Churning and Excessive Trading: The Customer Pays for Every Turn

Churning and excessive trading generate commissions and fees through a volume of broker-recommended trades that puts the broker’s interests ahead of the customer’s. The customer bears the cost of the activity while the firm and representative earn money from it. If you work in brokerage operations, sales or supervision, you may know how the trading compared with the customer’s objectives, what it paid the representative and why it continued after an account review.

This page follows the trading pattern, its cost and the firm’s response when the activity appeared in its own reports. Our page on Regulation Best Interest cases covers the broader comparison between a recommendation, the customer’s needs and the product’s risks.

How Do You Measure Excessive Trading?

Turnover, cost-to-equity and in-and-out trading show different parts of an excessive-trading pattern. The Securities and Exchange Commission’s order concerning Salomon Whitney LLC, known as SW Financial, explains the ratios and describes the repeated purchases and sales behind them. The order identifies a cost-to-equity ratio of 20% or higher and annual turnover of six as measures that have been regarded as indicative of excessive trading.

Annual turnover compares the total value of annual purchases with the account’s average monthly balance. It shows how much buying occurred relative to the money in the account.

Cost-to-equity is the return the account needs just to break even after trading costs, including commissions and other fees. It makes the cost of the strategy visible as a hurdle the customer’s investments must clear.

In-and-out trading describes rapid purchases, sales and repurchases. In the SW Financial order, the agency alleged that representatives repeatedly bought a stock, sold it and bought it again within the same week, sometimes on the same or consecutive days.

What Do Customer Objectives and Account Records Show?

Customer objectives and account records show whether the recommended trading served the person paying for it. The customer profile, confirmations and account statements can be compared with compensation records and supervisory exceptions. We connect that evidence across the firm’s records to the actual recommendations and the costs they generated.

The Securities and Exchange Commission’s Regulation Best Interest rule makes the retail recommendation central to the review. As the SW Financial order explains, a series must serve the customer’s interests when taken together, even when an individual transaction looks appropriate in isolation. Reviewing each purchase separately can miss what repeated purchases cost the account.

In the SW Financial action, the agency alleged that a speculation objective in a customer profile did not relieve the firm of its duty of care. Neither did the customer’s acknowledgment of letters about active trading. A customer could want an active strategy, but the firm still needed a reasonable basis to believe its recommendations served that customer.

What Did the SEC Allege in the SW Financial Accounts?

In its September 28, 2023 settled order, the Securities and Exchange Commission alleged that SW Financial recommended a short-term, high-volume strategy without a reasonable basis. Five representatives recommended and executed more than 2,000 trades for at least 16 retail customers during the period from August 2018 through June 2022. The agency said the representatives disregarded the costs their recommendations imposed.

According to the order, cost-to-equity exceeded 100% for many affected accounts, meaning the investments needed returns above that level just to cover commissions and fees. Annual turnover exceeded 60 in several accounts. The Securities and Exchange Commission alleged that the firm and representatives knowingly or recklessly disregarded a trading pattern with virtually no chance of producing a profit for those customers.

The alleged results put the incentives in view: customer losses exceeded $1 million, while the firm and representatives received more than $660,000 in commissions and fees from the trading. The commissions had a much easier hurdle.

The order required SW Financial to return $216,896 in profits. We see a firm ordered to give back far less than its customers lost.

Why Did Active-Trade Letters Fail to Stop the Trading?

SW Financial’s active-trade letters came after the excessive trading and were optional under the firm’s procedures, according to the Securities and Exchange Commission’s settled order. The agency alleged that the firm’s written supervisory procedures repeated the care obligation and provided for periodic review of active-account reports. Beyond those measures, the substantive response to excessive trading was a letter telling the customer the account had been actively traded. The order explained the failure:

The agency said the firm sent more than 260 active-account letters during the period covered by Regulation Best Interest, including letters to customers of the representatives described in the order. The letters kept coming. So did the same short-term, high-volume recommendations.

We examine what the review identified, what the written procedure called for and what happened to the recommendations afterward. An insider may know why an account stayed active after the firm had already recognized the pattern.

Is Churning Illegal?

The Securities and Exchange Commission can pursue excessive trading as securities fraud, as it did against SW Financial. The settled order alleged securities fraud alongside failures under Regulation Best Interest. It connected the fraud allegations to recommendations that knowingly or recklessly disregarded the high costs and the customers’ prospects of earning a profit. The agency addressed both the care used in making recommendations and the firm’s procedures for achieving compliance. For an insider, those are connected questions: why the representatives recommended the trading, and why the firm’s review allowed that strategy to continue.

What Can a Brokerage Insider Show?

A brokerage insider can connect the account activity to the recommendations, compensation and supervisory decisions behind it. The customer-facing statement is one part of that story. The firm’s internal records can explain why the activity occurred and what the business did when it appeared in an account review.

• The customer and the recommendation: the investment profile and objectives alongside the reason for the trading strategy.
• The trades and their cost: transaction history, confirmations, account balances and fees, showing the sequence and the cost of repeated buying and selling.
• The compensation: records connecting the customer’s trading costs to what the firm and representative earned.
• The review and response: active-account reports, supervisory exceptions, written procedures, customer letters and communications explaining whether the recommendations changed.

If you handled one part of that process, we work with you to connect it to the others. We guide you through reporting securities fraud to the SEC, connecting what you know with what the agency can investigate.

The Securities and Exchange Commission can award eligible whistleblowers a combined 10% to 30% of the money collected in a qualifying action with more than $1 million in monetary sanctions. We work with you to build the strongest securities whistleblower submission your information supports.

If your information also concerns false claims against the government, we examine that separate opportunity with you. A whistleblower case under the False Claims Act can pay 15% to 30% of what the government recovers.

When the Account Review Changed Nothing

If you know why a broker kept recommending costly trades after the activity reached supervision, talk with our whistleblower experts about the accounts and the decisions behind them. We turn your knowledge of the trading and the firm’s response into a focused securities whistleblower case, bringing in securities fraud whistleblower lawyers who understand excessive-trading allegations. We stay beside you from that first account of what happened through the work of pursuing the case.