Churning (Excessive Trading)

Both broker-dealer (BD) and investment adviser (IA) state rules prohibit churning, but the NASAA text is narrower than many exam-takers expect: it asks one question, not a three-part test.

What Does NASAA's Churning Provision Actually Require?

• Churning means inducing transactions in a customer or client account that are excessive in size or frequency in view of the customer's financial resources and account character
• The investment adviser version of the rule also names the client's investment objectives, and it notes that an adviser can directly benefit from the number of transactions, since fee-per-trade advisers profit from turnover
• Applies to both broker-dealers and investment advisers under their respective NASAA dishonest-practices standards

Exam Tip: Gotchas

• NASAA's text does not list control, scienter, or a numeric turnover threshold as elements. Control (actual or de facto), intent or recklessness, turnover, cost-to-equity, and commission patterns can be relevant evidence under other, broader antifraud churning authorities, but a question that asks specifically what NASAA's broker-dealer or adviser provision requires is answered by "excessive in size or frequency," full stop.

Evidence Regulators Look At (Not Separate Legal Elements)

• High turnover ratio: repeated buying and selling relative to average account equity. NASAA sets no fixed ratio that automatically proves or disproves churning; a turnover figure is evidence to weigh, not a trigger number
• High cost-to-equity ratio: the cost of trading relative to the account's equity
• Frequent in-and-out trading: buying and selling the same or similar securities in rapid succession
• A pattern of trading that primarily generates commissions rather than profits for the customer
• Control: whether the professional directed the trading, either through formal discretionary authority or de facto control (the customer routinely follows every recommendation without independent judgment)

Exam Tip: Gotchas

• Do not treat 2/4/6 as NASAA turnover thresholds. A question may describe a turnover ratio of 6, but NASAA's provision does not deem any specific ratio "conclusive." The ratio is one fact to weigh against the customer's resources and account character.
• Independent customer trading cuts against a churning finding, since the rule turns on the firm having induced the excessive activity. If the customer devised and placed every order without the professional's input, induced excessive trading is hard to establish even at high turnover.

Churning vs. Suitability

These are related but distinct concepts:

Exam Tip: Gotchas

• A suitable trade can still be part of churning. Suitability evaluates each recommendation individually; churning evaluates the account as a whole. An agent can recommend individually reasonable trades while still generating an overall pattern that is excessive.

What Should You Check on Exam Day?

• If a question asks what NASAA's own churning provision requires, answer with "excessive in size or frequency" relative to resources and account character (add investment objectives for the adviser version). Do not import control or scienter as required elements unless the question is explicitly testing a broader antifraud framework.
• No turnover ratio is automatically conclusive under NASAA's text; treat any stated ratio as evidence, not a bright line.
• Suitability judges one recommendation; churning judges the whole account, even when every individual trade was suitable.