Churning, in its most basic form, occurs when a stockbroker/financial advisor buys and sells securities for and account, without regard for the customer’s investment interests, for the purpose of generating commissions. Churning can involve almost any kind of security ─ stocks, options, bonds, mutual funds or variable annuities. It is an unethical and illegal practice that violates both federal and state law.
Churning is often accompanied by the use of “margin.” Trading on margin means that one is borrowing money from the brokerage firm in order to buy securities. Margin can also be used when one withdraws cash from an account that does not actually have any cash. In that situation, the investor is using the securities within an account as collateral to secure a loan. Of course, any time margin is employed, an investor is required to pay interest.
While there are quantitative measures for churning, these measures alone may or may not reflect churning. In general, frequent buying and selling of securities that does little to meet the client’s investment objectives may be evidence of churning. Churning may cause substantial losses in the client’s account.
The two most common methods for determining whether an advisor has churned or excessively traded a client’s account are analyzing the turnover ratio and the cost to equity ratio of the account. The “cost to equity ratio,” is the total commissions and fees divided by the average net equity of the account. This figure represents how much a portfolio must generate in profit just to break even
David A. Weintraub can help determine whether this or other areas of investment-related offenses were committed.