How Financial Advisers Should React to SEC Actions Involving Penny Stock and other Fraudulent Schemes that Target Seniors

The SEC recently announced the filing of an emergency action and the obtaining of an asset freeze against operators of a South Florida-based investment scheme that defrauded over 100 retail investors, many of them seniors. The announcement noted that two of the defendants charged were previously barred by the SEC from acting as brokers and offering penny stocks to investors. SEC v. NIT Enterprises, Inc. et al. The complaint is here.

Unfortunately, while these kinds of actions are not new, these cases should serve as a reminder to financial institutions (including investment advisers and broker-dealers) that their senior clients may be the targets of such fraud. The pattern is a familiar one — that of older clients with diminishing mental or physical capacity becoming a frequent and easy target for financial abuse. Before it happens, investment advisers and broker-dealers may find themselves serving as a kind of first “line of defense” in identifying signs of potential elder financial fraud.

For reasons that are obvious, they may be first to notice whether someone appears to be seeking to exploit an elderly client based on their position of trust or influence over an elderly client: thus, making it easier to gain access to the client’s assets. Whether it’s through the Senior Safe Act of 2018 (enacted May 2018) or other regulatory policy, federal and state regulators have provided meaningful guidance aimed at educating and training advisers to identify red flags when it comes to elder financial abuse. Signs include:

  • Sudden reluctance to discuss financial matters
  • Investing in private offerings of securities promising inflated investment returns
  • Unusual or unexplained account withdrawals, wire transfers, or other financial changes
  • Cash or other items missing from the home
  • Drastic shifts in investments
  • Abrupt changes in wills, trusts, power of attorney or beneficiaries
  • Concern or confusion about missing funds

BUT WHY BOTHER? WE’RE NOT LIKE THESE ALLEGED FRAUDSTERS”

Believing (i) that these actions have little to do with their legitimate financial service offerings, (ii) perhaps fearing, among other things, a violation of the client’s privacy (an excuse that is less persuasive given the Senior Safe Act’s immunity availability) or (iii) the time-consuming nature of investigating, reporting and taking steps to protect an uncooperative client’s assets, an adviser may be reluctant to get involved. So what is the cost of doing nothing or simply dropping the elder client because they won’t accept your advice?

First, advisers and broker-dealers may be required under their state’s law to report suspected cases of financial abuse of an elderly client to an adult protective service or similar agency whose role is to investigate and intervene if needed. Twenty-one states have adopted laws covering both guidance and mandates on the topic. In some instances, failure to report may subject the financial institution to statutory fines and penalties, and expose them to the civil claims of third parties, including an elder client’s later-appointed guardian or family member claiming losses of the client’s assets.

Second, the SEC may end up reviewing what the adviser has chosen to ignore. As with the above case, for some time now, the SEC has taken a multifaceted approach to senior investor abuse that includes (in addition to education, regulatory policy) examinations and enforcement actions. As for examinations, OCIE has sought to protect seniors through risk-based exams (i.e. its Senior-Focused Initiative examing 200 advisers doing significant work with seniors). OCIE has examined broker-dealers to review how they identify how seniors might be financially exploited. Similarly, the FINRA examines broker-dealers to review (including suitability, training, use of designations, marketing, supervision, etc.) their compliance with FINRA Rules 4512 (Customer Account Information) and 2165 (Financial Exploitation of Specified Adults).

In May 2019, the SEC published a white paper entitled How the SEC Works to Protect Senior Investors describing what the SEC is doing to protect senior investors. The paper noted, in addition to the above concerns, that both FINRA and SEC exams will continue to examine practices that ask question about (i) whether advisers obtained trusted contact information from senior clients; (ii) how advisers and broker-dealers handle concerns about a senior client’s diminished capacity, (iii) what policies and practices are used to handle client beneficiary change requests, and what training the investment advisers were providing their staff on elder financial exploitation and protecting senior clients.

Investment Advisers and broker-dealers would do well to read the paper. The Ponzi schemes targeting seniors will continue; as will the number of SEC enforcement actions. What will not change is federal and state regulators’ determination to ensure that advisers and broker-dealers do their part to protect their senior clients from financial exploitation. If you didn’t read it, the white paper can be found here.

Author: Dexter Johnson

The author is a an attorney who for the past 14 years has concentrated his practice in representing, successfully, investment advisers, broker-dealers, corporations and individuals who are subject to SEC, FINRA, State or other regulations and who may be the subject of regulatory examination, review or investigation. He formerly worked at the SEC. His regulatory and litigation experience has encompassed virtually every type of securities issue in the industry. He has also negotiated favorable outcomes in many of these matters for his clients.