Some experts estimate that investors lose billions of dollars a year to churning,
or excessive trading in their securities accounts. Because some brokers make money based on the number of trades they make, they may be tempted to churn a client’s account to generate higher commissions.
For example, if a broker moves money quickly in and out of similar securities or frequently recommends replacing one product with another similar product, there may be reason to suspect churning. Another indication may be that you are paying more in commissions than you are earning on your investments.
What the regulators say
Churning is illegal but it is often hard to prove. Both FINRA and the SEC define churning as unauthorized trading in a discretionary account — or an account in which the broker is authorized to trade without the prior approval of the client. In these cases, regulators will look at the turnover rate and the ratio of commissions paid to the account’s rate of return to determine whether the account is being churned.
Regardless of the type of account you hold, if you have reason to suspect that your broker is not acting in your best interests, make sure you understand the reasoning behind his or her recommendations or decisions. If you’re not satisfied with the answers, it may be time to take your business elsewhere.
Churning in your securities account not only generates high commissions: It may also generate high taxes. When your broker quickly turns over stocks in your account, it may create short-term capital gains,
which are taxed at your income tax rate rather than the lower long-term capital gains rate for stocks held more than a year.
