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4.3 Churning and Unauthorized Trading

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Series 63 Uniform Securities Agent State Law

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1 Introduction

About the Series 63 Exam How to Use This Guide

2 Chapter 1: USA Definitions

1.1 Key Terms Overview 1.2 Definition of Person 1.3 Definition of Security 1.4 Offer and Sale 1.5 Exclusions from Definitions

3 Chapter 2: Registration of Persons

2.1 Broker-Dealer Registration 2.2 Broker-Dealer Exemptions and Exclusions 2.3 Agent Registration 2.4 Agent Exemptions and Exclusions 2.5 Investment Adviser and IAR Registration 2.6 IA and IAR Exemptions

4 Chapter 3: Registration of Securities

3.1 Registration Methods Overview 3.2 Registration by Coordination 3.3 Registration by Qualification 3.4 Registration by Filing (Notice Filing) 3.5 Exempt Securities and Transactions

5 Chapter 4: Fraudulent and Unethical Practices

4.1 Anti-Fraud Provisions 4.2 Prohibited Business Practices 4.3 Churning and Unauthorized Trading 4.4 Misrepresentation and Omissions 4.5 Market Manipulation 4.6 Insider Trading and Front-Running

6 Chapter 5: Administrative Provisions

5.1 State Administrator Powers 5.2 Investigations and Subpoenas 5.3 Administrative Orders 5.4 Cease and Desist and Injunctions 5.5 Criminal and Civil Penalties

4.3 Churning and Unauthorized Trading

Key Takeaways Explain This Topic AI

Churning requires control, excessive trading, and intent.

Turnover ratios above 6 are strong churning indicators.

Cost-to-equity ratios above 10% are red flags.

Unauthorized trading violates non-discretionary rules.

Time and price discretion alone is not true discretion.

Last updated: January 2026

Churning and unauthorized trading are two serious violations that can result in significant penalties for securities professionals. Both practices harm customers and violate the trust relationship between financial professionals and their clients.

What Is Churning?

Churning (also called "excessive trading") occurs when a securities professional engages in frequent buying and selling in a customer's account primarily to generate commissions, rather than to benefit the customer.

Elements of Churning

For churning to exist, three elements must typically be present:

  • Element Description
  • Control The agent must have control (explicit or implicit) over the account
  • Excessive trading The trading activity must be excessive given the customer's objectives
  • Intent The trading must be primarily for generating commissions
  • Control Over the Account

Control can be either:

  • Explicit control : The agent has formal discretionary authority over the account
  • Implicit control : The customer routinely follows the agent's recommendations without independent judgment

Exam Tip : Churning can occur even in non-discretionary accounts if the agent has de facto control because the customer always follows recommendations.

Measuring Excessive Trading

Several metrics are used to identify potentially excessive trading:

Turnover Ratio

The turnover ratio measures how many times the equity in an account has been turned over during a period.

Formula : Total Purchases ÷ Average Account Equity

  • Annual Turnover Interpretation
  • 2-4 Generally normal for active accounts
  • 4-6 Potentially excessive; warrants review
  • 6+ Strong indication of churning
  • Cost-to-Equity Ratio

The cost-to-equity ratio (also called "break-even analysis") calculates the annual return the account must earn just to cover transaction costs.

Formula : Total Annual Costs ÷ Average Account Equity

  • Cost-to-Equity Interpretation
  • Under 5% Generally reasonable
  • 5-10% Potentially problematic
  • Over 10% Strong indication of churning
  • In-and-Out Trading

In-and-out trading involves buying and selling the same security within a short period. While not always improper, frequent in-and-out trading can indicate churning.

Customer's Investment Objectives

The customer's stated investment objectives are crucial in determining whether trading is excessive:

  • Objective Expected Activity
  • Long-term growth Lower trading frequency
  • Income Lower trading frequency
  • Speculation Higher trading acceptable
  • Day trading High frequency expected

Key Point : High turnover in an account with conservative, long-term objectives is more likely to constitute churning than the same activity in a speculative account.

Unauthorized Trading

Unauthorized trading occurs when an agent executes transactions in a customer's account without proper authorization.

Types of Accounts

  • Account Type Authorization Required
  • Non-discretionary Customer must authorize each transaction before execution
  • Discretionary Agent may trade without prior approval for each transaction
  • Requirements for Discretionary Authority

To exercise discretion over a customer account, an agent must have:

  • Written authorization from the customer (trading authorization or power of attorney)
  • Acceptance by the broker-dealer (firm must approve)
  • Proper documentation on file

What Constitutes "Discretion"?

Discretion means the authority to determine:

  • Which security to buy or sell
  • The number of shares or units
  • Whether to buy or sell

Important Exception : If a customer specifies the security, action, and amount, but leaves only the timing and/or price to the agent, this is NOT considered discretion. For example: "Buy 100 shares of ABC whenever you think the price is right" does not require written discretionary authority.

Time and Price Exception

The time and price exception states that if a customer specifies:

  • The security
  • The action (buy or sell)
  • The quantity

And only gives the agent discretion over timing and/or price, written discretionary authority is not required .

Customer Instruction Discretionary Authority Required?

  • "Buy some stocks for me" Yes
  • "Buy 100 shares of XYZ today" No
  • "Buy 100 shares of XYZ at the best price" No (time/price exception)
  • "Buy some XYZ for me" Yes (quantity not specified)
  • Consequences of Violations

Both churning and unauthorized trading can result in:

  • For the Agent/Adviser
  • Suspension or revocation of registration
  • Civil penalties and fines
  • Criminal prosecution
  • Requirement to pay restitution
  • Permanent bar from the industry
  • For the Broker-Dealer/Firm
  • Supervisory failures
  • Fines and penalties
  • Reputation damage
  • Required enhanced supervision
  • Key Takeaways
  • Churning is excessive trading primarily to generate commissions
  • Three elements of churning: control, excessive trading, and intent
  • Turnover ratios above 6 and cost-to-equity ratios above 10% are strong indicators of churning
  • Unauthorized trading is executing transactions without proper authorization
  • Discretionary authority requires written customer authorization and firm approval
  • The time and price exception: if only timing/price is discretionary, no written authorization needed
  • Both violations can result in civil, administrative, and criminal penalties

Turnover Ratio Flags (Annual)