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Enforcement News: SEC Settles Charges Against Minneapolis Broker-Dealer for Improper Switching or Replacing of Variable Annuities

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  • Posted on: Jun 3 2022

By: Jeffrey M. Haber

Variable annuities are complex securities pursuant to which customers, typically seniors and vulnerable adults, enter into long-term contracts with an issuing company, such as a life insurance company. Variable annuities entitle customers to certain payments depending on the terms of the contract and the performance of an underlying portfolio of securities. Variable annuities often have surrender periods, before the end of which customers must pay a fee for selling or exchanging their annuity contract. 

Although the industry is regulated by state and federal law, such as the Investment Company Act of 1940 (“ICA”), there is no shortage of fraud and other improper conduct involving the purchase and sale of annuities. 

As with any fraud, annuity scams are limited only by the scammer’s imagination. We highlight a few of the more common types of annuity fraud.1

  • Cutting Out Beneficiaries. Scammers convince their targets to buy an annuity contract in which any money left in the annuity at the target’s death will remain with the adviser, broker or insurance agent (collectively, “Agents”) or the advisory firm, broker-dealer or insurance company instead of the annuitant’s beneficiaries. 
  • Fear Mongering and High-Pressure Tactics. Agents conduct high-pressure sales meetings to profit from clients’ fears. On top of the fear mongering, Agents typically offer signing bonuses and today-only deals to manipulate investors into buying annuities that they may not want or need and/or that may not be suitable for their investment needs and objectives. 
  • Twisting and Churning. In “twisting,” an agent will convince a client to exchange an annuity from one company for an annuity from another company. Unbeknown to the client, however, the second annuity is worth less. When the transaction is complete, the client incurs a surrender charge from the old policy. Agents urging the purchase of the new policy “earn” a commission on the transaction. In “churning”, an Agent will convince a client to trade one annuity policy for another one from the same company. The Agent will convince the client to engage in multiple transactions over a period of time so that the Agent can “earn” a commission on the transactions. Often, the client loses the value on the policy they previously owned and must pay a surrender charge to complete the transaction.

Against this backdrop, we examine In the Matter of RiverSource Distributors, Inc., an administrative proceeding that the SEC settled involving the alleged perpetrators of annuity fraud.

Defendant, RiverSource Distributors, Inc. (“RDI”), is a registered broker-dealer headquartered in Minneapolis, Minnesota, and a wholly owned subsidiary of Ameriprise Financial, Inc. (“Ameriprise”), a publicly traded company. RDI is a principal underwriter of variable annuities issued by RiverSource Life. 

Between January 2017 and May 2018 (“Relevant Period”), RDI offered and sold variable annuities to retail investors through AFS, an affiliated broker-dealer/investment adviser. To support these efforts, RDI employed a team of approximately forty wholesalers. RDI wholesalers were responsible for assisting AFS registered representatives to understand these financial instruments. The wholesalers received commissions from the sale of variable annuities underwritten by RDI. RDI’s variable annuity business experienced downward pressures in the years leading up to the Relevant Period.

According to the SEC, during the Relevant Period, certain RDI wholesalers developed and implemented a sales practice that involved the creation of lists of variable annuities that were still in effect and owned by AFS customers, and then color-coding those lists to highlight exchange opportunities, including information about commissions from exchanges that could be earned by AFS registered representatives. The SEC found that some RDI wholesalers were trained on how to create and use these “in-force” annuity lists. 

The AFS registered representatives’ compensation depended, in part, on whether the annuity contract was out of the surrender period or how long it had been out of that period. Depending on the annuity, if the contract was out of the surrender period or had been out of that period for a certain number of years, AFS registered representatives would receive full compensation on any exchange. On contracts that were not out of the surrender period or had not been out of this period for the requisite number of years, the registered representative’s compensation would be reduced.

According to the SEC, certain RDI wholesalers caused exchange offers to be made to holders of variable annuities during the Relevant Period. These efforts included in-person and virtual meetings with AFS registered representatives during which RDI wholesalers were granted access to the AFS registered representatives’ computers, pulled customer lists and holdings, filtered the lists to focus on in-force annuities, and color-coded variable annuities based on their surrender status in order to highlight how registered representatives could increase their compensation. Subsequent to these meetings, said the SEC, certain individuals exchanged their variable annuities.

According to the SEC, variable annuity exchanges increased during the Relevant Period from $671 million in 2015 and $768 million in 2016, to $1,006 million in 2017 and $1,049 million in 2018. The SEC said that contemporaneous RDI emails and other internal documents suggested that at least some portion of the increase likely resulted from the use of in-force annuity lists. 

The SEC found that RDI’s compliance department became aware of the RDI wholesalers’ efforts and use of lists in or around March 2018. The department investigated the wholesalers’ conduct, and as a result, in May 2018, reprimanded the wholesalers and/or the wholesalers’ supervisors who were involved in the scheme. The SEC said that RDI’s remedial efforts to end the practice included a training program for wholesalers during which its Chief Compliance Officer explained in detail how the creation and use of the in-force annuity lists violated Section 11 of the ICA.2 After the Relevant Period, RDI’s variable annuity exchanges decreased from $1,049 million in 2018 to $838 million in 2019.

Without admitting or denying the SEC’s findings, RDI consented to an order finding that it violated Section 11 of the ICI and imposing a cease-and-desist order, a censure and a $5 million civil penalty.

“Congress enacted Section 11 to prohibit the improper ‘switching’ of investors from one investment product to another for the purpose of generating additional selling charges – precisely the conduct our order finds RiverSource to have engaged in,” said Sanjay Wadhwa, Deputy Director of the SEC’s Division of Enforcement. “Protecting retail investors from abusive sales practices is a mainstay of our enforcement program, and we remain committed to holding accountable those who engage in such conduct.”

A copy of the press release announcing the settlement can be found here.

A copy of the cease-and-desist order can be found here.


Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.

This article is for informational purposes and is not intended to be and should not be taken as legal advice.

References

  1. See Alanna Ritchie, Annuity Scams, Annuity.Org (updated Feb. 25, 2022) (here).
  2. Section 11 of the ICA prohibits any principal underwriter from making or causing to be made an offer to exchange the securities of registered unit investment trusts (including variable annuities) unless the terms of the offer have been approved by the SEC or they fall within certain limited exceptions. According to the SEC, none of the exceptions applied to RDI.
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