Loading the player...

What is 'Churning'

Churning is a term applied to the practice of a broker conducting excessive trading in a client's account mainly to generate commissions. Churning is an unethical and illegal practice that violates SEC rules (15c1-7) and securities laws. While there is no quantitative measure for churning, frequent buying and selling of securities which does little to meet the client's investment objectives may be evidence of churning.

BREAKING DOWN 'Churning'

Churning may often result in substantial losses in the client's account, or if profitable, may generate a tax liability. Since churning can only occur when the broker has discretionary authority over the client's account, a client may avoid this risk by maintaining full control. Another way to prevent the chances of churning or of paying excessive commission fees is to use a fee-based account. However, placing a customer in a fee-based account when there is little to no activity to justify the fee is indicative of another form of churning called reverse churning.

Types of Churning

The most basic churning comes from excessive trading by a broker to generate commissions. Brokers must justify commissionable trades and how they benefit the client. When there are excessive commissions with no noticeable portfolio gains, churning might have occurred.

Churning also applies in the excessive or unnecessary trading of mutual funds and annuities. Mutual funds with an upfront load called A-shares are long-term investments. Selling an A-share fund within five years and purchasing another A-share fund must be substantiated with a prudent investment decision. Most mutual fund companies allow investors to switch into any fund within a fund family without incurring an upfront fee. A broker recommending an investment change should first consider funds within the fund family.

Deferred annuities are retirement savings accounts that usually do not have an upfront fee like mutual funds. Instead, annuities typically have contingent deferred surrender charges. Surrender charge schedules vary and can range from 1 to 10 years. To prevent churning many states have implemented exchange and replacement rules. These rules allow an investor to compare the new contract and highlight surrender penalties or fees.

Sanctions for Churning

Churning is a severe offense and, if proven, can lead to employment termination, barring from the industry, and legal ramifications. Also, the Financial Industry Regulatory Authority (FINRA) may impose fines ranging from $5,000 to $110,000 per instance. FINRA also has the right to suspend the broker for between ten business days to up to one-year. In more egregious cases, FINRA can suspend the violator for up to two years or even bar the broker indefinitely.

RELATED TERMS
  1. Two Dollar Broker

    A two dollar broker is a floor broker who executes orders for ...
  2. Broker

    1. An individual or firm that charges a fee or commission for ...
  3. Commission

    A commission is a service charge assessed by a broker or investment ...
  4. Each Way

    A slang phrase used when a broker earns commissions from both ...
  5. Overtrading

    Overtrading refers to excessive buying and selling of stocks ...
  6. Full Trading Authorization

    A level of trading authorization that grants an agent or broker the ...
Related Articles
  1. Investing

    4 Dishonest Broker Tactics and How to Avoid Them

    Protecting yourself from dishonest broker practices means knowing how to spot them.
  2. Financial Advisor

    Broker Commissions Are Here To Stay

    With two developed nations adopting a firm anti-commission stance, questions have arisen over whether or not the United States should follow suit. Find out why such a development is unlikely.
  3. Financial Advisor

    4 Signs Your Financial Advisor Is Ripping You Off

    Pay attention to the habits of your financial adviser to avoid him ripping you off by commingling, churning, scamming or embezzling your money.
  4. Financial Advisor

    Is Fee-based or commission-based investment advisor better?

    Out of the many types of advisors, understand the difference between fee-based and commission-based Investment advisor. Find out which type fit best with your style of investment.
  5. Investing

    Picking your first broker

    If you're a rookie investor, choosing a broker may be your first big investment decision. Learn more on whether you should you go with a full-service broker or a discount broker.
  6. Investing

    Brokerage Accounts, Explained

    Brokerages bring together customers or institutions and world financial markets. Here's everything to know about how they operate and what they do.
  7. Financial Advisor

    How to Avoid Advisors Who've Been Disciplined

    It's not hard to find out if a potential financial planner has a shady past. Here's why it's so important to check an advisor's credentials and history.
  8. Personal Finance

    Research Report Red Flags For Brokers

    Discover how to look past analysts' ratings to find winning stocks for your clients.
  9. Investing

    8 Investing Fees That You Should Never Pay

    In investment management and financial planning there are a plethora of fees that are unnecessary.
  10. Investing

    Full-Service Brokerage or DIY?

    Determine what you are getting for your fees and commissions and whether to use a broker or do it yourself.
RELATED FAQS
  1. What Is Financial Double Dipping?

    Double-dipping occurs when a broker gets paid twice for the same transaction. Read Answer >>
Hot Definitions
  1. Gross Margin

    A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. ...
  2. Inflation

    Inflation is the rate at which prices for goods and services is rising and the worth of currency is dropping.
  3. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  4. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  5. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  6. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
Trading Center