Churning (stock trade)

From Wikipedia, the free encyclopedia

Churning is the practice of executing trades for an investment account by a salesman or broker in order to generate commission from the account. It is a breach of securities law in many jurisdictions, and it is generally actionable by the account holder for the return of the commissions paid, and any losses occasioned by the broker's choice of stocks.

Courts generally look at the turnover of an investment account, or the number of times the investment capital has been re-invested during a year. For example, for an actively traded mutual fund, the entire assets of the fund will be involved in buying and selling transactions once every six to twenty-four months. In churning cases, the entire assets of the investor are often traded once a month, or even more frequently. As a commission is paid on each trade, commissions can substantially destroy the value of an investment account in a very short period of time.

Critics of the practice of paying brokers commissions for managing investment accounts point to churning as one of the indicators that the brokerage system indirectly encourages such behavior by its members to the detriment of investors. Accounts invested in securities with steady returns and little price fluctuation generate no commissions, and brokers are therefore not encouraged to invest their client's money in such investments. There have been several instances of brokers rising very high in the hierarchy of their firm who have later been shown to have been generating commission income from churning or placing their client's stock into investments with an unnecessary degree of risk.^{[citation needed]}