Legal Definitions - churn

Churning is an unethical and illegal practice in financial investing where a stockbroker or financial advisor makes an excessive number of trades in a client's investment account. The primary motivation for these frequent transactions is to generate higher commission fees for the broker, rather than to benefit the client or align with their stated financial goals and risk tolerance.

Essentially, churning occurs when a broker prioritizes their own earnings over the client's best interests by unnecessarily buying and selling securities, leading to increased transaction costs that erode the client's investment value.

• Example 1: The Conservative Retirement Account

  An elderly couple, nearing retirement, instructs their financial advisor that their main objective is capital preservation and generating a steady, low-risk income stream. They explicitly state they have a very low tolerance for risk. Despite this, their advisor frequently buys and sells various bonds, mutual funds, and dividend stocks in their account, often holding them for only a few weeks or months before trading them again. Each transaction incurs a commission fee.

  This illustrates churning because the numerous, short-term trades are excessive and inconsistent with the couple's stated conservative, income-focused objectives. The frequent activity primarily serves to generate commissions for the advisor, rather than to enhance the couple's long-term financial security.

• Example 2: The Young Professional's Savings for a Home

  A young professional is saving for a down payment on a house within the next five years. They inform their broker that they need moderate growth with limited risk, as they cannot afford significant losses. Over several months, the broker repeatedly moves their funds between various sector-specific exchange-traded funds (ETFs) and individual growth stocks, often selling holdings shortly after purchasing them. This results in numerous transaction costs and no significant improvement in the portfolio's overall performance, and in some cases, even a slight decline due to fees.

  This demonstrates churning because the constant, short-term trading is excessive and does not align with a moderate-risk, growth-oriented strategy focused on a specific future goal. The primary beneficiary of such frequent and unnecessary activity would be the broker's commissions, not the client's progress towards their homeownership goal.