KKBS Settles another “Churning” Claim
The firm announces a settlement of another FINRA arbitration claim involving broker misconduct referred to as “churning.” The firm recently filed a case against a Los Angeles-based stock brokerage firm and its registered representative, alleging that they engaged in fraud by buying and selling securities, mostly common stock, in their customer’s account for the purpose of generating substantial commissions.
“Churning” typically occurs in a “commission-based-account” where the broker is entitled to a commission for each buy or sell transaction he or she completes in the account. Some unscrupulous brokers see this as an opportunity to make lots of money from the account, when the customer believes that they are trading in the account in order to achieve their investment objectives. Brokers can come up with many excuses for trading heavily in their customers’ accounts (i.e. market conditions, loss avoidance, taking advantage of opportunities, etc). But with the trend over the past decade or so to flat fee accounts, where the broker charges a percentage of assets under management regardless of the number of transactions, churning cases have fallen off. But the churning cases that remain tend to be quite strong. Indeed, a broker can no longer so easily explain heavy trading in an account when the follow up questions would be: “If you planned to trade the account, why didn’t you recommend a flat fee account to your client?” That would avoid the hefty commissions the broker charged his customer.
FINRA arbitrators typically will find churning in an account if the so-called annual account equity “turnover ratio” is in the range of 4 and 6 times. In other words, if the total purchases (not sales) divided by the average account balance is between 4 and 6 times, that is a good indicator of churning. This is a rule of thumb and the required ratio may vary with the facts of the case.
Another problem arises with flat fee accounts, though. It is called “neglect.” Think about it. If a broker, who tends to be quite busy finding new clients, makes the same flat fee (give or take) by doing nothing in your account, there is less incentive for him or her to spend time actually managing your investments. In such cases, brokers may be guilty of neglecting your account. Neglect can often times be worse than “churning.”
Vincent D. Slavens, handles FINRA arbitration claims for the firm. He can be reached at (619) 232-0331; firstname.lastname@example.org