In a recent Financial Industry Regulatory Authority (FINRA) arbitration case, an elderly woman and her power-of-attorney holding daughter were awarded more than $50,000 in total payments for what the arbitrator deemed insufficient advice regarding the tax consequences of an IRA distribution. The $50,000-plus in payments was awarded even though the claimants had only suffered an increase in taxes of about $9,000 as a result of the total distribution of a roughly $30,000 IRA CD, and despite the fact that no investment had been purchased from the advisor in question.
Facts of the case
Marilyn Green owned a certificate of deposit (CD) in an IRA that was held with her bank. As Marilyn was already in her 80s and suffering from dementia and depression, her financial affairs were largely tended to by her daughter, Melissa Green, who had been granted power of attorney. Sometime close to the maturity date, Melissa Green discussed her mother’s CD with Samuel Izaguirre, a Registered Representative of LPL Financial. LPL and Izaguirre had entered into an agreement with the bank that issued Marilyn’s CD to provide investment advice and brokerage services to its clientele.
During Melissa’s conversation with Izaguirre, he recommended that Melissa withdraw the roughly $30,000 held in the maturing IRA CD and place the funds in a personal checking account. He did not provide any information with respect to the potential tax consequences of such a transaction.
Following Izaguirre’s advice, in August of 2014 Melissa closed the IRA CD and transferred the funds to her mother’s personal checking account. The following year, when Melissa visited her mother’s tax preparer to complete her 2014 return, she learned that the $30,000 IRA distribution resulted in roughly $9,000 of additional income taxes.
The Greens sought a veritable laundry list of awards and remuneration, including:
• Compensatory damages of $9,000
• All cost and expenses associated with the FINRA arbitration
• All attorneys’ fees incurred in connection with the arbitration proceeding
• Punitive damages of at least three times compensatory damages
• Additional amounts to cover the tax bill resulting from any award
In what came as a bit of a surprise to many in the financial services industry, arbitrator Barth Satuloff determined that the Greens were entitled to significant awards. Satuloff determined that the Greens showed an actual and implicit business relationship with Izaguirre and that he held a “position of trust.” He further concluded the relationship of trust was breached when they were not given enough information about the possible tax consequences of his recommendation.
A $52,000 award for a $9,000 tax bill!
Amazingly, the Greens were awarded a grand total of more than $52,000. The $52,000-plus award included $10,260 in compensatory damages, $20,202 in attorneys’ fees and $21,240 in treble damages pursuant to a Florida state law preventing the “exploitation of an elderly person,” words no advisor wants to see anywhere near their name.
The question that should be on every advisor’s mind now is, “Where do we go from here?” To answer that question, it’s important to understand exactly what happened, or perhaps more appropriately, did not happen in this case.
The advisor in this case was not accused of recommending an investment gone awry. He was not accused of providing the Greens with incorrect tax information or advice. Instead, he was accused of “failing to notify Claimants regarding the adverse consequences” of an IRA distribution.
By all accounts, the advisor does not appear to be a CPA, enrolled agent or other tax professional. So the question becomes, did he really have a responsibility to address the tax consequences of his recommendation with clients? This arbitrator certainly thought so… and he’s not alone.
The final Department of Labor Fiduciary Rule, released in early April, makes significant changes to the advisor landscape when it comes to giving “rollover” advice. Under the rule, advice received by a client in connection with a distribution from their retirement account can be considered advice, subject to a fiduciary standard, separate and apart from any recommendation made with regard to an investment. Thus, advisors will be held to an even higher standard of care with regard to acting in clients’ best interests when it comes to recommending rollovers and distributions from retirement accounts.
Also worth keeping in mind is that while the Greens, themselves, claimed that the advisor’s failure to provide them with adequate tax information led to a $9,000 tax bill, their ultimate award was for more than $52,000. That’s more than the entire IRA CD was worth!
That begs the question, what if the investment in the CD hadn’t been $30,000, but instead, was $300,000? Instead of a $52,000 award, it could have been a $520,000 award. And, what if the mistake had involved a million dollar IRA?
The bigger the account, the bigger the potential consequences of making a mistake. And of course, the actual award is only a small part of the problem. As evidenced by the Green case, even a mistake with a fairly modest IRA could cause long-lasting, or even irrevocable, damage to a professional reputation.
One also has to wonder in what other situations failure to provide adequate information regarding “adverse tax consequences” could be applied. For instance, all of the following 5 scenarios could result in adverse tax consequences:
Selling a non-qualified asset and triggering a resulting capital gain.
Taking a distribution from a non-qualified annuity that results in ordinary income.
Suggesting a client make salary deferrals to a Roth 401(k) instead of a tax-reducing traditional 401(k) or suggesting an in-plan Roth conversion – both of which are irrevocable elections.
Failing to suggest a qualified charitable distribution to a 70½+ year-old client who is charitably inclined and making “regular” charitable contributions.
Not informing a client about the “new” once-per-year rollover rule.
Could we see advisors facing FINRA arbitration or other actions for any of the above? Perhaps. Once Pandora’s Box has been opened there’s no telling where it will lead.
Note that Roth IRA conversions can also create negative tax consequences (although they are often beneficial over the long run). They are not included in the above list, however, because they can generally be undone — recharacterized — even after such tax consequences are discovered by a client’s tax professional.