Articles Posted in Variable Annuities

United Planners Financial Services of America (Scottsdale, Arizona) agreed to the payment of a $200,000 fine to the Financial Industry Regulatory Authority (FINRA) to settle allegations involving the failure to properly supervise and detect the unsuitable sale of variable annuities (VAs). According to FINRA, United Planners allowed supervisors to self-approve their own VA sales and the firm failed to implement proper supervisory procedures and training of VA transactions. United Planner’s Chief Compliance Officer Douglas Hall (Phoenix, Arizona) was fined $15,000 in a related disciplinary action.

Despite increased efforts from regulators, our securities law firm continues to see abuses in the sale of VAs. Two areas of particular concern are the sale of VAs to elderly investors and the unnecessary exchange or replacement of existing VAs.

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taxes1.jpgToday’s blog posting examines another recent trend that I am seeing both at my California securities law practice and at the University of San Francisco Investor Justice Clinic where I am an adjunct law professor. In the past few weeks, there has been a sudden increase in complaints from investors who were advised to replace their old variable annuity contracts with new ones and, to make matters worse, their financial advisors (i.e., stock broker and/or investment advisor) failed to exercise due diligence by making sure that the transaction qualified as a tax-free exchange pursuant to Section 1035 of the Internal Revenue Code. In a “1035 exchange,” a variable annuity owner replaces their current annuity contract with a new one without paying any tax on the income and investment gains attributable to the old variable annuity. However, if an investor simply surrenders their old annuity in return for cash and uses the cash to purchase a new annuity, the ability to perform a 1035 exchange can be lost and the investor will have to pay taxes on the surrender. Any financial professional who fails to facilitate a 1035 exchange of a customer’s variable annuity opens themselves up to a securities arbitration claim seeking damages for the customer’s fees, costs and taxes incurred as a result.

Another problem that often arises when exchanging or replacing a variable annuity is the potential for surrender charges. Customers are subject to charges whenever an annuity is surrendered before expiration of the applicable surrender period, which typically runs for 6 to 8 years from the date of purchase. Surrender charges also reduce the amount that an investor will have available to reinvest in a new annuity, thereby lowering the investor’s potential return. Also, when a new replacement annuity is purchased, the investor’s funds will be subject to a new surrender period, which means that their funds will be locked up for an additional 6-8 years.

Variable Annuities Are Inappropriate for Seniors

The state of California will receive $779,795 as its share of a multi-state settlement with Nationwide Life Insurance Co. and Nationwide Life and Annuity Insurance Co. who agreed to pay a fine totaling $2.1 million due to the alleged unsuitable exchange or replacement of two variable annuities developed for and sold by financial advisory firm Waddell & Reed, known as the Waddell & Reed Advisors Select Plus Annuity and the Waddell & Reed Select Annuity. The regulators contend that Nationwide failed to exercise proper supervision and control over the sale and exchange of these variable annuities. Nationwide’s settlement agreement was entered into with insurance regulators for California, Kansas, Missouri, Minnesota and Wisconsin.

As part of the settlement, customers from California, Kansas, Missouri, Minnesota and Wisconsin who replaced their United Investors Life Insurance Company annuity with a Waddell & Reed Select or Select Plus annuity between January 1, 2001, and August 31, 2002, will receive a notice advising them about their right to receive reimbursement of fees and charges incurred and other applicable remedies such as rescission and modification of their policies.

Broker-dealers affiliated with Wells Fargo and Washington Mutual, two large banks with close ties to the San Francisco Bay Area, have entered into a settlement with the Financial Industry Regulatory Authority (FINRA) agreeing to pay fines of $275,000 and $250,000, respectively, and consenting to the entry of findings regarding their inadequate supervision of variable annuity, mutual fund and unit investment trust (UIT) transactions with customers. The two bank’s sell securities through Wells Fargo Investments and WM Financial Services, which is now doing business as Chase Investment Services. The other firms sanctioned by FINRA are IFMG Securities, PNC Investments and McDonald Investments (now KeyBanc Capital Markets, Inc.). Collectively, the five firms will pay fines to FINRA totalling $1.65 million.

These firms are referred to as “bank broker dealers” because of their close affiliation with a retail bank. A large percentage of a bank broker dealer’s business comes directly from referrals by employees of the bank. This arrangement can be misleading to bank customers who are often unaware that they have been referred to a stockbroker who often has a desk or office inside the bank branch.

According to FINRA, the sanctioned firms failed to properly supervise the sales practices of their brokers and did not conduct necessary suitability reviews or investigate questionable variable annuity, mutual fund and UIT sales to its customers, many of whom were elderly. The $1.65 million dollar fine was part of a settlement with FINRA in which the firms consent to the entry of FINRA’s findings, but do not actually admit or deny FINRA’s findings. Customers affected by these sales practice violations are not entitled to any restitution as a result of the settlement. In order to recoup any losses, affected customers are advised to consult with a securities lawyer.

In May 2008, new suitability rules went into effect attempting to stop the proliferation of variable annuity complaints. Yet, from all appearances, variable annuities are still being sold to uninformed consumers, many of them elderly, who do not understand what they are getting themselves into–until it is too late.

A variable annuity is a hybrid product that includes both insurance and securities features. Due to their complexity, many customers are at the mercy of their brokers when deciding whether a variable annuity is a suitable investment. Because of the insurance element, many investors wrongly assume that their investment will not lose value.

Variable annuities come with a lot of costly features that are unnecessary for most investors. For many investors, particularly elderly ones, a variable annuity is a poor investment choice that can expose them to unnecessary market risk.

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