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FINRA Proposes New Anti-Churning Rule

By Erwin J. Shustak, Esq. of Shustak Reynolds & Partners, P.C. posted on Wednesday, April 25, 2018.

Erwin J. Shustak, Esq.
619.696.9500 ext. 109
[email protected]

In an effort to locate and identify brokers who excessively trade their clients’ accounts to benefit themselves through excessive trading commissions to the detriment of their clients, FINRA announced a new proposal to widen the net to ensnare brokers who “churn” client accounts.

Under the proposal released April 20, FINRA, the Financial Industry Regulatory Authority, would no longer require a preliminary finding that a broker actually control a client's account to find that the broker has churned it. Under current rules, a broker can only be found liable for churning only if the broker has discretion over the account.

In the regulatory notice, FINRA said that upon review, it determined that requiring broker control over the account places "a heavy and unnecessary burden on customers" when trying to prove excessive trading.  "FINRA is concerned that the control element serves as an impediment to investor protection and an unwarranted defense to unscrupulous brokers," the regulatory notice states.

The proposed rule targets situations where a customer is relying on the brokers' guidance even though the broker does not have de facto control over the account and the actual customer must authorize and approve the buying and selling of investments in the account.  The new rule, however, if adopted, would still require FINRA to demonstrate the transactions at issue were "excessive and unsuitable" based on the circumstances of a particular case.

FINRA and the SEC have been targeting churning of accounts in their examination priorities over the last few years.  There actually are two kinds of churning they are focused on. The first, traditional churning which involves heavy buying and selling of securities for the primary purpose of generating commissions for the broker in a commission type account, and the second form of churning, known as reverse churning, which occurs when financial advisers put buy-and-hold clients into advisory accounts that charge an asset-based fee, which fees would greatly exceed the minimal commissions generated from a buy and hold account.

The proposal will be open for a public comment period that ends June 19. The SEC must approve Finra rule proposals before they become final.

Shustak Reynolds & Partners, P.C. regularly represents firms and individuals in SEC, FINRA, securities, investment, and financial services matters, including litigation, arbitration, enforcement and investigation matters. If you or your company require counsel in these areas, contact us today for a confidential, complimentary consultation.

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