Churning

A broker earns brokerage every time a client trades. That creates a temptation: trade the client's account more than the client needs, and the broker earns more whether or not the client does.

The workbook's definition: "Churning" refers to when securities professionals make unnecessary and excessive trades in customer accounts for the sole purpose of generating commissions.

Three words carry the definition:

• Unnecessary — the trades do not serve the client's objectives.
• Excessive — the volume is out of proportion to the account.
• Sole purpose of generating commissions — the motive is the intermediary's income.

The defence the workbook gives the investor is simple and practical: review your monthly account statements and investigate any abnormally high trading activity.

Churning sits in Chapter 10 alongside other abuses the workbook warns investors about — promises of high return or risk-free investments, unsuitable investment recommendations, and unsuitable products pitched at investor seminars.

It is worth separating it from its nearest neighbour:

Both can happen together, and derivatives make both easier, because leverage lets a small account generate large traded value.

The broader Chapter 10 framework is the guard against it: the broker must understand the client's risk profile, issue and obtain a signed Risk Disclosure Document, and recommend F&O only where it reasonably believes the client can evaluate and bear the risks. The investor's own safeguards are to review statements, insist on contract notes, and complain through the exchange and then SCORES if unresolved.

Illustrative. The client, account size and trade counts are hypothetical. The brokerage rate is the 0.03% the workbook itself uses in its trading-cost example and describes as only illustrative.

Mrs Lakshmi Rao, 67, opens an account with Rs 5,00,000 and asks for occasional, low-risk investing.

Her statement for one month shows 40 round-trip futures trades, each of one lot with a contract value of Rs 8,75,000 (the workbook's own example contract).

Brokerage per side      = 0.03% × 8,75,000     = Rs 262.50
Brokerage per round trip= 262.50 × 2           = Rs 525
Brokerage for the month = 525 × 40             = Rs 21,000

That is 4.2% of her capital in brokerage alone, in one month — before STT, exchange charges, GST and any trading losses.

Two problems are visible:

1. Churning — 40 round trips a month in an account meant for occasional investing is unnecessary and excessive, and the only certain beneficiary is the broker.
2. Unsuitable recommendation — futures at all, for a 67-year-old with low risk tolerance, is the workbook's own example of unsuitability.

Reviewing the monthly statement is exactly how she, or her family, would spot it.

Chapter 10 (Sales Practices and Investor Protection Measures) defines churning in its opening list of investor cautions, next to unsuitable investment recommendations. Section 10.2 and the Chapter 8 rules on the Risk Disclosure Document set the suitability duties that churning breaches, and section 10.4 covers the complaint route. Expect a definition question, often with "unsuitable recommendation" as the distractor.

• Churning is about trading frequency for commission, not about the choice of product. Wrong product for the client is an unsuitable recommendation.
• The motive in the definition is generating commissions — not tax, not hedging, not window dressing.
• The investor's check is the monthly account statement.
• Churning does not require the client to have lost money; the harm is the unnecessary cost and risk.