The Harms and Indicators of Excessive Trading

 

Many securities brokers work for commissions. This means that they charge investors a fee whenever executing a trade on their behalf. This method of compensation has, in the past, enticed some nefarious brokers to increase their compensation by making more trades on a customer’s behalf than is in the customer’s best interest.

What is Excessive Trading?

Excessive trading, also known as churning, occurs when a securities broker executes trades in a customer’s account at an unsuitable frequency in an effort to increase their own commissions. Make no mistake, excessive trading is illegal. Unfortunately, in all but the most egregious circumstances, you may need to consult a professional to determine whether you are a victim of excessive trading. There is no “one size fits all” test to determine whether a broker is churning a customer’s account. Instead, courts and regulators balance several factors to determine whether a broker’s trading would be deemed excessive. It is determined by the volume at which trades are being executed, the type of security being traded, the investor’s stated investment objectives and the investor’s risk tolerance (including their age, net worth, and investment experience). For instance, the same number of trades may be suitable for an investor with more speculative objectives but unsuitable for an investor with more conservative objectives. Moreover, one type of product traded a certain number of times may be suitable; whereas, a different type of product—not meant for that volume of trading—traded just as many times may be unsuitable.

The Harms of Excessive Trading 

            Excessive trading can cause significant and irreparable harm to investors beyond simply loss of principal. It will almost always prevent the desired growth due both to excessive fees that accompany it and the excessive switching of investment products that will only yield growth if they are held onto for certain periods of time. Even if an investor’s principal investment remains intact after a ten year period, the fact that an account achieved no, or minimal, growth over that period—when a properly traded account would have seen the growth the investor desired—can cause damage to an investor’s financial health which cannot be undone. 

The Evolution of Excessive Trading           

Excessive trading primarily occurs when securities brokers engage in unnecessarily frequent switching of equities sold on public securities exchanges. When this occurs, the broker “earns” a commission for each trade. Over time, these charges compound and cause substantial harm. In recent years, more and more securities brokers are starting to engage in excessive trading of more long term investment products not sold on public exchanges such as mutual funds, unit investment trusts, private equity funds, closed-end funds, and, most notably, variable annuities. Long-term product switching, especially when it involves variable annuities, does not need to occur at the same volume as equity switching in order to be deemed excessive. For example, annuities are specifically designed to be held onto long term and are often marketed to elderly vulnerable investors with very low risk tolerance. Investors placed in products such as variable annuities may be charged inordinately high[1] fees when they are both placed in and exit the product. That means that the fees investors incur as a result of excessive trading will rack up even more when the trading involves individually tailored private investment products like annuities.

The Indicators of Excessive Trading 

            Regulatory agencies such as FINRA have two main tools to identify excessive trading. One is by looking at the Turn-Over Rate. This is the number of times the securities in the account turn into new securities. The second is called the Cost-Equity Ratio. This is the amount the account would need to appreciate in order for the customer to simply cover the fees they are being charged. A turn-over rate of 6 and a cost-equity ratio of 20 percent are the prime indicators that excessive trading is most likely occurring. However, as noted above, these are just two indicators of many. Excessive trading still may exist where these indicators are not met.

Who Can Stop Excessive Trading? 

More so than both FINRA and the customers themselves, it is actually the broker-dealer who is in the best position to both spot and put a stop to excessive trading. Many securities firms have alert systems in place where they will be automatically be notified if an investor’s turn-over rate reaches 6 and their cost-equity ratio reaches 20 percent; however, case-law dictates that these two numbers are not necessary to make someone liable for excessive trading. Many brokers engaging in this practice know how to effectively skirt these alerts and avoid raising red flags by engaging in trading that falls just shy of reaching the numbers necessary to trigger the alerts. For this reason, FINRA has called on all broker-dealers to be more vigilant in broker supervision beyond merely “checking in on things” once an alert has gone off.

            Unfortunately, it is incredibly difficult for investors to recognize when excessive trading is actually occurring. The investor is not trained in this industry and may only receive quarterly or annual statements from their broker. In some of the most egregious violations, brokers will skirt supervision mechanisms by fraudulently changing an investor’s preferences to allow for more frequent and speculative trading, essentially banking on investors not noticing the change in preferences on their account statements.

