“excessive trading from advice designed to enrich the financial advisor”
According to the Financial Industry Regulatory Authority (FINRA), brokerage firms and its financial advisors that excessively traded or “churn” a brokerage account are in violation securities industry rules and regulations. In a FINRA arbitration claim of excessive trading or “churning” in a brokerage account, Claimants may allege a breach of fiduciary duty and conflict of interest for recommended investment strategies whose sole purpose is to enrich the brokerage firm and/or its financial advisor through excessive commissions, fees or costs. FINRA arbitrations will generally be successful in an excessive trading or “churning” claim if a customer can prove two case facts. First, the panel must conclude the financial advisor controlled or solicited the activity in the account and second, the activity in the account was excessive based on the Claimant’s risk tolerance and investment objectives.
What is Excessive Trading?
Excessive trading, sometimes called account churning, occurs when a broker or financial advisor recommends or executes a high number of trades on a clients account which do not align with their client’s investment or financial goals. Brokers and registered securities advisors are required to work in the best interest of their clients.
There are many factors an arbitration panel will consider to determine whether a financial advisor had control over the activity in a financial brokerage account. Several factors that may be considered include:
- Client Level of Sophistication;
- Unsuitable Investment Strategy Based on Objectives;
- Prior Transactions of a Similar Nature and Frequency;
- Client Trust and Reliance Upon a Financial Advisor;
- Time Client Devotes to Independent Research;
- Number of Transactions Solicited vs. Unsolicited;
- Similar Positions with Different Brokerage Firms; and
- Client Understanding of Investment Strategy.
Arbitration panels must determine whether the financial advisor was in control of the transaction in the brokerage account at issue. An analysis of statistical measures of account activity can help determine whether the transaction history for a brokerage account was excessive. The statistical measurements used are the turnover ratio and the cost-equity ratio of a trading strategy in a brokerage account. The turnover ratio measures level of activity and is calculated based on total annual purchases divided by the average balance in the brokerage account during a year. The cost-equity ratio measures the total annual costs incurred from an investment strategy calculated based on total annual costs (commissions and margin interest) divided by the average balance in the financial brokerage account. This is frequently referred to as the “breakeven” rate of return. An investor’s level of sophistication and their ability to understand the risks associated with the particular investment strategy will help determine whether the level of activity is considered excessive.
Different levels of “churning” in a brokerage account may represent presumed or conclusive evidence of a financial advisor’s control over the account. An arbitrator might consider whether it is reasonable to expect investment returns to cover the costs associated with a recommended the investment strategy. As the required breakeven rate of return increases can an investor logically be able to understand the risks of the recommended strategy?
The national investment fraud lawyers at KlaymanToskes can help you determine whether an investment loss is the result of a financial brokerage firm and their financial advisor’s unauthorized trading, excessive trading or “churning of an investment account. If an investor suffers losses as a result of excessive trading or “churning they may be able recover their losses in a FINRA arbitration claim.
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