Danger! Unscrupulous GREED heading your way. Your financial adviser (aka. stockbroker) contacts you often and persuades you to buy-sell, buy-sell in your stock portfolio or retirement account; this form of repetitive and excessive trading activity is called Churning and is a direct violation of Federal and State Securities. The ultimate goal of churning is to generate commissions which goes directly into the pocket of your financial adviser/broker because in churning, the only winner here is your financial adviser.
The SEC (Securities and Exchange Commission) defines “churning” as “the excessive buying and selling of securities in your account by your broker, for the purpose of generating commissions and without regard to your investment objectives.” If your broker has been aggressively trading your account (or urging you to trade your account) directing a high volume of trades that make money for him but not for you, there is a good chance that he (or she) is guilty of churning the account.
FINRA (Financial Industry Regulatory Authority), the self-regulatory agency of the financial industry, has strict rules against churning, which is a violation of the broker’s duty to only make investment recommendations that are suitable for the client’s investment objectives. Churning often occurs at the end of a quarter, year, or sales promotion period, when brokers may have an incentive to run up commissions in order to reach a sales goal, to win a sales contest, or qualify for a higher percentage or bonus. Brokers who are contemplating a move to another firm also have a particular incentive to churn accounts, because their compensation at the new firm is typically based upon their previous production.
Many churning cases also involve unauthorized trading, because a broker is not legally permitted to make a trade on behalf of a client without prior approval as to the name of the security and the amount to be purchased—unless the broker has a power of attorney, which is rare. Often unscrupulous brokers will gain the confidence and trust of a client and then assume de facto control over the account without proper legal authorization, which is fraught with the possibility for excessive trading and other abuses.
According to investor’s rights attorney Craig T. Jones, “if the equity in an account is completely turned over more than once or twice a year, there is a good chance that the account is being excessively traded to generate commissions.” Jones, is a partner in the Atlanta law firm of Page Perry, LLC, which represents investors in securities industry arbitrations all over the country – many of which involve allegations of churning and other unsuitable trading. “There are court decisions,” says Jones, “that have held that there is a rebuttable presumption of churning if the annualized turnover rate in an account is greater than 6—for example, if the account was being traded so aggressively that it would turn over more than 6 times if that level or trading were maintained for a full year.” Many experts have concluded that a much lower turnover rate qualifies as churning. Link
Churning keeps a portfolio constantly in flux - always moving.
Beware of full service brokers from major firms (such as the Merrill Lynches, Morgan Stanley MSDW and Janney Montgomery Scott of the world), who generate 100% of their income by means of commissions. These are the fees that you and I (the unsuspected client) pay each time you make an investment transaction. The more trading that occurs in your portfolio, the more fees and commission it generates for your stockbroker. You might as well cut a hole in your Lee Jeans because you are bleeding money.
There is an inherent conflict of interest between the investor and his financial advisor. A built in incentive exists to over-trade a client’s account and often the temptation is too great for financial advisors to resist. The more trading that occurs in an account the greater the fees and commissions to the advisor. The advisor customer relationship is one of the few professional relationships where the interests between the parties are diametrically opposed.
Stockbrokers and financial advisors have a built in incentive to trade a client’s account because it will increase the compensation in the broker’s pocket at the direct expense of the investor. Brokerage firms have an incentive to look the other way because the trading creates compensation for the firm as well. Fortunately for investors, most state securities acts prohibit either excessive trading or churning. Link
The job of your financial adviser is to improve your LONG-TERM financial health by prudently investing your savings. Any adviser who constantly persuades you to buy and sell funds is breaking the first rule of investment: Never Lose Money. If you just started investing or have a small stock portfolio of less than 100K, a good financial adviser should be minimizing expenses such as sales commission and fund switching fees. These expenses are a LOSS to your portfolio (but a GAIN for your broker) whether the market is up or down. Basically, your adviser should setup your portfolio with a strong foundation at the very beginning and you should NOT be hearing from him or her to make changes for months (or even years).
In conclusion, financial advisers engaging in churning absolutely do NOT have your best interest. They suffer from an insidious disease = GREED. Your adviser can be your neighbor, your best friend, your future in-laws or even a family member, like your Sister - if there is a history of selfish Greed, be sure to be suspicious of their repeated recommendations to make trades within your account. If you follow his or her advice, you will lose your investment Pearl around your neck. The solution is to immediately move your account away from unscrupulous advisers and seek out accounting or legal advice.
Greed! Screw family or friendship, all these people see is money, money, money!