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Protecting Senior Investors - Deconstructing a Supervisory Failure

Posted by Jack Duval

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.

 

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

Protecting Senior Investors - 2nd Circuit Decision

Posted by Jack Duval

Mar 20, 2018 8:04:09 AM

 

Accelerant - Protecting Senior Investors.png

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.)

A recent 2nd Circuit decision is of interest to Broker-Dealers (“BDs”) implementing policies and procedures necessary to protect senior investors.

In brief, Claimant Alba T. Pfeffer filed a FINRA arbitration claim against Wells Fargo Advisors, LLC (“WFC”) and its Registered Representative Andre Mirkine.  The claim was based upon WFC and Mirkine’s refusal to transfer money from a trust account of Claimant Pfeffer’s husband that benefited their children to a trust account that benefited only Claimant Pfeffer.

“Mirkine explained that he did not transfer the assets because he became concerned following conversations with Mr. Pfeffer and Mr. Pferrer's son that Mr. Pfeffer was not competent and was being unduly influenced by Mrs. Pfeffer.  After receiving two letters from physicians opining that Mr. Pfeffer was not capable of making financial decisions, Wells Fargo froze both trusts."[1]

The FINRA arbitration panel denied all of Pfeffer’s claims.  Pfeffer then attempted to have the district court vacate the award and was there also denied.  Finally, Pfeffer appealed the district court’s decision to the 2nd Circuit Court of Appeals, which affirmed the district court’s ruling.[2]

There are a number of interesting items in the 2nd Circuit’s decision.

Refusing to Transfer Client Funds

Primarily, the decision to affirm the district court's denial of the vacature claim should bolster BDs in their efforts to protect senior investors.  It appears that WFC broker Mirkine and WFC supervisors did their job well by making a decision that would leave them open to potential litigation - refusing a request from an account holder to transfer money.[3]

This goes directly to FINRA Rule 2165 - Financial Exploitation of Specified Adults, which "provides a safe harbor for a member to place a temporary hold on a disbursement of funds or securities from the account... if the member reasonably believes that financial exploitation of the specified adult has occurred, is occurring, has been attempted or will be attempted."[4]

Manifest Disregard of the Law and Evidence?

Secondarily, the 2nd Circuit wrote:[5]

"On appeal, Mrs. Pfeffer argues that the award was procured by undue means, evident partiality, and misconduct because the Panel was intimidated by defense counsel and refused to consider relevant evidence.  She alleges that the Panel exhibited manifest disregard for the law and facts…

This Circuit does not recognize manifest disregard of the evidence as proper ground for vacating an arbitration panel's award and will only find a manifest disregard of the law where there is no colorable justification for a panel's conclusion."  (Emphasis added)

The 2nd Circuit found that the FINRA panel did not disregard evidence.  However, the fact that manifest disregard of evidence is not proper ground for vacating an award is bracing.

Finally, the 2nd Circuit sets the “manifest disregard of the law” standard so low at “no colorable justification” that it would seem highly remote to meet it.

Supervision

While it is no trivial matter to stop client distributions, supervisors should take quick action to stop suspect activity and to seek input from medical professionals and, if necessary, make referrals to law enforcement.

----------

Notes:

[1]       United States Court of Appeals for the Second Circuit; Summary Order; Alba T. Pfeffer Plaintiff-Appellant v. Wells Fargo Advisors, LLC, et al. Defendants-Appellees; 17-1819-cv; February 15, 2018; 3.  Available at: http://caselaw.findlaw.com/us-2nd-circuit/1889422.html; Accessed March 20, 2018.

[2]       Plaintiff Pfeffer was pro se for all three proceedings.

[3]       The FINRA panel denied Respondent Mirkine’s request for expungement of his CRD records and applied all forum fees to Respondent WFC.  This could indicate the Panel’s displeasure with some aspect of Respondent’s actions, however, without a reasoned award this is speculation.  See FINRA Award at: https://www.finra.org/sites/default/files/aao_documents/15-00294.pdf; Accessed March 20, 2018.

[4]       See FINRA Rule 2165 FAQs; Available at: http://www.finra.org/industry/frequently-asked-questions-regarding-finra-rules-relating-financial-exploitation-seniors; Accessed March 20, 2018.

[5]        See Supra Note 1 at 4-5.

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Topics: fraud, Senior Investors, supervision, Protecting Senior Investors, Elder Abuse, dementia, Alzheimer's, financial exploitation, 2nd Circuit

Protecting Senior Investors - Nationwide Elder Fraud Sweep

Posted by Jack Duval

Feb 27, 2018 7:49:13 AM

Accelerant - Senior Investors DOJ Image-1.jpeg 

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 February 22, 2018, the Justice Department announced a nationwide sweep that resulted in over 200 criminal charges for financial crimes targeting the elderly.

