WASHINGTON - NASD is switching gears on variable annuities.
Instead of taking action against broker-dealers who sell unsuitable variable annuities, the organization is conducting a series of "sweep" exams on brokers who recommend that clients sell variable insurance products to buy equity index annuities.
The sweep is one of the new initiatives securities regulators are undertaking to protect the elderly as the baby boomer generation starts turning 60 this year (InvestmentNews, April 3).
The targeted examinations were announced at a hearing held by the Senate Special Committee on Aging by Elisse Walter, NASD executive vice president for regulatory policy and oversight.
"We recently commenced a sweep focusing on the suitability of recommendations to exchange, withdraw funds or take other distributions from variable insurance products in order to fund investments in equity-indexed annuities and the associated supervision of this activity," she told the committee, which held the March 29 hearing on the subject of investment fraud targeting the elderly.
"Equity-indexed annuities are a concern of ours," NASD executive vice president for enforcement James S. Shorris said in an interview with InvestmentNews. "In particular, the practice of registered representatives making recommendations to surrender variable annuities, mutual funds or other types of securities to put money into an equity-indexed annuity."
Such annuities are insurance products, not securities.
That means that NASD, the Washington-based broker-dealer self-regulatory organization, does not have jurisdiction over the sale of equity index annuities. As a result, NASD's taking regulatory action regarding the products "can be challenging from a jurisdiction perspective," Mr. Shorris said.
While most regulatory actions focus on unsuitable recommendations to buy securities, in this case, NASD is eyeing possible unsuitable recommendations to sell them.
"Where the registered representative is making a recommendation to sell a security for the purpose of buying an equity-indexed annuity, if that recommendation to sell is not suitable, we believe that can be a violation of our rules," Mr. Shorris said. "It's an evolution in our position."
No enforcement cases have yet been announced by NASD in connection with the sweep, and Mr. Shorris would not say how many firms are being examined.
The life insurance industry stresses the fact that Americans are going to need annuities to guarantee lifetime income as they live longer than previous generations. The industry also says regulators should provide more empirical evidence of alleged problems with life insurance products such as variable annuities and equity index annuities.
"As long as the NASD has a reason to believe there's a need for a sweep, it's important to let the process run its course," said Carl Wilkerson, vice president and chief counsel for securities and litigation at the American Council of Life Insurers in Washington.
However, he said, "we expect regulators to be responsible when they're initiating a sweep, and we trust that the NASD must have done more than to just have gone on a hunch."
The organization said that it has been concerned for a number of years about possibly unsuitable recommendations to buy equity index annuities that pay returns based on equity indexes such as the Standard & Poor's 500 stock index. An insurance company typically guarantees a minimum return, but contract holders can lose money, especially if they need to cancel before the contract period is up, industry observers say.
"What is disturbing is, some marketing materials for equity index annuities are very aggressive," Mr. Shorris said. "We're worried about prospective purchasers' being misled."
In August, NASD issued a notice to members advising brokerage firms that allow registered representatives to sell equity index annuities as an outside business activity that it would be a good practice to either require them to stick to selling registered securities or to impose higher levels of supervision of sales of equity index annuities.
Since NASD put out that notice, the Securities and Exchange Commission has been conducting its own information-gathering sweep of insurance firms that underwrite the products.
SEC spokesman John Heine would not comment further on that inquiry.
"About all we have to say at this point is, we're still looking at the issue," he said.
Meanwhile, plaintiff's lawyers are beginning to file lawsuits in situations where elderly people are counseled to sell variable products to buy equity index annuities.
"We have a number of cases where that has been the phenomenon, where a senior has been in a variable annuity and may not either understand what they're in or what that product is supposed to be doing," said Cristina Pierson, a shareholder at Fort Lauderdale, Fla., law firm Gordon Hargrove & James PA.
"In some cases, advisers haven't looked at the variable annuities to see what benefits they've given up," she said. Financial advisers are touting equity index annuities as safe, Ms. Pierson said, and convincing elderly people that they should switch from the variable annuities based on the crystal ball prediction that the markets will drop.
One of Ms. Pierson's clients, a 67-year-old man with a heart ailment who was living on proceeds from his variable annuity, had experienced stock market losses for the variable product and was convinced by an insurance agent to transfer $150,000 to an equity index annuity, only to discover that he could not get ready access to the money in the new product without a 12% surrender charge.
People who have worked with the elderly say that part of the problem is the different culture in which the old folks grew up. "It's my theory that older Americans grew up in a more trusting era," said Susan Wyderko, acting director of the SEC's division of investment management. "Older Americans grew up in an era where it was rude to hang up on a salesperson. They grew up in an era where your word was your bond.
"Cultural norms have shifted. They are not as cynical as younger Americans. That makes them vulnerable to be exploited by unscrupulous salespeople."