Excessive trading or churning refers to the practice of a financial advisor recommending or placing trades for the purpose of generating fees or commissions. It is the classic example of a financial advisor putting his or her interests in front of the client’s interests. The Financial Industry Regulatory Authority (FINRA) requires that financial advisors uphold the highest degree of commercial honor and just principles of trade. Engaging in churning or excessive trading violates that requirement.
In situations where a financial advisor has engaged in excessive trading or churning, it is not uncommon for the financial advisor to tout the performance of the account on an annualized basis. However, the measure of performance must take into account the cost of transactions throughout the same time period.
How Do I Know if My Account Is Being Churned?
Churning can be difficult to detect and often times requires an analysis of the “turnover ratio” in the account, which measures the total value of securities that have been purchased and sold in a defined period of time. A higher turnover ratio can be indicative of churning. An alternative test to detect churning requires an evaluation of the cost ratio of the trading activity. For example, if your portfolio has an annualized return of 5% but the financial advisor has charged fees and commissions of 5%, there has been no value added by the financial advisor.
Signs of potential investment churning may include:
- A high number of transactions in a relatively short period of time
- Your broker recommends trading one security for another similar security
- Your broker frequently tries very hard to convince you to make trades to realize short-term gains
- High-performing securities are sold off frequently or quickly, while you notice more poorly performing securities remaining in your portfolio for a long period of time
- High turnover rate
- The broker is exercising a great deal of control over your account
- The broker emphasizes your account’s performance on an annual basis while glossing over monthly or short-term performance (and the overall cost of transactions during those same time periods)
What Is an Example of Churning or Excessive Trading?
A classic example of excessive trading occurs when a financial advisor recommends selling one security (oftentimes a mutual fund) and purchasing another mutual fund offered by a different mutual fund issuer within a short period of time. The transactions, which are commonly referred to as “Swaps” or “Switches,” may not present any benefit to the client and may only present a financial benefit for the financial advisor.
Financial advisors may attempt to justify the trade by touting the positive features of one investment without explaining the cost of the trade (between the buy and corresponding sale). With regard to mutual funds, there may be special fees owed by the investor if the investment sold within a short period of time. Again, many financial advisors fail to disclose the hidden fees.
Contact a Law Firm with Expertise in Handling Matters Involving Churning
The Wolper Law Firm has extensive experience with claims involving churning and excessive trading. If you believe that your financial advisor has engaged in churning or excessive trading, please contact the Wolper Law Firm for a free consultation and case assessment to determine if a viable cause of action exists. Call 954.406.1231 today.