$21,000 of Commissions on a $250,000 Income Account
Over 14 months, RR Patel has traded a retired schoolteacher's $250,000 account whose stated objective is 'income and capital preservation.' The account generated $21,000 in commissions and markups and $3,000 in margin interest; average monthly equity was about $200,000 and total purchases over the period were $1,400,000. Patel never obtained written discretionary authority, but after the client said 'you know what's best for me,' he began selecting securities and position sizes without calling her. He also had the client sign a form naming him as beneficiary of her IRA and arranged for her to lend him $15,000 personally. The client's daughter now calls the branch and asks that statements be redirected to her.
1. Compute the annualized cost-to-equity (break-even) ratio and annualized turnover, and assess the churning question.
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Annualize the 14-month figures by a factor of 12/14 = 0.857.
- Total costs: $21,000 + $3,000 = $24,000 over 14 months, or about $20,571 annualized.
- Cost-to-equity ratio: $20,571 / $200,000 = ~10.3%. The account must earn 10.3% a year just to break even - an impossible hurdle for an income-and-preservation objective.
- Turnover rate: $1,400,000 / $200,000 = 7.0x over the period, or ~6.0x annualized.
Churning requires three elements: excessive trading relative to the client's objectives, control over the account, and intent. Here the 10.3% break-even and 6x turnover supply the excess; the de facto discretionary handling supplies control; the pattern of trading a conservative retiree's account against stated objectives supports intent. Any one number alone is suggestive; the combination is the case.
2. Was Patel permitted to trade the account without calling her each time? What documentation is required?
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No. 'You know what's best for me' is not written authorization. Discretion requires:
- A written power of attorney or limited trading authorization signed by the client, and
- Written acceptance of the account as discretionary by a designated principal of the firm.
Without those, every transaction Patel chose without prior customer approval is unauthorized trading - a separate violation from churning, and one that survives even if the trades made money. Time-and-price discretion also requires written client authorization and firm approval.
Note the sequencing problem: the absence of discretion does not excuse the trading; it converts each trade into its own violation. The firm should be reconstructing every trade against call records to determine which were authorized.
3. Rank the issues in the file and describe the escalation the branch must take.
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Severity ranking:
- Borrowing $15,000 from a client - the most serious item. Prohibited unless a specific exception applies (registered lender arrangement, immediate family, or a financial institution) and the firm's written procedures permit it. Presumption of undue influence; potential private securities transaction issues.
- Named beneficiary of the client's IRA - a fiduciary conflict and a classic undue-influence/elder-exploitation red flag, likely barred by firm policy regardless of the client's wishes.
- Unauthorized trading/churning - as above.
- The daughter's request - the firm cannot change the statement recipient on a third party's instruction. It needs the client's written authorization, and the call itself should be logged as a possible diminished-capacity or exploitation signal.
Escalation: suspend new trading, notify supervision and compliance the same day, preserve all records and correspondence, contact the firm's trusted-contact person if one is on file, consider a regulatory filing, and involve legal before any contact with the client about the loan.