            The best thing that investors can do is make sure that their investment objectives and risk tolerance are listed correctly on account statements, actively communicate with their broker, and take thorough notes of their conversations. If investors do have any suspicions, they should never be afraid to call the broker-dealer and speak to a supervising manager. Legitimate brokers are not offended by this action and it will have no affect on your working relationship.

            Here at Cosgrove Law Group, LLC, we have substantial experience dealing with fraud related to brokers and financial professionals. If you suspect that you are a victim of excessive trading, contact the experienced attorneys at Cosgrove Law Group, LLC.

Author: Alexander Oakes, J.D. Candidate 2023, St. Louis University School of Law

---

[1] It is not uncommon to see an investor charged 25 percent of their principal investment if they exit an annuity early.

Gary Gensler Nominated to be the New SEC Chairman

On January 18^th, a few days before Biden was sworn in as President, he announced his nomination for the new Securities and Exchange Commission (“SEC”) chairman.  President Joseph Biden named Gary Gensler as his pick for SEC chairman[1].  While Gensler still needs to be confirmed by the senate[2], it is expected that he will be approved. Gensler’s confirmation will create a 3-2 democratic majority in the SEC commission.

Gary Gensler has an extensive resume within the financial industry.  He is a former Commodity Futures Trading Commission (“CFTC”) chairman, and is known for supporting intensive regulation. During his tenure at the CFTC, he introduced new rules concerning derivative markets, and implemented the Dodd-Frank Act of 2010.  Gensler has also worked inside the industry he regulated, as an executive at Goldman Sachs from 1979 to the late 1990s[3]. Gensler has served as Secretary of the Treasury for Domestic Finance and Assistant Secretary of the Treasury for Financial Markets[4]. Currently, he is a professor of Global Economics and Management at MIT Sloan School of Management[5].

Gary Gensler is recognized as an aggressive regulator. He is known to be direct about his policy decisions and not straying away from controversy[6]. Gensler’s transparent conduct can be beneficial for the SEC, and also beneficial to those who fall under SEC regulation. Transparency in decision making can make it easier to predict what new polices could be passed, but more importantly, how those polices will affect the securities industry. This is primarily because Gensler is unambiguous about what he wants to accomplish. Gensler is consistent. While Gensler is transparent about his policy decisions, he advocates for that same transparency within securities markets. Possible changes include an increase in ESG disclosures[7], possible new rules to “swaps” (similar to his actions as CFTC Chairman), and increased whistleblower protections[8].

Gensler may impact the cryptocurrency industry. Gensler is a supporter of Bitcoin and other cryptocurrencies, however, he has also indicated the possibility of some cryptocurrencies falling under the scope of securities definitions (such as XRP)[9]. Overall, we can expect Gensler and the SEC to become more hands-on when it comes to regulation. 

At Cosgrove Law Group, we will be keeping a close eye on potential new regulation by the SEC. If you have any questions regarding securities regulations and rules, please feel free to give us a call at 314-563-2490.

Please follow us on Twitter @CosLawGroup, on LinkedIn at Cosgrove Law Group, LLC, and on Facebook at Cosgrove Law Group, LLC. 

 

[1] Politi, J. (2021, January 18). Biden names Gensler as SEC head in push towards more scrutiny. Retrieved January 21, 2021, from https://www.ft.com/content/a1ddd082-a253-4148-975a-1ec85b5e94d0

[2] Dizikes, P. (2021, January 19). MIT Sloan's Gary Gensler to be nominated for chair of Securities and Exchange Commission. Retrieved January 21, 2021, from https://news.mit.edu/2021/gary-gensler-nominated-chair-sec-0119

[3] Gary Gensler. (n.d.). Retrieved January 21, 2021, from https://ballotpedia.org/Gary_Gensler

[4] Sprunt, B. (2021, January 18). Biden Taps Veteran Financial Regulators To Lead SEC, CFPB. Retrieved January 21, 2021, from https://www.npr.org/sections/biden-transition-updates/2021/01/18/958023670/biden-taps-veteran-financial-regulators-to-lead-sec-cfpb

[5] Lundy, J. G., MacPhail, M. R., & Porteous, D. W. (2021, January 19). President Biden Announces Gary Gensler as SEC Chair Nominee. Retrieved January 21, 2021, from https://www.natlawreview.com/article/president-biden-announces-gary-gensler-sec-chair-nominee

