Account churning occurs when a financial advisor buys and sells investments, such as stocks in your account, to generate excessive commissions.
The act of churning is a breach of the advisor’s duty to recommend suitable investments and investment strategies and is considered to be fraud. You might be a victim of account churning if you find a supposed inactive account that is buying and selling at high volume.
Concerning annuities, we use the term “twisting.” Twisting involves the buying and selling of annuities to generate commissions.
Why Does Account Churning Hurt Me?
Churning violates the suitability standard and motivates a broker’s desire to generate sales commissions. Churning constitutes fraud under the federal securities laws and violates the conduct rules of securities regulators.
Courts have considered various metrics in evaluating churning, including the frequency of trading, the turnover ratio, the cost-equity ratio, and the commission-to-equity ratio.
“Turnover ratio” is the ratio between the total cost of purchases for an account divided by the account’s average net asset value during a specified period. There is no annual turnover rate that has a consensus as constituting churning.
Why and How do Brokers Do It?
The SEC presumes that a turnover ratio over 6 reflects excessive trading. However, the SEC also found much lower turnover levels can indicate excessive trading. A customer’s investment objectives are also critical factors in determining whether a particular turnover ratio supports a claim for churning or excessive trading.
The commission-to-equity ratio is dividing the total commission charges by the average equity in the customer’s account. The cost-equity ratio reflects the rate of return an account would have to earn on an annual basis to “break-even” after accounting for all costs and charges. The SEC has taken the position that a break-even cost ratio over 20% is indicative of excessive trading.
Despite the complicated formulas for determining account churning, investors often detect this illegal practice through common sense and intuition. For example, investors initially identify it because they begin receiving an excessive amount of trade confirmations in the mail.
Investors commonly call the financial adviser and ask why so many trades are occurring, and the financial adviser does not provide an adequate answer.
How to Tell if Your PFA is Churning Your Account?
Brokerage firms owe their customers a duty to supervise the activities of the financial advisers. Most firms have technology-based software programs that detect bad behavior like account churning.
When the firm’s supervisory systems detect churning in an account, supervisors at the brokerage firm first typically reach out the financial advisers for an explanation. As a result, if you suspect account churning, it may be a good idea to reach out to the compliance department or a supervisor at the brokerage firm and start asking questions.
Also, it may be a good idea to contact a securities arbitration attorney. Attorneys that practice in this field often will provide a free case evaluation and will tell you whether you likely have a problem related to churning. Furthermore, communications with attorneys are confidential, so you may be able to get valuable information about your situation without having the confront the financial adviser.
In recent years, twisting has become a more common problem because the number of retirees and annuity sales has risen. As explained above, twisting is the practice of replacing life insurance or annuities to generate a new commission to the salesperson. When investors get annuity products, the insurance company issuer often pays a high commission to the salesperson upfront.
How Do I Get My Money Back?
In order recoup that upfront sales commission, annuity purchasers are required under the annuity contract to hold the product for 10+ years. If the annuity liquidates during that initial period, investors are required to pay a surrender charge. Typically, the surrender charge penalty extends over 10-12 years, and the penalty amount declines over that period.
Unscrupulous sales agents will convince investors to liquidate their existing annuity to purchase a new one, which exposes the investor to a new surrender charge penalty period. Not surprisingly, the salesperson also receives a new commission.
Brokerage firms are required to have supervisory systems in place to detect unsuitable annuity replacements. Brokers must justify why the new annuity is necessary. If your financial adviser has recommended that you sell an existing annuity for a new one, beware and you may very well be a victim of twisting.
A Securities Arbitration Attorney can Help you
If you suspect account churning is happening to you, you should consult with experienced counsel. The Doss Firm attorneys have substantial experience in representing investors in a wide variety of matters, including churning. Call us for a free consultation.