Brokers have been pitching their clients who have been seeking yield, “indexed annuities”, a confusing product which really doesn’t fit the clients’ needs.
Indexed annuities, which appear to simulate the returns of stocks, have come under the scrutiny of FINRA according to a report over the weekend by industry newspaper InvestmentNews. FINRA is looking for red flags such as the cost to clients, as high as 6-8% and whether these complicated fees were adequately disclosed by the broker to clients, according to reporters Bruce Kelly and Darla Mercado.
Indeed, stock brokers are becoming more of a force in the world of equity indexed annuities, which have typically been sold by insurance agents. One positive note regarding this trend is that brokers are more highly regulated than insurance agents. Those agents have no central self-governing and regulatory organization like FINRA to watch over the hundreds of thousands of insurance agents currently pumping out expensive and confusing equity indexed annuities. Instead, they are regulated solely by individual states.
According to InvestmentNews, during recent exams of brokers, FINRA “has put under its microscope some firms’ policies and procedures related to exchanges into fixed annuities from variable annuities, according to broker-dealer executives. Such variable annuity exchanges are known as “1035 Exchanges” because they fall under section 1035 of the Internal Revenue Code.”
The practice of variable annuity switching has routinely drawn the eye of securities regulators. It’s an area that has historically been ripe for abuses by unscrupulous brokers. By switching a client from one annuity to the other, a broker generates another high commission from the transaction. While not all annuity switches harm clients, it’s a transaction that the broker needs to walk his client through with an abundance of detail. The broker must explain how a 1035 exchange will benefit the client. If he doesn’t make such an explanation in convincing and clear detail, the client needs to head for the door.
Securities regulators are once again curious about the exchange, according to InvestmentNews. “’The 1035 exchange, overall, is something we’re looking at,’ acknowledged Susan Axelrod, executive vice president, regulatory operations with Finra. It’s incumbent on broker-dealers to have the procedures and controls in place when such an exchange is recommended because it involves the sale of a security, she said’”.
“’It is an important area to focus on,’ she added. ‘We’ve seen some deficiencies in this area. Not all firms have stepped up on this to insure that procedures and controls are reasonable.’ And the indexed annuity business is booming, with sales reaching $38.6 billion last year, up 13.2% from $34.1 billion in 2012,” according to research cited by InvestmentNews.
As InvestmentNews noted, there are several danger signals regarding the exchanges, including undisclosed fees. FINRA will also take notice if the reason for a 1035 exchange was misstated, according to the article. For example, if a rep told a client that fees would be lower in the new product but are actually higher.
Variable annuities are often a staple of senior investors’ portfolios, and that fact makes the product stand out to FINRA, according to InvestmentNews.
Annuities can generate a reliable income stream for older investors in retirement. However, they are expensive, come with restrictions to the investor and carry a high commission to the broker. So, if a broker comes calling on you to exchange your annuity with a brand new product, make sure he spells out exactly the cost of the new product and the benefit. If the broker stammers, or can’t answer your questions about the exchange, run for the hills. The 1035 exchange is likely for the brokers benefit, not yours.
Zamansky LLC are investment and stock fraud attorneys representing investors in federal and state litigation and arbitration against financial institutions.