The Risks of Brokerage Churning and Regulatory Failures in Retail Investor Protection

Brokerage churning-the excessive trading of customer accounts to generate commissions-remains a persistent threat to retail investors, eroding returns and undermining trust in financial markets. Recent enforcement actions by the Financial Industry Regulatory Authority (FINRA) reveal systemic compliance weaknesses and a troubling pattern of regulatory failures, despite heightened scrutiny. As data from 2024 enforcement actions demonstrates, firms continue to neglect critical supervisory obligations, leaving investors vulnerable to predatory practices.

A Surge in Enforcement, But Systemic Gaps Remain

In 2024, FINRA imposed 15 "supersized" fines of $1 million or more, reflecting a 22% increase in disciplinary actions compared to 2023. However, the total value of fines dropped by 35% to $59 million, largely due to a one-time $24 million penalty in 2023. This shift underscores a regulatory pivot toward restitution over punitive fines, with investor compensation rising by 207% to $23 million in 2024. While this focus on redress is commendable, it also highlights a broader issue: firms are often allowed to continue operating despite repeated failures to detect and prevent misconduct.

For example, Western International Securities was fined $475,000 for failing to establish adequate supervisory systems to monitor excessive trading between 2016 and 2020. The firm's written supervisory procedures (WSPs) lacked guidance on evaluating cost-to-equity ratios-a key metric for identifying churning-and allowed accounts to incur ratios as high as 55%, with one client losing over $1.5 million in trading costs. Similarly, Spartan Capital Securities faced allegations of allowing 1,200 accounts to exceed a 20% cost-to-equity ratio, generating $46 million in revenue while inflicting $8 million in losses on investors. These cases illustrate a recurring failure: firms either ignore red flags or lack the systems to identify them in the first place.

Cost-to-Equity Ratios: A Critical Red Flag

FINRA has long emphasized cost-to-equity ratios and turnover rates as indicators of churning. A ratio exceeding 20% or a turnover rate of six or higher typically signals excessive trading. Yet, enforcement actions reveal that firms often fail to act on these metrics. In one case, broker Charles Malico churned a client's account to a 158% cost-to-equity ratio, generating $54,000 in commissions-a practice FINRA deemed a clear violation.

The financial toll on investors is staggering. Spartan Capital's alleged churning practices, for instance, resulted in $10 million in trading costs and $8 million in investment losses. Such outcomes not only devastate individual portfolios but also erode confidence in the integrity of brokerage services. When investors perceive that their accounts are being manipulated for a firm's profit, trust in the system deteriorates, potentially deterring participation in capital markets.

Regulatory Failures and the Need for Stronger Oversight

The 2024 enforcement data also exposes broader regulatory shortcomings. Spoofing, trade reporting inaccuracies, and technological errors contributed to systemic compliance gaps, with one firm fined $1.4 million for providing flawed interest rate data due to coding errors. Meanwhile, the failure to fingerprint non-registered individuals-a basic compliance requirement-led to a $1.25 million penalty for a firm that neglected to screen 3,980 individuals(https://www.eversheds-sutherland.com/en/united-states/insights/2024-finra-sanctions-study). These cases suggest that even foundational compliance protocols are frequently overlooked.

FINRA's emphasis on restitution, while laudable, cannot substitute for proactive oversight. The 2024 sanctions study notes that total monetary sanctions-including fines, restitution, and disgorgement-fell to $87 million, a 14% decline from 2023. This trend raises questions about whether regulators are adequately deterring misconduct. Strengthening supervisory requirements, such as mandating real-time monitoring of cost-to-equity ratios and turnover rates, could help close these gaps. Additionally, imposing stricter penalties for repeated violations might compel firms to prioritize investor protection over short-term profits.

Investor Vigilance: A Necessary Countermeasure

While regulatory reforms are essential, investors must also remain vigilant. Understanding key red flags-such as unusually high trading activity, unexplained losses, or excessive margin usage-can empower retail investors to challenge suspicious practices. For example, Spartan Capital's clients were repeatedly flagged in active account exception reports, yet supervisors failed to intervene. Had investors scrutinized these reports and raised concerns, the firm's misconduct might have been curtailed earlier.

Investors should also demand transparency from their brokers. Requesting detailed trade confirmations, reviewing account statements regularly, and questioning the rationale behind frequent trades can help identify churning. FINRA's guidance on suitability obligations provides a useful framework for evaluating whether trading activity aligns with an investor's financial goals.

Conclusion

Brokerage churning and regulatory failures pose a dual threat to retail investors: financial harm and systemic distrust. The 2024 enforcement actions underscore the need for stronger supervisory systems, stricter penalties for non-compliance, and a regulatory focus on proactive oversight. At the same time, investors must take an active role in safeguarding their interests by recognizing red flags and demanding accountability. Without a combined effort from regulators and investors, the risks of churning-and the erosion of trust it entails-will persist.