Growing bank accounts, luxury vehicles, exotic vacations, expensive jewelry, and an extravagant lifestyle are several examples of red flags that an investment adviser or registered representative may be living beyond his or her means, particularly when increasing expenses are coupled with declining commissions.
David McMillan, a former registered representative of Royal Alliance Associates, Inc., operated a one-man satellite office in Bullhead City, Arizona. McMillan defrauded at least 28 investors in a classic Ponzi scheme. He told his clients that he was investing their money in particular investments, but instead used the money for his own use and to repay other investors.
Even though Royal Alliance prohibited registered representatives from depositing client checks into bank accounts owned or controlled by the registered representative, the broker-dealer did not have supervisory policies and procedures in place requiring review of bank records and addressing red flags. In a recent enforcement action, the SEC determined that a substantial drop in McMillan’s commissions coupled with continuing high expenses was a red flag and imposed a penalty on Royal Alliance of $500,000 for its failure to implement an adequate supervisory system.
Some broker-dealers are taking to heart the lessons learned from the Royal Alliance penalty and other post-Madoff Ponzi schemes uncovered by the SEC. For example, as part of enhanced procedures to supervise registered representative expenses, a Minnesota-based brokerdealer announced that it monitors the financial circumstances of its registered representatives, as well as their spouses and “significant others.”