Weak state oversight of insurance sales hurts investors and advisers

The more one looks into the divide between the states' oversight of agents selling insurance products and the regulation of advisers and reps selling securities like mutual funds or individual stocks, the more the brain shakes and rattles.

Insurance salesman and financial advisers operate under two completely different regulatory regimes, although they frequently offer similar services that address a client's overall financial health, including financial and estate planning.

This is where the two sides of the financial advice industry divide.

Brokerage executives routinely — but privately — complain about the highly regulated industry in which they operate. They believe they work under the oppressive watch of the Securities and Exchange Commission, the Financial Industry Regulatory Authority Inc. and individual state regulators, chief among them William Galvin, the Secretary of the Commonwealth of Massachusetts, who is disliked by many industry executives.

On the insurance side of the street, individual state insurance commissioners oversee the salesman and whether they have a license to sell products. And when it comes to bad actors hanging onto their insurance licenses and holding themselves out to the public as a planner, the states are doing a pretty terrible job.

Take, for example, the case of Brett Pittsenbargar, an insurance agent in Texas who was arrested this month and faces felony charges of securities fraud, money laundering and theft, according to the Texas State Securities Board. The charges stem from Mr. Pittsenbargar's sale of $9.3 million of notes from the Woodbridge Group of Companies Ponzi scheme.

According to the Texas Department of Insurance website, Mr. Pittsenbargar's status as an insurance agent is deemed "active," giving him the appearance of propriety. On his website, Mr. Pittsenbargar, who did not return calls to comment, touts himself as a "business investor & turnaround strategist," with a focus on small businesses.

There's no mention of the charges he faces on either the Texas site or his own.

Confusion over such salesmen reigns. Why?

"Insurance is regulated on a state-by-state basis and state systems are often fragmented," said Benjamin Edwards, associate professor of law at the University of Nevada, Las Vegas. "Functionally, this means that brokers with checkered pasts may slip through the cracks and operate in the insurance space when they should be barred."  

"When state systems allow known bad actors and fraudsters to operate, they put their citizens at significant risk," Mr. Edwards said. "This issue remains a frequent priority for state regulatory organizations for both the securities and insurance spaces."

Why would the insurance industry tolerate this?

Unfortunately, there is no clear answer. InvestmentNews has focused on this issue for years, and recently this column has renewed that spotlight on the topic. Instead of gaining clarity around the issue, each column seems only to raise more questions.

I’ve been pestering the National Association of Insurance Commissioners about this issue for several weeks. The general response is that, although the NAIC and Finra have recently embarked on an attempt to share data regarding brokers and agents in the industry, it is up to the states to police insurance agents.

On the surface, the data-sharing agreement between the two groups seems profoundly inadequate in terms of protecting not only the public, but also the reputations of financial advisers, who recoil when they hear tales of advisers like Mr. Pittsenbargar. A stain on one financial adviser is a stain on all.

The data feed that Finra provides the NAIC includes all registered reps in BrokerCheck, current and former, with their registration numbers (known as CRD numbers in the industry) and a flag indicating whether their registration status is active or inactive. 

The data feed does not include disclosure events, such as investor complaints, being fired from a firm or tax liens, because those disclosure events are already made public through Finra's BrokerCheck system. Such disclosure events are commonly regarded as red flags and are important for consumers to know about because they scream, "Buyer, beware."

The NAIC does not provide disclosure events to Finra; nor does the group have a public website similar to BrokerCheck where Finra and the public can retrieve that information. Finra wants to get such information in the future.

A spokesperson for the NAIC, Alana LaFlore, noted that the two groups are sharing limited information, such as whether an active insurance agent holds a license or registration with a broker-dealer.

The NAIC also shares Finra's public monthly disciplinary report with state insurance regulators, who then review Finra actions and decide whether they should take action on an individual’s producer license, Ms. LaFlore added.

This is the flimsiest level of information sharing between the two groups. If a state insurance commissioner had not already been checking Finra’s monthly report for bad actors in his or her state, that commissioner is incompetent.

The collapse of the $1.2 billion Woodbridge Ponzi scheme, much of which was sold by active insurance agents like Mr. Pittsenbargar, brings the issue of weak insurance regulation into focus.

Why doesn't the insurance industry give information about a sales agent's misconduct to Finra and the broader public, keeping in mind, as Mr. Edwards earlier noted, that the insurance business works under a fractured, porous regulatory regime?

And how can the industry improve itself so its salespeople don't become the conduits for the another massive Ponzi scheme, the next Woodbridge-type disaster?