Broker makes out well, but her clients and their heirs take it in the teeth. A Palm Beach, Fla., jury has directed Merrill Lynch by to pay $6 million in compensation for hoodwinking two of its wealthy clients, the late philanthropist George Rothman and his wife Phyllis.

According to the complaint brought by the trustees of the George Rothman Irrevocable Trust, Merrill broker Karen McKinley took advantage of Rothman's increasingly unsteady mental condition to shift his money into investments with higher commissions -- despite assuring Rothman, in writing, that his investments bore no fees or commissions.

Citicorp and two of Rothman's daughters, Doris Rothman-Browning and Barbara Rothman Thomas, are co- trustees of their father's irrevocable trust.

Vulnerable adults

Rothman, a real-estate tycoon who helped develop the Long Island, N.Y., bedroom community of Levittown and swathes of now-suburban New Jersey, died in 2004. He had been pronounced "judicially determined incapacitated" at age 81 in October 1999. Phyllis Rothman, then 76, was similarly declared incompetent at the same time. She is still alive.

McKinley became the Rothmans' financial advisor in 1991. At that time, the bulk of the Rothmans' assets were in "tax-free municipal bonds, U.S. Treasuries and real estate investments," according to the compliant.

Starting in October 1995 and continuing through July 1999, McKinley "continuously advised the Rothmans to liquidate a significant portion of their portfolio to purchase and continually fund variable annuities," says the complaint.

The Rothmans ended up investing $32 million in variable annuities at McKinley's behest.

McKinley's advice to the Rothmans to sell holdings to buy the "annuities was inappropriate, unreasonable, self-serving, financially unwise, negligent and fraudulent for numerous reasons," the complaint continues. Among the reasons cited: The Rothmans, who were extremely wealthy, had no need for the 'steady income' allegedly to be generated by the annuities. There was in fact no guaranteed 'steady income' from the annuities. The sale of investments to purchase the subject annuities forced the Rothmans to recognize income and to pay taxes on it. The Rothmans' receipt of distributions from annuities obliged them to pay income taxes on them in an amount exceeding that which they would have been obliged to pay had their portfolio remained unchanged or had they purchased more suitable alternatives to the annuities in question. The Rothmans' estate plans provided for distribution of the bulk of their assets to George's daughters. Holding the pre-existing investments until death would have resulted in a "step-up" in basis for the daughters. The conversion of the investments to annuities resulted in the loss of the "step-up" in basis and caused unnecessary and avoidable income taxes to the Rothmans' beneficiaries. The purchases of the annuities generated high fees and commissions for defendants and caused the Rothmans to incur taxes. The same level of taxes, fees and commissions would not have been incurred had the Rothmans' portfolio remained unchanged or had the Rothmans purchased more suitable alternatives to the annuities.

Wade Bowden of the West Palm Beach, Fla. -based law firm Jones Foster Johnston & Stubbs represents the trustees of the Rothmans' estate. He says that McKinley played on Rothman's predilection for bonds by taking the unusual step of coaching her written pitches for the largely equity-based variable annuities in terms commonly used for fixed-income investments, in the process misrepresenting the degree to which his investments would yield secure returns.

McKinley's record

The $6 million compensation award the jury hit on covers about $2.5 million in excess fees and commissions that Merrill took from the Rothmans in addition to an amount the Rothmans were determined to have paid in excess taxes for taking McKinley's advice. McKinley seems to have received about $600,000 in fees and commissions from the Rothmans' annuities.

Palm Beach-based McKinley, a Merrill employee for the past 24 years, has been in hot water before, according to FINRA records. In 1997, arbitrators made Merrill pay one of her clients $538,086 for putting the client in unsuitable investments and churning the account. In 2002, Merrill had to fork out to McKinley's clients on two occasions: $32,500 for what arbitrators determined was a series of unsuitable investment recommendations and $21,661 for the same reason plus "misrepresentation."

Merrill and McKinley denied the allegations in each of these cases.

And Merrill seems to be taking a similar line with the Rothman case. "The verdict is astonishing in light of the undisputed fact that the Rothmans, who were wealthy, sophisticated investors, made $10 million on the annuities at issue, and did not lose money," Merrill spokesman Mark Herr told the Record newspaper of Bergen County, N.J.

More to come

Bowden questions this line of reasoning. "Their idea seems to be that it's acceptable to embezzle as long as you leave the people you're embezzling from some of the profits," he says.

Merrill is seeking to have the verdict set aside and plans to appeal the decision if it stands. Late next week the jury is scheduled to say what, if any, punitive damages Merrill and McKinley should pay the Rothmans' estate.

Bowden says he's "hopeful" the jury will decide on a substantial punitive settlement for his clients. "How do you punish a company that's worth more than some small countries?" he asks. "You make them pay a large amount."

In addition -- and quite apart from the matter of McKinley and the variable annuities -- Bowden says Merrill is facing legal action by the Rothman estate over the Wall Street firm's attempts to have itself made a trustee against the Rothmans' expressed wishes.

Among other philanthropic endeavors, Rothman donated $4 million to Madison, N.J.-based Fairleigh Dickinson University, where the school's entrepreneurial studies institute and an athletic center bear his name. -FWR

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