[6] Nicodemus, A. (2021, January 19). 'A very strong and vocal regulator': Biden taps Gary Gensler to lead SEC. Retrieved January 21, 2021, from https://www.complianceweek.com/regulatory-policy/a-very-strong-and-vocal-regulator-biden-taps-gary-gensler-to-lead-sec/29931.article

[7] Glazer, E. (2021, January 18). Companies Brace Themselves for New ESG Regulations Under Biden. Retrieved January 21, 2021, from https://www.wsj.com/articles/companies-brace-themselves-for-new-esg-regulations-under-biden-11610719200

[8] Schweller, G. (2021, January 18). Biden Picks Gary Gensler to Chair SEC. Retrieved January 21, 2021, from https://whistleblowersblog.org/2021/01/articles/whistleblower-news/biden-picks-gary-gensler-to-chair-sec/

[9] Basar, S. (2021, January 21). Crypto Industry Eyes Gary Gensler at SEC. Retrieved January 21, 2021, from https://www.tradersmagazine.com/am/crypto-industry-eyes-gary-gensler-at-sec/

 

ONCE AGAIN, IT WAS JUST TOO GOOD TO BE TRUE

           The SEC recently filed suit against a Texas man it alleged to have defrauded investors out of $14,000,000.  Many of the scheme’s victims were retired police officers.  

            According to the civil complaint, which you can read here, Victor Farias and his company, Integrity Aviation and Leasing, solicited investments from almost 100 different individuals.  The defendant company was supposed to use the funds as capital to support a business model in which it bought and leased aviation parts.  Instead, millions went toward unrelated ventures and personal expenses, such as country club bills.  Moreover, in true “Ponzi” fashion, funds from new investors were used to satiate the demands of earlier investors. 

            On a somewhat happier note, a Georgia businessman will pay back $23 million to at least 100 investors in his plan of converting landfill waste in to fuel.  As is common, the promoter over-stated the success of his business model and promised generous investment returns while diverting funds to support a lavish lifestyle.  According to the SEC, the businessman knew his company “never had the ability or expertise to develop [the project].” 

            The attorneys and paralegals at Cosgrove Law Group, LLC have been representing defrauded investors around the nation for over a decade.  Let us know if you need our help.

Arbitration Panel Finds Merrill Lynch Defamed Former Employee

Merrill Lynch, Pierce, Fenner & Smith, Inc., a brokerage firm registered with Financial Industry Regulatory Authority (“FINRA”) and investment adviser firm registered with Securities Exchange Commission (“SEC”), as well as Merrill Lynch International Finance, Inc. (collectively, the “firms”), have been ordered by an Arbitration Panel to pay former employee, Miguel Andres Ballestas, $750,000.00 in compensatory damages based upon the firms having been found liable for defamation on FINRA Form U5 relating to the circumstances of Ballestas’ termination. (FINRA Office of Dispute Resolution Arbitration Award No. 14-01946, April 30, 2018).

According to the Arbitration Award, the firms brought an arbitration against Ballestas alleging unjust enrichment and breach of contract, contending that Ballestas failed to pay a promissory note executed on January 9, 2009. Ballestas counterclaimed, alleging that the firms, inter alia: breached duties of good fair and fair dealing; violated FINRA Rule 2010; wrongfully terminated Ballestas; breached fiduciary and contractual duties owed to Ballestas; and committed Central Registration Depository (“CRD”) Form U5 defamation pertaining to Ballestas’ termination from the firms.

In the “Termination Disclosure” section of the Form U5, the firms were apparently asked if Ballestas voluntarily resigned from the firms, or had been discharged or permitted to resign from the firms, after allegations were made that accused Ballestas of: (1) violating investment-related statutes, regulations, rules or industry standards of conduct; and/or (2) fraud or the wrongful taking of property. Evidently, those questions were answered by the firms in the affirmative.

The Arbitration Award revealed that the firms collectively sought: $407,451.40, which reflected the outstanding promissory note balance, as well as interest, costs and attorneys’ fees; and for Ballestas’ counterclaim to be completely dismissed. However, Ballestas sought a total of $26,000,000.00 in damages from the firms based upon the loss of Ballestas’ book of business, pension, and deferred compensation, and for having suffered from mental pain and anguish by the firms. Moreover, Ballestas sought for his promissory note to be cancelled or at least offset by service payments pertaining to his employment with those firms, and for his CRD Form U5 to be expunged. Evidently, on June 27, 2017, FINRA Office of Dispute Resolution was provided a notice of settlement regarding a portion of the claims made by the firms and Ballestas against each other.

