What Is Reverse Churning?

15 March, 2024

Your broker may not be charging you on a per-trade basis, like you may be used to when you open an account. They may be charging you a fee, and you fully expect them to provide the services for which you are paying. If not, your broker may have committed reverse churning.

If you have lost money due to this illegal practice, you may be entitled to compensation after you take legal action against the broker. Call Rikard & Protopapas to learn more about your legal options from an experienced broker misconduct lawyer.

How Brokers Are Compensated for Their Services

Investors may pay their broker in two different ways:

  • They may pay a commission or markup to the broker on an individual trade basis.
  • They could pay a fee to the broker on an annual basis, so the broker will manage their account and make trades. Oftentimes, this fee is around 1.5% of assets under management in the account. The broker may also charge a flat fee each year for their services.

Many investors learn about churning the hard way. The broker, who may have a financial incentive to generate commissions, excessively trades in the customer’s account. The customer then loses money because they are paying so much to their broker.

Your Broker Wants You to Be Paying Fees

Wall Street has been moving towards the fee-based model for managing customer accounts, especially as competition has shrunk brokers’ margins for commission-based trades.

When your broker is charging you a fee, they may even be receiving additional confirmation from the brokerage house that actually executes your trades. You can understand why your broker may be trying to pitch you on a fee-based account.

One example of a broker allegedly improperly using fee-based accounts was a reverse churning claim against Edward Jones. Customers complained that the broker tried to force them into fee-based accounts that resulted in higher fees for the broker with no additional effort.

Your Broker May Charge You for Doing Little to Nothing

Investors often have no idea there is such a thing as reverse churning. This illegal practice occurs in flat fee accounts.

The broker needs to earn the money that they charge you. They must strike a fine balance in how much they trade in your account. Overtrading may not be in your best interest, but they also must do enough to justify the fee. If your broker undertrades, and just pockets a fee for doing little, they can commit reverse churning.

If a broker is charging you a flat fee for doing nothing, it becomes excessive. Hypothetically, let’s say that you have $100,000 in your account. If you are being charged a 1.5% flat fee, you are paying your broker $1,500 per year. If they are only executing a handful of trades in your account, you would be far better off if you paid on a per-trade basis because it would cost you far less money.

As a result, the broker is violating their fiduciary duty that they owe to you as a customer. In addition, recommending a fee-based account is unsuitable for customers who do not trade as much in their account.

However, there is a fine line between standing pat when the client is making money and reverse churning. It may be in the client’s best interests to keep their money in investments that are working for them and will continue to in the future. That can be prudent money management.

The broker does not have to trade solely to justify the fees that they are charging.

How Reverse Churning Violates FINRA Rules

What constitutes fraud is when the broker does not make any transactions, and it is in their best interests. In that case, the broker is acting in their own interests and not yours, when they are charging you money to look out for you.

Reverse churning is a fraud in connection with the sale of securities that violates the Securities and Exchange Commission’s antifraud rule and FINRA obligations to adhere to just and fair principles of trade. Further, it may be unsuitable for the broker to recommend a fee-based account when you are not an active investor.

You Must Detect Reverse Churning and Take Legal Action

You must keep up with the activity in your investment accounts. You should periodically review your account statement and activity to see what the broker is or is not doing in your account. If you do not understand what you see, make sure to ask your broker questions. They need to explain to you what they are doing.

You can see the confirmations of the individual trades that the broker has made on your behalf to gauge the level of activity. You must come to understand how the broker is managing your account, and if the level of trading activity is consistent with your investment objectives and situation.

If you believe that your broker has committed reverse churning by doing little while charging you a fee, you may be able to take legal action against the broker.

Under the terms of your agreement with the broker, you can file a FINRA arbitration claim. An arbitrator, or a panel of arbitrators, would hear your case and issue a decision. In addition, if you believe that other customers of the broker were also defrauded, you may file a class action lawsuit against the broker. (In the Edward Jones case described above, the case went to court as part of a class action lawsuit.)

Contact a Broker Misconduct Attorney Today

The attorneys at Rikard & Protopapas fight for customers who have lost money from their broker’s wrongdoing. We can represent you in the FINRA arbitration process, working to prove that you deserve compensation from your broker for how they wronged you.

Request a consultation to learn how we can represent you in the legal process. Call us today at (803)-805-7546 or send us a message online to discuss your case. You owe us nothing unless you win.

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