SEC Case Against Wells Fargo Adviser Highlights Need for Supervision of Account Statements Sent to Clients

On February 19, 2019, the United States District Court for the Southern District of Ohio granted a consent judgment against John Gregory Schmidt, a former Wells Fargo Advisors Financial Network (FINET) advisor.  The Securities and Exchange Commission had filed a complaint against Schmidt in September 2018, alleging that Schmidt sold securities that belonged to some of his retail brokerage customers and covertly used the proceeds from those sales to conceal shortfalls in customer accounts.  According to the SEC’s complaint, Schmidt sent his customers fake account statements which overstated their account balances in order to cover up his conduct.  This case demonstrates the need for broker-dealers and registered investment advisers to adopt and enforce policies that effectively give them the ability to detect the use of such fraudulent statements.

Schmidt worked as a registered representative and the branch manager of a FINET office from about December 2006 through October 2017.  By October 2017, he had about 325 retail brokerage customers, many of whom were retirees who were dependent on withdrawals from their accounts to pay living expenses.

The SEC’s complaint alleges that from about 2003 through October 2017, a significant number of Schmidt’s customers had shortfalls in their accounts.  To conceal the fact that these customers were experiencing shortfalls, Schmidt sent clients false brokerage account statements that materially overstated the clients’ account balances and featured securities holdings that the clients did not in fact own.  Schmidt also misrepresented to some of his clients that the valid account statements Wells Fargo sent to the customers were inaccurate because some of his clients’ securities were held at other brokers or were not shown on the statements for tax reasons.

For example, the actual balance of one customer’s account never went above $20,000 from about January 2017 to October 2017.  The SEC found that instead of telling the customer his actual account balance, Schmidt supplied him with fake account statements that showed a balance of about $1.5 to $1.7 million, nearly 75 times the account’s actual value.  Schmidt also informed another customer that her account in March 2013 was worth about $187,369 when in reality the actual value was only about $3,400.  The SEC also found that Schmidt sent three customers through the mail false account statements that overstated their account values.  The SEC’s complaint also alleged that since most of these customers relied on withdrawals from their accounts to pay living expenses, their withdrawals would have depleted their accounts without the addition of new principal.

The SEC also found that Schmidt sold securities belonging to other customers and used the proceeds from those sales to conceal the shortfalls and obtain the principal needed to avoid overdrafts.  To achieve this, he would execute sales and withdrawals that the customers had not authorized from variable annuities that these customers owned.  He would also use fraudulent Letters of Authorization to authorize the sales.  From 2003 to about October 2017, Schmidt misappropriated about $1,169,193 from various customers.  Schmidt also did not inform either the customers who were experiencing shortfalls or the customers he was misappropriating securities from that he was shifting funds from one group to the other.  Moreover, most of the customers he misappropriated securities from were elderly customers with little financial experience.

To prevent the customers from discovering the misappropriation of funds, Schmidt would destroy or discard fraudulent withdrawal forms after delivering them to annuity companies.  He also established fake email accounts to prevent customers from receiving confirmations of annuity sales.

As a result of these actions, Schmidt was found to have violated the Securities Act of 1933 and the Securities Exchange Act of 1934.  He was ordered to pay disgorgement of $235,614, prejudgment interest of $34,049, and a civil money penalty of $864,301.  Wells Fargo also assured its customers that Schmidt had been discharged.

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