How to Identify Churning in a Brokerage Account
Churning is an investment term that describes the excessive buying and selling of securities in a portfolio often for the purpose of generating commissions by registered representatives. While investors have the capability to buy and sell as they deem fit, registered representatives are forbidden from churning in client accounts even if they are making money.
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Instructions
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Review the account statement, looking for "Buys" and "Sells" of the same security. While it is not uncommon to get in and get out of a security quickly, repeated buys and sells of the same security suggest excessive trading of the item.
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Review tax returns specifically looking at capital gains and losses. Every time a stock or bond is sold, it generates a tax consequence: either a gain or a loss. When churning happens, there will be excessive capital gains and losses compared with the capital invested. These gains/loses are treated as short-term tax consequences (taxed at a higher rate).
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Listen to your broker carefully. When a stockbroker sells a stock, he is generally pitching the long-term value of the stock. If, after you buy the stock, he is recommending to sell it for a quick win, review what your objectives were in buying the stock to begin with. Repeated calls such as this suggest the broker is looking to generate sale tickets for commission.
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Mark your calendar as to when your broker calls. End-of-the-month stress can have brokers looking down the client list to see who they can make a quick sale to. This may involve a pitch to sell one asset to buy another, creating two tickets for the broker: a buy and a sell. If the asset sold is similar to the asset being bought in market capitalization, industry and overall strength, this may be a case of churning.
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Contact the brokerage house compliance office if you have any concerns about activities about your broker. They should review the account and can take disciplinary actions.
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Contact FINRA---the Financial Industry Regulatory Authority---if you have any questions or concerns about churning and the brokerage house has not been of use. They can conduct a full audit of the broker, his managed accounts and the brokerage firm. If churning appears to be occurring, disciplinary actions may be taken against the broker and possibly the brokerage firm. Monetary remuneration may be available.
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Tips & Warnings
Discretionary accounts are most susceptible to churning since a broker has complete control over the asset management.
