NASD reignites annuity probe

Regulators this fall expect to announce a new round of enforcement actions against sellers of variable annuities.

One knowledgeable industry consultant, requesting anonymity, says that the current probe likely includes Citigroup Inc. subsidiary Salomon Smith Barney.

Regulators are also believed to be looking at broker-dealers selling bonus annuities for American Skandia Inc., ING Financial Services International North America and Pacific Mutual Holding Co.

In a separate probe, Pacific Mutual’s Pacific Life and Annuity Co. unit is also the subject of a market conduct exam by the Arizona Department of Insurance.

Andrew Favret, regional chief counsel of NASD Regulation Inc., the National Association of Securities Dealers’ enforcement arm, confirmed that “a second sweep is under way involving several more firms.”

He told a regulatory conference last week in Washington that his office is responding to surging sales of the annuities.

Mr. Favret, who works at the NASD’s New Orleans regional office, declined to identify which broker-dealers are part of its current sweep.

The consultant says that as much as 30% of Salomon Smith Barney’s May annuity sales volume involved so-called 1035 exchanges – switching to another annuity contract.

That’s an area of particular concern to NASD officials.

A Salomon Smith Barney Inc. spokeswoman didn’t respond to requests to confirm whether the New York wirehouse is under examination.

A spokeswoman for the insurance department in Phoenix, while declining to discuss the examination, acknowledges that such investigations can be launched in response to complaints.

earlier actions

Mr. Favret played a prominent role in the NASD’s initial round of disciplinary actions last February involving the improper marketing and selling of annuities.

Accused in that probe were American United Life Insurance Co., Prudential Securities Inc., First Union Brokerage Services Inc., Allmerica Investments Inc., Lutheran Brotherhood Securities Corp. and Ralph C. Evans, a Morgan Stanley Dean Witter Inc. broker.

All the companies except American United settled the charges by agreeing to censures and fines ranging from $10,000 to $32,500. Rick Wacker, associate general counsel of American United in Indianapolis, says that the company is still working on a resolution with the NASD.

As for the current investigation, Mr. Favret said it “does not appear to be one that is going to diminish anytime soon, especially given the increase in activity.”

NASD officials are already having discussions with at least one of the companies involved in their second sweep exam and expect to have discussions shortly with another.

In addition, the enforcement unit has another wave of exams either in the planning stage or already under way.

“I would expect that NASD enforcement actions in this area will continue over the next year or two at least, and probably indefinitely,” Mr. Favret told executives attending a session on managing litigation and enforcement-action risk.

Mr. Favret said that the sweep exams were initiated in response to the explosion in variable-annuity sales, not after a rash of complaints.

So far, the NASD has targeted the broker-dealers that it believes are among the biggest sellers of variable annuities.

Examiners from NASD offices in New Orleans, Dallas and Washington are looking at broker-dealers’ books and records to determine whether the sales are properly documented.

“We have found that some firms are very good at accumulating information either at the point of sale or some time during the process, but not very good at having it in any place where someone can review it,” said Mr. Favret.

The agency has “almost universally” found problems. In some cases, it’s unclear who is responsible for the supervisory review of variable-annuity sales. In others, supervisors lack sufficient information to decide whether the sales are appropriate.

“We understand that a lot of firms are struggling to catch up in getting documentation online or in some form where it can be easily reviewed,” said Mr. Favret.

“That being said, firms that engage in this type of business have a responsibility to the customers to see to it that these things are being properly reviewed.”

Though the NASD hasn’t yet brought many individual suitability cases related to annuity sales, it expects that to change in the next six to 12 months.

“A question a lot of the staff has is, `Does the firm make a determination that there is anybody who’s not suitable for one of these products? A lot of firms seem to equate suitability with the ability to pay for the product,”‘ said Mr. Favret. “We think that suitability goes far beyond that, especially in terms of investment objectives.”

Mr. Favret said that some new-account forms seem to funnel all customers into an annuity.

“We’d like to see something on the new-account form, which gives a potential investor an option of indicating investment objectives, which could mean that some other securities product may be more appropriate for them.

“Just as a bond may be more appropriate for a customer than 100 shares of a high-tech stock, so a variable product may be unsuitable for a customer as opposed to a bond.”

Mr. Favret added: “The one thing that is always in the forefront of our minds is that individual brokers typically make more money selling variable products than most other products. There is a special incentive for the broker to sell these products.”

Tom Conner, vice president and general counsel of NAVA, cited the complicated nature of annuity products and asked if the NASD would balance the extra effort needed in selling annuities with the high commission rates they carry.

Mr. Favret said that the NASD isn’t unilaterally opposed to higher commissions, but rather that the industry often defends the higher payout rates by insisting that more work goes in to preparation, review and training – yet little extra work appears to occur.

“If they can show us that their training is more involved, their suitability review and other structures are much more detailed for this product, that’s a great thing,” he said.

“But if all the supervisor is doing at the end of the day is checking off and initialing the sales blotter that has 100 names on it, where is the additional review given the complexity of this product?

“We want to see some demonstration by the firm that the customer is actually getting some bang for its buck in terms of what the firm is providing,” he said.