We have represented a number of customers whose brokers engaged in what is known as proceeds trading in their accounts.
Proceeds trading is a form of “churning” that occurs in brokerage customers’ accounts when the broker sells one security and then recommends that the proceeds of that sale be used to purchase another security, usually when there was no good reason to recommend this change in the holdings in the customer’s account. Even if the broker is able to articulate a reason for the transaction, if the transaction is inconsistent with the customer’s stated investment objectives or appears to be motivated by the broker’s desire to generate commission income or other revenue for the broker or the brokerage firm, a claim for proceeds trading can be maintained.
Churning is a fraudulent practice in which brokers take advantage of their customers’ trust and engage in excessive transactions for the purpose of enriching themselves. There are a number of different ways in which a broker can “churn” the customer’s account. Even one transaction can constitute churning if the transaction is recommended by the broker to generate income for the broker. The law defines churning as constructive fraud, that is, one need not prove that the broker acted with intent. It is sufficient to show that the customer suffered a loss as a result of excessive trading inconsistent with the character of the account.
Proceeds trading can occur with stocks, options, mutual funds and any other types of securities in your account. One tell-tale sign is the sale of the stock of one company in an industry and the prompt purchase of another in that same industry: for example the sale of Bank of America shares and the purchase of JP Morgan securities, when there is no good reason for such a switch. Speaking of “switching,” that is a term that can be applied to the sale of one mutual fund for the purchase of another with the proceeds of that sale. A more difficult switch to discover is when one “house” stock or fund is sold to finance the purchase of another. A “house” stock or fund is one in which the brokerage firm maintains a position or has sponsored and recommends frequently to its customers because it makes a greater profit on such sales than on other securities. The firm motivates its brokers for such house stock transactions by offering them a greater share of the mark-up or commission involved than the broker would receive for other transactions that are not “house” stocks or funds. Even one such switching transaction can be the basis for a claim of churning. Your broker’s sales of energy industry stocks that resulted in purchases of other energy industry stocks with the proceeds of the sales would have led to substantial losses in your account when the energy industry recently suffered a meltdown. Those losses may be recoverable in FINRA arbitration proceedings you can bring against your brokerage firm.
Claims for proceeds trading, as with other claims against stock brokers and brokerage firms, are almost invariably resolved in arbitration or mediation through FINRA, the Financial Industry Regulatory Authority. This is because when you opened your brokerage account you were required to sign an opening account agreement that contains a mandatory arbitration clause. It is in bold print on the form you signed. The arbitration clause is routinely enforced by the courts.
Customers need to look at their statements each month and, if a sale is immediately followed by a purchase of a similar security or a different security in a related industry, the broker should be asked to justify the rationale for the transactions. This should be done in writing, although brokers are supposed to make written note of any customer complaint, written or oral. Brokers rely on the passage of time to show that their customers ratified the transactions, arguing that the customer only complained later when losses were suffered. Customers should monitor the confirmations and monthly statements they receive for any signs of suspicious activities. We have often been able to amicably resolve customer issues with their brokers through correspondence, conferences and mediation, so that is almost always worth considering.
If you have any questions about proceeds trading or would like to discuss any other broker negligence or investment fraud concerns, please contact me at dbrecher@sh-law.com
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