The Financial Industry Regulatory Authority (FINRA) fined and suspended broker Douglas Dannhardt (Dannhardt) concerning allegations that between January 2010, and December 2011 Dannhardt engaged in several different violations of the industry’s rules including: 1( excessive and unsuitable trading in three IRA accounts (also known as churning); 2) improperly exercising discretion in these three accounts by executing transactions days and weeks after obtaining customer approval; 3) accepting trade orders for a customer’s account from a third party without written authorization.
Dannhardt became associated with a FINRA firm in 1984. From March 1995 through December 2013, Dannhardt was employed by Prospera Financial Services. Inc, (Prospera). The firm filed a Form U5 for Dannhardt as a result of his voluntary resignation from the firm.
Under the FINRA rules excessive trading occurs when: (1) a broker exercises control over a customer’s account: and (2) the amount of trading activity in that account is inconsistent with the customer’s investment objectives, financial situation, and needs. This conduct violates FINRA’s suitability standards. When making such a determination FINRA looks to see if the trading in an account can becomes so quantitatively unsuitable by unreasonably raising the costs associated with the investment strategy to the point where the additional risk in order to generate the return is not offset by those costs.
Two metrics commonly used to measure excessive trading include the account’s “annualized turnover ratio” and its “cost to equity ratio.” The cost-to-equity ratio represents the percentage of return on the customer’s average net equity needed to pay commissions and expenses over a given period of time just to break even.
FINRA found that Dannhardt exercised control over three IRA accounts a customer and used this control to excessively trade these accounts in a manner that was inconsistent with the customer’s investment objectives, financial situation, and needs. Specifically. FINRA alleged that Dannhardt engaged in a strategy that was predicated on short-term “scaling in and scaling out’ of closed-end mutual funds. FINRA found that Dannhardt would liquidate or reduce three to five positions in the accounts at issue during any given month and would then purchase or sell these positions in a series of transactions executed over several days or even weeks.
The number of trades, the performance, and the annualized cost-to-equity ratio for these accounts was found to be excessive and with ratios measuring between 23-26.8% annualized causing over $100,000 in losses. Each of the accounts was designated as having a conservative to moderate risk tolerance. FINRA found that by requiring a minimum return of 23% just to break even Dannhardt’s closed-end fund trading strategy was unsuitable for these accounts.
In addition, brokers are not allowed to exercise any discretionary power in a customer’s account unless the customer has given prior written authorization and the account has been accepted by the firm on that basis as evidenced in writing. FINRA found that Dannhardt was not approved to exercise discretion in any customer accounts but that he routinely obtained authorization to acquire and liquidate a particular position in a customer’s accounts and executed these transactions in the days or weeks after he had obtained authorization.
In order for an exercise of time-and-price discretion to be valid a trade must be executed on the same day that authorization was received. By executing trades outside of the same-day window required for the exercise of time-and-price discretion FINRA alleged that Dannhardt violated industry rules.
Investors who have suffered losses may be able recover their losses through securities arbitration. The attorneys at Gana Weinstein LLP are experienced in representing investors in cases of excessive trading and brokerage firms failure to supervise their representatives. Our consultations are free of charge and the firm is only compensated if you recover.