Variable Annuities Abusive Sales Practices and Liability By Joel D. Feldman Anapol, Schwartz, Weiss, Cohan, Feldman & Smalley

Introduction Individual Investors NASD and NYSE Arbitration Programs Tort Law Concepts Personal Injury Settlement Proceeds

Variable Annuities What are they? – Annuities – Insurance Contracts – Tax Deferred Growth – Annuitization

Sub-accounts Variable Annuities subject to stock market risk based upon the nature of sub-account investments

Potential for Abuse 1990 – $35 Billion 2000 – $850 Billion Complicated Product – Insurance and Securities High Fees and Commissions for Brokers

Suitability Requirements Supervisory Responsibilities &

Suitability NASD Conduct Rule 2310 – Recommending Purchase, Sale, or Exchange – Reasonable Grounds for Believing Recommendation is Suitable for the Customer Facts Disclosed by the Customer – Other Security Holdings – Financial Situation

Investment Objectives RiskTolerance &

Supervision NASD Conduct Rule 3010(a)(1) Members must establish systems to supervise activities of agents designed to achieve compliance with applicable securities laws and regulations.

Mr. and Mrs. Jones Mrs. is retired – age 62 Mr. is retired – age 66 Both have a high school education Both need a current income Neither need life insurance Both are Risk Averse

Mr. and Mrs. Jones Prior Investment Experience – U.S. Savings Bonds – Bank CD’s – Mr. Jones – Participated in Company Retirement Plan

Investment Objectives and Risk Tolerance I do not want to worry about losing my money I do not need to make a lot of money, I just want to be secure and have a guaranteed income I do not trust the stock market

Mr. and Mrs. Jones Mrs. Jones Personal Injury Settlement Net $750,000 What should be done with the money? Financial Advisor

Broker Recommends $500,000 into a variable annuity 8 sub-accounts – Equally divided as to $ – 2 Bond Mutual Funds – 6 Equity Funds International Portfolio Aggressive Growth Small Cap Growth Capital Appreciation Portfolio Small Cap Value Mid Cap Growth

Almost 35% loss in value $500,000 is now $340,000

Confusion Misunderstanding Deception? It is guaranteed you cannot lose your initial investment A minimum level of income payments is guaranteed

Principal is Guaranteed Correct – But only if and when Mrs. Jones dies

Guaranteed Minimum Income Benefit Yes – But – Policy must be in force for 10 years – Annuitization is Necessary

Other Negatives Not a short-term investment, lack of liquidity – CDSC Unfavorable tax consequences – conversion of capital gains tax rates to ordinary income No “stepped up” cost basis if appreciation when assets passed at time of death Fees – 1.25% to 3%

Mr. and Mrs. Jones Never should have been sold any variable annuity – Tax deferral not important – No need for life insurance – Had a real need for guaranteed principal Negligence, Breach of Contract, Breach of Fiduciary Duty, Uniform Trade Practices Consumer Protection Law (UTPCPL), Fraud

Deceived or Confused Or Both?

Damages Rescission – Return of $500,000 investment (less actual value) Interest from Date of Sale of Variable Annuity Attorney’s Fees and Costs UTPCPL – Treble Damages

NASD Conduct Rules Actual and Proposed Heightened Suitability Requirements “Plain English” Risk Disclosures – See Exhibit ?? Heightened Supervisory Requirements

Warning Signs Older Clients Qualified Accounts Need for Liquidity No Need for Life Insurance Unsophisticated Clients Need for Income and Preservation of Capital “1035” Exchanges

Variable Annuities Abusive Sales Practices and Liability By Joel D. Feldman Anapol, Schwartz, Weiss, Cohan, Feldman & Smalley