Enforcement News: SEC Charges Broker with Scheme to Defraud Mostly Elderly Retail Brokerage Customers and Investment Advisory Clients

• Posted on: Feb 17 2020

Elder financial exploitation is a significant problem. Everyone reading this article may be affected in some way. Our family, friends, neighbors, colleagues, and/or customers may fall victim to financial exploitation. All of us are at risk of being financially abused and/or exploited as we grow older.

Seniors are Particularly Vulnerable to Financial Abuse and Exploitation

Research indicates that as seniors grow older, they become too trusting and fail to recognize false or misleading claims, suspicious intentions and evidence of risky behavior. One study of senior adults found that many exhibited risky behaviors, such as believing deceptive and misleading advertisements and buying falsely advertised products (here). Other researchers have found that older persons possess a “doubt deficit,” in which false and misleading claims fail to trigger doubt in the listener (here). Such persons are often unable to detect the intentions of others, including those with the intent to deceive. As a result, the inability to doubt “provide[s] a compelling rationale why highly knowledgeable and intelligent older people are often susceptible to deception and fraud.” (Id.)

As readers might expect, cognitive impairment and diminished financial capacity play a role in senior’s vulnerability to scams. Cognitive impairment can be caused by disease, such as dementia, or by the aging process. When impairment occurs because of aging, seniors lose or experience a decline in important skills, such as comprehension, problem-solving and learning. When a senior loses these skills, it can be more difficult to manage money and make financial decisions.

Financial capacity, on the other hand, concerns the ability “to manage money and financial assets in ways that meet a person’s needs and which are consistent with his/her values and self-interest.” See Naomi Karp & Ryan Wilson, AARP Public Policy Institute, Protecting Older Investors: The Challenge of Diminished Capacity (2011) (internal quotation marks and citation omitted) (here). A decline in financial capacity can materially impair a person’s financial judgment and render him/her unable to understand the consequences of an investment decision.

[For a full discussion of the foregoing, see Stephen Deane, “Elder Financial Exploitation, Why It is a Concern, What Regulators are Doing About It, and Looking Ahead”, U.S. Securities and Exchange Commission, Office of the Investor Advocate (June 2018) (here).]

The Financial Costs of Elder Financial Abuse and Exploitation are Staggering

As the incidence of financial exploitation and abuse increases, so do the costs to its victims. An oft-cited study by the MetLife Mature Market Institute, the National Committee for the Prevention of Elder Abuse, and the Center for Gerontology at Virginia Polytechnic Institute and State University, titled “Broken Trust: Elders, Family & Finances,” estimates that about one million seniors lose approximately $2.6 billion annually from financial exploitation and abuse. (Here.) In 2011, MetLife updated its estimate to at least $2.9 billion. Other, more recent studies estimate the losses to exceed $36 billion a year, 12 times the MetLife estimate.

The Many Forms of Financial Abuse and Exploitation of the Elderly

The financial exploitation and abuse of seniors and vulnerable persons come in many forms. The most common involves, among others: (a) investment fraud (e.g., churning, unauthorized trading, unsuitable investing, over-concentrating an investor’s portfolio in a single type of investment or industry segment, and misrepresenting the risk or potential returns of an investment product for the purpose of generating high commissions), (b) insurance fraud (e.g., selling unneeded or too costly insurance, the unauthorized trading of life insurance policies, and annuity fraud), (c) acts of dishonestly by trusted persons (e.g., fraud, misappropriating assets, falsification of records, forgery, and unauthorized check-writing), (d) email scams (e.g., “phishing” to induce the recipient into providing passwords and other personal and financial information), and (e) lottery fraud (e.g., inducing the person to transfer or pay money to collect unclaimed prizes from lottery or sweepstakes organizers.

In today’s post, we highlight annuity and investment fraud.

Annuity Fraud

An annuity is a contract between a buyer (a/k/a an annuitant) and an insurance company that requires the insurance company to make guaranteed periodic payments to the buyer once he/she reaches retirement and requests the payments. Annuities can be fixed or variable.

Annuitants are typically charged fees and commissions when they purchase an annuity. One such charge is the “surrender charge”. A surrender charge is a sales charge the annuitant must pay if he/she sells or withdraws money from a variable annuity during the “surrender period” – the period after the annuity is purchased (e.g., typically six to eight years). As one would expect, surrender charges reduce the value of, and the return on, the investment underlying the variable annuity.

