Recognizing the Warning Signs of Churning

In the securities industry, churning occurs when an advisor excessively trades in a client’s account for the purpose of earning commissions. The practice is illegal in the United States under SEC rules. While the practice may benefit the advisor, it could also result in significant account losses and/or excessive tax liabilities for the client. If you recognize the warning signs of churning, talk to an accountant, regulator, and/or an attorney to understand your rights.

Common Warning Signs of Churning

Any investor who gives complete account control to an adviser or pays an advisor commissions may face an increased risk for illegal churning practices. Look for these common warning signs of churning to signal the need for further investigation:

• Unauthorized trading. As the account holder, you reserve the right to know about and make the final decision regarding all transactions. If you notice any unauthorized transactions or see transactions that do not make sense based on your investment profile, look into the advisor’s account actions.
• High turnover rates. The simplest form of churning occurs when advisors buy and sell products quickly to obtain commissions on the trade. Some may even buy and sell the same product over and over. An advisor should readily justify the reason for buying and selling within a larger investment strategy if a client asks. For low risk, long term investment strategies, an investor should not receive transaction confirmations once a week or more frequently.
• Specialty product recommendations and investments. Mutual funds, annuities, and other specialized financial products often cost more upfront. While advisors may earn a commission on each specialty product transaction, an investor may not receive most benefit in the switch. If you receive notification forms about specialty product changes or your advisor highly recommends changing specialty products shortly after a purchase, consider investigating the practice.
• Unexpected fees and tax liabilities. If you see an upward trend in fees in an account or part of your portfolio or face unreasonable tax liabilities associated with your investments, your advisor may have mismanaged the account and engaged in illegal churning. Another sign of excessive fees may include noticing your account value decline as the market enjoys growth.

If you notice any unexpected or unauthorized activities in account documentation, confront your advisor or ask for a second opinion. Often, investors who rely on their advisors fail to notice the warning signs of churning until they’ve already experienced significant losses.

Protecting Your Investment Accounts from Churning

Investors can take certain steps to protect their accounts and portfolio from churning practices. Do not give your advisor unchecked control of your accounts. When investors fail to take an interest in account performance, the temptation of churning may increase. If possible, search for advisor fee arrangements that do not involve commissions. Non-commission fee arrangements eliminate the incentive to engage in churning activities.

Talk to your advisor routinely, ask questions, and talk to the firm’s compliance department if you feel uncertain about your advisor’s explanations. Protect your investments with proactive account management.

What to Do if You Notice the Signs of Churning

If you recognize any of the warning signs and do not receive a complete and valid explanation from the advisory firm, report the incident to the SEC. If you experienced serious losses, you may also want to reach out to an attorney who specializes in securities fraud and misconduct.

Investors who can prove an advisor made controlling decisions about account investments, excessively or improperly traded investments, and that the advisor did so on purpose, may file a legal claim to recoup losses. If an SEC or FINRA investigation yields evidence of churning, an advisor may face additional sanctions and reputation damage. You have the right to hold any advisor accountable for illegal churning and fraudulent advisory practices.