Attorney General Jeff Sessions was quoted, saying:

The Justice Department and its partners are taking unprecedented, coordinated action to protect elderly Americans from financial threats, both foreign and domestic... Today's actions send a clear message:  we will hold perpetrators of elder fraud schemes accountable wherever they are.  When criminals steal the hard-earned life savings of older Americans, we will respond with all the tools at the Department's disposal - criminal prosecutions to punish offenders, civil injunctions to shut the schemes down, and asset forfeiture to take back ill-gotten gains.

Today is only the beginning.  I have directed Department prosecutors to coordinate with both domestic law enforcement partners and foreign counterparts to stop these criminals from exploiting our seniors.

The Perpetrators

As I have written about before, many of the perpetrators were known to the victims.  The DOJ press release gave this description:

The actions charged a variety of fraud schemes, ranging from mass mailing, telemarketing and investment frauds to individual incidences of identity theft and theft by guardians.  A number of cases involved transnational criminal organizations that defrauded hundreds of thousands of elderly victims, while others involved a single relative or fiduciary who took advantage of an individual victim.  (Emphasis added)

While few crimes could be more heinous than those targeting senior investors, those perpetrated by guardians, relatives, or fiduciaries would qualify.

Supervisory Implications

The financial abuse of senior investors is not an isolated problem.  The DOJ press release stated that the schemes undertaken by the alleged criminals caused more than $500 million in losses to over a million victims.  

These sweep results should be a call to action to broker-dealers, RIA firms, and banks across the country to raise their supervisory oversight of senior investors accounts.

In the past, there has rightfully been significant focus on cases that involve senior investors with Alzheimer's or dementia.  However, unsophisticated and wholly trusting senior investors, who do not have the wherewithal to question recommendations, can also be subject to abuse by unscrupulous advisors.

Compliance and supervisory personnel at all financial firms need to be aware of the potential for abuse and should have special policies and procedures in place to monitor the activity in the accounts of senior investors.  At a minimum, these policies and procedures should detect financial fraud such as: unnecessary trading, unsuitable investments, and suspicious withdrawals.

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

Protecting Senior Investors - FINRA FAQs

Posted by Jack Duval

Jan 17, 2018 7:48:00 AM

 

accelerant - senior investor fraud.jpg

 

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

On January 3, 2018, FINRA posted guidance in the form of Frequently Asked Questions (“FAQs”) relating to protecting senior investors.

They did this in advance of FINRA Rule 2165 – Financial Exploitation of Specified Adults and Rule 4512 – Customer Account Information becoming (respectively) effective and amended on February 5, 2018.  Both rules were approved by the SEC in March 2017 and discussed in FINRA RM 17- 11.

I summarize and discuss a few of the more important points made in the FAQs and how they relate to account supervision.

Rule 2165 – Financial Exploitation of Specified Adults[1]

Q.1.1. May a member place a temporary hold on a securities transaction pursuant to Rule 2165?

A. Rule 2165 provides a safe harbor for a member to place a temporary hold on a disbursement of funds or securities from the account of a specified adult if the member reasonably believes that financial exploitation of the specified adult has occurred, is occurring, has been attempted or will be attempted. (Emphasis added)

This FAQ illustrates one of the key deficiencies with Rule 2165, that trading may continue in accounts where financial exploitation is occurring.  This is especially relevant to instances where the perpetrator of the exploitation is the Registered Representative.  In these instances, the Registered Representative could generate excessive compensation for herself without triggering a red flag under Rule 2165.  Indeed, it is conceivable that abusive trading could occur even if the account was under a temporary hold.

In these instances, the Registered Representative would be making withdrawals from the account through the broker-dealers own compensation mechanism.

An example of this could be the selling of a long-held low cost basis stock and using the proceeds to buy a high commission products.  The Registered Representative would get paid twice, once on the stock sale and once on the product purchases.  The payment of the commissions would not be reflected as a “disbursement of funds” and thus not flagged by a compliance system.

This scenario is not far-fetched.  I have seen cases where Registered Representatives have churned accounts after the client has died.

Supervisors must know the clients and their accounts well enough to detect abuse by Registered Representatives.

Q.1.2 Under Rule 2165, may a member that has a reasonable belief of financial exploitation of a Specified Adult regarding a disbursement or disbursements place a temporary hold or restrictions on an entire account if the member permits legitimate disbursements from the account?

