How can a certified public accountant or tax preparer help protect their clients from becoming victims of investment fraud? Many investment fraud cases have been referred to our law firm by CPAs and other tax professionals. The fact is, CPAs can serve as a strong frontline defense in helping to detect and prevent instances of investment fraud. If you’re a CPA or tax professional, there are several red flags that you can look out for to help protect your clients from unscrupulous stock brokers and investment advisors. 

Excessive trading and churning is a tactic that some brokers use to generate excessive commissions. A good rule of thumb is that if your client’s Schedule D on the Form 1040 for capital gains and losses is more than one page long, look into the transactions more closely. Are there multiple listings for the same securities?

Large losses are also a red flag for inappropriate investments, especially in the accounts of clients who have limited assets, who are recent widows or widowers, or who have recently inherited funds. You should be alert to a client who expresses surprise at their losses. If your client’s 1099 from the brokerage firm reflects significant losses, consider looking closely at their brokerage account statements to determine what the client invested in and if it is appropriate for them.

Another red flag is money being returned to the client as return of principal instead of income. Sometimes, brokerage customers mistakenly believe that their principal is safe and intact, when in fact, it is being depleted through distributions that the client believes are from income. The client’s brokerage statements may not reflect the source of the distributions, however, you can reconcile distributions the client receives from reports such as the K-1s of partnerships and 1099s.

Finally, because of their unique knowledge of their clients and financial situation, CPAs may be able to detect the financial exploitation of elderly or vulnerable clients such as the recently widowed. Be on the lookout for erratic or unusual banking transactions such as frequent, large withdrawals, uncharacteristic attempts to wire large sums of money, or the closing of CDs or accounts without regard to penalties.

By keeping an eye out for these red flags, tax professionals can play a vital role in protecting their clients from investment fraud.