Finra proposes to widen net for churning violations
Under new rule, brokers would not have to have control of account to be found liable.
Finra is seeking to cast the net wider to capture brokers who are excessively trading in their clients’ accounts to increase their own revenue.
Under a proposal released April 20, the Financial Industry Regulatory Authority Inc. would no longer require that a broker control a client’s account in order to find that the broker has churned it. Under current rules, a broker can only be found liable for churning if he has discretion.
In the regulatory notice, Finra said that requiring broker control over the account places “a heavy and unnecessary burden on customers” when trying to prove excessive trading.
“Finra is concerned that the control element serves as an impediment to investor protection and an unwarranted defense to unscrupulous brokers,” the regulatory notice states.
The rule targets situations where a customer is relying on the brokers’ guidance even though the customer must authorize the buying and selling of investments in the account.
“As a practical matter, the broker is making the decisions, and the client is routinely accepting them, particularly an unsophisticated client who may not be in a position to recognize churning as it occurs,” said Ira Matetsky, a partner at Ganfer & Shore.
The new rule would still require Finra to demonstrate that transactions were “excessive and unsuitable” based on the circumstances of a particular case.
Finra and the Securities and Exchange Commission in their examination priorities over the last few years have been targeting churning — both the traditional kind and reverse-churning, which occurs when financial advisers put buy-and-hold clients into advisory accounts that charge an asset-based fee.
Tightening the churning parameters reflects the evolution of the suitability rule that governors broker interactions with clients, according to Todd Cipperman, principal at Cipperman Compliance Services.
He said Finra has been moving suitability — which requires brokers to sell products that meet a client’s objectives but allows them to recommend expensive ones — toward more of a best-interests standard.
Last week, the SEC proposed a new Regulation Best Interest for brokers.
“It’s the right approach,” Mr. Cipperman said of the Finra churning proposal. “This idea of segmenting accounts between those brokers have control over and those a client controls is a vestige of how suitability used to be defined. Brokers can give recommendations that clients are relying on in any [account]. So, it’s a distinction without a difference.”
The proposal will be open for a public comment period that ends June 19. The SEC must approve Finra rule proposals before they become final.
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