Churning is an illegal practice that involves brokers excessively trading on behalf of a client to generate unnecessary commission. This corrupt practice is detrimental to investors as it can lead to significant financial losses in their portfolio. In this blog post, we will discuss the workings of churning, how to identify it, its impact on investors, and preventive measures to avoid it.
How Churning Works
Brokers engage in churning by making excessive trades to generate commission. They may use tactics such as trading in high-risk stocks or selling and repurchasing securities to create the illusion of portfolio growth. Brokers may also conceal churning by providing false justifications for their trades.
Identifying Churning
Prosecutors rely on the justification for the trades made by the broker to determine whether churning has taken place. Signs that indicate churning may be taking place include a high volume of trades, low returns, and failure to meet investor’s goals.
Impact of Churning
Churning can have a severe negative impact on an investor’s portfolio, leading to financial losses, and tarnishing the reputation of the stock market. Brokers convicted of churning can be sanctioned with fines, long suspensions, or permanent bans, depending on the severity of the offense.
Preventive Measures
Investors should protect themselves from churning by managing their own accounts or using fee-based managed accounts that do not involve trading volume-based commissions. Day traders should be wary of brokers who offer trade assistance services or encourage a high volume of trades, as it may be a sign of churning.
Churning is a corrupt practice that undermines the integrity of the stock market. It is important for investors to understand how churning works, how to identify it, and to take preventive measures to avoid it. In the end, ethical behavior in the stock market is critical to maintaining investor trust, and protecting our financial future.
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