What’s the real story behind the zillionaire widow defrauded by her grandsons?

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Via TravelBloggerBuzz, last week I read a fascinating story about the resolution of a FINRA arbitration complaint against two JPMorgan financial advisors by their grandmother, whose money they had supposedly misallocated for the benefit of themselves and their employer. Unfortunately, for the usual reason (laziness) the business journalist was unable to actually describe the content and stakes of the dispute, which left me with many more questions than answers.

Beverley Schottenstein is unimaginably wealthy

What is absolutely essential to understand about the case is that Beverley Schottenstein, the widow of Alvin Schottenstein, possesses almost incalculable wealth. To be clear, by all indications, she appears to have come by it completely honestly: she married an executive at a successful privately-owned company, then he died and left her an enormous fortune. One reason that fortune is so enormous is that she doesn’t seem to spend any money: in order to participate in her FINRA arbitration she “rented a computer and hired an IT specialist.” Judging by the photos of her apartment she has a taste for vintage crystal fruit and candy bowls, but unless she has a warehouse full of the stuff it’s highly unlikely to break the bank.

Real estate appears to be her only real weakness, if you can call it that. The same grandchildren who went on to rip her off are described as “setting up in Manhattan apartments their grandmother had bought years earlier.” She owns a condo in Bal Harbour, Florida, a few floors up from her son, the father of the crooks. She also seems somewhat active in the Jewish community, which may attract some of her charitable giving.

But other than real estate she appears to own exclusively financial assets. Her family was bought out of the furniture business in the late 80’s, and since then her fortune has grown, and grown, and grown.

What is an “aggressive” investment for a 93-year-old zillionaire?

Like most guilds, the finance industry sometimes uses ordinary terms in peculiar ways, and this comes up in the Bloomberg article: “Her paperwork with JPMorgan characterized her as an aggressive investor. That could explain trading in instruments the attorneys say were too complex and risky for someone of her age—like $72 million in so-called autocallable structured notes that were traded in her account in 2014 and 2015, leading to losses the lawyers put at $10 million.”

To understand what’s going on here, you have to understand the way financial advisors are required to think about asset allocation. In simplified form, there are two dimensions to asset allocation: the allocation that gives you the ability to meet your financial goals, and the one you have the tempermental willingness to tolerate. An individual investor’s position on those two axes is supposed to resolve into a risk tolerance or investment strategy between “conservative” and “aggressive.” For example, I think that to a first approximation everyone under the age of 50 should have 70-90% of their retirement accounts invested in the stock market, with only a small remainder in cash or bonds. But at age 20, a 70% allocation to stocks might be considered a “moderate” risk tolerance, while at age 50, a 70% stock allocation might be considered “aggressive.”

How useful you find this framework is a matter of taste, the point here is simply that it has been institutionalized over time. In Schottenstein’s case, as the above quote suggests, you have a problem at the intersection of finance industry jargon and the real world. Her grandsons wanted her to invest in some exotic speculative Cayman Islands investments, and in order to do so they had to classify her as an “aggressive” investor. But this classification mangled the two dimensions of risk tolerance: she had a high ability to sustain investment losses, but a low willingness to do so. When the investments lost money, she got upset, even though it didn’t affect her lifestyle in any way (she remained a zillionaire even before her $15 million FINRA payday).

There’s absolutely nothing surprising or unusual about this situation. In fact, the experience is practically universal: as your investment balances grow, you should expect to experience price volatility as increasingly painful. A 45% decline in a $10,000 portfolio reduces your wealth by $4,500, while the same decline in a $1,000,000 portfolio reduces it by $450,000. What possible comfort are you supposed to glean from the fact that you have $550,000 left?

What I suspect really happened

Reading between the lines, I suspect the real story is simple: Beverley’s grandkids were broke, unemployable, and in her will. Rather than wait for another few decades, they thought they’d get a head start on their inheritance: sign on at JPMorgan as her investment advisors and get paid a percentage of the assets they managed. At this point, Beverley may even have been in on the scam. As the article points out, “Their arrangement wasn’t unusual. It’s common and legal for money managers to work for relatives. Family money, in fact, often provides the seed for advisers to break into the business.”

