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 that 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 (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 anywhere from ten business days 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. Reverse Churning

    Reverse churning is the practice of a financial advisor placing ...
  2. Commission Broker

    A commission broker is an employee of a brokerage company who ...
  3. Broker

    1. An individual or firm that charges a fee or commission for ...
  4. Rules of Fair Practice

    The Rules of Fair Practice is a code of conduct for U.S. broker-dealers ...
  5. Discretionary Account

    A discretionary account is an investment account that allows ...
  6. Two Dollar Broker

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

    Deal Effectively With Difficult Clients

    Learn how to tame the most shrewish clients with these simple methods.
  3. Investing

    Frontier Q3: Watch for Cost Cuts, Churn, ARPU (FTR)

    Frontier Communications reports third quarter results Tuesday and investors will want to know about Verizon wireline asset integration.
  4. 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.
  5. 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.
  6. Personal Finance

    Research Report Red Flags For Brokers

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

    8 Investing Fees That You Should Never Pay

    In investment management and financial planning there are a plethora of fees that are unnecessary.
  8. 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.
  9. Investing

    Consider These Fees When Evaluating Mutual Funds

    The best way to evaluate a mutual fund is by digging a bit deeper into the fees charged.
  10. Investing

    How to sell mutual funds to your clients

    Learn about the top talking points to cover when discussing mutual funds with clients – and how explaining their benefits can help you close the sale.
RELATED FAQS
  1. What does churning mean?

    A. Trading with yourself, or with someone else in attempt to make the tape appear more active than it really is.B. Trading ... Read Answer >>
Trading Center