What to Do if Your Broker is Churning Your Account

Excessive trading, also known as churning, is a financial practice in which brokers engage in excessive transactions (buying or selling) within an investor’s account without necessarily increasing returns for the investor. Instead, the primary goal is for the financial advisor or broker to profit from transaction fees.

How can churning occur?

Churning often takes place in accounts where the advisor has been given discretionary authority to make transactions without asking the client first, but it can also happen in accounts that simply aren’t regularly or closely scrutinized by the client. In either case, unethical financial advisors and brokers may take advantage of the lack of oversight to engage in excessive trading.

How will I know if my broker is churning my account?

Even if you do keep a close eye on your accounts, it can be difficult for the average investor to notice and identify churning. While there is no single test that determines whether or not churning has occurred, helpful metrics include looking at the turnover ratio and cost-to-equity ratio in the account. 

A turnover ratio is calculated by dividing the aggregate amount of purchases in an account by the average monthly investment. The average monthly investment is the cumulative total of the net investment in the account at the end of each month, exclusive of loans, divided by the number of months under consideration. A turnover ratio of two times may be indicative of excessive trading for a conservative investor, but it’s important to compare the turnover ratio in a suspicious year to a more standard year in your account. Most investments turn over once a year or even less often, so any rate higher than that could set off alarm bells for potential churning.

A cost-to-equity ratio represents the percentage of return on the customer’s average net equity needed to pay broker-dealer commissions and other expenses. The cost-to-equity ratio is a useful tool to determine what percentage of the equity in the account was used to pay the broker commissions, and a high cost-to-equity ratio is a hallmark of churning or excessive trading. 

What are the consequences of churning?

• Expensive Brokerage Fees: The fees charged on each transaction can cost you a lot of money, cutting into potential investment gains you could otherwise realize. 
• Tax Consequences: You could face tax consequences for most of, or all of, the transactions taking place. Multiplied by excessive trades, these consequences can be quite significant.
• Negligent Investing: Since a broker engaging in churning is already prioritizing their financial gain over your financial well-being, it is likely that they may also be making poor investment choices on your behalf. 
• Violation of Fiduciary Duty: Churning represents a breach of the fiduciary duty owed to you by your broker, who is required to act in your best interest and to put your best interest above his or her own profits. 

How can I protect myself against churning? 

First, do your due diligence when selecting a financial advisor or broker, and don’t provide them with discretionary trading authority. One useful tool is FINRA’s BrokerCheck website, which allows you to search your broker’s record and to glean valuable information such as whether your broker has other customer complaints, criminal convictions, tax liens, or was fired from previous firms. Second, review your accounts on a regular basis so that you will be familiar with the typical activity level in the accounts and able to easily identify new or unexpected activity. 

What can I do if my account has been churned? 

FINRA has established rules to prevent churning. Brokers are required to adhere to ethical standards and face strict disciplinary actions for violations. Because of these rules, investors can pursue legal action against brokers engaging in churning, seeking recovery of financial losses and damages resulting from unethical trading practices.

If you suspect that churning has taken place in your investment account, contact an investment fraud attorney to review your account as soon as possible. You may be able to recover losses that resulted from the broker’s investment recommendations and excessive trades.