Beware of Brokers Who Churn

Over the past decade, the securities industry has moved from commission based stock brokerage accounts to “fee-based” accounts to curtail “churning” by stockbrokers of their customers’ accounts.

Regulators were concerned that brokers who were charging commissions for each trade had an incentive to churn the accounts. The hope was that fee based accounts (typically one percent) would put an end to churning. Churning occurs when brokers turn over their clients’ stocks and bonds continuously in order to generate commission dollars.

Another form of churning is when a broker switches clients from one mutual fund or annuity to another, generating further upfront or back-end commissions for himself without necessarily benefiting the client.

Despite these regulatory concerns, it seems that churning is still alive and well and that investors need to beware of brokers who are turning over their accounts primarily to generate large commissions for themselves and their firms.

The lesson for investors is to keep a close watch on the activity of trades in their brokerage accounts. Too many, or even too few, trades of stock, bonds, mutual funds and ETFSs – exchange-traded funds, could be eroding the value of a client’s account during a record-breaking Bull Market.

As the stock market continues to rise to record heights, most investors who simply held a stock index would have reaped large returns.

But some commission based stockbrokers, instead, assumed discretion over customers’ accounts, meaning they had the ability to trade in a client’s account without first asking the client, and churned their accounts to generate large commission revenues. The losses in those accounts were often disguised by the rising stock prices but the large commission amounts dramatically reduced investors’ returns.

Investors can see if their account is being churned when their account value is declining despite an upward moving market, or one that is declining faster than a downward moving market. That’s because unnecessary commissions will erode an account and cause the account to underperform relative to the market.

According to statistics kept by FINRA, the self-regulatory agency, securities arbitrations which involved “churning” and “unauthorized trading” constituted over 13% of all securities arbitration cases filed from 2012 to 2014.

This level of investor complaints involving damaging trading activity by brokers is a clear concern. A recent report by Jean Eaglesham of the Wall Street Journal did an extensive survey of stockbrokers who failed their Series 7 exams. The study found that stockbrokers who failed their exams at least three or more times were more likely to have engaged in “unauthorized trading, churning or excessive trading in customer accounts to generate commissions.”

FINRA does not require its brokers to show that information on its database of industry personnel, called BrokerCheck. Would you want to go to a doctor who had failed his medical boards several times?

Conversely, the Wall Street Journal recently reported that the Securities and Exchange Commission says the practice of so-called “reverse churning”–putting investors in accounts that pay a fixed fee but generate little or no activity to justify that fee–is on its radar. Regulators will be watching for signs of double-dipping by advisers who generate significant commissions within a client’s brokerage account, and then move that client into an advisory account and collect additional fees.

“Broker-dealers, experts say, should consider offering detailed training to representatives on how to approach such transfers with customers; documenting discussions with customers that include clear disclosure of the available options, their benefits and detriments; and surveillance reports that monitor for low-volume activity in fee-based accounts and high volume activity in commission-based accounts as well as similar reports that evaluate the purchase of high up-front load products followed by switches to fee-based accounts,” according to the Journal’s Daisy Maxey.

As investors review their monthly account statements, they need to be aware of the amount of commissions being charged and whether their accounts are being “churned” or “reverse churned” by their brokers. Keep a close eye on the trading activity and the dollar amount in fees and commissions that you are being charged. A careful eye on the expenses charged in your account is a simple step to take to ensure your hard-earned savings continue to work for you rather than your broker or his company.

Zamansky LLC are investment and stock fraud attorneys representing investors in federal and state litigation and arbitration against financial institutions.

About Jacob H. Zamansky 57 Articles

Jacob (”Jake”) H. Zamansky is one of the country’s foremost authorities on securities arbitration law, the legal recourse for investors claiming broker wrongdoing, or for brokers claiming wrongful termination or other misconduct by their employer. Zamansky & Associates, the New York-based law firm he founded, represents both individuals and institutions in complex securities, hedge fund, and employment arbitrations.

Mr. Zamansky was at the forefront of recent efforts to “clean up” Wall Street. In 2001, he successfully sued former Merrill Lynch analyst Henry Blodget on behalf of a New York pediatrician misled by Blodget’s stock research. The case’s successful resolution was the catalyst for New York Attorney General Elliot Spitzer to investigate the conflicts of interest on Wall Street and resulted in the well-reported $1.4 billion Global Settlement, which included many of the biggest names on Wall Street.

More recently, Mr. Zamansky is one of the leading litigators and opinion leaders of the subprime mortgage crisis and the related hedge fund collapses, representing both investors and mortgage borrowers who were defrauded by Wall Street firms and mortgage lenders. Among Mr. Zamansky’s early actions is filing the first arbitration case on behalf of institutional and high net worth investors against Bear Stearns Asset Management with regard to the two hedge funds which collapsed as a result of exposure to subprime mortgage backed securities. He also has filed claims on behalf of individual investors victimized by brokers that steered their portfolios into unsuitable subprime stocks and mortgage borrowers who were fraudulently coerced into inappropriate mortgage and investment transactions.

Earlier in his career, Mr. Zamansky worked for more than 30 years as a litigator, including positions at Skadden Arps, Slate, Meagher and Flom LLP. His tenure also included serving as a federal prosecutor with the Federal Trade Commission.

A native of Philadelphia, Mr. Zamansky has been a frequent expert commentator on CNBC, CNN, and FOX News and has published opinion pieces in The Wall Street Journal, Financial Times and USA Today. He is regularly quoted and his cases have been chronicled in major financial and news publications including The New York Times, USA Today, The Washington Post, BusinessWeek, Fortune and Forbes. He is a frequent lecturer for industry and legal groups around the country. He also writes a blog that can be viewed here.

Visit: Zamansky & Associates

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