Churning And Suitability Of Investments: A Financial Industry Regulatory Authority Arbitration Case Study

The identities of all parties in this matter have been changed to maintain confidentiality. An investor claimed that a broker at a well established securities firm was churning her account and had placed her funds in an account that was not suitable, given her investment objectives. She retained legal counsel. Her attorneys hired a consultant who wrote a report that discussed whether the investments were suitable, as well as whether there was excessive trading. The consultant’s report and ultimately the author’s testimony were expected to be introduced as evidence in Financial Industry Regulatory Authority (FINRA) arbitration. Ms. Laura Smith, a 72 year old retired widow, opened a brokerage account with Establishment Securities in March 1997, in response to a telephone solicitation from George Shady, an Establishment registered representative. Ms. Smith’s primary investment account was with another securities firm. In March 2000, Ms. Smith transferred her primary investment account to Establishment Securities in response to another telephone solicitation from Mr. Shady. Based upon a review of documents that Ms. Smith signed when the Establishment account was created, Ms. Smith had specified that the account was nondiscretionary, meaning that Mr. Shady could not make trades or changes to her portfolio without her permission and that her investment objectives were income and growth. Subsequently by 2003, Ms. Smith noticed that there was unusual activity in her account, which prompted the legal action discussed in this paper. In particular, Ms. Smith’s legal counsel filed claims against Establishment Securities alleging that her account had been churned and that her investments were not suitable, relative to her investment objectives. Pursuant to the agreement originally signed in the brokerage agreement, the parties agreed to settle disputes according to FINRA Code of Arbitration. This case study is appropriate for Senior Level and Graduate students of Accounting and Finance.