Broker-Client Relationship

A Unique Relationship

In most states the stockbroker-client relationship is unique and is designed to benefit and protect the investor. Many states impose a fiduciary duty upon financial advisors who make recommendations and investments on behalf of clients.

This fiduciary duty means that brokers are at all times required to act for the sole benefit and interest of the client. Under this requirement a broker is more than just an order taker. He has an affirmative duty to act, and look out for the interests of his or her clients.

The Issue of Commissions

This fiduciary duty often comes into conflict with the way financial advisors are compensated. Most advisors are compensated by getting paid commissions. Commissions are paid only when a transaction is made, and not for spending time with a client. Unfortunately, advisors are paid whether an investment is consistent with a client’s objectives, and whether the investment is successful or not.

Commission levels vary with the type of investment sold. Typically an advisor makes 1-2% for mutual fund sales 3-4% for stock sales, and 8-10% for direct participation investments, like REITs, oil and gas programs, or equipment leasing deals. Don’t hesitate to ask your advisor what his commission level is on a transaction.

Is Your Account Active?

Every time a transaction is made in a traditional brokerage account (and even many managed accounts), a commission is charged. The securities industry attempts to keep track of the average number of transactions executed in a typical customer’s account. In recent years various industry studies have indicated that the typical account is “turned over” 1.3 times per year. This means that in a $100,000 account, there will likely be $130,000 in purchases executed in the account for the year. This ratio of 1.3X does not mean that this level of turnover is appropriate or suitable for any individual. Many investors prefer a buy and hold strategy, and some investors may choose a more aggressive approach.

Six Times Turnover?

The industry consensus on when an account goes from being active to the presumption it has been abused is when an account is turned over six times in a calendar year. In the example above, if that $100,000 account generated $600,000 in purchases in a year, that equals a “six times” turnover ratio. If the financial advisor controlled the account i.e. made most or all of the purchases, there is a presumption the account was traded excessively or “churned.” Churning implies a broker acting to maximize commissions without regard to his clients well being or safety. Churning or excessive trading is a violation of federal, state and industry regulations.

The professionals at The Law Office of David Liebrader can do a churning analysis as part of our initial face to face, free consultation. You will need to have all your monthly statements and trade confirmations in order to complete the task. If these documents are unavailable, they can be requested from the brokerage firm.