Churning is excessive trading on a client account by a broker to generate commissions, which is illegal and unethical. It is considered unauthorized trading and subject to fines and imprisonment. Brokers violating the rules may be temporarily barred from trading. It’s important to contact the broker if you notice suspicious activity and transfer the account if necessary.
Churning is a slang term defined as excessive trading on a client account by a broker. The purpose of the business is not to benefit the investor, but to generate additional commissions for the broker. Also referred to as twisting, the practice of churning is considered highly unethical and is illegal in many markets.
Abuse of a customer’s account is expressly illegal in the United States. The Securities and Exchange Commission understands churning as a form of unauthorized trading in a discretionary account. For this reason, the practice is subject to fines, up to and including imprisonment. However, abandonment is not always easy to prove, as the activity could simply be a series of bad decisions by the broker, with no intent to defraud the investor.
Along with the SEC, churning is also a violation of NASD rules as they pertain to the trading process. Brokers who appear to be breaking the rules may find themselves temporarily barred from trading. During this period, an investigation will be launched to determine whether recent transactions on a customer account have actually been conducted with no regard for the customer’s financial well-being. In the event that the broker is found to have executed your orders in good faith, your trading privileges are reinstated.
There are circumstances that lend themselves more easily to churning potential. When the broker is granted broad powers to act on behalf of a client, such as with authorized access to a discretionary account, it is possible for the broker to conduct transactions involving similar securities rapidly. This flurry of buying and selling with no apparent gains to the investor could indicate overtrading activity.
However, it’s also possible that a quick succession of trades isn’t actually a churning business. In case an investor notices this type of activity on their brokerage account, it is definitely a good idea to contact the broker and ask about the series of trades. If the broker is unable to articulate the reasoning behind the trades to the investor’s satisfaction, then it is definitely time to transfer the account to another brokerage firm.
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