Churning (stock trade)
Encyclopedia
Churning is the practice of executing trades for an investment
account by a salesman or broker
in order to generate commission
from the account. It is a breach of securities law in many jurisdictions, and it is generally actionable by the account holder for the return of the commissions paid, and any losses occasioned by the broker's choice of stocks.
Courts generally look at the turnover of an investment account, or the number of times the investment capital has been re-invested during a year. For example, for an actively traded mutual fund, the entire assets of the fund will be involved in buying and selling transactions once every six to twenty-four months. In churning cases, the entire assets of the investor are often traded once a month, or even more frequently. As a commission is paid on each trade, commissions can substantially destroy the value of an investment account in a very short period of time.
Critics of the practice of paying brokers commissions for managing investment accounts point to churning as one of the indicators that the brokerage system indirectly encourages such behavior by brokers to the detriment of investors. Accounts invested in securities with steady returns and little price fluctuation generate no commissions, and brokers are therefore not encouraged to invest their client's money in such investments.
Investment
Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
account by a salesman or broker
Stock broker
A stock broker or stockbroker is a regulated professional broker who buys and sells shares and other securities through market makers or Agency Only Firms on behalf of investors...
in order to generate commission
Commission (remuneration)
The payment of commission as remuneration for services rendered or products sold is a common way to reward sales people. Payments often will be calculated on the basis of a percentage of the goods sold...
from the account. It is a breach of securities law in many jurisdictions, and it is generally actionable by the account holder for the return of the commissions paid, and any losses occasioned by the broker's choice of stocks.
Courts generally look at the turnover of an investment account, or the number of times the investment capital has been re-invested during a year. For example, for an actively traded mutual fund, the entire assets of the fund will be involved in buying and selling transactions once every six to twenty-four months. In churning cases, the entire assets of the investor are often traded once a month, or even more frequently. As a commission is paid on each trade, commissions can substantially destroy the value of an investment account in a very short period of time.
Critics of the practice of paying brokers commissions for managing investment accounts point to churning as one of the indicators that the brokerage system indirectly encourages such behavior by brokers to the detriment of investors. Accounts invested in securities with steady returns and little price fluctuation generate no commissions, and brokers are therefore not encouraged to invest their client's money in such investments.