Variable annuities are investment contracts, and are therefore securities under the federal securities laws.
In 2004, the North American Securities Administrators' Association ("NASAA") ranked the sale of Variable Annuities "often pitched to seniors" as one of the "Top Ten" investment scams affecting the investment public, and particularly senior citizens.
On March 29, 2006, Patricia D. Struck, the President of NASAA, in her testimony before the Special Committee on Aging of the United States Senate, stated:
A perennial fixture on NASAA's annual list of top scams involve the sale of variable annuities to investors with little regard to whether or not the product is suitable. While these are legitimate and suitable investments for some, regulators are concerned that many investors aren't being told about high surrender charges for early withdrawals, the potential of exposure to market risk, and the steep sales commissions agents often earn when they move investors into variable annuities. Often pitched to seniors through investment seminars, these products are unsuitable for many retirees.
(P. Struck Testimony, Mar. 29, 2006 at 3)(emphasis added).
Noting that "high commissions, typically above 5% for variable annuities, help drive sales of these products," a Joint report issued by the United States Securities & Exchange Commission and the NASD in June 2004, found that "unsuitable variable product recommendations were made without a reasonable basis in light of information the broker may have had regarding the customer's:
Financial or tax status (e.g., sales that exceed a pre-determined percentage of the customers net worth; sales that require the mortgage of a home to finance the purchase;
Sales that require a customer to borrow from an existing life insurance policy or annuity; or sales to a corporation, trust, or other non-natural entity that did not hold as agent for a natural person, and whose purchase therefore caused the loss of tax-deferral status in the annuity);
Investment objectives (e.g., same product recommended to all customers (one size fits all), or a customer's current need for income); Investment sophistication and ability to understand the complexity of variable products generally, and to monitor the investment of the separate account;
Low risk tolerance (e.g., high risk equity funds are recommended to an investor with low risk tolerance);
Need for liquidity (e.g., sale of an illiquid variable product to persons who need their funds soon, and as a result incur surrender charges to obtain their funds);
Lack of need or desire for life insurance.
Joint SEC/NASD Report on Examination Findings Regarding Broker-Dealers Sales of Variable Insurance Products, June 2004 at 9.
The Joint Report also identifies, "examples of exception reports that may be useful in identifying abusive sales practices and violations in the sale of variable insurance products" include:
Clients age over firm's internal maximum;
Clients with low net worth;
Clients with low annual income;
Clients in the lowest tax bracket;
Clients with limited investment experience;
Id. at 26. Almost without exception, as set forth above, and in the Statement of Claim, each of these exceptions, or \"red flags" are present in this matter.
Similarly, NASD Regulation (now the Financial Industry Regulatory Authority ("FINRA") has specifically cautioned members that "as securities, the sales and distribution of Variable Contracts are fully subject to the NASD's sales practice rules", and the when a Variable Contract is recommended and sold to a public customer, Rule 2310 requires that:
In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.
The NASD has further stated that in connection with evaluating a customer's suitability, that Annuities may be unsuited for customer needing "liquidity and short term investments", and "the customer's immediate need for retirement income". (Exhibit "N" at 706); (See also NASD Notice to Members 99-35)("The registered representative should inquire about whether the customer has a long-term investment objective and typically should recommend a variable annuity only if the answer to that question, with consideration of other product attributes, is affirmative").
In 2000, the NASD has found, in connection with more than 80 disciplinary actions involving the sale of annuities to retirees, that among the most common misrepresentations, is the misrepresentation that "Variable life policies were not insurance but were an investment savings or retirement plan." NASD Notice to Members 00-44, July 2000 at 300("Unsuitable sales to customers including retirees and person who did not know that they were purchasing insurance or did not want life insurance").
In May 2008, FINRA Conduct Rule IM-2821 became effective, and specifically provides that:
(2) Prior to recommending the purchase or exchange of a deferred variable annuity, a member or person associated with a member shall make reasonable efforts to obtain, at a minimum, information concerning the customer's age, annual income, financial situation and needs, investment experience, investment objectives, intended use of the deferred variable annuity, investment time horizon, existing assets (including investment and life insurance holdings), liquidity needs, liquid net worth, risk tolerance, tax status, and such other information used or considered to be reasonable by the member or person associated with the member in making recommendations to customers.
Commentators agree, and note that variable annuities are a notorious vehicle for abusive sales practices. (J. Duval, Variable Annuities: A Primer, Securities Arbitration 2003, Practicing Law Institute (2003) at 9-18, P. Michaels, Variable Annuities: Has the Arbitration Floodgate Opened?, Arbitration 2003, Practicing Law Institute (2003); See also, An Overview of Equity Indexed Annutiies, C.McCann and D.Luo.