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Protecting Senior Investors - Deconstructing a Supervisory Failure

Posted by Jack Duval

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Aug 30, 2018 8:10:55 AM

 

This blog post continues a series I began in 2012 highlighting regulatory efforts to protect senior investors.  (My previous blog posts on protecting senior investors can be found here.)

On August 24th, The New York Times published an article relating the predatory abuse of senior investors by a broker engaging in unauthorized trading and churning of their account.[1]

Client Profile

The profile of the senior investors is typical in many abuse cases.  The father was 89 years old, had suffered two strokes and was residing in an assisted living facility.  The mother was 84 years old, had been diagnosed with Alzheimer’s, and was in the process of being moved to the same facility as her husband.

There was an younger adult daughter living in a community for adults with developmental disabilities and an older adult daughter who had been overseeing the parents accounts.

Fact Pattern

In 2017, Trevor Rahn, a broker at JP Morgan, began unauthorized trading in the account (which was worth about $1.3 million at the time) and in the first six months of the year  generated $128,000 in commissions.

It appears Mr. Rahn was selling positions that had been held for years and using the proceeds to purchase new-issue closed-end funds (“CEFs”).  The closed-end fund purchases were not mentioned in the article, but Mr. Rahn’s CRD lists CEFs as a product involved in the dispute.[2]

Furthermore, the commissions generated could not have been generated from stock trades alone, and were almost certainly from high-commission new issue CEFs.  The New York Times article mentions $47,600 in commissions in August 2017.  A look at the statement page in the article reveals there were $822,000 in sales proceeds and $796,300 in purchases.  At a 1.25 percent commission rate on the purchases and sales, there would have been $20,500 in commissions generated.  Less than half of the $47,600 reported.

However, if the sales of stock were made at a 1.25 percent commission rate and the proceeds invested in new-issue CEFs paying 4.5 percent commissions, the math works out very close:

  • $822,000 sold at 1.25% = 10,275;
  • $796,300 in purchases at 4.5% = 35,833;
  • This results in total commissions of $46,108 versus the $47,600 reported.

Supervisory Red Flags Missed

There were a host of missed supervisory red flags.  So many that it defies simple explanation.  What’s worse is that many of the red flags existed before the unauthorized churning trades took place.  The following is a list of supervisory red flags that should have been triggered under standard industry practice and systems:

Pre-Trade Red Flags

The following account traits should have resulting in the account being on heightened supervision and/or generated exception reports:

  • Two senior investors, aged 84 and 89;
  • Special needs adult child;
  • An unsophisticated daughter overseeing the account;
  • High cash flow needs for two parents and one child in assisted living communities;
  • Asset allocation of 93 percent equities (and possibly higher given the six percent in mutual funds could also have been in equities), and;
  • Lien on Trevor Rahn:[3]
    • Rahn had a $763,000 lean outstanding against him from Deutsche Bank Securities.
    • Under a forgivable loan, Mr. Rahn owed Deutsche Bank $748,011 when he resigned to go to JP Morgan. Upon signing with JP Morgan, Mr. Rahn received an upfront loan of $1,404,084 and $468,000 in restricted stock.
    • He chose not to use any of his upfront cash to pay back the loan from Deutsche Bank.

Client Statement:

Accelerant Protecting Senior Investors Jack Duval - Client Statement

Trading Red Flags

Even if the pre-trade red flags were missed, the trading in the account should have triggered multiple supervisory red flags immediately:

  • Sudden and uncharacteristicaly high turnover;
  • 344 unsolicited trades being entered in one account;
  • Multiple small odd-lot orders instead of block trades;
  • Large purchases of new-issue closed-end funds, and;
  • 10 percent cost/equity ratio (the costs were 10 percent of the account value).

Account-Related Red Flags 

Finally, if the pre-trade and trading red flags were missed, the following account-related red flags should have generated supervisory inquiry:

  • Sudden decline in account value (unrelated to market movements), and;
  • Realizing over $342,000 in long- and short-term gains on sales.

Supervision

Even casual supervision should have prevented the abuse described above.  The SEC and FINRA have made the protection of senior investors a regulatory priority since 2006.  (See my blog post with a timeline of regulatory actions to protect senior investors.)  Their focus has only intensified over the years and broker-dealers have been well informed of their obligations in this area.  (Access my Protecting Senior Investors white paper.)

Because of the high potential for abuse by brokers, family members, and fraudsters, all accounts of senior investors should be on heightened supervision.  Today’s supervisory systems can easily add age-based triggers for exception reports.  Indeed, because age is a hard number and not subject to debate (such as the suitability of certain investments) this should be a trivial red flag to implement.

There can be no excuse for failing to supervise the accounts of senior investors.

__________

Notes:

[1]      “Caring for Aging Parents, With an Eye on the Broker Handling Their Savings”; Tara Siegel Bernard; The New York Times; August 24, 2018; Available at: https://www.nytimes.com/2018/08/24/business/brokers-excessive-trading-retirement.html?login=email&auth=login-email; Accessed August 27, 2018.

[2]      CRD of Trevor Rahn; Available at: https://files.brokercheck.finra.org/individual/individual_2196155.pdf; Accessed August 27, 2018.

[3]      Deutsche Bank Securities Inc., v. Trevor Rahn; Case No. CV13-5534 RGK (VBKx).  Mr. Rahn attempted to have the arbitration decision to award Deutsche Bank the $748,011 vacated.  His claim was denied.

 

For information about securities expert Jack Duval, click here.

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Topics: Protecting Senior Investors, Senior Investors, fraud, Elder Abuse, dementia, Alzheimer's, supervision, financial exploitation

    

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