July 21, 2021
Massachusetts State House.
Massachusetts state securities regulators charged Charles Schwab & Co. over an alleged compliance flaw that allowed a third-party investment advisor on its custodial platform to continue collecting advisory fees from customers years after his registration lapsed, according to a Wednesday announcement.
The ex-advisor, James P. O’Connell of Gloucester, Mass., had not been registered since 2014 but managed to thereafter collect at least $125,000 in investment advisory fees from seven clients whose accounts remained at Schwab, according to an administrative complaint filed by the Securities Division of Massachusetts Secretary of State William Galvin.
The regulator seeks a court order requiring Schwab to reimburse investors fees paid to O’Connell after his registration lapsed and to undergo an independent compliance review to establish policies and procedures to prevent similar violations. The regulator also wants Schwab and O’Connell to pay unspecified fines.
“The Division brings this action to protect investors from the dishonest practices of Schwab and O’Connell, to provide relief for the harm done to those investors by O’Connell, and to address a compliance failure on the part of Schwab,” the complaint said.
Galvin’s office discovered the unlawful fee collections of 1% per year while investigating a complaint of “potential exploitation” brought against O’Connell by senior citizens whom he had continued to advise while unregistered, according to the complaint. The state regulator then uncovered “a complete blind spot in Schwab’s compliance practices regarding payments to unregistered individuals for purported advisory services,” the complaint continued.
“Despite acknowledging in internal emails the risk Schwab faced from potentially permitting O’Connell to receive investment advisory fees while unregistered, Schwab took no steps to monitor O’Connells client accounts,” Galvin’s office said. “As of the date of this action, Schwab continues to have no policies or procedures designed to monitor customer accounts following the removal of a third-party advisor.”
A spokesman for Schwab, the largest RIA custodian by client assets, declined to comment on specific allegations but said the company is “committed to earning our clients’ trust and working diligently to fulfill our compliance responsibilities.”
“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,” the Schwab spokesman said in an emailed statement.
The charges hit on a potentially sensitive topic for custodians–how much responsibility they have to supervise third-party advisors who hold assets on their platform.
Brian Hamburger, chief executive of MarketCounsel which provides regulatory compliance consulting to RIAs, called the Massachusetts complaint “utterly ridiculous” and said the custodian has no responsibility to “protect” the customers from their own lack of due diligence.
“It amounts to an effort by regulators to try to pass along culpability to Schwab for something the regulators themselves should be the ones responsible,” he said. “This would be akin to regulators holding Visa accountable for a bad actor spending ill-gotten gains by using someone else’s credit card.”
O’Connell, who first registered as an investment advisor in Massachusetts in 2007 at his own firm, JP O’Connell Financial, LLC, did not respond to a request for comment sent through social media.
He started his career with Commonwealth Financial Network in 2001 and moved in November 2006 to Raymond James Financial Services, where he remained until launching his RIA in 2007, in Portsmouth, New Hampshire, according to Securities and Exchange Commission records.
O’Connell had initially been removed from Schwab’s platform in 2012 for allowing his registration to lapse for nearly two years, which also resulted in a reprimand from the state’s Securities Division. Despite this removal, Schwab took “no steps” to monitor customer accounts for further payments to O’Connell, the complaint said.
The regulator had notified O’Connell in January 2015 that continuing to provide investment advisor services while unregistered was “unlawful and would subject him to enforcement actions,” to which O’Connell “indicated” he was retiring from the business, according to the complaint.
“Despite his representations, O’Connell did not in fact retire at this time and continued to provide investment advisory services to his clients at least through April 2021–all while unregistered,” the complaint continued.
The complaint, which names as defendants Schwab and O’Connell, further alleged that the ex-advisor, while unregistered, made “unsuitable” recommendations that were issued “without respect to individual client needs” and included over-concentrating portfolios in global communication infrastructure companies.