What Is Churning?
Let me start by defining churning for you—it's the illegal and unethical practice where a broker excessively trades assets in your account just to rack up commissions. There's no exact number that defines it, but if you're seeing frequent buys and sells that don't align with your investment goals, that could be a red flag for churning.
Understanding Churning
You need to understand that churning can lead to big losses in your portfolio, even if some trades turn a profit, because it often creates unnecessary tax burdens. Brokers might overtrade to boost their earnings, sometimes pushing new securities from their firm's underwriting to hit bonuses, which isn't in your best interest. Spotting it isn't easy, but if trades are happening so often that commissions eat into your returns without clear benefits, churning might be at play.
Types of Churning
At its core, churning is about excessive trading to generate commissions, but it extends to things like mutual funds and annuities where upfront loads or surrender charges make frequent switches costly and unnecessary. Then there's reverse churning in flat-fee accounts, where the broker does almost no trading but still takes a cut of your assets annually. I've seen this in credit card churning too, where people open and close cards for rewards, though issuers crack down on it now. In insurance, it's agents pushing policy switches for commissions, which is illegal in many states.
How to Prevent Churning
To stop churning before it starts, keep discretionary authority out of your broker's hands—insist on approving every trade yourself. Switch to a fee-based wrap account, where you pay a flat percentage like 1% to 3% of assets, removing the incentive for overtrading. But watch for reverse churning there; if nothing's happening, that fee might not be worth it. Stay active: review every transaction notice and monthly statement, and know exactly what commissions you're paying.
How to Prove Churning
Proving churning takes vigilance on your part—monitor your account closely and question frequent trades, especially in long-term holdings like mutual funds or annuities. If notifications are coming daily or weekly and commissions are high without portfolio growth, that's evidence. Discuss buys and sells with your broker upfront if you want, but always review statements. If you suspect it, report to the SEC or FINRA with your records.
Sanctions for Churning
Churning violates SEC Rule 15c1-7, FINRA rule 2111, and NYSE Rule 408(c), so if proven, brokers face serious consequences like job loss, industry bans, fines from $5,000 to $116,000, or suspensions from one month to indefinitely. The SEC and FINRA investigate complaints where brokers prioritize their commissions over your interests, and you can file directly with them to trigger action.
Churning FAQs
You might wonder about credit card churning—it's opening multiple cards for rewards then closing them, but issuers limit it now. Reverse churning is when flat-fee brokers do minimal work for their cut, so choose your account type wisely: commission-based risks overtrading, while flat-fee risks inactivity. In insurance, churning means agents pushing unnecessary switches for commissions, banned in most states. Always clarify your expectations with your broker upfront to avoid these issues.
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