Churning (Excessive Trading): Proving Broker Control and Excessive Activity

Understanding Churning in Brokerage Accounts

Churning is a particularly deceptive form of broker misconduct that occurs when a securities broker excessively trades in a client’s account primarily to generate commissions for themselves rather than to benefit the investor. This unethical practice directly violates FINRA rules and SEC regulations governing broker conduct, as it fundamentally breaches the broker’s fiduciary duty to place the client’s financial interests first.

At Patil Law, we specialize in identifying churning patterns and helping investors recover losses caused by this exploitative practice. Our extensive experience with churning cases has given us unparalleled insight into how brokers attempt to disguise excessive trading and how to effectively prove these violations in FINRA arbitration proceedings.

The Three Essential Elements of Churning Claims

To successfully pursue a churning claim, we must establish three critical elements:

1. Broker Control Over the Account

Control exists when the broker, rather than the client, makes the actual trading decisions. This can be established through:

• Formal discretionary authority: When a client has signed documents explicitly granting the broker decision-making power
• De facto control: When a client consistently follows the broker’s recommendations without independent research or decision-making
• Technical complexity: When investments are so complex that clients must rely entirely on broker expertise
• Client vulnerability: When factors such as age, health, or financial sophistication prevent meaningful participation in trading decisions

Our attorneys meticulously document evidence of broker control through:

• Communication records between broker and client
• Testimony regarding the decision-making process
• Account opening documents and trading authorizations
• Pattern analysis showing broker-initiated transactions

2. Excessive Trading Activity

Not every actively traded account involves churning. The key is proving that the trading volume was excessive relative to the client’s investment objectives and financial situation. We utilize several quantitative measures to demonstrate excessive trading:

• Turnover ratio: This fundamental metric measures how many times the entire account value is traded annually. Most experts consider annual turnover rates exceeding 6 to be presumptively excessive, while rates above 12 strongly indicate churning.
• Cost-to-equity ratio: Also known as the “break-even percentage,” this calculation reveals what percentage return the account must generate just to cover transaction costs. A cost-to-equity ratio exceeding 20% is typically considered excessive, as it creates an unrealistic hurdle for profitable investment.
• In-and-out trading: This pattern involves the rapid buying and selling of securities without apparent investment strategy, particularly when positions are held for very short periods.
• Commission-to-equity ratio: This measures commission charges as a percentage of the account’s equity, highlighting when fees become disproportionate to account size.

Our legal team works with financial experts to analyze account statements, trading records, and commission reports to calculate these metrics precisely and build compelling evidence of excessive trading.

3. Intent to Defraud or Reckless Disregard

The final element involves proving the broker’s state of mind—specifically that they acted either with intent to defraud or with reckless disregard for the client’s interests. We establish this by demonstrating:

• Trading patterns that served no legitimate investment purpose
• Dramatic divergence from the client’s stated investment objectives
• Commission structures that incentivized excessive trading
• History of similar conduct with other clients
• Violation of the firm’s internal policies on trading frequency
• Failure to adequately explain trading strategies or associated costs

Quantitative Metrics Used to Prove Churning

Our firm employs sophisticated analytical techniques to document churning activity:

Turnover Rate Calculation

The annual turnover rate is calculated by dividing the total dollar amount of purchases by the average monthly investment, then adjusting for the time period. For example:

• Total purchases over 12 months: $1,200,000
• Average monthly account value: $100,000
• Annual turnover rate: 12.0 (indicating the entire account was turned over 12 times in one year)

A turnover rate between 2 and 4 may be questionable depending on the investment strategy, while rates exceeding 6 typically indicate excessive trading, and rates above 12 strongly suggest churning.

Cost-to-Equity Ratio Analysis

This critical metric reveals the performance burden created by trading costs:

• Annual commissions and fees: $25,000
• Average account equity: $100,000
• Cost-to-equity ratio: 25%

This means the account must earn a 25% return just to break even after covering transaction costs—an extremely high hurdle that few investment strategies can overcome consistently.

Trading Frequency Assessment

We meticulously document:

• Number of trades executed per month
• Average holding periods for securities
• Percentage of portfolio value traded monthly
• Comparison to appropriate benchmarks for the stated investment strategy

Damages Recoverable in Churning Cases

Victims of churning may be entitled to several forms of compensation:

• Direct commission damages: Recovery of excessive commissions paid to the broker
• Transaction fee reimbursement: Recouping costs for unnecessary buy/sell transactions
• Market-adjusted losses: Compensation for underperformance compared to appropriate benchmarks
• Interest on lost capital: Recovery of time-value of money on funds inappropriately depleted
• In some cases, punitive damages: Additional penalties in particularly egregious situations

How Patil Law Builds Successful Churning Claims

Our approach to churning cases is comprehensive and detail-oriented:

1. Thorough account analysis: We conduct a complete review of all account statements, trade confirmations, and fee disclosures.
2. Expert testimony: We collaborate with financial experts who can calculate key metrics and testify to industry standards.
3. Communication evidence: We compile all broker-client communications to establish control and document any misrepresentations about trading strategies.
4. Comparative analysis: We demonstrate how the trading activity diverged from the client’s stated investment objectives and risk tolerance.
5. Regulatory precedent: We leverage relevant FINRA and SEC decisions that establish standards for churning violations.

Red Flags That May Indicate Churning in Your Account

Be vigilant for these warning signs of potential churning:

• Sudden increase in trading activity without corresponding changes in your financial situation or objectives
• Multiple trades in the same security within short time periods
• Consistent pattern of buying and selling without clear investment rationale
• Dramatic increase in commission costs or transaction fees
• Account statements showing high activity but minimal or negative returns
• Recommendations focused on investment products with high commission structures
• Limited or confusing explanations when questioning trading activity

Contact Our Churning and Excessive Trading Attorneys

If you suspect your broker has engaged in churning or excessive trading, contact Patil Law today.  Our experienced securities attorneys will provide a confidential consultation to evaluate your potential claim.

Don’t let unscrupulous brokers profit at your expense. Our team stands ready to help you recover your losses and hold accountable those who have violated your trust.