I touched on how both the federal and Missouri State security laws work in a post entitled Missouri Securities Fraud. In that post, I pointed out that brokers and investment advisers with authority to trade securities are fiduciaries to their clients. As such, many of the securities laws apply directly to them.
One of the more common complaints I have personally heard — and which is indeed securities fraud — is excessive trading within an account by a broker. At first glance, this doesn’t seem like it would be a problem; however, when you consider that many of the commissions earned by brokers arise out of their trading, then it can be problematic. This specific type of securities fraud is aptly called churning.
To prove churning, there has to be (1) excessive trading of securities (2) bought or sold to generate commissions (3) without the customer’s interests in mind after the customer(s) (4) relied on the broker/adviser for advice. This can be extremely difficult to prove. The excessive trading element has to be analyzed contextually because some customers’ portfolio’s necessitate and allow for more trading (e.g., options trading), while others do not. Further, as with all securities laws, a special state of mind needs to be shown; namely: that the churning was done to generate commissions, rather than serve the customers’ best interest. Lastly, the relationship between the customer and broker needs to be closely scrutinized to determine whether there has been reliance by the customer on the broker.
Churning is one of the devices, schemes or artifices that both the Securities Exchange Commission and Missouri Securities Act outlaw. It is also a breach of fiduciary duty by the broker.