Finra is continuing its crackdown on variable annuity misconduct this year, following a blistering year of fines related to VA sales in 2016.
Two recent enforcement actions from the Financial Industry Regulatory Authority Inc. demonstrate the watchdog's attention on variable annuities, especially faulty annuity exchanges.
In one disciplinary proceeding, Finra's enforcement department suspended broker Cecil E. Nivens for two years and ordered the broker disgorge nearly $186,000 in commissions for causing "considerable monetary harm" to customers related to VA exchanges, according to a Finra filing made Sep. 18. In another proceeding, filed Oct. 6, the regulator suspended broker Walter Marino for one year for similar annuity abuses.
Brokers typically recommend clients replace annuities under Section 1035 of the tax code. That provides a tax-free transfer for the client, but also generates additional commission for the broker. As such, 1035 exchanges are typically how abusive account churning occurs with annuity products.
In these cases, not only did clients incur higher annuity fees and surrender charges (sometimes in the tens of thousands of dollars) due to the exchanges, but they also had significant tax liabilities because the brokers, in trying to conceal their abuse, didn't categorize the annuity replacements as 1035 exchanges, Finra said.
Neither Mr. Nivens nor Mr. Marino could be reached for comment.
"Regulators haven't been focused on these products for the last several years, because there are several other things to be worried about," such as exchange-traded funds and derivatives, according to Amy Lynch, president and founder of FrontLine Compliance. "They are starting to focus on them again."
Finra levied $30.3 million in fines among 30 variable annuity cases in 2016, the second-largest fine total behind that for anti-money laundering cases, according to statistics from law firm Eversheds Sutherland. The VA fines increased 191% over their level in 2015, and the number of cases rose 20%.
Last year was also the first time since 2009 that variable annuities have made it to the list of Finra's top enforcement issues as measured by total fines assessed, according to Sutherland.
The pace of enforcement has slowed a bit so far this year — Finra reported 12 cases involving variable annuities, generating $510,000 in fines, through the first half of the year. But that doesn't necessarily signal that the regulator is shifting its focus.
"I do think the trend for Finra on variable annuities will continue in the future, because a rising stock market covers so many abuses," said Andrew Stoltmann, an attorney who represents investors in Finra arbitrations. "To Finra's credit, they're trying to get ahead of the issue before we see the inevitable market crash."
Although Finra hasn't explicitly called out variable annuities in recent annual letters laying out regulatory and examination priorities, enforcement officials have indicated the products are at the "sweet spot" of scrutiny, because they are complex products marketed to retirees and people about to retire.
"I think exchanges are a red flag for regulators, because so many times we're seeing exchanges without a real bona fide reason for doing the exchange," said Mr. Stoltmann, the president-elect of the Public Investors Arbitration Bar Association. "So I think it's easy hunting for Finra enforcement to go after these exchanges."
One way brokerage firms can be more careful is by better monitoring the types of annuity products they're selling, said Ms. Lynch, former head of variable product inspections in the Securities and Exchange Commission's Office of Compliance Inspections and Examinations.
Products have become broader and more "exotic," Ms. Lynch said, referencing such types as hybrid annuities (a cross between variable and indexed annuities) and no-load VAs, which have become more popular in the wake of the Labor Department's fiduciary rule. Not understanding the products and their risks is brokerages' "biggest weakness," she said.