New York Securities Lawyer Blog
On October 18, 2016, the Securities and Exchange Commission (“SEC”) issued cease-and-desist proceedings pursuant to Section 8A of the Securities Act of 1933 (“Securities Act”), Sections 15(b), and 21C of the Securities Exchange Act of 1934 (“Exchange Act”), Section 203(f) of the Investment Advisors Act of 1940 (“Advisors Act”), and Section 9(b) of the Investment Company Act of 1940 (“Investment Company Act”) against Paul T. Lebel. Mr. Lebel was a broker and former representative of registered broker-dealer and investment advisor, LPL Financial LLC (“LPL”). The Order alleges that Mr. Lebel churned client accounts by purposely and excessively trading mutual fund shares and other class A shares that carry large front-end load fees and therefore generate large commissions. Such shares are intended to be part of a buy and hold strategy, and not traded at a high frequency. Mr. Lebel has submitted an Offer of Settlement (the “Offer”), in response to the SEC issuance and the SEC has accepted and granted terms for this offer.
Churning occurs when, in pursuit of commissions, a broker causes securities in a customer’s account to be traded at a frequency that does not reflect the customer’s best interest or financial needs. There are three components necessary for a churning ruling to be established: (1) is broker control of trading activity either through direct written trade placement, or through de facto discretionary authority (i.e. the broker recommends to the client which trades to make and the client regularly agreed to every trade recommended); (2) the broker engaged in excessive trading contrary to client investment objectives and risk tolerances; (3) the broker acted with scienter in that he or she willfully engaged in this trading activity with reckless disregard for costumer interests, usually in pursuit of commissions.
A frequent statistical test used in determining whether churning has occurred on an account is the “turnover ratio.” The turnover ratio is the ratio of the total cost of security purchases made relative to the average monthly dollar amount in the account. While courts have not defined a specific ratio that constitutes churning, for example, any ratio over six (6) is considered excessive trading, and in conjunction with other evidence such as broker scienter can be grounds for a churning claim. Another tool used to measure churning is the ‘break-even’ metric: the amount an investment would have to earn in returns in order to cover the fees of placing it. If an investment has to appreciate by more than 8% to cover fees it is considered excessive trading. If it has to appreciate by more than 12%, the metric is conclusive evidence of churning. In summary, if trading transaction costs are high enough that there is little reasonable expectation that the account could achieve a consistent positive rate of return, the broker must justify the trading conducted. Additionally, while damages on churning are limited to commissions and interest, a plaintiff can bring a claim regarding the suitability of investments (which is often applicable in churning cases, given that brokers will trade whatever securities earn them the highest commissions rather than what suits the financial needs of their client) and additional damages related to trading losses may be awarded.
Mr. Lebel defrauded four customers at LPL by churning their accounts for a total of $50,037 in commissions. The Order alleges that Mr. Lebel traded numerous mutual fund A shares that violated SEC suitability provisions, and which met the criteria of churning. Mr. Lebel agreed to disgorgement of fees in the full amount of $50,037.00 plus prejudgment interest of $6,489.00. However, due to the Mr. Lebel’s Statement of Financial Condition and lack of funds, $10,000 shall be paid over the course of quarterly installments.
The attorneys at Lax & Neville LLP have extensive experience in successfully prosecuting claims on behalf of customers who have suffered losses as a result of sales practice abuses, such as churning and investment and securities fraud. If you are a victim of fraud, please contact Lax & Neville LLP today at (212) 696-1999 to schedule a consultation.