According to FINRA, Michael James May was fined $5,000, suspended from association with any FINRA member in all capacities for three months, and ordered to pay $10,349 plus interest in restitution to a customer for engaging in excessive and unsuitable trading, including the use of margin, in a customer's account.
May recommended trades to the customer, who accepted his recommendations and relied on May's expertise. However, May's trading recommendations were excessive relative to the account size and generated commission costs that made it nearly impossible for the customer to profit.
Although the customer's account had an average month-end equity of only approximately $25,331, May recommended trades with a total principal value of more than $265,044. This extraordinarily high turnover—trading volume many times the size of the account—is a hallmark of churning or excessive trading done primarily to generate commissions.
The trades May recommended caused the customer to pay $10,349 in commissions, trading costs, and margin interest. This resulted in an annualized cost-to-equity ratio in excess of 40 percent, meaning the customer's account would have had to grow by more than 40 percent annually just to break even after paying all costs. This is an unrealistic expectation for most investment strategies and demonstrates that the trading was unsuitable for the customer.
The use of margin made the situation worse. Margin involves borrowing money from the brokerage firm to purchase securities, using the securities in the account as collateral. While margin can amplify gains, it also amplifies losses and incurs interest charges. For an account with average equity of only about $25,000, the margin interest costs from the trading further reduced any potential profits and increased the breakeven hurdle.
FINRA's findings require May to pay full restitution of $10,349 plus interest to compensate the customer for the excessive commissions and costs. The three-month suspension and $5,000 fine provide additional punishment and deterrence.
This case illustrates several warning signs investors should watch for: trading volume that far exceeds account size, high commission charges relative to account equity, use of margin in accounts with modest assets, and cost-to-equity ratios that require unrealistic investment returns just to break even. When representatives recommend frequent trading or margin usage, investors should question whether these recommendations truly serve their investment objectives or primarily generate commissions for the representative.
Investors with smaller accounts should be particularly cautious about active trading strategies and margin usage, as the fixed costs of commissions and margin interest can quickly consume a substantial portion of account value.