Annuities can be complex. For this reason, scammers target vulnerable seniors, especially those with some type of cognitive impairment or diminished financial capacity. They do so by, among other ways, employing high-pressure sales and marketing tactics to induce the buyer to purchase an annuity – e.g., promising a large, up-front cash bonus for purchasing the annuity; making misrepresentations or omissions about the structure, terms, fees and charges, and risks involved with buying an annuity; investing the annuity in high risk and unsuitable mutual funds, leaving the purchaser exposed to stock market losses without their knowledge or consent; and engaging in annuity switching – i.e., recommending the switch from one annuity to another one, causing the annuitant to pay significant withdrawal fees to remove their money from the existing annuity. Annuity switching can be especially egregious when the recommendation to switch occurs immediately prior to maturity.

In today’s post, we examine an SEC enforcement action against a broker and financial adviser who financially exploited his elder customers and clients into buying an allegedly “safe” investment with a “guaranteed minimum” return. Securities and Exchange Commission v. Edward E. Matthes, 2:20-cv-00125-LA (E.D. Wis. filed Jan. 28, 2020) (here). As discussed below, the SEC charged Edward E. Matthes (“Matthes”), a former Wisconsin-based registered representative and investment adviser, with defrauding 26 of his mostly elderly retail brokerage customers and investment advisory clients out of approximately $2.4 million by, among other ways, inducing them to sell quality annuities for a fictitious investment.

Securities and Exchange Commission v. Edward E. Matthes

According to the SEC complaint (here), between April 2013 and March 2019, Matthes allegedly misappropriated approximately $2.4 million from 26 of his customers and clients, most of whom were elderly and lacked investing experience. Many of the victims, said the SEC, had been customers and clients of Matthes for several years and trusted him to manage their money and investments.

Starting in 2013, Matthes allegedly began telling certain of his brokerage customers that he had a new investment opportunity that would generate a higher return than certain variable annuity contracts he previously had sold them. Matthes purportedly described the investment opportunity as a safe “fixed investment” that would earn a guaranteed minimum annual yield of 4% and could possibly provide higher returns in the future. The SEC claimed that Matthes provided his customers with few additional details regarding the investment opportunity and did not provide them with any documentation. In reality, alleged the SEC, the fixed investment did not exist and Matthes used all of the funds he raised for his own personal use and to make Ponzi-like payments to certain customers.

Relying on Matthes’ representations, said the SEC, 15 customers sold or authorized Matthes to sell, in part or whole, the securities underlying their variable annuities and received the proceeds, minus surrender fees and other charges, directly from the annuity provider. According to the SEC, several of these customers held their variable annuities in tax-advantaged retirement accounts.

In addition, Matthes allegedly convinced eight of his brokerage customers to withdraw money from their personal savings accounts for investment in the fictitious fixed investment. According to the SEC, the money for these transfers came from, among other things, life insurance proceeds, inheritance proceeds, house sales, and land sales.

In 2018, Matthes allegedly made false statements to three of his investment advisory clients, all of whom were also brokerage customers, in order to convince them to sell securities from their managed portfolios with a third-party investment adviser and transfer the proceeds to him for investment in the fictitious fixed investment. The SEC alleged that at the time of the transfers, the clients relied upon Matthes for investment advice.

Matthes allegedly made other false statements to many of his customers and clients regarding the purported fixed investment, including telling them that: the fixed investment had “no risk” and was “guaranteed never to lose money,” was “a bright spot in the investment landscape” and would be held in a “new” or “more safe and secure account” with the broker-dealer.

According to the SEC, Matthes used the majority of the approximately $2.4 million that he misappropriated, including approximately $2.17 million between October 2014 and March 2019, for personal expenses, including his credit card payments, mortgage payments, car payments, child support, luxury items and gifts, and home renovation expenses. In order to keep his scheme alive, said the SEC, Matthes used approximately $170,000 to make Ponzi-like payments to certain of his customers.

In March 2019, the scheme allegedly came undone. According to the SEC, one of Matthes’ customers complained to FINRA about an account statement that appeared to be fake. After FINRA contacted the broker-dealer with whom Matthes worked, the firm conducted an internal review. Based upon its review, the firm allegedly concluded that Matthes had diverted customer and client funds to his personal bank account and created fictitious account statements for multiple customers and clients. The broker-dealer terminated Matthes’ employment on March 12, 2019.

The SEC filed its complaint in the United States District Court for the Eastern District of Wisconsin. The SEC charged Matthes with violating the antifraud provisions of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940.

Without admitting or denying the allegations in the complaint, Matthes consented to the entry of a judgment that permanently enjoins him from violating the provisions charged in the complaint and orders him to pay disgorgement, prejudgment interest, and penalties in amounts to be determined by the court at a later date. The settlement is subject to court approval.