If you’re planning to leave your grandkids a few million dollars one way or the other (“If they needed something—anything, god forbid, that had to be done with money—I was right there,” Beverley is quoted as saying at the end of the article), then why not also add a high-profile entry to their resumes, a few years of seniority at a global bank, and the kind of prestige and reputation money can’t buy outright but has to be laundered for?

Then the grandkids got greedy, and then they lost their minds. I’ve now seen a few e-mails sent around by brokers to friends and family members saying something like, “you have $10,000 in JCPenney bonds in your account that Fidelity would like to buy from you.” There’s nothing unusual about it: somebody comes to Fidelity asking to buy some bonds, Fidelity checks the accounts of their clients and makes them an offer. It might be a good offer, it might be a bad offer, but Fidelity is doing it in order to make a market between customers who want to own JCPenney bonds and customers who don’t particularly care what bonds they own. If you’re the broker who happens to identify the bonds that get moved around, you get a taste of the action. Otherwise, why would you bother your clients in the first place?

Still, the grandkids don’t strike me as particularly bright, and the first time it happened Evan and Avi might not even have realized what they were doing. Their supervisor may have called up and simply asked, “we’re trying to locate $10 million in Big Lots shares, can you ask Beverley if she’ll sell?” And that quarter, their paychecks had a little extra in them. Before long, they realized that they could earn kickbacks from both buying and selling the securities JPMorgan made markets in. When JPMorgan needed a buyer, they bought, and when JPMorgan needed a seller, they sold. The clue that this is what was going on is mentioned in passing in the Bloomberg piece: “In all, the brothers’ unauthorized buying and selling added up to about $400 million in transactions over the years.” But they didn’t manage $400 million for their grandmother: they were churning the same $100 million or so, over and over and over again!

Now think about this from the grandkids’ perspective: their grandmother didn’t need the money. She spent all day lounging by the pool in Bal Harbour doting on her extended family — very much including themselves. On the other hand, they were grown men: they didn’t want to ask their grandmother for an allowance, or a loan in order to buy the first class tickets they were sure they deserved. They prided themselves on their independence. When they churned her accounts they surely thought of themselves as taking a small advance on the inheritance they were due any day now.

And they weren’t even investing in Ponzi schemes or trading in bitcoin! Sure, some of the securities they bought and sold were a little illiquid, but they were making markets for one of the largest banks in the United States and the world. As the Bloomberg piece points out, a key part of their defense was that Beverley actually made money on many of their antics.

Unfortunately for Evan and Avi, absolutely everything about this was a violation of securities law, and they knew it. We know they knew it because of another sentence buried in the Bloomberg article: “They logged more than 500 transactions as direct requests from Beverley in 2015 through 2018 that she didn’t know about.” This may come across as a throwaway line but has enormous significance: if any investor, from the most conservative to the most aggressive, directs their advisor to buy some security, no matter how inappropriate it is for their investment strategy, the broker is naturally obliged to comply. But trades initiated by the advisor have to fall in line with the investor’s strategy. Evan and Avi were treating trades they initiated as being directed by Beverley, in order to evade investor protection laws and enrich themselves. Case closed.

Conclusion

Ultimately, the Schottenstein drama is in some ways both more interesting and more banal than the Bloomberg Wealth article was able to convey. On the one hand, you have what is essentially an ipso facto violation of securities laws, due to both the mischaracterization of trades as unsolicited (initiated by Beverley) instead of solicited (initiated by her grandkids), and the apparently-constant churning of her account in order to generate commission revenue for the firm instead of meet her investment goals.

Buried beneath that layer is a much more interesting story about an extended family that is obviously struggling with money (“Members of Bobby’s [the father of the grifter grandchildren] family told relatives that he’d drained their share of the settlement by the time Evan hit high school. They blamed bad investments”) and yet surrounded by incalculable wealth. The grandchildren themselves clearly blame their cousin, Cathy Schottenstein Pattap, for “turning their grandmother against them” in order to secure a larger share of her estate. And without knowing anything else about the family, they might be right! But their cousin didn’t make them break the law. Once she found out they were ripping their grandmother off, what was she supposed to do?

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