Massachusetts Secretary of the Commonwealth William F. Galvin charged Charles Schwab over an advisor’s unethical and deceptive practices discovered during an investigation of alleged elder exploitation. The administrative case under the Massachusetts Securities Act highlights the regulatory scrutiny custodians face when they don’t do enough to weed out advisors who fail to follow rules and may be harming clients.
Former Schwab investment advisor James Patrick O’Connell collected at least $125,000 in investment advisory fees from at least seven clients while unregistered since 2014, according to a complaint filed by the Enforcement and the Registration, Inspections, Compliance and Examination Sections of the Massachusetts Securities Division in Galvin’s office.
Yet Schwab did not take action to monitor customer accounts for further payments to O’Connell after he was removed from the platform in 2012 for allowing his registration to lapse for two years, the complaint alleges.
The complaint also says O’Connell made unsuitable investment recommendations to clients and repeatedly lied to the Securities Division.
O’Connell violated six Massachusetts laws, the complaint alleges. Attempts to reach him were unsuccessful.
“We are dedicated to giving our clients the highest level of confidence when doing business with us and take our obligations to them extremely seriously,” a spokesperson for Schwab says in an email to Financial Planning. “We are committed to earning our clients’ trust and work diligently to fulfill our compliance responsibilities.”
Before starting his own limited liability company, O’Connell worked at Commonwealth Financial Network for four years beginning in 2001, and at Raymond James Financial Services for less than one year in 2006.
In 2007, O'Connell entered into an agreement with the IRS involving $115,000 in medical expenses that were not covered by insurance. He agreed to pay the agency $25 per month for 12 months, and then to negotiate regular payments, according to BrokerCheck, which had no further details on the situation.
The IRS did not respond to media requests in time for publication.
Allegations of senior exploitation
The division opened an investigation in April 2021 after receiving emails from a woman who was concerned about an elderly family member who was a client of O’Connell.
“Many of these individuals are senior citizens, and their average age is 77 years old,” the complaint alleges.
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O’Connell told the office of the Secretary of the Commonwealth of Massachusetts that he decided to remain unregistered because “it was too expensive to stay registered for just seven clients,” according to the court documents.
When a 69-year-old client decided to sell their house and buy a condo, O’Connell recommended taking out a 30-year variable interest rate mortgage on the new property and investing the house-sale proceeds with him.
“If they do not accelerate payments, Client 1 will be a few months shy of 100 years old at the time the mortgage is paid,” Galvin’s office writes in court documents. “O’Connell’s recommendation… constitutes unethical and deceptive practices under Massachusetts law given the client’s age and investment profile.”
‘Unsuitable’ recommendations
The complaint says that O’Connell made recommendations to his clients while unregistered that were “unsuitable given their current financial situations and investment objectives,” according to the complaint from the Massachusetts Securities Division. “Without consideration of individual client needs, O’Connell issued blanket recommendations to purchase and hold positions almost exclusively in communication infrastructure companies.”
Galvin's office says O’Connell placed most if not all of seven clients’ non-cash or cash equivalent holdings in four global communication infrastructure sector companies — Corning, Ribbon Communications, Advanced Micro Devices, and Qorvo — while unregistered.
“These holdings remained substantially the same from January 2014 through April 2020,” according to the complaint. “Despite not recommending or executing trades in these accounts, O’Connell continued to collect the same 1% advisory fee month after month.”
Other major platforms should take note of this case and ensure they have a system in place to ensure advisors who fall out of compliance and lose their registration are not allowed to facilitate payments, says Benjamin Edwards, associate professor of law at University of Nevada, Las Vegas, William S. Boyd School of Law, whose areas of expertise are business and securities law, corporate governance and consumer protection.
The case also points to a flaw in one of the financial planning industry’s most popular business models, he says.
“One of the dangers with the assets-under-management fee model is that some unethical advisors may not do much beyond simply gathering assets and collecting a fee,” he says. “Here, O'Connell appears to have over-concentrated client assets in a single asset class and done little else. It's difficult to see how a competent advisor would recommend this to a client.”
Expired registrations
O’Connell, from Gloucester, Mass., was registered as the sole investment advisor representative of JP O’Connell Financial. The limited liability company first failed to register in December 2010 and did not renew after its registration expired again in December 2014.
In October 2012, O’Connell filed a Form U4 and O’Connell Financial filed a Form ADV to become registered as an investment advisor representative and an investment advisor, respectively.
In February 2013, Galvin’s office allowed O’Connell and his firm's applications pursuant to a consent order entered between the parties as a result of the unregistered activity. Yet O’Connell did not report the consent order on the Form U4 or Form ADV, according to the complaint.
In January 2015, a month after O’Connell and his limited liability company again failed to renew their respective registrations, the office of the Secretary of the Commonwealth of Massachusetts sent a letter to O’Connell Financial noting that “it is unlawful for any person to transact business in this commonwealth as an investment advisor or investment advisor representative unless he is so registered under this chapter.”
Over a month later, staff from Galvin’s office spoke with O’Connell, who claimed he had retired, though he never took formal steps to terminate his registration nor that of his firm, O’Connell Financial.
