Illegal Investment Schemes Investors need to know about: Churning, Pump & Dump
What is churning?
In investment-speak, “churning” is when a broker engages in excessive trading within an investor’s account. Trades generate commissions for brokers, and excessive trading is the pursuit of excessive profits for the broker at the expense of the client/investor. Churning is not only unethical, but illegal according to the Securities Exchange Commission: SEC Rules 15c(1-7)
Churning tends to have a negative impact on the client, often in the form of dwindling account balances and heavy financial losses. If the excessive trading is not depleting the client’s account, but rather resulting in very rapid profits for the client, it can then create a tax liability for the investor.
How do you know if your broker is trading excessively or just the right amount?
The term “excessive” can be difficult to measure. Here are some ways you can detect excessive trading:
- You are sustaining heavy financial losses that don’t seem to match the market trends.
- You are receiving a high volume of notices about transactions made in your account. An investor with a conservative profile should not see a large number of trades in a short period of time in their accounts. The investment firm is required to send you notice after every transaction. Keep track of how often you are receiving transaction notices. This includes exchanges regarding your mutual funds or annuities.
- The trades your broker is making don’t seem like they match your investment profile or objectives. Are you a conservative investor but your broker is investing in high risk, volatile stocks? Make sure the trades in your accounts aren’t in conflict with your investment objectives.
- Your broker will not provide you the documentation you are requesting. It is a requirement that brokers have accurate bookkeeping and records of their trades. It is also a requirement that you receive notices of trade transactions, and of mutual fund and annuity exchanges.
- You have detected discrepancies in your broker’s bookkeeping. “Mismarking” is when a broker documents that a trade was initiated by the client (called an unsolicited trade), when in fact it was recommended by the broker (a solicited trade). It is more difficult for the broker to be held accountable for a bad trade if the broker has concealed that it was the broker who recommended the trade.
What is “pump and dump” in the investment world?
The phrase “pump and dump” or P&D refers to an illegal investment scheme that violates securities laws.
The investment advisor, broker, or securities dealer will “pump” the hype of a stock to a number of clients, recommending they invest using false, misleading or exaggerated statements about the stock’s value or expected growth. Increased investments in the recommended stock will result in the boost of the stock’s price, thereby inflating a stock’s value. The broker or advisor will already have had a strong position in the company’s stock as well, and will sell (or “dump”) their positions after their actions have led to a higher share price. This typically results in the stock price suddenly plummeting, often to a lower rate than its original selling price. The clients who were talked into investing will usually suffer heavy financial losses because they are unable to sell their shares in time.
The recent film “The Wolf of Wall Street” is an excellent example of manipulation of customers and stocks through P&D, where firms and their brokers turned huge profits at the expense of their customers. This short video by One Minute Economics provides a short illustration of how these schemes can work.
Do you suspect your broker of Churning or Pump & Dump?
The SEC has information available about how to file a complaint and what to expect from SEC involvement. If you suspect you may have been a victim of churning or P&D, Contact a Fishman Investment Fraud Lawyer to learn more about recovering your losses.
