Variable Annuities Abusive Sales Practices and Liability

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

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

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

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

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

8. Suitability Requirements & Supervisory Responsibilities

9. 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

10. Investment Objectives & Risk Tolerance

11. 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.

12. 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

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

14. Investment Objectivesand 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

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

16. 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

17. 1999 - 2003 • Almost 35% loss in value • $500,000 is now $340,000

18. ConfusionMisunderstanding Deception? • It is guaranteed you cannot lose your initial investment • A minimum level of income payments is guaranteed

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

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

21. 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%

22. 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

23. Deceived or Confused • Or Both?

24. 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

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

26. 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

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