate measures the overall level of activity of trades. The turnover rate is calculated by dividing the total annual purchases in the account by the average balance of the account during a year. If this number is high, then the level of activity in the account is high. For your stockbroker, a higher turnover will generate more commissions and fees.
Note that high turnover in your account doesn’t necessarily mean that there is a problem. In some situations, you may have changed your investment goals throughout the year. Or, you might have needed to sell some financial instruments for tax reasons. There can be perfectly legitimate reasons for a high turnover rate that have nothing to do with broker misbehavior or excessive trading. However, fraud can occur when brokers artificially increase turnover for the sole purpose of generating higher fees.
Cost-Equity Ratio
The cost-equity ratio is another objective measure used to evaluate a trading strategy and test it to see if your broker has behaved fraudulently. The cost-equity ratio measures the annual costs an investor incurs from an investment strategy. This metric is calculated by dividing the total annual account costs (which include commissions and interests) by the average balance in the brokerage account. This objective measure can tell you a bit about how commissions and costs are being allocated to your account by excessive trading. The cost-equity ratio may sometimes be referred to as the “break-even rate of return.”
Subjective Factors
A securities fraud lawyer or arbitrator will also review subjective factors when assessing whether you have been the victim of investment churning. A few key factors to consider are:
- The level of risk-tolerance communicated to your stockbroker;
- The stated investment objectives for your account;
- Your trust and reliance upon your stockbroker;
- Your understanding of the investment strategy;
- Your age and level of investment sophistication; and
- Your net worth and level of funds in your investment account.
Taking into account all objective and subjective factors will give your securities fraud lawyer a better picture of your losses. Subjective factors are also important to consider if the use of high-priced or inappropriate securities have been part of your stockbroker’s excessive trading strategy. Looking at your risk-tolerance and stated investment objectives can tell both your lawyer and a potential arbitrator quite a lot about what kind of securities should be in your investment accounts.
It will also help a potential arbitrator understand the losses you have suffered and the potential for future harm if the stockbroker is allowed to continue their behavior.
What to Do if You’ve Been Harmed by Commission Abuse
The most important thing you can do if you believe you’ve been harmed by excessive trading in your account is to speak with a securities fraud lawyer right away.
An experienced securities lawyer can assess your claim according to the steps outlined above. They can also explain to you what the process might be for proceeding to FINRA arbitration.
What Is FINRA Arbitration?
FINRA provides investors who may have been defrauded or suffered other losses a way to have their claims heard before a panel of arbitrators. FINRA arbitrators are typically well-versed in securities law.
Arbitration is like a streamlined court process. It typically has all the elements of a traditional litigation process (claim, discovery, some motions, and a trial-like setting for hearing the dispute). However, the process is very abbreviated compared to regular jury trials. By proceeding to FINRA arbitration with your claim for damages when you’ve been harmed by excessive trading losses, you’re likely to get a resolution much faster than going through the courts.
What Will an Arbitrator Look for in My Case Against My Financial Advisor for Commission Abuse in My Account?
The arbitrator or securities arbitration panel will look at several factors in determining whether the stockbroker exercised the necessary control over the account to hold them responsible. They’ll also review the objective and subjective factors mentioned above to see whether there was actually excessive trading or investment churning in your account. Importantly, an arbitrator or securities arbitration panel will look closely to see whether you have suffered any losses.
It is possible (but not common) to have churning in investment accounts where the investor does not suffer any actual damages.
In the rare event that you’ve suffered from excessive trading in your account with no losses, you can still file an investor complaint to make FINRA aware of the bad behavior. An experienced securities fraud lawyer can also help you make your complaint. You may even help to save a vulnerable investor from serious future losses!
How Can Patil Law Help?
At Patil Law, we’ve represented hundreds of investors across the U.S. and around the world. Our goal is to help investors like you navigate the challenges of FINRA arbitration while regaining your financial stability. In fact, we have recovered over $25,000,000 for defrauded investors. If you think that you have been the victim of excessive trading, investment churning, or other investment fraud, contact our experienced nationwide investment fraud lawyers today for a free consultation today. Call (800) 950-6553 or email cp@patillaw.com.
