SEC Issues Alert on Excessive Trading

sec eThe Office of Investor Education and Advocacy (OIEA) and the Broker-Dealer Task Force of the Securities and Exchange Commission (SEC) jointly issued an Investor Alert to help investors identify excessive trading in their brokerage accounts and to educate investors about steps they should take if their brokerage firm notifies them of a high volume of trade activity in their accounts.

The SEC’s Broker-Dealer Task Force has identified churning and excessive trading as key areas of focus, and the Investor Alert was issued on the same day as the SEC brought enforcement action involving allegations of excessive trading against two New York brokers.  In SEC v. Dean and Fowler, the SEC charged two individuals with fraud for churning three customers’ brokerage accounts and for recommending an investment strategy to twenty-seven customers without a reasonable basis to believe that the strategy was suitable for anyone.  The customers allegedly opened the accounts after receiving cold calls from the defendants. The SEC alleged that the three customers whose accounts were churned signed account-opening documents that did not reflect the customers’ true investment objectives. For the twenty-seven customers, the defendants allegedly recommended a short-term investment strategy with high per-trade transaction costs and use of margin trading, without a reasonable basis to believe that the strategy was suitable for anyone.  In particular, the SEC alleged that this strategy was unsuitable for anyone because the frequent trading, combined with high per-trade costs charged, all but guaranteed losses for the customers. According to the SEC’s complaint, the defendants’ purpose was to generate commissions and other costs, and the defendants charged approximately $1 million in costs to the twenty-seven accounts.

It was also noted that In the Matter of Paul T. Lebel, the SEC charged an individual for churning several brokerage accounts of four customers. According to the Commission’s settled order, the individual engaged in excessive trading of certain of his customers’ mutual fund A shares (designed for long-term investing) to the detriment of those customers and with no justification other than to generate commissions. The individual was found to have received $50,037 in commissions for these trades.

The Alert pointed out that when investors reviewed their account statements, trade confirmations, or online account, they should be looking for these red flags that may indicate excessive trading:

  • Unauthorized Trading – Investors become aware of trades in their account that they did not authorize their broker to make.
  • Frequent Trading – Frequent in-and-out purchases and sales of securities that don’t seem consistent with the investors investment goals and risk tolerance.
  • Excessive Fees – Investors should be suspicious if the total amount of fees seems high or if one segment of their portfolio consistently generates high fees.

The Alert also noted that if an investors brokerage account has a high volume of trade activity, the investors brokerage firm may request an acknowledgement of the trading or to confirm that the investor is satisfied with how the broker is handling the investor’s account.  If an investor receives such notification, the investor should ask its broker to explain:

  • The rationale for the broker’s recommended trading activity and investment strategy given the investors investment objectives;
  • The total commissions or other transaction fees paid over the past month, quarter, or year; and
  • What percentage return on investment would be needed to break even on the fees paid by the investor.

Once the investor has the information, the SEC observed the investor may want to escalate the matter by speaking with the broker’s manager or the firm’s compliance department to understand and to question the nature of the trading in the investors account, in light of investment goals and risk tolerance.  Ultimately, if an investor is not satisfied with the responses and believes that a broker has engaged in excessive trading including churning, the SEC recommended that the investor submit a written complaint to the brokerage firm and to the SEC or FINRA.