At Bakhtiari & Harrison, we turn the tables on unethical trading practices. If you’ve been affected by churning or suspect your investments might be at risk, hiring our experienced team ensures that you have staunch advocates fighting to protect and recover your assets. This guide delves into the definition of churning, its impact on investors, legal implications, protective measures, and specific formulas used to identify this practice.
What is Churning?
Churning occurs when a broker engages in excessive trading of securities in a client’s account primarily to generate commissions, which can erode the value of the investment portfolio through unnecessary fees and is illegal under securities law.
How Does Churning Happen?
Churning can take place in accounts where brokers exert significant influence or where clients may be less vigilant. It often remains undetected due to its resemblance to normal trading activity but can be identified through meticulous monitoring and understanding of account activity.
Protecting Yourself Against Churning
Investors can guard against churning by:
- Regularly reviewing account statements for unusual activity.
- Understanding the broker’s fee structure.
- Establishing clear and direct communication regarding investment goals.
Legal and Regulatory Framework
Churning violates multiple regulatory standards, including FINRA Rules 2020, 2111, 2010, and the SEC’s Regulation Best Interest (Reg BI). These regulations mandate brokers to prioritize clients’ interests, making churning not only unethical but also illegal.
Penalties for Churning
Sanctions for churning include fines, suspension, or permanent bans, dependent on the firm’s size and the severity of the misconduct:
- Small firms may face fines ranging from $5,000 to $310,000.
- Midsize or large firms can see fines starting at $50,000 with no cap, reflecting the gravity of such violations.
Churning Case Studies from Bakhtiari & Harrison
The Case of Retired Schoolteacher:
A retired schoolteacher noticed her retirement savings dwindling due to frequent trades made by her broker. After retaining Bakhtiari & Harrison, we demonstrated that the turnover rate in her portfolio was excessively high with no reasonable strategy. The firm successfully recovered significant losses.
The Entrepreneur’s Portfolio:
An entrepreneur with a diversified portfolio became a victim of in-and-out trading that benefited only the broker through substantial commission fees. Our legal team used detailed trading records to prove churning, resulting in a full recovery of the client’s investment losses plus interest.
Settlement for a Widow:
A widow, unfamiliar with investment management, trusted a broker who churned her late husband’s investment accounts. Bakhtiari & Harrison intervened, recovering not only the depleted assets but also securing additional compensation including punitive damages, against the brokerage firm.
Detecting Churning: Key Formulas
To determine if an account has been churned, investors and regulators use several metrics:
Annualized Turnover Ratio
- Formula: Total purchases made in a year divided by the average monthly account value.
- Interpretation: A ratio of 4 to 6 or higher typically indicates churning, though lower ratios may also suggest excessive trading depending on the account’s investment profile.
Cost-Equity Ratio
- Formula: Total annual trading costs divided by the average account balance over the same period.
- Use: This ratio helps measure the viability of an account’s trading strategy by showing the percentage of the portfolio that must be gained to break even on costs.
In-and-Out Trading
- Identification: Frequent buying and selling of the same securities, which can suggest attempts to generate commissions through “wash” transactions.
Why Hiring Bakhtiari & Harrison in Churning Cases is Crucial
Bakhtiari & Harrison have extensive experience in handling churning cases, offering expert legal representation to recover losses and address broker misconduct. We analyze detailed trading records, broker-client communications, and alignment of transactions with client objectives.
Ryan Bakhtiari, a highly esteemed attorney, has an exceptional background that includes serving as President of PIABA (Public Investors Arbitration Bar Association) and chairing the FINRA NAMC (National Adjudicatory Council) Committee. His extensive experience in securities law and deep understanding of FINRA’s regulatory framework make him uniquely qualified to handle complex investigations and ensure your rights are effectively protected.
David Harrison brings a wealth of litigation experience to the table. His career includes time at the District Attorney’s Office, where he developed his litigation skills, and as in-house counsel at Morgan Stanley Dean Witter, where he represented the firm and its stockbrokers. David also held a Series Seven license from his time at Shearson Lehman Brothers, further enhancing his understanding of the financial industry and its regulatory demands.
Questions & Answers on Churning
What constitutes churning in financial accounts?
Churning involves unnecessary frequent trading by a broker primarily for generating commissions. This practice is harmful as it prioritizes broker earnings over client interests.
How can investors detect churning in their accounts?
Investors should look for high annualized turnover ratios, significant in-and-out trading, or a high cost-equity ratio, as these can be indicators of churning.
What steps should be taken if churning is suspected?
Review transaction histories, question your broker about the trading strategy, and consult with experienced lawyers. Firms like Bakhtiari & Harrison can provide crucial advice and representation.
What are the financial impacts of churning?
Churning can lead to diminished returns due to unnecessary commissions and fees, disrupting long-term investment strategies and financial goals.
Can churning occur in any investment account?
Yes, churning can happen in any brokerage-managed account, particularly where the broker has significant control or discretion.
What are common penalties for brokers found guilty of churning?
Penalties can range from fines to suspension or expulsion from the brokerage industry, depending on the severity of the offense.
How does Bakhtiari & Harrison approach suspected churning cases?
We conduct thorough investigations of trading activities, evaluate broker-client interactions, and assess whether transactions align with client objectives to formulate a robust legal strategy.
How can investors prevent churning?
Maintain active oversight of your investment accounts, understand your broker’s compensation structure, and ensure all trading activities align with your stated investment objectives.
Is recovery possible for losses due to churning?
Yes, investors can often recover losses through legal actions or arbitration, especially with the assistance of experienced securities litigation attorneys.
Understanding churning and its indicators is crucial for maintaining the health of your investments. If you suspect churning or observe high turnover and cost-equity ratios in your accounts, seeking professional guidance is imperative.
Bakhtiari & Harrison is an AV-rated, battle-tested law firm focused on the worldwide representation of clients in complex arbitration, litigation, and related legal services in securities industry matters.
The firm’s partners have extensive experience in securities, employment and regulatory matters. Our focus is on delivering strategic and creative client-centric solutions.
We represent high net-worth individuals, institutions, and hedge funds in securities arbitration and litigation claims before FINRA (Financial Industry Regulatory Authority), AAA (American Arbitration Association), other arbitration providers, and state and federal courts.
The firm represents financial services professionals, registered investment advisors and broker-dealers in employment matters, industry disputes and regulatory investigations. For further assistance or to discuss potential churning in your accounts, please contact Bakhtiari & Harrison. We are dedicated to protecting your investment interests and achieving your financial objectives.