Excessive Trading: A Comprehensive Guide for Investors and Brokers

Stockbrokers’ practice of excessive trading, also known as “churning,” is considered fraudulent activity and may give rise to a cause of action in a damages arbitration claim brought against FINRA. While excessive trading benefits stockbrokers and the brokerage firms they work for, it can result in substantial losses for investors.

Excessive trading is when a stockbroker trades more than the investor wants to in order to make money on commissions. A breach of fiduciary duty and a conflict of interest may result if the suggested investment strategy’s only goal is to enrich the brokerage firm and/or stockbroker by generating exorbitant commissions, fees, or costs.

Generally speaking, an investor can successfully sue a brokerage firm or stockbroker if they can demonstrate the following:

An investor has the right to file an arbitration claim against the brokerage company or stockbroker if they believe they have suffered losses due to excessive trading or churning. When assessing whether the stockbroker exerted the required control over the account, the arbitrator or securities arbitration panel will consider a number of factors, including but not limited to the following:

To ascertain whether the trading was excessive, statistical formulas are frequently employed. The utilization of in-and-out trading in a customer’s account, the turnover rate, the cost-equity ratio, and other variables “may provide a basis for a finding that a member or associated person has violated the quantitative suitability obligation,” according to FINRA regulations. The turnover ratio, which is computed by dividing the total yearly purchases by the average account balance over the course of a year, assesses the overall level of activity.

The more activity in the account, the higher this number is. The percentage of mutual funds or other holdings that have been “turned over,” or swapped out for new ones, over the course of a year is known as the turnover. A higher turnover will generate more brokerage transaction fees. There may be a fraud case if brokers purposefully boost turnover to increase fees.

When assessing a trading strategy, the cost-equity ratio is also taken into consideration in addition to the turnover ratio. This ratio calculates the entire annual cost of an investment plan. It may also be called the breakeven rate of return. The average balance in the brokerage account is divided by the total annual costs (commissions, margin interest, and margins) to arrive at the cost-equity ratio.

Churning happens in many small or regional businesses as well as at large Wall Street firms. There are still a lot of instances where stockbrokers cold call investors before engaging in excessive trading. Churning frequently occurs in conjunction with inappropriate investments in penny stocks or other speculative assets.

There will always be fees, costs, and other associated expenses associated with any investment you choose to make. Many investors might simply view them as “the cost of doing business,” failing to take into account the implications for their portfolio and specific investments.

Charges and fees may seem small but add up quickly. They have the potential to gradually reduce your investment and portfolio size. Spending money on fees and expenses reduces your returns over time because it is not invested.

To find out how much your account is costing each month, you should routinely review your brokerage statements. These statements include:

These are only a few of the numerous fees and charges you could run into when opening a brokerage or investment account.

On your account statement or confirmation statement, the fees and costs that are incurred on your behalf might not always be clearly stated. It is advisable for you to proactively inquire about all fees assessed and comprehend the rationale behind them. Speak with your broker-dealer and ask for a detailed explanation of all the fees if any are unclear or confusing.

As a portfolio grows, so does the amount of fees. In an example from Investor. gov, three investment strategies with varying fees and costs have significantly different returns on three investments of $100,000 each over a period of three years with an annual return of 4%:

The difference is considerable and could be reinvested. For this reason, considering the long term is necessary to comprehend the effects of fees and costs.

Before making any financial investments, investors should always conduct their own due diligence and carefully consider any advice provided by their broker. Clients who fail to at least look over any recommendations run the risk of committing to something that may end up costing more than they had anticipated.

Two elderly men who were clients of a broker by the name of Mirsad A Muharemovic (CRD# 312259) who made recommendations. They both blindly followed Muharemovic’s advice because they trusted him, even when it meant taking the dangerous step of making a margin purchase. Furthermore, Muharemovic overtraded, making unnecessary purchases and sales, which resulted in exorbitant fees and commissions for these clients. One client reported losses of $185,966 in his account, and the other reported losses of $74,338 across two accounts.

It’s possible. One big difference is actively managed fees vs. passively managed fees. According to a Morningstar analysis, actively managed fees typically amount to one 2%, while fees for electronic traded fund (ETF) average 0. 44%. Morningstar discovered in that same report that lower fees resulted in higher investor returns.

It’s crucial to understand when to transfer money and when to wait because doing so can increase costs. Each trade includes costs. An investment that is traded more frequently than it ought to be will incur higher costs and may have an adverse effect on your principal. For this reason, investing and holding rather than trading frequently usually yields higher returns.

Make sure you are aware of all the fees and costs involved with the account before opening one. Ask your broker or broker dealer about ways to reduce your investment costs if you think they are too high. However, Silver Law Group can provide a thorough review of your accounts if you find that you are being overcharged for account-related expenses and your broker is unable to assist you.

