IRVINE, Calif. - A closely watched case involving the sale of equity index annuities by a brokerage firm is set to begin today with an administrative hearing in Boston.
Charges filed against Investors Capital Corp. by Massachusetts securities regulators allege that the Lynnfield, Mass., independent-contractor firm should have supervised sales of equity index annuities made by its representatives since 2001.
Industry observers believe that the case is the first action brought against a brokerage firm over the sale of these increasingly popular annuity products. Meanwhile, some lawyers and industry groups say they are skeptical about the state's suit - announced last fall with fanfare by Secretary of the Commonwealth William Galvin.
Equity index annuities aren't securities, and broker-dealers have never been required to supervise sales of the products, some critics say."We're watching it closely, because it appears the [securities
division of Mr. Galvin's office] is reaching beyond their jurisdiction," said Dale Brown, executive director of the Financial Services Institute Inc. in Atlanta, which represents independent-contractor firms.
"If this case goes against ICC, it could mean 50 different state regulators' imposing supervisory requirements for non-securities products on all our [broker-dealer] members," he said. "That would be a nightmare scenario."
Brian McNiff, spokesman for Mr. Galvin in Boston, declined to comment on the jurisdictional issue.
In December, Investors Capital asked a state superior court to rule on whether Massachusetts securities regulators had jurisdiction over equity index annuities. In January, state court Judge Allan van Gestel ruled that the issue should be addressed in the administrative proceeding.
Last month, after the firm petitioned the state to appoint a neutral hearing officer, the state's securities division named Herbert Lemelman, a professor at Boston-based Suffolk University Law School, to judge the case.
Holes seen in case
Massachusetts has a "number of problematic areas" with its case, said Roy Washington, Houston-based director of compliance consulting at Capital Forensics Inc. in Arlington Heights, Ill. Mr. Washington, a lawyer who provides expert-witness work in the insurance area, isn't involved in the case.
The state's definition of "securities" "specifically excludes all annuities, including variable annuities," he said.
At the federal level, the Securities Act of 1933 exempts insurance products from registration if the products are regulated by an authority such as a state insurance commissioner.
A 1986 SEC rule exempts fixed annuities from registration if they are issued by an insurer subject to state regulation, the insurer assumes most of the investment risk, and the product isn't marketed primarily as an investment.
Massachusetts doesn't argue specifically that the products are securities, but its complaint against Investors Capital cites sales pitches made by the firm's reps claiming that equity index annuities allow participation in the market with limited risk.
In 2002, a federal court in Kentucky ruled in Malone v. Addison Insurance Marketing Inc. that an equity index annuity isn't a security.
In that case, the product sold by Dallas-based Addison guaranteed a return of 100% of principal, plus interest, Mr. Washington said. For single-premium products, a guarantee of 90% of principal, after surrender charges, has been the "general standard" as to how much investment risk an issuer must retain in a fixed product, he said.
Washington-based NASD has already acknowledged that it doesn't have jurisdiction over equity index annuities, though it strongly suggested last August that its member firms begin to supervise the sale of the products.
Mr. Washington wonders if Massachusetts targeted Investors Capital because of a 2003 settlement with NASD in which the firm paid a $250,000 fine over alleged shortcomings in its supervisory procedures - similar to allegations the state is making now.
It looks like the state may have "picked carefully whom they're going after," he said. Those past charges could make its current allegations more believable, Mr. Washington said.
Massachusetts' "aggressive tactics" in going after Investors Capital "are problematic," Mr. Brown said. For example, the state released the complaint to the press before the firm had a chance to see it, he said.
"We're actively looking at ways we can be constructively involved" in helping Investors Capital, Mr. Brown said, "because this case has tremendous potential to be a precedent-setting case."
The Milwaukee-based National Association of Fixed Annuities has criticized Massachusetts and Mr. Galvin for targeting a variety of insurance products.
In the fourth quarter, the firm reported that it had spent nearly $400,000 in outside legal fees in defending itself against the Massachusetts complaint. That amount was about equal to its operating profit for the quarter.
"The case has suppressed our stock price some," said Ted Charles, Investors Capital's chairman and chief executive.
But he disputes the state's case and said any problem with equity index annuities is a matter for the Massachusetts Division of Insurance.
Mr. Charles added that he is reminded of the case when he passes the Rebecca Norse homestead in Danvers, Mass., on his way to work each day. She was accused of witchcraft in 1692 during the Salem witch trials.
"The tradition has carried on here," Mr. Charles said.