After having considered the evidence, testimony and pleadings, the Arbitration Panel concluded that the firms were jointly and severally liable for CRD Form U5 defamation of Ballestas, and ordered the firms to pay Ballestas $750,000.00 in compensatory damages. Further, the Arbitration Panel recommended that the firms’ answers in the “Termination Disclosure” section of Form U5 be changed to “No” based on the firm’s initial responses being of a defamatory nature.

Cosgrove Law Group, LLC has represented former employees in several U5 defamation cases nationwide, helping them obtain settlements and awards ranging from $100,000.00 to $3,500,000.00. If you feel that you have been a victim to U5 defamation, call Cosgrove Law Group and speak to our experienced counsel today.

The Opaque World of Arbitration Might Soon Become Clearer in New York

The New York Legislature has two bills pending in the Assembly and Senate which would make public, for the first time, details of private arbitrations. A09769 and S07146, sponsored by Matthew Titone and Brian Kavanagh respectively, are both crafted to provide information related to private arbitrations to the public. Information such as:

· the name of the non-consumer party,

· the state and zip code in which the consumer party resided at the time of arbitration, the type of  

  dispute involved,

· whether the consumer was the prevailing party,

· on how many occasions, if any, the non-consumer party has previously been a party in an 

  arbitration or mediation administered by that same private arbitration organization,

· the date the private arbitration organization received the demand for arbitration,

· the date the arbitrator was appointed,

· the date of disposition by the arbitrator or private arbitration organization,

· the type of disposition of the dispute, if known,

· the amount of the claim,

· the amount of any award or settlement, and any other relief granted,

· the name of the arbitrator,

· the arbitrator's total fee for the case,

· and the percentage of the arbitrator's fee allocated to each party.

The bills also define and prohibit certain financial conflicts of interest. Recurring parties as paying customers to the arbitrators is not listed as a financial conflict of interest and still remains a concern for consumers. The bills do provide for private causes of action and civil penalties for violations. The New York Attorney General would enforce the provisions. Neither Bill is retroactive.

The Senate bill was referred to the Consumer Protection Committee, but has not moved. The Assembly bill, however, was referred to the Consumer Affairs and protection Committee and passed on March 6, 2018. Should one of these bills pass, the impact on private arbitration in favor of consumers would be significant. Currently, businesses can bind customers with an arbitration agreement, have multiple arbitration claims brought against them and other customers and the general public would never know. Under these bills, customers would have access to the arbitration history a specific business has with a particular arbitration company. Should this pass, given arbitration’s significant and increasing prevalence, it is likely other states will look into passing similar consumer protections in an effort to shed light on the currently opaque arbitration process.

While these bills seem to strive to protect consumers by making important information public, some may argue the bills go too far by requiring the amount of a settlement, which is typically confidential. The bills could likely get to the same destination of providing important information to the public about companies without requiring this information.  

Even General Counsels Get Defamed

What happens when the media re-states bluntly what you tried to say cleverly? A jury might find you liable for defamation, even if your statement was made in a legal document.

This observation is one of many take-aways from the litigation victory achieved by Minnesota attorney Chet Taylor. A jury awarded Chet $600,000 for a defamatory statement his former broker-dealer made in a corrective action plan attached to a FINRA consent order. The defendant added another $250,000 after the initial verdict to end the case.

Would a broker-dealer really throw former employees, including its General Counsel, under the proverbial bus? Perhaps. In this instance, broker-dealer Feltl and Company implied in the corrective action plan with FINRA that the “replacement” of certain employees, including its General Counsel, would “enhance a culture of compliance at the firm.” The Wall Street Journal subsequently published an article about Feltl utilizing a direct summary of the rather ham-handed plan: “The firm also said it replaced its general counsel...to beef up compliance.” The jury obviously did not care that Chet was not identified by name in the corrective action plan or Journal article. But they certainly cared that Chet had voluntarily departed for private practice about 2 years before the execution of the Consent Order and plan. Food for thought.

David Cosgrove has obtained monetary awards and expungements for various members of the financial industry from broker-dealers such as U.S. Bancorp Investments, Raymond James Financial Advisers, and Questar. He has also achieved negotiated confidential resolutions on behalf of other advisers and employees.