As baby boomers continue to age, securities regulators focus on protecting the growing population of seniors and retirees. For example, the regulators are seeking to ensure that broker-dealers’ systems and procedures for assessing the suitability of particular types of investments and the mental competence of their customers are adequate. Regulators are also focusing on suitability determinations and disclosures surrounding recommendations that retiring workers roll over their retirement plans into IRAs. (See our recent

FINRA’s Enforcement Action Regarding VA Switches

A recent FINRA enforcement action reminds us that FINRA continues to focus on variable annuity (VA) sales practices. In that formal disciplinary proceeding, FINRA found that the subject firm had engaged in almost no VA business until a registered representative who concentrated in VAs joined the firm. According to FINRA, during one year, the broker recommended that 17 customers surrender their VAs and replace them with another annuity.  Each customer paid a surrender charge of at least $1,000, for a total of $70,000, and all but one of the customers surrendered significant death and/or living benefits in the surrendered contract.

Even though the customers varied widely in age, net worth and liquid net worth, the broker recommended that all 17 customers purchase the exact same product to replace their surrendered annuity, and select the same optional living benefit rider and underlying subaccounts. On all 17 switch forms, the broker provided the exact same three reasons for the recommended exchange, and the reasons were untrue in many cases.

FINRA found that the named respondents – the broker-dealer and its President/Chief Compliance Officer – failed to reasonably supervise these VA exchanges and failed to recognize that the exact same product was being sold to a diverse group of customers, and that the broker used the same justifications for all of the exchanges, some of which were not consistent with the VA he was recommending. The firm itself, FINRA found, did not engage in reasonable efforts to determine that the supervisors or compliance personnel reviewing the transactions were qualified to review VAs. Among other sanctions, FINRA fined the firm, which consented to the sanctions without admitting or denying the findings, $30,000 and suspended it from executing any VA transactions for a year.

Suggestions for Ensuring Adequate Procedures

In its 2014 Exam Priorities Letter, FINRA indicated that this year its examiners “will continue to focus on how firms engage with these senior investors, especially with respect to suitability determinations as well as disclosures and communications.” FINRA reported that in 2013 it had worked with the SEC to assess firms’ policies and practices with respect to their senior investor client base. Among other things, FINRA found that age plays a role in many firms’ supervisory processes. For example, many firms have established product-specific suitability guidelines for senior investors purchasing products such as VAs, equity-indexed annuities, REITs and other high-yield alternative products.

FINRA guidance on suitability and sales practices in the sales of VAs dates back at least to 1999, and so it is high time that firms ensure that they have robust procedures built around these products, as well as other issues affecting seniors. The customers that FINRA was seeking to protect in 1999 are 15 years older now, and FINRA’s approaches to examinations have increased in their sophistication and focus in that same period. FINRA’s pronouncements and recent enforcement action suggest that the following practices would be appropriate elements of a firm’s supervisory procedures:

  • Review all VA exchanges for suitability.
  • Ensure that the reasons given for a VA exchange on the switch form match up with the features of the purchased VA.
  • Ensure that the customer is told, and understands, the cost of an exchange and any benefits of the switch.
  • As another threshold means of reviewing suitability, compare all switches done by a broker within a narrow period to determine if the broker differentiated among customers.
  • Ensure that all brokers who are engaged in VA sales receive training for all features of these instruments.
  • Ensure that the supervisors of brokers engaged in VA sales are competent to evaluate VA switches and other transactions involving VAs.
  • Ensure that the broker-dealer has a robust procedure for determining the mental capacity of aging customers, and that supervisors review application of these procedures.