Churning is a type of investment or securities fraud, defined by the Securities and Exchange Commission (SEC) as “excessive buying and selling of securities in a customer’s account chiefly to generate commissions that benefit the broker." The broker must have control over the account or the client’s investment decisions in order for churning to occur. Churning acts in direct violation of a broker’s fiduciary duty to a client and may result in significant financial losses.
A recent decision by a Financial Industry Regulatory Authority (FINRA) panel shows just how damaging churning can be to an investor. On July 13, 2012, a three-person arbitration panel awarded $1.7 million to a claimant who filed a case alleging excessive trading and churning, negligence, breach of contract and various other violations of securities laws and rules from July of 2009 to April of 2010. The claim was filed by John Sisk against JHS Capital and a former broker at the firm in 2011, originally seeking $3.1 million in damages. According to Sisk’s attorney, the mishandling of Sisk’s account meant that it would have had to generate returns of 160% just for him to break even. The July 2012 FINRA arbitration award includes $1.5 million in compensatory damages, plus interest until the award is paid in full. It also includes punitive damages totaling $100,000 and attorneys’ fees totaling just over $93,000.
The above case proves just how seriously FINRA and other regulatory agencies take churning and other forms of broker misconduct and negligence. Investors rely upon their brokers and financial advisors to make recommendations and decisions that will forward their investment objectives, not lead to their financial ruin.
When stockbrokers or brokerage firms take part in churning, they are acting in their own interests as opposed to the best interests of their customers. Brokers are generally paid on a commission basis for their services, and increasing the number of trades in clients’ accounts may serve to increase their commissions. This violates FINRA Rule 2111 related to quantitative suitability, which requires a broker to ensure that the number of transactions carried out are suitable for the client and are in his or her best interests. Suitability applies not only to the type of investment but the number of transactions as well. Churning is considered a type of securities fraud under the Securities Exchange Act of 1934 and also violates SEC Rule 15c1-7, and other securities laws.
There are three primary elements that must be proven by an investor who files a churning claim against a broker. First, the investor must prove that the number of trades was excessive, given his or her investment profile and objectives. Second, the investor must prove that the broker had control over the account or accounts in question. Third, the investor must prove that the broker acted with willful or negligent disregard for the investor’s best interests or intentionally defrauded the investor.
One of the best ways to avoid becoming the victim of churning or any type of investment fraud is to be as involved as possible. Keep a close eye on your accounts and take note if you believe there are an excessive number of trades occurring. Ask your broker about the activity and do not hesitate to seek legal counsel if you believe your broker is acting against your best interests. If you suffered financial losses, you may be able to file a claim to recoup these.