A. FINRA has stated that, where a questionable disbursement involves less than all assets in an account, a member should not place a blanket hold on the entire account. Each disbursement should be analyzed separately.  (Emphasis added)

Here FINRA wants to avoid the failure of paying of legitimate bills and other disbursements even if a temporary hold has been placed on the account.  This would require significant diligence from the supervisor and Registered Representative to insure the disbursements were legitimate.

Rule 4512 – Customer Account Information[2]

Q.3.2. does the requirement in Rule 4512(a)(1)(F) to make reasonable efforts to obtain the name and contact information for a trusted contact upon the opening of a non-institutional customer’s account or when updating account information for an existing non-institutional account apply to all non-institutional accounts?

A. Rule 4512(a)(1)(F) provides that the trusted-contact provision “shall not apply to an institutional account”.  Accordingly, the trusted-contact provision applies to any account that does not meet the definition of an “institutional account” in Rule 4512(c), including accounts of non-natural persons that do not meet the definition.

FINRA defines an “institutional account” as:[3]

(1)  A bank, savings and loan association, insurance company or registered investment company;

(2) An investment adviser registered either with the SEC under Section 203 of the Investment Advisers Act or with a state securities commission (or any agency or office performing like functions); or

(3) Any other person (whether a natural person, corporation, partnership, trust or otherwise) with total assets of at least $50 million.

The key provision of this guidance is that member firms should try to obtain trusted contact information for all accounts, including entities such as trusts, corporations, and partnerships.

Also, in my experience, even if a client meets the “institutional” account criteria by having assets of $50 million or greater, they are just as subject to potential abuse as anyone else.  Furthermore, having more assets does not imply greater sophistication or protection from bad actors.

Supervisors should monitor these accounts with the same diligence as they do other accounts.

Q.3.4. When is a member required to seek to obtain the trusted-contact information for accounts in existence prior to the effective date of the amendments to Rule 4512 (“existing accounts”)?  When is a member required to update the trusted-contact information?

A. Consistent with the current requirements of Rule 4512(b), a member would not need to seek to obtain the trusted-contact information for existing accounts until such a time as the member updates the information for the account either in the course of the member’s routine and customary business or as otherwise required by applicable laws or rules.

Since knowing the client is an ongoing duty[4], asking clients for trusted contact information should be done at least as soon as the next contact with the client.  Client contact could be when making a trade recommendation, when presenting an account review, or for other reasons.

Q.4.1.  What is a member allowed to disclose to the trusted contact about a customer’s account?

A. Supplementary Material .06(a) to Rule 4512 requires that, at the time of account opening, a member disclose in writing (which may be electronic) to the customer that the member or an associated person is authorized to contact the trusted contact and disclose information about the customer’s account to address possible financial exploitation, to confirm the specifics of the customer’s current contact information, health status, or the identity of any legal guardian, executor, trustee or holder of a power of attorney, or as otherwise permitted by Rule 2165.[5]

… A member also could reach out to a trusted contact if it suspects that the customer may be suffering from Alzheimer’s disease, dementia or other forms of diminished capacity.

The disclosures should be limited to what the trusted contact would need to know to help make a determination as to any suspected exploitation or diminished capacity.  In most instances, it would not be necessary to disclose the total account value and details about a client’s investments with the trusted contact.

In the case of suspected possible financial exploitation, the focus would likely be on distribution requests.  If diminished capacity is suspected, no financial information would need to be disclosed, unless it was part of the indicia of the diminished capacity.

_________________

Notes:

[1]       Frequently Asked Questions Regarding FINRA Rules Relating to Financial Exploitation of Seniors;  January 3, 2018; Available at: http://www.finra.org/industry/frequently-asked-questions-regarding-finra-rules-relating-financial-exploitation-seniors; Accessed January 15, 2018.

[2]       Id.

[3]       FINRA Rule 4512 – Customer Account Information; Available at: http://finra.complinet.com/en/display/display.html?rbid=2403&element_id=9958; Accessed January 16, 2018.

[4]       See FINRA Rule 2111 – Suitability, regarding client profiling, and FINRA Rule 2090 – Know Your Client regarding diligence in the maintenance of client accounts.

[5]       FINRA also confirms that disclosures of financial information to a trusted contact would not be in violation of Regulation S-P (the SEC’s Privacy of Consumer Financial Information rule), since any disclosures would have been made with the customer’s consent.  See Regulation S-P Final Rule, available at: https://www.sec.gov/rules/final/34-42974.htm.  Accessed January 17, 2018.

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