Churning / Excessive Trading

When a broker buys and sells investments in your account for no reason other than to generate commissions, that’s churning, also known as “trading fraud.” Account turnover rates of 6x are usually automatically considered churning by FINRA arbitration panels. You’d have to make multiple times your account’s value to turn any profit after the broker’s commissions. This can also lead to tax issues for customers.

Churning can involve everything from stocks to bonds, fixed and variable annuities, to mutual funds and unit investment trusts. Certain mutual funds and products with an insurance element can involve surrender charges in the event they are sold too early after being bought.

Churning is illegal as well as unethical, and can subject a broker and their firm to fines and other, greater penalties from FINRA, the SEC, and state securities regulators. Brokers who churn accounts may be in breach of SEC Rule 15c1-7, which governs manipulative and deceptive conduct. FINRA governs overtrading under rule 2111 and the NYSE prohibits the practice under Rule 408(c).

Churning isn’t always easy to spot right away. Customers have to keep a close eye on their brokers’ activities in the account, and make sure also that trades weren’t made without their authorization. Customers also need to keep close track of their email and other communications with the broker, especially if they wish to pursue a claim of churning at some point later.

There is also “reverse churning,” where a broker puts you in a “managed” or “fee-based account, charging you 1-3% per year of the total assets under management, but no commissions. Seems like a good idea until you find out the broker did nothing in the account at all, yet took a slice off the top every year.