Which of the following scenarios would be considered a prohibited practice known as 'churning'?
- AA registered representative executes trades for a client based on their specific instructions, resulting in frequent transactions.
- BA registered representative initiates an excessive number of trades in a client's discretionary account solely to generate commissions, without regard for the client's investment objectives.
- CA registered representative advises a client to hold their investments long-term, resulting in minimal trading activity and low commissions.
- DA registered representative recommends a diversified portfolio to a client, leading to several purchases across different asset classes.
Show answer & explanationAnswer & explanation
Correct answer: B. A registered representative initiates an excessive number of trades in a client's discretionary account solely to generate commissions, without regard for the client's investment objectives.
Churning is an unethical and illegal practice where a registered representative excessively trades in a client's account, particularly a discretionary one, primarily to generate commissions rather than to benefit the client. The key elements are excessive trading, control over the account, and intent to defraud or reckless disregard for client interests.
Why the other options are wrong
- A. This describes solicited trading, which is permissible if aligned with client objectives.
- C. This describes a sound, long-term investment approach, the opposite of churning.
- D. Diversification is a sound investment strategy and does not, by itself, constitute churning.
Churning
An unethical and illegal practice where a registered representative excessively trades in a client's account to generate commissions, disregarding the client's investment objectives.
- Requires control over the account (often discretionary).
- Involves excessive trading frequency or volume.
- Motivated by commission generation, not client benefit.
- Violation of FINRA rules and securities laws.
Memory trick: Churning makes your account 'churn' profits for them, not you.