Wise use of your money may include placing it in investment accounts in the hope of generating a strong return over time. However, if you are like most in New York, you are more than likely a “hands off” investor that leaves the management of your portfolio to a professional. There is wisdom in this; after all, the industry specific knowledge and experience a broker brings makes him or her more likely to develop a sound investment strategy. However, relying solely on him or her may open the door for fraud. One form of such fraud is known as “churning.”
What exactly is churning? Your broker makes commissions when he or she uses your money to execute sales and trades. Thus, he or she is incentivized to do so. Churning occurs when he or she engages in excessive trading to generate increased commissions. According to the Securities and Exchange Commission, a broker that has discretionary power over your investment accounts and effects transactions that are excessive “in view of the financial resources and character” of your account is guilty of fraud.
What does this all mean? To prove churning, you must identify the following three elements:
- Control
- Excessive trading
- Intent
“Discretionary power” means that the authority to effect trades with your accounts rests in the hands of your broker (he or she cannot be liable for transactions he or she does not control). Excessive trading in view of your account’s resources and character speaks to the design of your accounts. For example, if you have chosen a conservative investment pathway, one would not expect to see your portfolio produce a high turnover ratio. If and when it does, that may serve as evidence that your broker is trading excessively with the intent of generating commissions.