Churning refers to the practice of buying and selling securities for the purpose of generating commissions. Simply put, some brokers and advisors will buy stocks and then sell them off only to buy the same stocks later. Superficially, the practice appears to cause no harm to the investor because, at the end of the day, the only thing he or she has lost is a “small” commission; however, churning is illegal and unethical. It violates both Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) rules. It also harms the investor by charging him or her excessive fees for trades that are unwarranted and unnecessary. The practice may also subject the investor to greater taxation.
There is not a hard and fast rule as to when churning exists or becomes actionable. In order to determine if churning has occurred or is occurring, it is necessary to examine the reasons for a particular series of trades. The focus should be on whether the trade(s) were in the investor’s best interest or the advisor’s best interest. Churning, even if unintentional, may be a sign of defective investment strategy or negligence.