Over Trading an Account?

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Oct 13, 2011 3:44 pm

Hello everyone! I have been lurking around here for sometime and really enjoy the discussions. Figured I would contribute with a question of my own for once. I have been managing run of the mill low risk portfolios for a while now and thats exactly what most of my clients are looking for. There are, however, a few clients that are looking for something a lot riskier with a lot higher profit potential. To that end I have constructed an actively traded value portfolio adjusted for large market swings. I have tested this porfolio over the last 9 months and will continue for a full year before making it available to these clients. The portfolio is currently up 34.67% on the year. Now the problem. Over lunch I was discussing the new model portfolio with a colleague. He mentioned it is infact illegal to turn a clients account over more than 15 times in a 1 year period. To date the portfolio has turned over 13 times and will breach 15 before the year end. I have been searching for the specific rule which states that it is infact illegal to turn over a clients account more than 15 times in a one year period but have come up empty handed so far. Was my colleague blowing smoke or can someone point me in the right direction? Ethically there are no issues with the active porfolio as I do not recieve any compensation from executed trades. This portfolio is also only for a select few high worth individuals who know the risks and can handle any losses without issue. I would greatly appreciate any input. And let me just say this forum rocks!

Oct 26, 2011 11:43 am

Are you managing the trades as an RIA?

Oct 26, 2011 1:51 pm

Yes.

Oct 26, 2011 6:07 pm

What does the wording in your Investment Advisory Agreement say?  My clients got sick of the "buy, hold, lose" strategy and demanded more from me.  With the help of a consultant, we re-wrote the advisory agreement so that I am legally meeting my fiduciary responsbilities.  I will say, however, that I only trade about half of the portfolio as often as you do, while the remainder stays in dividend-producing stocks.  Good luck!

Oct 26, 2011 6:07 pm

What does the wording in your Investment Advisory Agreement say?  My clients got sick of the "buy, hold, lose" strategy and demanded more from me.  With the help of a consultant, we re-wrote the advisory agreement so that I am legally meeting my fiduciary responsbilities.  I will say, however, that I only trade about half of the portfolio as often as you do, while the remainder stays in dividend-producing stocks.  Good luck!

Oct 26, 2011 6:36 pm

It looks like the SEC has two takes on this. Churning and Excessive Trading.

http://www.sec.gov/answers/churning.htm says:

"Churning refers to the excessive buying and selling of securities in your account by your broker, for the purpose of generating commissions and without regard to your investment objectives. For churning to occur, your broker must exercise control over the investment decisions in your account, either through a formal written discretionary agreement or otherwise."

"Excessive trading is the same as churning, but without the requirement that the person engaging in the trading does so for the purpose of generating commissions. Churning and excessive trading can violate FINRA Rule 2310, FINRA Rule 2310-2(b)(2), NYSE Rule 408(c), and NYSE Rule 476(a)(6)."

I would not bank on what your colleague has stated about turning an account over 15 times. The rules above are directly from the SEC's website. It may be that turning an account over once constitutes excessive trading for some clients. Very subjective.

You have to tread carefully and err on the side of disclosure. Your compliance consultant will be your greatest ally here. I would venture to say you will need to disclose in your ADV the goals and objectives of the proposed style of management with emphasis on the fact that there will be higher commissions involved because of the frequent trading. The disclosure should circumvent the "without regard to your investment objectives" part of the rule. You may also have need to address wash sales. You will also need signed and dated client profiles acknowledging the suitability of this particular portfolio or management style.

Just curious. Have you looked into joining NAAIM?

http://www.naaim.org/