Churning is Basically Hard-to-Detect Outright Theft
Churning is a particularly vicious and invidious type of fraud. It differs little from outright theft, except that churning is harder to detect. It is a direct violation of the duty owed by a broker to his customer to exercise good faith in his dealings with his client and to make recommendations based solely on the customer’s goals and objectives. It is one of the more injurious types of fraud possible.
Here’s How Churning Works:
Excessive trading, often referred to as “churning,” involves a broker or advisor trading securities in the account in an excessive manner for the purpose of generating additional commissions and fees. In this type of case, the broker places his own interests ahead of those of his customer. When brokers buy and sell securities in an account to generate commissions, they often convince their clients to take profits. While these reasons seem valid, these are often excuses for the broker or advisor to charge excess commissions. While churning often occurs by trading in and out of stocks, excessive trading can also occur by short-term activity in bonds, mutual funds, or annuities. Churning may often result in substantial losses in the client’s account, and even if profitable, may generate a tax liability for the client.
Detect Churning by Looking at the Pattern of Trading in Your Account
To establish that your broker or advisor has churned your account, the account activity will reflect a pattern of trading in your account that was excessive. This is demonstrated by calculations to determine the annualized rate of return that would be necessary to cover the commissions charged in your account; the number of times the equity in your account was turned over to purchase securities; and the purchase and sale trading activity that occurs in your account.