Churning is the only way to complete a fraud operation. The other broker-related stock frauds include misrepresentation/omission methods, unsuitability of stocks and overconcentration. The very knowledge about them will help you to find out if you are cheated.
- A misrepresentation/omission form of fraud occurs when a broker intentionally misleads you about material facts, regarding the stock. A stock fraud, involving misrepresentation or omission, often hides risk factors, associated with every particular stock.
- Unsuitability stock frauds may take place when brokers recommend stocks that are outside the client's risk tolerance. Pushing undesirable stocks, a broker obtains his percent of profit, a client, however, has losses and they are usually much higher than he can bear.
- In order to protect a client's assets, a broker should vary the types of stocks, purchased and diversify a client's portfolio. Failure to vary the portfolio can also be a form of stock fraud; overconcentration strips are not desirable, when avoiding frauds.
We have finally come to churning. A usual situation, leading to enormous accounts payable and making churning possible, appears when a company is growing its sales faster than it can finance them. Some brokers with a discretionary authority over an account use an unethical practice of churning to increase the commissions. Churning, like any fraud, is done to benefit a broker rather than an investor, as the only purpose is to increase commissions and not the client's profits. If there is no legitimate purpose for a trade, it can be considered to be churning. A warning sign is seen when there are transactions without any gains in the portfolio value of yours.
The only way to save your investments from overtrading (churning) is to have a wrap account opened. A wrap account, in its turn, means an account, by which a broker manages a portfolio in exchange for a flat fee. A wrap account will protect you from overtrading risks, since a broker gets nothing, but an annual fee you pay him, which is advantageous to your portfolio. You need your money to work for you primarily and it seems to be a way out. Still, any person, and brokers are not the exception, needs to be controlled; thus, it would be better for you if you are always aware of what is going on in your portfolio.
If churning has had place and you need to prove it, you need to show that the pattern of the trading activity in your account was excessive. It can be done in several ways: calculations, concerning the annualized rate of return to cover the commissions and the number of equities movements in your account can inform you whether you are being fraud.
All forms of stock fraud are designed to violate the investor/broker's trust. For a fraud broker the investor's interest are secondary in front of his own interests and financial gain. The more you know about the types of frauds and the ways to avoid them, the more you save during your investing processes. The larger are the levels of stock frauds, the more harm they bring, destroying entire companies by manipulating their stock values. Using the same tactics and fraud schemes, however, keep failing businesses funded. Therefore, a smart interpretation and use of fraud methods can bring profits in your legal actions. Latin "Scientia - potentia est" remains the only truth.