FINRA Bars Broker Over Allegations of Churning (Excessive Trading) and Unauthorized Trading in Customer Accounts

The Financial Industry Regulatory Authority (FINRA) has barred Chad David Kelly (Kelly) concerning allegations of churning (excessive trading) and unauthorized trading.  “Churning” is excessive investment trading activity that serves little useful purpose or is inconsistent with the investor’s objectives and is conducted solely to generate commissions for the broker.  Churning is also a type of securities fraud.

FINRA alleged that Kelly willfully violated Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act of 1934”), Rule 10b-5, and violated FINRA Rules 2020, and 2010, NASD Rules 2120, 2110, 2310, and IM-2310(a) and (b).

According to FINRA, excessive trading violation occurs when: 1) a broker has control over the account and the trading in the account, and 2) the level of activity in that account is inconsistent with the customer’s objectives and financial situation.  Where an intent to defraud or reckless disregard for the customer’s interests is present the activity is also churning.  Section 10(b) of the Exchange Act of 1934 prohibits the use of “any manipulative or deceptive act or practice” in connection with the purchase or sale of a security and Rule 10b-5 prohibits “any device, scheme, or artifice to defraud.”  NASD Rule 2310(a) provides that when recommending the purchase, sale, or exchange of any security a broker “shall have reasonable grounds for believing that the recommendation is suitable for such customer…”  A broker’s recommendations must “be consistent with his customer’s best interests.” NASD IM-2310-2(a)(1) also require that the broker must “’have reasonable grounds to believe that the number of recommended transactions within a particular period is not excessive.”  NASD IM-2310-2(b)(2) prohibits brokers from excessively trading in customer accounts.

FINRA alleged that Kelly’s customers relied entirely on his investment advice and Kelly exercised de facto control over their accounts.  In addition, the level of activity in the customers’ accounts was inconsistent with the customers’ objectives and financial situation.

From August 2000, to May 2006, Kelly was registered with Morgan Stanley.  From May 2006 until July 2010, Kelly was registered Wells Fargo Advisors, LLC.  In July 2010, Wells Fargo terminated Kelly for “failing to discuss transactions with non-discretionary clients prior to execution and excessive trading in client accounts.”  From September 2010, until October 2011, Kelly was associated with Petersen Investments, Inc.

FINRA alleged that between October 2006, and June 2010, Kelly engaged in unsuitable excessive trading, churning (excessive trading, and made unauthorized trades in at least six customer accounts.  Most of the customers were unsophisticated, with no education beyond the high school level, had annual income levels of less than $100,000, and a total net worth of under $500,000.  The customers lost a significant percentage of their retirement savings.

The two most common indicators used to determine a claim of excessive trading and churning are the turnover ratio and the cost-to-equity ratio.  These ratios attempt to measure whether the activity in the account bears indications of activity designed merely to generate commissions.  FINRA alleged that the trading activity in the customers’ accounts at issue average annualized cost-to-equity ratios of over 30% and average turnover rates of 5.47.  For two customers, the average turnover rates for this period exceeded 6 and was as high as 8.3 at times.  Kelly also generated more money in commissions in two customer accounts than the accounts had equity.  In total, Kelly made over $73,000 in commissions while the customer accounts suffered losses of approximately $37,000.

In addition, Kelly made unauthorized trades in at least 15 additional customer accounts.  A broker is always responsible for obtaining the customer’s consent prior to purchasing or selling a security in a customer’s account unless the account is authorized for discretionary trading.  Unauthorized trading in a customer’s account violates NASD Rule 2110 and FINRA Rule 2010.

The attorneys at Gana Weinstein LLP are experienced in investigating claims of excessive trading and churning.  Our attorneys can help you detect and uncover suspicious activity in your accounts.  Our consultations are free of charge and the firm is only compensated if you recover.

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