With the mutual fund industry in turmoil amid federal allegations, regulators are now broadening their investigation to include the life insurance industry.
Specifically, the Securities Exchange Commission (SEC) and the National Association of Securities Dealers (NASD) are investigating whether insurance companies that sell variable annuities have used improper sales practices or have engaged in market-timing or late trading.
"I think the regulatory agencies will take the same kind of actions, but I just don’t know if that conduct has been as widespread in the annuity industry as it has been in the mutual fund industry," said Gary Cohen, a partner in the Washington, D.C. office of the Foley & Lardner law firm. "We don’t have the facts yet. But the SEC is looking at it."
The impact of the federal investigations into the annuity industry could be staggering. According to a recent report by Forbes magazine, 42 million annuity contracts are in force, holding $958 billion in assets.
A variable annuity is a contract between an investor and an insurance company, under which the insurer agrees to make periodic payments to the investor, typically at retirement. The investor purchases a variable annuity contract by making either a single purchase payment or a series of payments.
The investment options for a variable annuity typically are mutual funds that invest in stocks, bonds, money market instruments or combinations of those instruments.
Some insurance companies, including Northwestern Mutual Life Insurance Co., Milwaukee, combine annuities with whole life insurance policies, in which the investor is guaranteed a death benefit.
The NASD, which is a self-regulatory and enforcement body for firms that sell securities, is conducting a review of the life insurance industry. Specifically, the NASD is examining the sales practices of agents that sell variable annuity life insurance policies for companies, including Northwestern Mutual, sources said.
NASD officials declined to comment on the details of the review or speculate about its outcome.
A Northwestern Mutual spokesman could not be reached for comment on this report.
In recent months, the SEC has been investigating the mutual fund industry. In that investigation, regulators discovered that about half of the 88 mutual fund companies reviewed admitted to some forms of improper trading of securities.
Since life insurance annuities also involve trading of securities, the possibilities for improper trading actions also exist in the insurance industry, according to SEC spokesman John Nester in Washington.
"There’s certainly every opportunity that it has been occurring in the annuities," Nester said. "There certainly is enough smoke with the mutual fund industry to believe that. To the extent that improper or illegal trades have taken place, that certainly is within the SEC’s jurisdiction."
The trend in the life insurance industry is for annuities to be sold on behalf of the insurance companies by independent dealers and brokers. That trend helped open the door to improper trading, according to Cohen.
"That’s where you might be getting into more hanky panky," Cohen said. "We know there have been market timers that own variable annuity contracts …. The SEC is looking into it. We’re sort of waiting with baited breath to see what’s been going on."
The SEC is proposing new rules to curb the practices of late trading and market-timing. (See accompanying graphic).
The new rules, while clamping down on the improper trading practices, will have a negative impact on investors who are fond of shifting their funds to different investment vehicles often to capitalize on economic trends, Cohen said.
"I think long-term investors will be better off, but people who like to move their money around will not," Cohen said. "You won’t be able to get your money out as quickly or move it as quickly."
The impact of the federal mutual fund investigation has had a significant impact on investors in Wisconsin. The SEC filed a civil lawsuit in December against Heartland Advisors Inc. in Milwaukee, alleging improper pricing of bond funds and illegal insider trading.
Strong Capital Management Inc. in Menomonee Falls was named by New York Attorney General Eliot Spitzer in September as one of four firms that allegedly provided special trading opportunities to a New Jersey hedge fund. At press time, no one at Strong had been criminally charged, although several class-action lawsuits have been filed against the company.
Jan. 9, 2004 Small Business Times, Milwaukee