SEC probe targets WMA

A Georgia securities firm with 9,000 brokers across the country, many part-time and working out of their homes, is under investigation by the Securities and Exchange Commission, according to an SEC letter obtained by InvestmentNews.

Meanwhile, in an unrelated matter, Northwestern Mutual Life Insurance Co. has warned its agents to steer clear of an investment being hawked by the firm, WMA Securities Inc. of Norcross, Ga.

Milwaukee-based Northwestern, which declined to comment, maintains in an internal newsletter that WMA has been marketing insurance policies to agents that could snare purchasers and their home mortgages in a “perpetual loop of debt.”

Insurance experts contacted by InvestmentNews say the policy is a variation of the “vanishing premium” concept, a type of policy that was widely sold in the 1980s. The policies provoked widespread fraud allegations and millions of dollars in lawsuits when they failed to perform as promised.

The SEC, as a matter of policy, declined to confirm or deny the investigation, as did Barry Clause, president of WMA. The staff attorney who wrote the letter did not return telephone calls.

The letter, however, suggests that the probe is related to WMA’s past scrapes with state regulators.

It states that the SEC is attempting to determine whether those matters involved violations of federal securities laws.

Most notably, in 1998 the company was forced by regulators to repay clients more than $2 million. The payment was part of a settlement with the state of Arizona, where WMA brokers were accused of selling viatical life insurance products the home office hadn’t approved.

This illegal practice, known as “selling away,” is an “industry issue,” says Mr. Clause. “It’s not specifically only our firm that’s at fault in that type of situation.”

The company, which neither admitted nor denied wrongdoing in the Arizona case, has and will continue to make changes in its overall supervisory and compliance procedures, says Mr. Clause.

This includes an increase in branch office supervisors, initiating mandatory training programs for supervisors and branch office managers and enhancing the training of agents on company policies.

Last year, a dozen investors filed arbitrations claims in Ohio, Florida and California, seeking an additional $2 million. A separate case filed by other investors in Ohio has since been settled for $344,500.

The SEC is seeking documents related to the claims to aid in its investigation, according to the letter.

In the Northwestern Mutual matter, the insurer criticized WMA’s “Prime Assets Home Loan,” in two internal newsletters obtained by InvestmentNews.

The loan includes a variable universal life insurance policy, that would supposedly pay off the mortgage by building up cash through stock market investments.

While marketing life insurance policies or annuities as a tool to make mortgages cheaper is uncommon, firms have tried it from time to time, says Kenneth Kehrer, an insurance industry consultant based in Princeton, N.J.

“This type of product takes on some extra risk, but on the other hand, if the market performs well, you come out ahead,” says Mr. Kehrer.

Mr. Clause declined to comment, saying he had not seen the articles.

“We represent hundreds of companies and we sell hundreds of products,” he says. “This [Prime Assets Home Loan] happens to be one of them. It’s a very small part of our business.”

The author of the articles, Northwestern sales support specialist Sean McGinn, also declined to comment. But in the article, Mr. McGinn says he was prompted to write about the product after being presented with a copy of its prospectus.

Entitled “Looking for a way to make home financing even more complicated?” his article explains the product this way:

A home buyer takes out an interest-only mortgage loan with a balloon payment at the end of 30 years. The money that would have been used to pay down the loan’s principal is used instead to buy a variable universal life policy with a death benefit large enough to pay off the loan, states the article.

The investor is supposed to build up enough tax-deferred value in the policy over 30 years to pay off the mortgage and potentially have money left over.

The problem with WMA’s product, writes Mr. McGinn, is that the underlying variable life policy must earn at least an average 12% gross return every year for it to work.

perpetual loop of debt

“If at the end of the 30-year period the cash value of the VUL policy is insufficient to pay off the loan in full, the mortgage balance must be paid out of pocket or a new mortgage negotiated.”

Mr. McGinn states that purchasers could be caught in a “perpetual loop of debt” where the policy is too expensive to terminate and too expensive to keep.

If the policy lapses, for example, the purchaser would owe tax on the gain, a situation he calls a “surrender squeeze.”

Of course, if the market performs as well as it has recently, “you come out way ahead. The question is how aggressive is a 12% return?” Mr. Kehrer says.

Based on the Wilshire 5000 index, the market has averaged a 14% return over the past 29 years, but that figure has been goosed by spectacular returns in the 1990s, according to Morningstar Inc. The average of the Wilshire 5000 from 1971 through 1989 was 12%.

In contrast, since 1926 the market overall has returned about 11%

Mr. McGinn expresses further concern in a follow-up article, because WMA’s prospectus suggests that the cash value would be sufficient to not only pay off the loan, but also to fund other uses.

Insurance experts say WMA’s “Prime Assets Home Loan” is a new twist on “vanishing premiums” an insurance concept that cost thousands of people their policies in the 1980s.

Policy holders bought variable insurance hoping the underlying investments would build up enough cash in the policy to pay off future premiums.

Instead, many insurance companies overestimated projected returns and many policy holders saw their policies lapse.

As late as last year, lawsuits over the practice were being pressed against a number of insurance companies, which in many cases have paid out millions to settle litigation.

“You’re really paying extra for insurance to shelter a tax-deferred accumulation,” says Peter Calfee, an independent financial planner who specializes in insurance planning.

He calls the program a marketing gimmick that’s too expensive. “Everything has to coincide with the moon, the stars and the sun for this product to have the possibility of working,” he says.