Principal Protected Note

How Do I Know If My Account Was Churned?

Jun 8, 2020

What Is churning?  Although most stockbrokers and investment professionals act with the utmost professionalism, unfortunately, there are always a few “bad apples” who are in it just for themselves. When a broker is trading your account simply to make commissions on the trading, this is called churning. As an investor, you need to be able to detect whether your brokerage account has been or is still being churned, and know what to do about it if you suspect you have been the victim of this activity. According to the Securities and Exchange Commission (“SEC”) churning occurs when a broker engages in excessive buying and selling of securities in a customer’s account chiefly to generate commissions that benefit the broker. For churning to occur, the broker must exercise control over the investment decisions in the customer’s account, such as through a formal written discretionary agreement, although a broker can be deemed to have control without such an agreement-especially if the customer always accepts the broker’s investment recommendations. Frequent in-and-out purchases and sales of securities that don’t appear necessary to fulfill the customer’s investment goals may be evidence that your account is being churned.  Churning is both illegal and unethical. Churning violates both the Federal and state securities laws, as well as FINRA industry regulations and standards. Such conduct may also violate a myriad of other laws, such as those requiring that brokers act as fiduciaries and always put their client’s interests first. Churning also violates FINRA’s suitability rules. What Does Churning Stocks Mean? Churning Stocks There are a number of types of churning investors should watch for. The most common is when a broker makes excessive trades in stocks. Excessive trading generates commissions for the broker but provides very little if any, the benefit to the investor.  One way churning is measured is by how many times the equity in the account is traded in a year. This is called the “turnover ratio” The turnover ratio can be calculated a number of ways. The simplest turnover measure divides total security purchases by the average month-end equity balance and then annualizes the turnover ratio by dividing it by the number of years covered in the analysis. More simply put, if the average yearly value of your securities account is 100,000 and a broker executed 300,000 worth of trading in a year, the turnover ratio would be 3x. The other measure of churning is called the cost-to-equity ratio. Cost-to-equity ratios are calculated by dividing the costs such as commissions, fees, margin charges, mark-ups, and mark-downs incurred in an account by the average yearly equity. In this measure, cost-to-equity ratios calculate the portion of the average equity in the account that is eaten up by the trading costs. A simple example would be if the average equity of the account was 100,000 but the costs of the trading in the account were 10,000. In this example, the cost-to-equity ratio would be 10%–meaning that the customer would have to earn at least 10% on the trading before breaking even.  Churning Bonds, Mutual Funds, Annuities, and Life Insurance While most people think of churning in the […]

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