Time at Schwab
From June 2007 to December 2010, O’Connell served as an investment advisor representative at Schwab with his limited liability firm, which served as a third party advisor for his client’s accounts custodied at Schwab, Galvin’s office wrote in the complaint.
In September 2012, a Schwab compliance unit became aware that O’Connell Financial had been unregistered since December 2010 and directed the firm’s account be closed as soon as possible.
Yet the account at the custodian remained open until December 2012, internal Schwab emails show, as Schwab commenced an internal review to determine the total fees collected by O’Connell Financial while it was unregistered, according to the complaint.
“Schwab permitted him to remain a third-party advisor while he sought to reinstate his registrations,” the complaint alleges.
In November 2012, the complaint alleges, O’Connell Financial and 45 owners of 78 accounts were notified by Schwab of its decision to remove O’Connell Financial from its platform. O’Connell Financial “is not able to draw fees directly from client accounts through the Schwab investment management fee system,” according to a letter to O’Connell Financial from Schwab in the complaint.
On Dec. 17, 2012, Schwab removed O’Connell Financial from its advisor services platform. This occurred while O’Connell was seeking reinstatement of both of his registrations.
All seven clients who paid O’Connell fees remained custodied at Schwab, the complaint alleges.
Yet at least two clients continued to pay O’Connell for investment advisory services “using check writing capabilities that drew on their Schwab account balance.” O’Connell received fees of more than $46,000 from these two clients’ Schwab accounts between August 2014 and May 2021.
Schwab’s inaction
Schwab’s Senior and Vulnerable Investor Investigation team was notified after a relative of Client 1 shared concerns that O’Connell was financially exploiting her family member.
The investigator assigned to the case placed restrictions on the account, requiring the team to review all outbound fund requests while the investigation was open. The Senior and Vulnerable Investor Investigation team completed its investigation in March 2021 and then removed the restrictions.
The client paid O’Connell fees two instances after restrictions on the account were removed, and Schwab permitted both checks, which contained memos like “Fee 919 + 917,” using funds from the client’s Schwab account.
“Following these communications and its internal investigation, Schwab continued to take no action to prevent O’Connell from receiving fees for unregistered investment advisory activity through its platform,” the complaint alleges. “By Schwab’s own admission, the removal of a third-party advisor from an account triggers no specific monitoring procedures.”
Schwab failed to flag any of the checks written to O’Connell, court documents allege. Since May 2018, Schwab has had an automated system that marks payments for manual review. While a Schwab department surveils for certain scenarios, there is no automatic review.
“Despite internal concerns that O’Connell had received investment advisory fees paid directly from Schwab accounts during his initial unregistered period, and the fact that at the time Schwab removed him from the Schwab advisor services platform he remained unregistered in Massachusetts, Schwab took no steps to monitor these accounts beyond those taken for the accounts of all retail investors,” the complaint alleges.
Email receipts
“Massachusetts is sending a strong signal that brokerages custodying assets need to have some compliance system to confirm that investment advisors using their platform remain registered,” Edwards says. “O'Connell had been warned repeatedly by Massachusetts and the allegations indicate that he made false statements to Massachusetts that he was getting out of the business. Instead, he just kept collecting fees from clients.”
O’Connell lied under oath, the state Securities Division alleges in the documents, and denied receiving any compensation for his services.
The division obtained emails and bank statements from his clients, according to court documents. One Dec. 1 2020 email reads “Nov. fee… $950.16.” He received payments every month from six other clients, who were all former advisory clients of O’Connell and O’Connell Financial.
“On information and belief, O’Connell transitioned from direct withdrawal of fees through Schwab to requesting and receiving checks for fees from Client 1 and never ceased collecting investment advisory fees either time his registrations expired,” Galvin’s office wrote in the court documents.
He also sent emails to clients with commentary on market conditions, the complaint says.
What Massachusetts hopes to achieve
In the complaint, the Massachusetts Securities Division requested that the respondents be censured and cease and desist from further activity. The office also wants to request an order requiring O’Connell and Schwab to provide an accounting of all the fees and commissions received in connection with O’Connell’s wrongdoing.
Galvin’s office also wants Schwab to reimburse the Massachusetts investors for all the wrongful fees, and require Schwab to review its supervisory procedures to “ensure compliance with applicable state and federal securities laws” and to disgorge all profits and other remuneration received from the alleged activities.
The office also wants to require Schwab to “engage an independent compliance consultant to review and establish written policies and procedures related to payments made from Schwab customer accounts and the monitoring of customer accounts following the removal of a third-party advisor.”
If the state action is successful, O’Connell will never again be able to offer financial advice as a business. Galvin’s office seeks to permanently bar O’Connell from acting “as a broker-dealer, broker-dealer agent, investment advisor, investment advisor representative, SEC-registered investment advisor, investment advisor exempted from registration, a person relying on an exclusion from the definition of investment advisor in any capacity, issuer, issuer-agent, or as a partner, officer, director, or control person for any of the forgoing.”
Galvin’s office also wants to impose an administrative fine on the respondents and to take “any such further action” for protection of Massachusetts investors and for public interest.