In cases involving securities and investment fraud, Silver Law Group represents investors. Our attorneys represent investors across the country in an effort to recover investment losses brought on by stockbroker misconduct. They are admitted to practice law in both Florida and New York. Give an experienced securities attorney a call if you have any questions about the way your account has been handled. The majority of cases are handled on a contingent fee basis, so you won’t be responsible for paying us until we help you get your money back. Give us a call at (800) 975-4345 today to discuss how we can be of assistance.

Charges and fees may seem small but add up quickly. They have the potential to gradually reduce your investment and portfolio size. Spending money on fees and expenses reduces your returns over time because it is not invested.

Before making any financial investments, investors should always conduct their own due diligence and carefully consider any advice provided by their broker. Clients who fail to at least look over any recommendations run the risk of committing to something that may end up costing more than they had anticipated.

In determining whether the trading was excessive, the use of statistical formulas is common. Under FINRA rules, “factors such as the turnover rate, the cost-equity ratio, and the use of in-and-out trading in a customer’s account may provide a basis for a finding that a member or associated person has violated the quantitative suitability obligation.” The turnover ratio measures the overall level of activity and is calculated by dividing the total annual purchases by the average balance of the account during a year.

On your account statement or confirmation statement, the fees and costs that are incurred on your behalf might not always be clearly stated. It is advisable for you to proactively inquire about all fees assessed and comprehend the rationale behind them. Speak with your broker-dealer and ask for a detailed explanation of all the fees if any are unclear or confusing.

As a portfolio grows, so does the amount of fees. In an example from Investor.gov, three investment strategies with different fee and cost amounts have markedly different returns on three investments of $100,000 each over a 20-year period with a 4% annual return:

Kaitlyn Kiernan: So, Chris, during our previous conversation, we discussed how enforcement is focusing on safeguarding senior investors. Today, we wanted to discuss excessive trading, which is another enforcement priority. So quantitative suitability, excessive trading, churning. What are we discussing here, and do all of these terms have the same meaning?

Kaitlyn Kiernan: Could you also share any important lessons learned from recent enforcement actions?

Kaitlyn Kiernan: Welcome to FINRA Unscripted. Im your host Kaitlyn Kiernan. I’m happy to welcome Chris Kelly, the deputy head of enforcement and the head of both main enforcement and sales practice enforcement, back to the show today. Chris, welcome back.

Chris Kelly: The short answer is no. With one significant exception, I don’t think you’ll notice much of a difference between the cases of excessive trading that we typically bring under FINRA suitability rules and the cases that we are likely to bring under Reg BI. Reg BI removed the element of control, which is one of the essential legal components of an excessive trading case that we must establish. Therefore, historically, the enforcement action would have to prove that the broker had actual control over the trading in the customer’s account or that it had de facto control in order to bring an excessive trading case against the broker. Reg BI expressly does away with this control requirement, so in order to file an excessive trading case under Reg BI, we no longer have to provide proof of it. Apart from that, I believe the cases will largely be the same.

Chris Kelly: Absolutely. Typically, we focus on two main markers of excessive trading: the turnover rate and the cost-equity ratio. The number of times the equity in the account turns over is what I mean when I say turnover rate. To put it another way, the turnover rate is the frequency with which new securities are added to an account and securities during a specific time period. The amount the account would need to increase by in order for the customer to break even is known as the cost-equity ratio. For instance, if the account’s cost equity ratio is thirty percent, the account would need to increase by thirty percent in order for the customer to be able to pay for all of the account’s costs and expenses. Furthermore, turnover rates of six or higher in cost equity ratios of twenty percent or higher are generally regarded by FINRA and other regulators as indicative of excessive trading.

Why 95% of Day Traders FAIL

FAQ

What is the reason for excessive trading?

What is considered excessive trading?

What are the causes of over trading and under trading?

What causes overtrading?

It is often triggered by a misinterpretation of market signals, psychological factors such as fear or greed, and easy access to trading platforms. The symptoms of Overtrading are excessive trading volume, rapid capital depletion, and a tendency for frequent short-term trades, often with disregard for long-term investment strategies.

Can emotional trading cause overtrading?

Emotional trading often results in impulsive buying or selling, increasing the likelihood of overtrading. Overtrading can manifest in different ways, depending on the trader’s behavior and the market conditions. Here are some common types of overtrading:

What is overtrading in trading?

Overtrading refers to the practice of conducting an excessive amount of trades that surpasses an investor’s financial capacity or the optimal trading volume for a specific market situation. What are the main causes of Overtrading?

What is excessive trading?

So typically, when we talk about excessive trading, we are talking about frequent buys and sells of equities. But what we’ve seen more frequently are brokers who are rapidly buying and selling more expensive products like mutual funds, variable annuities, unit investment trusts and closed-end funds.