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Churning, also known as excessive trading, is defined as overtrading by a registered representative or broker in a customer’s account for the purpose of generating commissions and without regard to the customer’s investment objectives. Churning is both illegal and unethical. Brokers and advisers have an obligation not to trade customer’s accounts excessively for the purpose of generating commissions or other fees for the broker or the investment firm. Allegations of churning can be found to violate various federal securities laws and other rules established by self-regulatory organizations (“SROs”), like the Financial Industry Regulatory Authority, Inc. (“FINRA”).

Recently, Lax & Neville LLP won a $900,000 FINRA Arbitration, which include compensatory damages, punitive damages, interest and costs against John Thomas Financial, Anastasios Belesis, George Belesis and Joseph Castellano for churning and failure to supervise after a hearing in New Orleans, Louisiana.

To establish a case for churning, the customer must establish that the broker: (i) exercised control over the account; (ii) the trading was excessive in light of the customer or investor’s investment objectives; and (iii) the broker acted with intent to defraud or with reckless disregard for the customer’s best interest.

First, a customer must establish that the broker exercised control over the account. If a broker has discretion over the account pursuant to a written agreement, the investor grants the broker discretion to make trades without obtaining authorization from the investor prior to placing a trade. In non-discretionary accounts, a broker may have implied or “de facto” control of the account. Implied or de facto control may be established if the client is not financially sophisticated and instead follows most of the broker’s recommendations.

Second, the customer must establish that the broker’s trading in the account was excessive. While there is no set test that help determine whether trading in a customer’s account was “excessive,” two commonly used indicators to determine whether excessive trading has transpired are the cost-to-equity ratio and the annualized turnover ratio. The cost-to-equity ratio examines the return on investment a broker will have to earn to “break even,” or cover firm expenses, broker fees, and any margin interest. The annualized turnover ratio examines the value of the securities purchased in the account over one year against the average equity of the account. In the past some, courts have found that in retail securities accounts for conservative investors, an annualized turnover rate of 2 is suggestive of churning, or 4 is presumptive of churning and of 6 or more is conclusive of excessive trading.

Finally, a customer must establish that the broker acted with intent to defraud or with reckless disregard for the customer’s best interest. Since churning claims are typically based on federal and/or state securities act violations, the intent to defraud element may differ between claims. For example, a claim based upon § 10(b) of the Securities Exchange of Act of 1934 requires that the customer establish the broker acted with scienter, or intent to defraud, by showing that the broker acted recklessly. Some states securities acts, however are based on § 12(2) of the Securities Act of 1933 which only requires that the broker act negligently or with reckless disregard.

Where churning or excessive trading is suspected, Lax & Neville LLP works with financial experts to review the customer’s account to determine whether churning transpired.

Our attorneys at Lax & Neville LLP have extensive experience in representing customers with churning claims and can formulate a strategy to potentially recover your losses from damages. Contact Lax & Neville today and schedule a consultation.

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