Churning is a serious crime. In many instances, churning refers to a broker-dealer representative’s overtrading the client’s account. Although many errors can occur in financial trading, including trade execution, unfilled or improperly filled orders, or commission mistakes, the client’s portfolio turnover ratio and overtrading of the account can ultimately result in serious capital losses and/or higher taxes on short-term trading gains.
Unnecessary and excessive portfolio activity is both unethical and illegal. The financial services firm may tell the client about the trades or execute them on an unsolicited basis. Typically, churning the client’s portfolio is performed to generate higher commissions for the broker. Continue reading this post to learn more about churning crimes.
How Series 7 Licensed and Registered Representatives Are Paid
Some broker representatives are paid on a percentage of commissions. Most don’t receive a salary. It’s always important to ask the broker rep about how Series 7 licensed and registered representatives at the employer are paid:
• In some instances, it may be challenging to identify commissions paid. Some financial products are traded net of commissions.
• Clients should specifically ask the broker rep, “If I decide to enter into the recommended transaction, what’s the markup on the stock [bond, mutual fund, exchange traded fund, etc.]?”
• Always ask the rep about the commission or fee associated with the transaction. Be wary of “trading opportunities” offered by phone. The broker firm may have acquired a large amount of the security being offered and encourage sales reps to market the idea to customers at higher than normal commission rates.
Initial public offerings (IPOs) are always offered by a prospectus. If the registered rep presents a new stock and says “the deal is commission-free,” it’s always important to read the prospectus. The broker rep will get paid by the Syndicate after the client pays for shares. After the shares or other financial product trades in the open market, the rep is paid a commission to sell.
Financial Representatives and Churning
Financial firms must monitor sales personnel. If the registered rep isn’t a Certified Financial Planner (CFP) but his or her card says “Financial Advisor,” it’s important to understand that the rep is dually responsible to protect his or her client’s capital and get paid for providing sound financial advice:
• Clients in search of a new broker-dealer firm should provide clear, concise instructions about their financial goals.
• If the client is risk-averse, it’s important to tell the intake representative this fact. Before signing new account agreement forms, review the financial goals associated with the account.
• A client with conservative financial goals isn’t a candidate for “trading opportunities” and shouldn’t be encouraged to make risky transactions.
If the client has a large portfolio and needs to transacts high volume trades on a regular basis, it’s a good idea to ask the broker-dealer for a discount. Lower commissions on trades may deter a broker or sales trader’s incentive to churn the account.
Other financial and professional services providers can be guilty of churning, too.
Insurance Agents, Twisting and Churning
Insurance agents are frequently paid on transactions and earn compensation based on fees and commissions. When an insurance agent urges his or her client to swap one policy for another—and the client doesn’t book a higher rate of return or book significantly lower premiums and other benefits—the agent may be “twisting” or churning the client’s assets.
Although the policyholder may obtain a bigger death benefit by swapping insurance policies, the act of churning frequently uses some of the policy cash value in the original policy. Losing some or all of the policy’s cash value causes financial harm to the client. In contrast, the agent is paid a commission by the insurer to write “new” business.
Other ethically inappropriate practices, such as offering the client a portion of the agent’s commission to switch policies, may occur with the agent’s pitch. Such an offer is an obvious warning sign. Don’t transact business with this agent.
Clients should proceed with caution with an insurance agent encourages switching out of an existing cash value policy. In some cases, it’s best to consider the purchase of a new policy that adds to the total amount of insurance instead of replacing the existing policy with a substantially identical one.
Lawyers and Churning
Professional service firms such as law firms and public accounting firms often have revenue goals:
• Over-billing at law firms is another form of churning clients’ accounts.
• If the client has a retained relationship with the law firm, it’s important to read monthly statements with extra care to make sure that the hours billed match with services rendered.
• Some of the world’s most preeminent firms have been legally charged with over-billing their clients. However, it’s important to realize that law firms large and small can and do over-bill their clients.
• Public accounting firms at work on a large project can and do augment staff from external sources to accomplish the job. Clients must monitor costs and ask questions to ensure accurate billing for services.
Any client with a financial account, legal representation, or accounting project can suffer from churning. It’s important to ask the provider questions about transaction costs. It’s also important to understand the offer proposed by the representative when a security or insurance product is proposed:
• Ask for a written recap of the representative’s verbal proposal. For instance, if the rep says the client pays nothing to acquire a financial asset, ask how he or she is paid to offer it.
• Check out the securities sales representative at Finra’s BrokerCheck site. If the representative has previously lodged customer complaints against him or her, consider taking your business elsewhere.
• Contact the sales representative’s manager to discuss or file a customer complaint if churning has already occurred at an insurance agency or law firm.
• Contact the state commission of insurance and banking to register a customer complaint against an insurance agent.
Registering a complaint against the offending sales representative, attorney, or CPA is an effective first step. A customer complaint may mean job loss, and a damaged record at Finra or the state insurance board can make it difficult to get a new job. The employer firm and the agent may be responsible for return of capital, fines, fees, and lost interest.
Contact an Experienced Attorney
Hiring an experienced lawyer may be necessary to recover funds lost from churning. Contact us at 1-888-533-5270 for a risk-free consultation now.