Investment brokers can help their clients generate wealth in many ways, and they can be well-compensated for that service. Many are paid through commissions on the transactions they make for their clients.
Unfortunately, some unscrupulous brokers abuse this process through excessive trading of investments in their clients’ portfolios, to maximize their own profit at the expense of their clients. This unethical process is known as churning, and it is illegal under federal law.
Where’s the harm?
If your broker is making a lot of trades, and those trades add value to your account, you may not see the problem at first. However, excessive trading can sometimes mean that more is coming out of your account in the form of commissions than is coming into the account in terms of value. Some trades can also increase your tax liability, costing you more money than the trades were worth.
This kind of trading is unethical because a broker has a fiduciary duty to their clients. This means they must act with care and confidentiality in the best interests of their client.
Industry groups such as the Financial Industry Regulatory Agency, the NYSE and the National Association of Securities Dealers police some breaches of ethics by themselves, but, depending on the circumstances, the federal SEC may also enforce laws against a broker accused of churning.
It is not easy to prove that a broker was intentionally churning your account. If you want to make a claim against your broker on the basis of churning, you must prove:
- The broker controlled your account
- Trading that was excessive when compared to your investment goals
- The broker intended to defraud you, or showed a reckless disregard for your interest
Proving the first factor may be relatively easy, but the other two present difficulties.
The difference between an appropriate trade and an excessive one may be a subjective matter in some cases. Investors who are making a claim against their brokers often rely on expert witnesses from within the financial industry. These individuals can tell the court whether they think the broker’s actions were justifiable under industry standards.
Proving intent can be especially difficult. It’s hard to know what another person was thinking.
Attorneys with experience in the financial industry can help an investor understand their options and how the law may apply to the specific facts of their case.