Churning

The broker usually has control or heavy influence over the account, because the client relies on advice or has granted discretion. In the US, regulators and courts look for three elements: control, trading that is excessive given the client's aims, and intent or reckless disregard for the client's interests. Warning signs include a high turnover ratio, which compares annual purchases with the account's average value, a high cost-to-equity ratio showing how much return the account must earn just to cover fees, and short holding periods. The practice breaches suitability and fiduciary duties and, in the US, antifraud rules. Firms guard against it with surveillance reports on turnover and commissions, reviews of discretionary accounts and pay structures that do not reward volume alone. Clients may recover losses and fees through arbitration or complaints.

A client with a cautious retirement portfolio of 200,000 gives her adviser discretion over trades. Over a year the account turns over 12 times and pays 18,000 in commissions, while its value falls slightly. A surveillance report flags the turnover. A compliance review finds no investment reason for most of the trades. The firm refunds the commissions, disciplines the adviser and restricts his access to discretionary accounts.