The Financial Industry Regulatory Authority (FINRA) has suitability rule – Rule 2310 which states:
(a) In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.
(b) Prior to the execution of a transaction recommended to a non-institutional customer, other than transactions with customers where investments are limited to money market mutual funds, a member shall make reasonable efforts to obtain information concerning:
(1) the customer’s financial status;
(2) the customer’s tax status;
(3) the customer’s investment objectives; and
(4) such other information used or considered to be reasonable by such member or registered representative in making recommendations to the customer.
(c) For purposes of this Rule, the term “non-institutional customer” shall mean a customer that does not qualify as an “institutional account” under Rule 3110(c)(4).

The landmark case of Piper, Jaffray & Hopwood, Inc. v. Ladin, 399 F. Supp. 292; 1975 U.S. Dist. LEXIS 16441 (S.D. Iowa August 26, 1975), holds that “The imposition of a duty to investigate the financial capability of an investor entering a margin transaction and to inform that investor of the implications of a margin purchase can also be justified as part of a stockbroker’s professional responsibility.” If you have been put on margin without your permission, were not fully warned of the risks of investing on margin, or do not feel that it was suitable for someone of your age, experience, risk tolerance or net worth to be placed on margin you may have legal rights against your broker and the brokerage firm.

The Financial Industry Regulatory Authority (FINRA) has rules prohibiting churning and excessive trading. Excessive trading is the same as churning, but without the requirement that the person engaging in the trading does so for the purpose of generating commissions. Churning and excessive trading can violate FINRA Rule 2310, and FINRA Rule 2310-2(b)(2).

It is also against state securities laws and federal securities laws to churn an account. If you are a victim of churning you may have legal rights against your broker and the brokerage firm.

Did you lose money due to a stock broker or financial advisor churning your account?

Broker-client disputes typically involve allegations that a brokerage firm and its registered representative churned or excessively traded a client’s portfolio in order to generate income for the broker and the firm and/or that the client was sold investments which were not suitable given the client’s investment objectives. At the root of churning cases is the question, “Was there a reasonable probability that the securities trading would be sufficiently profitable to cover its cost?”

Economists and securities industry professionals are often called as expert witnesses to assist arbitration panels in determining whether an account has been churned and, if so, what damages have been suffered by the client. Simple ratios and rules of thumb have long served as traditional economic analyses of liability and damages issues in churning cases. However, advances in computer technology and in our understanding of financial economics now allow for more thorough analyses.

The two common indicators of alleged excessive trading in churning cases: 1) turnover ratios and 2) cost-to-equity ratios. Turnover ratios measure how often, on average, the securities in a client’s portfolio are traded in a year. Cost-to-equity ratios measure the annual cost of the trading as a percentage of the client’s investments.

There are three common measures of damages in churning and suitability cases: 1) out-of pocket loss, 2) benchmark portfolio, or well-managed account, damages, and 3) trading costs. Out-of-pocket loss is the change in a client’s equity less any net deposits made during the period. Out-of-pocket loss is an inappropriate measure of damages because it ignores the opportunity cost of invested funds. Also, general market movements that are unrelated to the alleged fraud significantly affect the out-of-pocket measure.

The benchmark portfolio measure of damages corrects the deficiencies in the out-of-pocket loss measure. The benchmark portfolio measure of damages is the difference between what the client’s equity would have been had the portfolio been appropriately managed and the client’s actual equity at the end of the disputed period. The benchmark portfolio measure of damages is most widely used in cases where the primary allegation is that unsuitable securities were purchased for the client.

Trading costs (commissions, bid-ask spreads, mark-ups and markdowns, margin interest, and fees incurred by the client) are a widely used measure of damages in churning cases. Although not generally understood, the simple trading cost measure suffers the same flaws as the out-of-pocket loss because, like out-of pocket losses, it ignores the opportunity cost of invested funds. Fortunately, the adjustment necessary to correct the simple trading cost measure is straightforward and closely related to the benchmark portfolio measure of damages.

False statements often include promises about future performance, price predictions, any guaranties, and special knowledge about the performace of a particular security. Omissions are the failure to disclose known or discoverable risks about a the investment. If you are a victim of false statements or material omissions you may have legal rights against your broker and the brokerage firm.

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