Financial Abuse and Exploitation? (Part 1 of a 3 part series)

By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold, NJ Estate Probate Litigation Attorney

Most financial advisors are ethical and well intentioned towards their clients and their finances. I know this from professional experience. They are terrific! But not all. Recently I was confronted with a case that appeared to be a classic case of “churning” by a stock broker…

This caused me to do some research on the subject. I found very little NJ case law on churning. Of the NJ cases I found none of them offered a detailed framework for when a broker can be held liable for churning a client’s account(s). As I continued searching, various federal courts around the country cited the cases I reference below. For practical purposes, I reference the cases with the most detailed legal discussions of churning.

Here were the legal questions presented:

  • How can a person hold independent salesmen and saleswomen liable for churning their brokerage accounts?
  • If the salesman is bankrupt, can the insurance company who approved the transaction(s) to sell their financial products be held liable?

The short answer:

A cautious “Yes”. A claim that the broker breached his or her common law fiduciary duty as a broker to a client can ask for compensatory and punitive damages. The client can also claim that the broker violated federal securities laws under section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j and S.E.C. Rule 10b-5.

If the broker is bankrupt, or judgement proof, the companies who approved him to sell their financial products can be held liable under the doctrine of respondeat superior or controlling person liability.

An Overview about the Law of Churning:

In general, churning occurs when a securities broker enters into transactions and manages a client’s account for the purpose of generating commissions and in disregard of his client’s interests. Miley v. Oppenheimer & Co., 637 F.2d 318, 324 (5th Cir. 1981). “Once an investor proves that: (1) the trading in his account was excessive in light of his investment objectives; (2) the broker in question exercised control over the trading in the account; and (3) the broker acted with the intent to defraud or with willful and reckless disregard for the investor’s interests, the broker may be held liable for violation of the federal securities laws under section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j and S.E.C. Rule 10b-5. Id.

Both punitive and compensatory damages are commonly awarded in churning cases. The court notes that punitive damages may be awarded if allowable under state law when a state violation is joined with the federal violation.

The core issue, however, is how exactly the court determines how much to award the plaintiff in these cases.

In the case, the court used the formula: “by a preponderance of the evidence the difference between the amount of plaintiff’s original investment and dividends therefrom less any withdrawals received by Mrs. Miley and less the ending value of the client’s account with the defendant broker. This amount is to then be reduced by the average percentage decline in value of the Dow Jones Industrials or the Standard and Poor’s Index during the relevant period of time.” Id. at 328.

In simpler terms, the court essentially needs to, “…estimate how the investor’s portfolio would have fared in the absence of such misconduct.” Id.

In part 2 we will dive into the elements of churning.

To discuss your NJ Estate Probate Litigation matter, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at fniemann@hnlawfirm.com.  Please ask us about our video conferencing consultations if you are unable to come to our office.